CANADIAN TAX IMPLICATIONS OF DISTRIBUTIONS FROM FOREIGN TRUSTS

A Canadian resident who is a beneficiary of a foreign (i.e. non-resident) trust (which generally will include a foreign estate for this purpose) needs to be aware of the Canadian tax implications of any amount received as a distribution from that trust.

The comments below will assume that the relevant trust is not a “deemed resident” trust that is governed by special rules in subsection 94(3) of the Income Tax Act (“the Act”).

Prior to amendments to subsection 104(13) of the Act that apply after 2000, different rules applied to the taxation of distributions from foreign trusts than those that applied to distributions from Canadian resident trusts.

Under those former rules, a distribution was taxable unless it was a distribution of capital or proceeds of disposition of the beneficiary’s interest in the trust. In effect, the legal nature of the distribution determined the tax consequences.

However, after 2000, the same rules generally apply for both resident and non-resident trusts. Namely, to the extent that the distribution is a payment of an amount that would be income for tax purposes in the year of payment, it will be taxable. In this connection, it is significant to note that, under paragraph 250.1(b) of the Act, a foreign trust’s income will be computed in accordance with the Act, even though it may not be subject to tax in Canada. In addition, if an amount that would be the trust’s income under the Act for a year is “payable” to a Canadian resident beneficiary, that beneficiary will be taxable on that amount, even if that amount is not actually paid in the relevant year. For this purpose, if the beneficiary had a right to demand payment of that income in the year, it will generally be considered to be “payable”.

Because of the fact that a Canadian beneficiary will not receive a T3 slip from a foreign trust to guide him or her in terms of the income that needs to be reported, it might mean that information regarding the nature of the income of the trust will have to be obtained, and possibly a restatement of such income based on Canadian tax accounting rules. This can often be challenging. Prior to 2001, this would not have been required.

It is significant to note that, even if an amount is legally a distribution of capital, all or a portion of it might be taxable. For example, if the trust realized capital gains in the relevant year, the distribution might be viewed as consisting, at least in part, of the taxable portion of such gains.

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A Canadian resident beneficiary who receives a distribution from a foreign trust in a year will be required to file form T1142 for that year with the CRA, even if no amount is taxable. (This assumes that the beneficiary was not a “contributor” to that trust who is required to file form T1141). However, distributions from foreign estates are generally exempt from T1142 reporting. Although there is some conflicting case law on this, the relevant exemption likely only applies to distributions from an estate during administration, as opposed to an actual testamentary trust that was established as part of the administration of an estate.

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