ARCHIVED - Income Tax Interpretation Bulletin

From: Canada Revenue Agency

Preferred Beneficiary Election

What the "Archived Content" notice means for interpretation bulletins

NO: IT-394R2

DATE: June 21, 1999

SUBJECT: INCOME TAX ACT
Preferred Beneficiary Election

REFERENCE: Subsection 104(14) (also sections 74.1 to 74.5, subsections 56(4.1), 75(2), 104(4), (5), (5.2), (5.3), (6), (12), (13.1), (15), (18) and (21), 107(4), 118(1) and (6), 118.3(1), 248(25), 252(1) and (4), the definitions "accumulating income," "preferred beneficiary," "settlor," and "trust" in subsection 108(1) of the Income Tax Act, and section 2800 of the Income Tax Regulations)



Application

This bulletin cancels and replaces Interpretation Bulletin IT-394R dated July 14, 1989.

Summary

This bulletin deals with post-1995 elections that may be made by a trust and a preferred beneficiary to have a portion of the trust's accumulating income taxable in the hands of the preferred beneficiary rather than in the trust.

For a trust's taxation year that ends after 1996, a preferred beneficiary under a trust generally means an individual beneficiary who is eligible for a disability tax credit or an adult beneficiary for whom a dependant tax credit can be claimed by another individual because of the beneficiary's mental or physical infirmity. However, for a trust's taxation year that ends before 1997, a preferred beneficiary is generally restricted to an individual beneficiary who is eligible for a disability tax credit.

Any amount elected by a trust and a preferred beneficiary under the trust cannot exceed the allocable amount for the preferred beneficiary for a taxation year. The allocable amount for a preferred beneficiary for a taxation year generally means the trust's accumulating income for the taxation year.

A trust's accumulating income for a taxation year generally means its income for the taxation year calculated before deducting any amount included in computing income of a preferred beneficiary because of a preferred beneficiary election.

A preferred beneficiary election for a trust's taxation year must generally be filed within 90 days from the end of the trust's taxation year. Late, amended or revoked elections can be made in limited circumstances.

The above topics are discussed more fully below, as well as other topics relating to preferred beneficiary elections.

Discussion and Interpretation

Election by Trust and Preferred Beneficiary

¶ 1. Subsection 104(14) provides that a trust and a preferred beneficiary under the trust may jointly elect for a trust's taxation year as prescribed by section 2800 of the Regulations to have a portion of the trust's accumulating income for the trust's taxation year, not exceeding the allocable amount for the preferred beneficiary, included in computing the income of the preferred beneficiary for the beneficiary's taxation year in which the trust's taxation year ended. Such elected amount is also excluded from the income of any beneficiary under the trust (not necessarily the beneficiary making the election) for a subsequent taxation year in which it is paid.

Restricted Meaning of Trust

¶ 2. A trust listed in any of paragraphs (a) to (g) of the definition of "trust" in subsection 108(1) and its preferred beneficiaries are precluded from making preferred beneficiary elections. Such list includes an amateur athlete trust, an employee trust, a master trust, a related segregated fund trust, a retirement compensation arrangement trust, trusts governed by deferred income plans, a trust whose direct beneficiaries are one of the above-mentioned trusts, a communal organization, a trust governed by an eligible funeral arrangement or a cemetery care trust, a unit trust and certain trusts in which all interests have been vested indefeasibly, and in which no interest can become effective in the future (generally referred to as a commercial trust).

