Income Tax Interpretation Bulletin

Disposition of an Income Interest in a Trust

NO: IT-385R2

DATE: May 17, 1991

SUBJECT: INCOME TAX ACT
Disposition of an Income Interest in a Trust

REFERENCE: Subsection 106(2) (also subsections 56(2), 69(1), 74.1(1) and (2), 104(13), 106(1), (1.1) and (3), 108(3), 110.1(1), 112(1) and 138(6), paragraphs 108(1)(e) and 248(8)(c) and the definition of "personal trust" in subsection 248(1))

Application

This bulletin cancels and replaces Interpretation Bulletin IT-385R dated August 6, 1979. Current revisions are designated by vertical lines.

Summary

This bulletin discusses the disposition of an income interest in a trust and the circumstances under which the proceeds are required to be included in the transferor's income pursuant to subsection 106(2). The bulletin also considers the amount to be attributed to proceeds of disposition and the costs of the income interest that may be deducted.

Discussion and Interpretation

1. Paragraph 108(1)(e) defines an income interest of a taxpayer in a trust. Where such an interest in a trust was created or materially altered after January 31, 1987 and acquired after 10:00 p.m. Eastern Standard Time on February 6, 1987, it is an income interest in a trust only if it is the right of a person as beneficiary to receive all or part of the income of a personal trust. Income of a personal trust (or the trust's income referred to in 2 below) means income computed for trust accounting purposes and not for income tax purposes, and as further modified by subsection l08(3). A personal trust, as defined in subsection 248(1), is either a testamentary trust, or an inter vivos trust in which no beneficial interest was acquired for consideration payable to the trust or to a person who has made a contribution to the trust. For the purposes of the definition of a personal trust, love and affection will not be regarded as consideration. Further, the mere retention of an interest in the trust at the time the trust was created, by the individual or related individuals who settled the trust will not result in the disqualification of the trust as a personal trust .

2. Prior to the amendment of the definition as outlined in 1 above, an income interest in a trust was the right (whether immediate or future and whether absolute or contingent) of a person as a beneficiary under the trust to receive all or any part of the trust's income. This definition continues to apply to such interests that were created before February 1, 1987, have not been materially changed after January 31, 1987 and were acquired not later than 10:00 p.m. Eastern Standard Time on February 6, 1987.

3. As a result of the amendment to the definition of an income interest, any interest in a trust defined in paragraph l08(1)(j) (other than an income interest acquired in the circumstances outlined in 1 and 2 above) is treated as a capital interest, whether or not that interest is a right to receive all or any part of the income or capital of the trust.

Assignments and Other Dispositions

4. A taxpayer who assigns or disposes of an income interest in a trust in favour of another person will be subject to the provisions of subsection 106(2) and must include in income the proceeds of disposition. If the transaction is not at arm's length and the proceeds are less than fair market value, the taxpayer will be deemed by virtue of subparagraph 69(1)(b)(i) to have received proceeds of disposition equal to the fair market value of the interest disposed of. Where the taxpayer disposes of an income interest by gift inter vivos, subparagraph 69(1)(b)(ii) applies with the result that the proceeds of disposition are deemed to be the fair market value of the income interest.

5. Where the assignment in favour of another person is a payment in respect of proceeds of disposition of an income interest in a trust when it is due and the assignee has a legal right to receive it, subsection 106(2) does not apply to the assignee, but the transaction may be governed by the provisions of subsection 56(2).

6. A payment, as described in subsection 106(3), to a taxpayer from a trust in satisfaction of all or part of the taxpayer's income interest in the trust is not a disposition producing income under paragraph 106(2)(a) and no amount is included in the income of the taxpayer by reason of the payment.

Disclaimer

7. A taxpayer who executes a disclaimer (not in favour of any person) of an income interest in a trust at the time the taxpayer becomes aware of it (or within a reasonable time thereafter) will be considered not to have acquired that income interest in the trust. Subsection 106(2) will, therefore, have no application in such a situation. For the purposes of this paragraph "disclaimer" includes a renunciation of a succession made under the laws of the Province of Quebec that is not made in favour of any person. A person who has accepted any funds from the trust in respect of an income interest in the trust or executes a "disclaimer" in respect of an income interest in the trust in favour of another person would be considered to have acquired the income interest and therefore would be unable to execute a valid disclaimer.

Release or Surrender

8. Where a taxpayer formally releases or surrenders all or any part of an income interest in a particular trust in respect of future payments (amounts not due and payable at the time of the release or surrender) in favour of one or more other persons, the taxpayer will be deemed, by virtue of paragraph 69(1)(b), to have received proceeds of disposition equal to the fair market value at the time of the release or surrender of the income interest released or surrendered and must include that amount in income pursuant to subsection 106(2). It should be noted that paragraph 248(8)(c) does not apply to an income interest that arises upon the death of the deceased since such an interest could not have been property of the deceased immediately before death.

9. A taxpayer who for no consideration validly releases or surrenders an income interest in a trust in respect of future payments (not due and payable at the time the release or surrender is executed) and does not direct in any manner who is entitled to receive the benefits, will not be considered to have received any proceeds of disposition for the purposes of subsection 106(2). The result will be the same if the taxpayer designates or otherwise agrees which person or persons will benefit by reason of the release or surrender, if the same person or persons would be entitled to benefit in the same way under the trust without the taxpayer's designation or agreement. However, the attribution rules of subsections 74.1(1) and (2) are considered to apply if the person or persons who benefit under the terms of the trust as a consequence of the release or surrender are persons described in those subsections.

Cost of an Income Interest in a Trust

10. Subsection 106(1) permits a taxpayer to deduct an amount in respect of the cost of an income interest in a trust where amounts have been included in income either on the disposition of such interest pursuant to subsection 106(2), as described in 4 and 8 above, or where the taxpayer has income from the interest under subsection 104(13), or both. The amount that can be deducted in any year, however, cannot exceed the lesser of

For the purposes of subsection 106(1), the cost to the taxpayer of an income interest in a trust acquired directly from the person who was a beneficiary in respect of the income interest will generally be the amount paid for it. However, if the interest was acquired from the beneficiary in a non-arm's length transaction and the amount paid for it exceeded its fair market value, its cost will be deemed to be its fair market value by virtue of paragraph 69(1)(a) and, if the income interest was acquired from the beneficiary by way of gift, its cost will be deemed to be its fair market value by virtue of paragraph 69(1)(c). If the income interest was not acquired from a person who was a beneficiary in respect of the interest, its cost is deemed to be nil by virtue of subsection 106(1.1).