In certain cases, a distribution of capital by a trust[1] to a non-resident beneficiary will bring into play certain notification and tax clearance requirements found in subsection 116.
As a general rule, a distribution of capital by a trust to a beneficiary is considered a “disposition” by that beneficiary of all or a portion of that beneficiary’s capital interest in the trust[2].
If the interest of the beneficiary is “taxable Canadian property” (“TCP”), the beneficiary will be required to send a notification of such disposition to the Canada Revenue Agency (“CRA”) within 10 days after the disposition[3]. In addition, the CRA takes the position that the trust itself can be liable for tax, in such circumstances, if a tax clearance is not obtained[4]. It is doubtful that this position of the CRA is correct[5], but most tax advisors recommend compliance with the CRA’s position in this regard.
Up until major changes to the definition of TCP that went into effect in March of 2010, an interest in any trust resident in Canada was TCP. Thus, trustees of executors of all trusts resident in Canada always had to concern themselves with this troublesome requirement when making capital distributions (including distributions on winding-up the trust) to non-resident beneficiaries.
However, under the current TCP definition[6], an interest in a trust will generally only be TCP at any time if, at some time within the 60 months period ending at that time, more than 50% of the value of the interest is derived from real property situated in Canada, or property closely akin to Canadian real estate, such as timber or resource properties.
As such, the number of situations where issues relating to section 116 apply to distributions from trusts will be greatly diminished.
Nevertheless, because of the 60 month “look back rule”, an interest can be TCP even if there is only cash in the trust at the time of distribution. For example, if Mr. A, a Canadian resident dies, and the main asset in his estate is his personal residence, even if that residence is sold, and there is only cash in his estate, an interest in the estate will be TCP for 60 months following the sale of the residence.
In many cases, an interest in a trust that is TCP may be “treaty protected property” (“TPP”) at the time of the distribution[7]. This can often be the case because tax treaties generally only look to the asset composition of the trust at the time of disposition-there is never any “look back rule”[8].
If that is the case, the distribution from the trust will generally not be subject to the normal section 116 requirements[9]. However, if the beneficiary is “related” to the trust, form T2062C must be submitted to the CRA within 30 days following the distribution[10].
[1] Which, generally, for the purposes of the Income Tax Act (“the Act”), includes an estate-see subsection 104(1). All statutory references herein are to the Act.
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[3] Subsection 116(3)- normally, notification is implemented by filing form T2062
[4] Subsection 116(5).
[5] Although the Act deems the beneficiary to have disposed of an interest in the trust, it does not deem the trust to have acquired that interest, which is a pre-condition to the application of subsection 116(5).
[6] See paragraph “(d)” of the TCP definition in subsection 248(1).
[7] That is, property with respect to which the tax treaty between Canada and the beneficiary’s country of residence would preclude Canadian taxation of any gain.
[8] See particularly Article XIII(3)(b)(iii) of Canada’s tax treaty with the U.S.
[9] See paragraph “(i)” of definition of “excluded property” in subsection 116(6), and definition of “treaty-exempt property” in subsection 116(6.1).
[10] See paragraph 116(6.1)(b) and subsection 116(5.02)
ABOUT THE AUTHOR OF THIS ARTICLE
Michael I. Atlas, CPA,CA,CPA(ILL),TEP
Michael Atlas is one of the most prominent international tax experts in Canada. He advises accounting and law firms all across Canada, as well as select private clients (corporate and personal) worldwide. He can be reached by phone (416.860.9175) or email (matlas@TaxCA.com).