Preferred Beneficiary

¶ 3. A preferred beneficiary under a trust for a trust's taxation year that ends after 1996 generally means an individual beneficiary who is eligible for a disability tax credit under subsection 118.3(1) or a beneficiary 18 years of age or older for whom a dependant tax credit under subsection 118(1) can be claimed by another individual. More specifically, a preferred beneficiary under a trust for a trust's taxation year that ends after 1996 is a beneficiary under the trust at the end of the trust's taxation year who is resident in Canada at that time and who meets either of the following conditions:

(a) the beneficiary is an individual

(i) who is entitled to a disability tax credit under subsection 118.3(1) for the beneficiary's taxation year that ends in the trust's taxation year (or would be so entitled if there were no deductions claimed for an attendant or care in a nursing home for the beneficiary), and

(ii) who is the trust settlor, the settlor's spouse or former spouse, a child, grandchild or great grandchild of the settlor or a spouse (but not a former spouse) of a child, grandchild or great grandchild of the settlor; or

(b) where the beneficiary does not meet the condition set out in (a)(i) above, the beneficiary is an individual

(i) who meets the condition set out in (a)(ii) above,

(ii) who attained the age of 18 years before the end of the beneficiary's taxation year that ends in the trust's taxation year,

(iii) who was a dependant (within the meaning assigned by subsection 118(6)) of another individual for that beneficiary's taxation year and was dependent on the other individual because of a mental or physical infirmity, and

(iv) whose income for that beneficiary's taxation year does not exceed $6,456 (subject to annual indexing after 1996).

For the purpose of the condition in (b)(iii) above, an individual qualifies as a "dependant" of another individual for a taxation year if the individual is dependent on the other individual for support at any time in the taxation year and is:

  • the child or grandchild of the other individual or the other individual's spouse; or
  • resident in Canada at any time in the taxation year and is the parent, grandparent, brother, sister, uncle, aunt, niece or nephew of the other individual or of the other individual's spouse.

The expression "dependant" is also discussed in the current version of Interpretation Bulletin IT-513, Personal Tax Credits.

For the purpose of the income limit in (b)(iv) above, the beneficiary's income for a taxation year must be computed without reference to any amount designated under a preferred beneficiary election and allocated to the beneficiary. If the income limit above is satisfied for a beneficiary's taxation year that ends in the trust's taxation year, the trust and the beneficiary can elect any amount (not exceeding the beneficiary's allocable amount) whether or not this amount exceeds the income limit for the beneficiary's taxation year.

¶ 4. For a trust's taxation year that ends before 1997, the conditions set out in ¶ 3(b) above must be ignored in determining whether a beneficiary under a trust is a preferred beneficiary. Also, the condition set out in ¶ 3(a)(i) above is satisfied only if the beneficiary is entitled to the disability tax credit for the beneficiary's taxation year in which the trust's taxation year ends (and not for the beneficiary's taxation year that ends in the trust's taxation year).

¶ 5. Subsection 108(1) defines the expression "settlor" for the purposes of the provisions dealing with trusts and their beneficiaries. Under this definition, an inter vivos trust may have no settlor or may lose its settlor after its creation. For example, an inter vivos trust has no settlor if it was created by more than one individual (other than the individual and his or her spouse). In these circumstances, no preferred beneficiary election can be made on the trust's accumulating income as there would be no preferred beneficiary under the trust. This expression is also discussed in the current version of Interpretation Bulletin IT-374, Meaning of "Settlor."

¶ 6. A "child of the settlor" includes the following:

  • a person of whom the settlor is the natural parent whether the child was born within or outside marriage;
  • a person wholly dependent upon the settlor for support and who is presently, or was immediately before attaining the age of 19 years, under the custody and control of the settlor; and
  • a child of the settlor's spouse, an adopted child of the settlor, and the spouse of a child of the settlor.

¶ 7. A "spouse of the settlor" generally includes a common-law spouse of the settlor. A common-law spouse of the settlor is a person of the opposite sex who has been cohabiting in a conjugal relationship with the settlor for at least 12 consecutive months or who is a natural or adoptive parent of a child of whom the settlor is also a natural or adoptive parent.

Accumulating Income

¶ 8. A trust's accumulating income for a taxation year generally means its income for the taxation year after deductions under subsection 104(6) but without regard to amounts elected under preferred beneficiary elections. Income held by a trust for a minor beneficiary that is deemed to be "payable" under subsection 104(18) is deductible by the trust under subsection 104(6) and thus reduces its accumulating income.

