26 February 1996 Internal T.I. 9528037 - BENEFIT FROM A TRUST - LOANS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

application of 105(1) to loan from trust

Position:

15(2) applies not 105(1)

Reasons:

we should not ignore the legal form in this case as the benefit to the taxpayer can be assessed under 15(2) in this case without the use of a substance over form arguement

February 26, 1996

R. D. Léger
	Director
	Saint John Tax Services	L. Holloway
	      Office		(613) 957-2104
		Trusts Section
	Attention: Vince O'Neill	952803
	Estates & Trusts Group

Subsection 105(1) of the Income Tax Act -XXXXXXXXXX

This is in reply to your memorandum dated October 24, 1995, concerning the applicability of subsection 105(1) to the above named taxpayer. We apologize for the delay in our response. The facts of this scenario follow. All references herein to sections or components thereof will be to the Income Tax Act unless otherwise stated.

Facts

1. XXXXXXXXXX will provided for specific bequests such as:

XXXXXXXXXX

7.You proposed to reassess XXXXXXXXXX under subsection 15(2), to which XXXXXXXXXX argued that the loan was actually a loan from the estate to him (citing as support Joseph Zatzman v. MNR, 59 DTC 635 (TAB) and John W. Ramsay v. MNR, 61 DTC 191 (TAB)).

8.You therefore contend that subsection 105(1) applies to include the $XXXXXXXXXX loan in XXXXXXXXXX income for XXXXXXXXXX

Our Comments

It is well accepted that a beneficiary under a will has no property interest in the assets of the estate until administration is complete (in contrast with the position of a trust beneficiary who has an immediate property interest in a trust). Generally, beneficial ownership in the residue of an estate is transferred to the beneficiaries once assent has been given by the executor; such assent is to be inferred by a course of conduct once estate administration is complete, and after the passage of time and lack of further activity by the executors. (Catherine Brown, "The Transfer of Property on Death: Ownership, Control and Vesting," Canadian Tax Journal (1994), Volume 42, Number 6, pp. 1449 -1468.) Therefore, if the estate is not completely administered, the residual beneficiaries would not yet be entitled to the residue of the estate. An executor would be expected to invest monies of the estate until such time as the administration of the estate is complete.

Whether XXXXXXXXXX had the authority to invest in certificates of deposit of a corporation 100% owned by him is debateable.

XXXXXXXXXX

As noted by yourself, in paragraph 2 of Part II of The Trustees Act of New Brunswick we find the following statutory power:

"Unless a trustee is otherwise authorized or directed by an express provision of the law or of the will or other instrument creating the trust or defining his powers and duties, he may invest trust money in any kind of property, real, personal or mixed, but in so doing, he shall exercise the judgment and care that a man of prudence, discretion and intelligence would exercise as a trustee of the property of others."

It would appear from the examination of this Act, that a trustee under the New Brunswick Trustee's Act has very broad investment powers subject to the exercise of care, prudence, and discretion. D. Waters, a leading authority on trusts, makes the following comments with respect to loans made to a trustee on page 727 of his chapter "Conflict of Interest and Duty" in his book Law of Trusts in Canada:

"Loans by the trust to the trustee are also prohibited, and in this situation at least one Canadian court has not been prepared to waive that prohibition, whatever the circumstances, when asked in advance for that consent. In Re Lerner the trustees had the consent of all interested parties including a 19-year-old beneficiary, to exercise of a power of maintenance and advancement which would allow a widow/executrix to acquire trust capital by way of loan and thus purchase a 50 percent interest in her late husband's business. The Official Guardian on behalf of the minor objected that not only was this proposal outside the scope of the advancement power, and unauthorized by the investment power of the trust, but it was expressly prohibited by the conflict of interest and duty rule."

In the context of a trustee purchasing trust property, which is also a prohibited transaction, Waters writes (page 720):

"Alternatively, a trustee or other fiduciary may insert another between himself and the acquisition of the trust property. He buys through another, or sells to another and purchases from him. In this way he may seek to argue that he not purchasing trust property, but merely dealing with a third party, concerning property which no longer belonged to the trust. Where he simply buys through a nominee he is clearly attempting to do no more than conceal his tracks, and in these circumstances there will be no difficulty in securing the return to the trust of the property or its value. In Re Follis the court had ordered a deceased's estate to be sold by tender, and the executor submitted tenders through nominees. Every tender was for a different sum, and the tender of one of the nominees was accepted. The court simply ordered the sale to be set aside."

However, regardless of whether the investment was a prohibited transaction, liability for income tax is assessed on the basis of what a taxpayer has actually done. See, Steven Cooper v. Her Majesty the Queen, 88 DTC 6525 (FC -TD), at page 6535:

"A well-established principle of income tax law states that the illegality (if any) of actions of the taxpayer, in this case the payment to the Plaintiff in relation to the terms of the trust, is irrelevant in the assessment of tax liability. The obligation of the trustees to place the money loaned to the Plaintiff in income-generating investments is not a factor in my decision.

...The Minister has no interest in the proper administration of trust funds. This is the function of the provincial court systems, more particularly in this case the Probate Court, and any questions regarding the propriety of the actions of Mr. Cooper and his mother as trustees should be raised in that forum alone."

