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.
Principal Issues: What is the tax treatment of income derived from a trust on: (1) amounts paid out to beneficiaries; (2) amounts reinvested in the trust; and (3) any income earned on reinvested amounts.
Position: (1) Depends on the facts; (2) depends on whether or not subsection 75(2) applies; (3) income to the trust which may be taxed in the trust or paid to beneficiaries.
Reasons: Subsection 75(2) does not apply to secondary income.
XXXXXXXXXX
2010-037253
Lori Merrigan
(613) 957-8979
January 6, 2011
Dear XXXXXXXXXX :
Re: First Nations Land Claim Settlement Trust Income
This is in response to your letter of June 22, 2010, inquiring about tax issues concerning the establishment of a trust (the "Trust") to manage land claim settlement funds received by a First Nation (the "Band"). In this letter, unless otherwise expressly stated, all statutory references are to the provisions of the Income Tax Act (the "ITA").
It is our understanding that the Band will be directing the contributions to the Trust, and that the Band and its members will be the beneficiaries of the Trust. You have asked what the tax treatment is of the income derived from the Trust, specifically the income
1. paid out to the beneficiaries each year;
2. retained and held in the Trust (or "first generation income"); and
3. earned on first generation income (or "second generation income").
The situation outlined in your letter appears to relate to a factual one, involving a specific group of taxpayers. Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, "Advance Income Tax Rulings". This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the CRA website at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. Although we cannot comment on your specific situation, we are able to provide the following general comments, which may be of assistance.
The CRA's general views regarding the treatment of trust income are contained in Interpretation Bulletins IT-369R, "Attribution of Trust Income to Settlor", and IT-381R3, "Trusts - Capital Gains and Losses and the Flow-Through of Taxable Capital Gains to Beneficiaries", which may be viewed on the CRA website.
Trusts - General Taxation
For income tax purposes, a trust is deemed to be an individual under subsection 104(2) and is taxed as such; however, a trust is not entitled to personal income tax credits. In general, where income from a trust has been paid or becomes payable in the year to a beneficiary of a trust, that income shall be included in the beneficiary's income in accordance with subsection 104(13). The amount may be deducted in computing the trust's income for that year as provided by subsection 104(6). Any remaining income will generally be income of the trust and will be taxed in the trust. We note that the fact that a trust is a land claim settlement trust does not, in and of itself, make the trust exempt from tax.
Application of Subsection 75(2)
Income earned on and gains from the disposition of property held in a trust will be attributed to the person who contributed the property to the trust where any of the conditions described in subsection 75(2) apply. The definition of "person" in subsection 248(1) includes any corporation and any entity exempt from tax under Part I because of subsection 149(1). If the Band is exempt from tax pursuant to subsection 149(1) (for example, where paragraph 149(1)(c) applies), it is a person in accordance with subsection 248(1), and is therefore a person for the purpose of subsection 75(2).
Subparagraph 75(2)(a)(i) provides that where the terms of a trust are such that the property held by the trust may revert to a person who directed or contributed the property to the trust, any income or loss from that property, and any taxable capital gains or allowable capital losses from the disposition of any of the property contributed by that person to the trust, will be deemed to be the income or loss, or the capital gain or capital loss, as the case may be, of this person and not of the trust. In our view, where subsection 75(2) attributes income to a person who has directed or contributed property to a trust, that income was never income of the trust for tax purposes. Accordingly, it is neither taxable in the trust nor included in a beneficiary's income under 104(13) when paid or payable to the beneficiary. Subsection 75(2) only applies to first generation income.
Subsection 75(2) does not apply to second generation income, as this income is not earned on property contributed by a person. Thus, second generation income will not be attributable to the person who contributed the property to the trust and will generally be taxable in the trust to the extent that it is not paid or payable to the beneficiaries of the trust. Where an amount has become payable in the year to a beneficiary, the trust may
claim a deduction under subsection 104(6) in computing its income for that year. Such income would be included in the beneficiary's income under subsection 104(13).
Distributions out of the Trust
As mentioned above, the Band may be considered to be a tax exempt entity because of subsection 149(1). A First Nation is considered to be a public body performing a function of government within the meaning of paragraph 149(1)(c) if it has passed by-laws under both sections 81 and 83 of the Indian Act, or under both section 81 of the Indian Act and section 5 of the First Nations Fiscal and Statistical Management Act. Where neither of these situations applies, it is a question of fact whether a First Nation is a public body performing a function of government. For the purpose of this letter, we will assume that the Band is considered to be exempt from tax pursuant to paragraph 149(1)(c).
Whether any income of the Trust will be attributed back to the Band because of subsection 75(2), as described above, will depend on the terms of the Trust. If subsection 75(2) does apply, any income attributed back to the Band will be exempt from tax in accordance with paragraph 149(1)(c). Any income that is paid or payable to the Band as a beneficiary of the Trust, and that is included in its income under subsection 104(13), will also be exempt from tax pursuant to paragraph 149(1)(c).
Income that is paid or payable to an individual member of the Band as a beneficiary of the Trust will usually be included in the member's income under subsection 104(13) and will be taxable. However, where this income is property situated on a reserve within the meaning of section 87 of the Indian Act (the "IA"), and the Band member is an Indian as that term is defined as in subsection 2(1) of the IA, the income will be exempt from tax by virtue of section 87 of the IA and paragraph 81(1)(a) of the ITA, which excludes such amounts from income. It is always a question of fact whether particular income is property situated on a reserve. In the case of income from a trust, several factors are taken into account, including how and where the trust generates its income, the residence of the trustees (or those controlling the trust property), and the residence of the beneficiaries. The first of these factors is usually given the most weight.
We trust that these comments will be of assistance.
Yours truly,
Eliza Erskine
Manager
Non-Profit Organizations and Aboriginal Issues Section
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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