¶ 9. Although a taxable capital gain may not form part of trust income under trust law, for the purpose of computing a trust's accumulating income for a taxation year, income is computed pursuant to the provisions of section 3 and as a consequence generally includes net taxable capital gains. Except as stated in ¶ 10 below, a trust may allocate the net taxable gains (including those arising as a result of the 21-year deemed disposition rule) to a preferred beneficiary under the trust by making a preferred beneficiary election and by virtue of making a designation under subsection 104(21). (See also the current version of Interpretation Bulletin IT-381, Trusts -- Capital Gains and Losses and the Flow-Through of Taxable Capital Gains to Beneficiaries.)

¶ 10. Any income (including net taxable capital gains) arising from deemed dispositions of trust property under subsections 104(4), 104(5), 104(5.2) and 107(4) is excluded from the trust's accumulating income for a taxation year if it is one of the following:

  • a post-1971 spousal trust as described in paragraph 104(4)(a);
  • a pre-1972 spousal trust as defined in subsection 108(1) at the end of the taxation year; or
  • a trust that elected for a preceding taxation year under subsection 104(5.3) to defer the date of the 21-year deemed disposition.

Therefore, such income does not qualify for inclusion in a beneficiary's income under a preferred beneficiary election.

¶ 11. Amounts that are paid from a net income stabilization account under the Farm Income Protection Act and as defined in subsection 248(1), unless paid to a testamentary spousal trust described in paragraph 70(6.1)(b) and before the death of the beneficiary spouse, are ignored for the purpose of computing a trust's accumulating income for a taxation year.

¶ 12. The following rules apply with respect to trusts' taxation years that end after July 19, 1995:

  • If the trust fails to claim the maximum deduction under subsection 104(6), its accumulating income must be computed as if the trust had claimed the maximum deduction. Thus, the trust will not be able to pay all its income to a beneficiary, elect to have the income taxed in the trust under subsection 104(13.1), not claim the maximum amount as a deduction under subsection 104(6) and add the income to its accumulating income for the purpose of the preferred beneficiary election.
  • If the trust is a post-1971 spousal trust (as described in paragraph 104(4)(a)) and the spouse died on a day in the trust's taxation year, its accumulating income will be computed as if any disposition by the trust before the end of that day of capital property, land described in an inventory of the trust, Canadian resource property or foreign resource property had not occurred. As a result, the trust will not be able to avoid the tax effect of a disqualification of a taxable capital gain from a deemed disposition described in ¶ 10 above for the purpose of the preferred beneficiary election by means of a disposition of the property before the spouse dies.

Allocable Amount for Preferred Beneficiary

¶ 13. Except as described in ¶ 14 below, the allocable amount for a taxation year for each preferred beneficiary (who has a right of any type to any portion of the trust's accumulating income that is not entirely contingent on the death of another beneficiary who has a capital interest in the trust but no income interest in the trust) is the trust's accumulating income for the taxation year. In any other case, the allocable amount is nil.

¶ 14. However, where the trust is a post-1971 spousal trust (as described in paragraph 104(4)(a)) or a pre-1972 spousal trust (as defined in subsection 108(1)) and the preferred beneficiary spouse is alive at the end of the trust's taxation year, the spouse's allocable amount is the trust's accumulating income for the taxation year and the allocable amount for any other preferred beneficiary for the taxation year is nil.

¶ 15. A trust and a preferred beneficiary under the trust may elect for a trust's taxation year upon any amount of the trust's accumulating income for the taxation year up to the allocable amount for the preferred beneficiary. As mentioned in ¶ 13 above, the allocable amount for a taxation year for each preferred beneficiary under a trust generally means the trust's accumulating income for the taxation year. Therefore, it is possible that the total allocable amounts for a taxation year exceed the trust's accumulating income for the taxation year if there is more than one preferred beneficiary under the trust. However, it is not advantageous for a trust and its preferred beneficiaries to elect amounts in excess of the trust's accumulating income because the trust's deduction is limited under subsection 104(12) to the trust's accumulating income (see ¶ 17 below).