In the Zatzman case referred to by XXXXXXXXXX, one loan from the corporation to the shareholder/ taxpayer was considered to be put through the corporation as a pure conduit and thus that loan was considered to be a loan from the bank to the taxpayer, the court noting that the bank was repaid with funds supplied by the taxpayer out of personal income derived from a source other than the corporation. In the Ramsay case cited, the loan was passed through the corporation as the bank was not permitted to make loans on personal real estate. The security for the bank loan was the taxpayer's personal life insurance and principal residence. The court in Ramsay held that the loan was not a loan from the corporation. We see the cases cited by XXXXXXXXXX as inapplicable to the current situation. The certificates of deposit made by XXXXXXXXXX as executor of the estate have no security and do not provide for the payment of accrued interest other than upon redemption. There is no indication that the payment of interest and the repayment of the principal of the certificates of deposit will be made from the personal assets of

XXXXXXXXXX

See by analogy, Mansell Nellis v. Her Majesty the Queen, 86 DTC 6377 (FC -TD) and Kenneth Ans v. MNR, 77 DTC 396 (TRB).

The Tax Court in Jan Silden v. MNR, 89 DTC 75, made the following comment regarding the Zatzman case (page 78):

"Counsel relied on Zatzman v. MNR. That case does not turn on any principle which has application here. Certainly it is not an authority for the proposition that every time the actions of a subsidiary company (Muscan) are dictated and directed by a parent company (Musnor) in order to achieve some objective desired by that parent, the subsidiary's activities will be considered to be undertaken as agent of the parent. That proposition was rejected in Denison Mines Limited v. MNR. In the present case it was Muscan which loaned the money to the Appellant. It was Muscan which was the mortgagee. Nothing in the evidence suggests that Musnor was the Appellant's creditor in respect of the loan. This argument therefore fails."

In our opinion, therefore, the Zatzman and Ramsay cases are distinguishable from the situation at hand.

In the Cooper case referred to above, the court decided in the taxpayer's favour where the Department included in the beneficiary taxpayer's income a taxable benefit under subsection 105(1) for interest computed under Regulation 4300(6) on an interest-free loan. In reaching its decision the court examined the requirement for the inclusion of benefits under subsection 105(1) in light of similar inclusions required under sections 6 and 15. In analysing section 15 the following comments were made at page 6529:

"Subsection 15(2) does not speak of "benefits" as does paragraph 15(1)(c) but is addressed specifically to loans made to other shareholders....

I find it very interesting to note that subsection 15(2) of the Act and its predecessor existed independently of paragraph 15(1)(c). The treatment of loans under subsection 15(2) is not worded as an exception to any general rule enunciated with respect to the taxability of "benefits" under paragraph 15(1)(c). As to the interaction of the two sections, there has been no instance drawn to my attention where a low-interest loan was excluded under the provisions of subsection 15(2), (e.g., where it was a bona fide loan to an officer of the company to purchase a house with adequate provision for repayment), and where the differential in interest below market rate was nevertheless assessed as a taxable benefit under the provisions of paragraph 15(1)(c)."

And at page 6535:

"My conclusion (no benefit under subsection 105(1)) is instead based on the other factors discussed above, including the coexistence of subsections 15(1) and 15(2) of the Act. In my view, it is illogical to assume that these sections could be applied together without creating a perverse result. Any loan which escapes inclusion into income under subsection 15(2) must be understood to have escaped entirely whether interest-free or not, otherwise the purpose of the section is in part defeated."

The court concluded that prior to the enactment of section 80.4 in 1979, which deems prescribed interest on interest-free loans to employees and shareholders to be benefits, such interest was generally not a benefit that was taxable under sections 6 and 15; and since section 80.4 does not contain any reference to section 105, section 105 similarly does not apply to the value of interest-free loans to beneficiaries from trusts. The decision in the Cooper case has been adopted by the Department and will be applied in similar circumstances (response to question 22 of the 1990 Revenue Canada Round Table). Therefore, while the Cooper case has concluded that we cannot use subsection 105(1) to impute an interest benefit on low-interest or interest-free loans to beneficiaries of trusts, it does not stand for the proposition that subsection 105(1) cannot be used to tax appropriations from a trust. The question thus becomes in this case, whether the loan to XXXXXXXXXX indirectly received from the estate is an appropriation or taxable benefit under subsection 105(1). Again, the fact that subsection 15(1) applies to benefits, while subsection 15(2) applies to loans and other indebtedness provides support for the conclusion that subsection 105(1) benefits do not include loans.

The loans to XXXXXXXXXX do not meet the exempting criteria specified in subsection 15(2). As the Department has typically had a difficult time in applying the substance over form doctrine (Continental Bank v. MNR, 94 DTC 1858) we ask why in this case would we ignore the form when doing so would preclude the application of subsection 15(2)? While XXXXXXXXXX wishes to rely on the Zatzman and Ramsay cases in claiming that the corporation was merely acting as an agent on his behalf, we note that he has undergone considerable effort to create the legal arrangement that he now wants ignored (ie. XXXXXXXXXX ).

In conclusion we are of the opinion that subsection 15(2) applies to include the full amount of the loans in XXXXXXXXXX income.

Pursuant to paragraph 150(1)(c) and Regulation 204, XXXXXXXXXX is responsible for preparing and filing both the T3 Income Tax and Information Return on behalf of the estate and T3 slips on behalf of the beneficiaries with respect to any income payable to them. With respect to interest income of an estate, subsection 12(4) provides that interest income is to be reported on an accrual basis (to the anniversary day of the investment contract). If estate administration is not yet completed, the beneficiaries would not be entitled to enforce payment of any income and the income would thus be taxed in the estate and this notwithstanding that the beneficiaries are themselves tax exempt (see paragraph 4 of IT-286R2).

We trust our comments will be of assistance to you. If you have any questions please contact L. Holloway.

Section Chief
Manufacturing Industries, Partnerships
and Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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