¶ 16. A beneficiary under a trust includes a person beneficially interested in the trust (see subsection 108(1)) and beneficially interested is defined in subsection 248(25) to include a person who has any right whether immediate or future, whether absolute or contingent or whether conditional on or subject to the exercise of any discretionary power by any person or persons to receive any of the income or capital of the trust. Consequently, all beneficiaries (income beneficiaries and capital beneficiaries) who are preferred beneficiaries under a trust (as defined in ¶ 3 above) would generally be entitled to elect under subsection 104(14). As noted in ¶ 13 above, the only exception is a preferred beneficiary who has a right in the trust's accumulating income that is solely contingent on the death of another beneficiary who has a capital interest but does not have an income interest in the trust.

Deduction in Computing Trust's Income

¶ 17. The total of all amounts elected under subsection 104(14) for a taxation year may be deducted in computing a trust's income for the taxation year by virtue of subsection 104(12) to the extent it does not exceed the trust's accumulating income for the taxation year (see¶ 15 above).

Election

¶ 18. By virtue of section 2800 of the Regulations, a preferred beneficiary election under subsection 104(14) must be filed with the Minister within 90 days from the end of the trust's taxation year for which the election is made. The election must consist of the following documents:

(a) A statement making the election for the trust's taxation year, stating the part of the accumulating income on which the election is being made, and signed by both the preferred beneficiary and a trustee having the authority to make the election; and

(b) A statement signed by the preferred beneficiary indicating the beneficiary's social insurance number, his or her relationship to the settlor of the trust and whether

(i) the beneficiary is claiming a disability tax credit (see ¶ 3(a)(i) above);

(ii) a supporting individual is claiming a disability tax credit for the beneficiary (if yes, provide the name, address and social insurance number of the supporting individual); or

(iii) the beneficiary is 18 years of age or older, and in the beneficiary's taxation year which ends in the trust's taxation year, another individual can claim a dependant tax credit for the beneficiary, or could claim the dependant tax credit if the beneficiary's income is calculated before including the income from the preferred elections (if yes, provide a statement from the doctor, optometrist or audiologist confirming the beneficiary's infirmity in the first year the claim is made).

¶ 19. In many cases, the preferred beneficiary under the trust may not have the capacity to sign the statements required above (e.g. a mentally infirm child). In such cases, the Minister will accept an election that is signed on behalf of the beneficiary by the legal guardian of the beneficiary's property (in most cases, the beneficiary's parent).

¶ 20. As noted in ¶ 18 above, a statement making the election must be signed by a trustee having the authority to make the election; thus only one signature is required. If the trust is governed by more than one trustee, the trustee signing the election must do so with the consent and authorization of the other trustees. Consequently, the signing trustee must be sufficiently authorized to bind the trust.

¶ 21. If there is more than one preferred beneficiary under a trust, it is not necessary that all of the preferred beneficiaries elect for a trust's taxation year. Also, there is no need for a preferred beneficiary to be consistent in electing or not electing from one taxation year to the next. It is not necessary that the elected amount in respect of a preferred beneficiary either be ultimately payable to the preferred beneficiary or be paid to any preferred beneficiary. Finally, it is not necessary that the elected amount be ultimately payable to a beneficiary who has an income interest in the trust.

¶ 22. If an election is filed late for a trust's taxation year, the Department will tax the accumulating income in the trust (see also ¶ 23 below for late, amended or revoked elections).

Late, Amended or Revoked Election

¶ 23. In limited circumstances (generally those beyond the control of the trustee and the beneficiary), late, amended or revoked preferred beneficiary elections are permitted if the trustee and the preferred beneficiary apply to the Minister and the Minister extends the time for making the election or grants permission to amend or revoke the election. (See the current version of Information Circular 92-1, Guidelines for Accepting Late, Amended or Revoked Elections.)

¶ 24. A late, amended or revoked preferred beneficiary election is subject to a penalty of $100 for each complete month from the due date of the election to the date of the request to a maximum of $8,000.

Attribution Rules

¶ 25. If the preferred beneficiary is the spouse of the settlor or a child under the age of 18 years, application of the attribution rules (sections 74.1 to 74.5) may result in some or all of the elected amount being deemed to be income of the settlor or some other person who transferred or loaned property to the trust. Refer to the current versions of Interpretation Bulletins IT-510, Transfers and Loans of Property Made After May 22, 1985 to a Related Minor, and IT-511, Interspousal and Certain Other Transfers and Loans of Property, on this subject. Also, in situations where subsection 75(2) applies (see the current version of Interpretation Bulletin IT-369, Attribution of Trust Income to Settlor), income of the trust is attributed to the settlor or some other person who transferred property to the trust, regardless of any preferred beneficiary election made in respect of such income. Finally, depending on the facts of the situation, subsection 56(4.1) of the Act may apply to attribute some or part of the elected amount back to the settlor or some other person.


Explanation of Changes

Introduction

The purpose of the Explanation of Changes is to give the reasons for the revisions to an interpretation bulletin. It outlines revisions that we have made as a result of changes to the law, as well as changes reflecting new or revised departmental interpretations.

Reasons for the Revision

This bulletin has been revised because of amendments to the Income Tax Act that were enacted by the 5th Supplement to the Revised Statutes of Canada, 1985; S.C. 1994, c.7 (formerly Bill C-15), S.C. 1996, c.21 (formerly Bill C-36) and S.C. 1998, c.19 (formerly Bill C-28). The comments in this bulletin are not affected by any draft legislation released before March 25, 1999.

Legislative and Other Changes

¶ 1 (replacing former ¶ 1) is revised to reflect an amendment to subsection 104(14) that took effect for trusts' taxation years that begin after 1995. The amendment replaced the reference to "the preferred beneficiary's share therein" by a reference to "the allocable amount for the preferred beneficiary in respect of the trust." (See also explanation for ¶s 13 to 16 below).

¶ 2 (replacing former ¶ 5) is revised to reflect structural changes in the revised Act to the definitions in section 108. The definitions "preferred beneficiary," "settlor," and "trust" were removed from paragraphs (g), (h) and (j) of the Act, respectively, and instead placed (along with other definitions) in alphabetical order in subsection 108(1). These changes in the revised Act are reflected in this ¶ and also in ¶ 3 and ¶ 5 (which replace former ¶ 9 and ¶ 10 respectively).

¶s 3 and 4 (replacing former ¶ 6) reflect an amendment to the definition "preferred beneficiary" in subsection 108(1) that took effect for trusts' taxation years that begin after 1995. This amendment to the definition was made as a consequence of the elimination of the preferred beneficiary election except with respect to beneficiaries entitled to the disability tax credit under subsection 118.3(1). ¶s 3 and 4 also reflect further amendments to the definition which took effect for trusts' taxation years that end after 1996. These further changes first broadened the definition to include certain adults who are dependent on others by reason of mental or physical infirmity. These changes also provided that the beneficiary's entitlement to the disability tax credit under subsection 118.3(1) is satisfied where the beneficiary is entitled to it for the beneficiary's taxation year that ends in the trust's taxation year (and not for the beneficiary's taxation year in which the trust's taxation year ends).

New ¶ 7 has been added to the bulletin to define the term "spouse of the settlor" which is relevant in determining whether a beneficiary is a preferred beneficiary for the purpose of the preferred beneficiary election. The definition reflects changes which took effect for the 1993 and subsequent taxation years. The changes extended the definition to common-law couples and ensured that only a natural or an adopted child is considered for the purpose of that definition.

¶s 8 to 10 (replacing former ¶ 11) reflect amendments made to the definition "accumulating income" in subsection 108(1) as it has been amended from time to time since July 14, 1989. In ¶ 10, references to the trust described in the second and third bullets were added to the subsection 108(1) definition of "accumulating income" for the 1991 and subsequent taxation years.

New ¶ 11 has been added to the bulletin to reflect another change made to the definition "accumulating income" for the 1991 and subsequent taxation years that excluded from the definition amounts paid from a net income stabilization account in some circumstances.

New ¶ 12 has also been added to the bulletin to describe rules that took effect for trusts' taxation years that end after July 19, 1995. The first bullet reflects a change made to the definition "accumulating income" that ensured maximum deduction under subsection 104(6) is claimed for the purpose of the definition. The second bullet describes special rules for post-1971 spousal trusts (as described in paragraph 104(4)(a)).

New ¶s 13 to 16 have been added to the bulletin to describe the new expression "allocable amount for a preferred beneficiary" in subsection 104(15) allowing preferred beneficiaries to elect on a non-pro rata share of the trust's accumulating income for trusts' taxation years that begin after 1995.

¶ 17 (replacing former ¶ 2) is revised as a consequence of an amendment to subsection 104(15) which took effect for trusts' taxation years that begin after 1995. The amendment ensured that the subsection 104(12) deduction is limited to the trust's accumulating income.

¶ 18 replaces and clarifies the first sentence in former ¶ 3. ¶ 18 sets out the list of documents required by the Minister to be filed with a post-1995 preferred beneficiary election.

¶ 19 replaces and clarifies the last sentence in former ¶ 3. ¶ 19 clarifies when an election is considered valid by the Department in cases where the beneficiary cannot sign the election.

New ¶ 20 has been added to the bulletin to clarify when an election is considered valid by the Department where there is more than one trustee entitled to make the election.

New ¶ 22 has been added to the bulletin to clarify the tax consequences which generally arise from a late filing of a preferred beneficiary election.

New ¶s 23 and 24 have been added to the bulletin to describe circumstances where late, amended or revoked elections can be made.

¶ 25 (replacing former ¶ 22) is revised to add a reference to subsection 56(4.1) as this rule may apply in some cases where the attribution rules in sections 74.1 to 74.5 or subsection 75(2) do not apply.

Former ¶ 9 is cancelled in the new bulletin as it is clear in law (since the amendment to the definition "preferred beneficiary" in subsection 108(1) which took effect for trusts' taxation years that begin after 1995) that a trust cannot qualify as such.

Former ¶s 12 to 21 are discontinued in the new bulletin as they have no basis in law for trusts' taxation years that begin after 1995.

In addition to the changes described above, other changes in the new bulletin include:

  • the discontinuance of the discussion of matters that are considered to be outside the scope of the bulletin; and
  • clarification changes, including changes in wording and the provision of additional information.

Notice -- Bulletins do not have the force of law

Interpretation bulletins (ITs) provide Revenue Canada's technical interpretations of income tax law. Due to their technical nature, ITs are used primarily by departmental staff, tax specialists, and other individuals who have an interest in tax matters. For those readers who prefer a less technical explanation of the law, the Department offers other publications, such as tax guides and pamphlets.

While the ITs do not have the force of law, they can generally be relied upon as reflecting the Department's interpretation of the law to be applied on a consistent basis by departmental staff. In cases where an IT has not yet been revised to reflect legislative changes, readers should refer to the amended legislation and its effective date. Similarly, court decisions subsequent to the date of the IT should be considered when determining the relevancy of the comments in the IT.

An interpretation described in an IT applies as of the date the IT is published, unless otherwise specified. When there is a change in a previous interpretation and the change is beneficial to taxpayers, it is usually effective for all future assessments and reassessments. If the change is not favourable to taxpayers, it will normally be effective for the current and subsequent taxation years or for transactions entered into after the date of the IT.

A change in a departmental interpretation may also be announced in the Income Tax Technical News.

If you have any comments regarding matters discussed
in this IT, please send them to:

Director, Business and Publications Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch
Revenue Canada
Ottawa ON K1A 0L5

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