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Loss Of Status As A Testamentary Trust

September 25, 2017

EXCERPT FROM TAXATION OF TRUSTS:   

LOSS OF STATUS AS A TESTAMENTARY TRUST

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Reprinted from Chapter 2 “Types of Trusts and Planning”, s.2.1.4(a) “Loss of Status as a Testamentary Trust”, pp. 47-49, in Taxation of Trusts and Estates:

A Practitioner’s Guide 2011, by Larry H. Frostiak, John Poyser and Grace Chow, by permission of Carswell, a division of Thomson Reuters Canada Limited.

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A trust can be created on terms that clearly make it a qualifying testamentary trust at the outset, but it can lose that status in a number of ways after it has come into existence.  The most common reason results from mismanagement by the trustees.

A testamentary trust that loses its status will be taxed, as a result, as an inter vivos trust.  The following are some of the events which can result in the loss of status as a testamentary trust.

  • Contribution by Living Person — If property is contributed or settled into the trust by a living person,58 as would be the case if a beneficiary borrows money and voluntarily adds it to the trust,59 or if an income beneficiary to whom income is payable disclaims entitlement to the income and causes it to be retained in the trust.60  A trust retains its status, however, and is not disqualified as testamentary where a trust acquires property in return for fair market value consideration or as part of a bona fide and legitimate business arrangement,61 or cash flows into the trust as dividends or redemption proceeds on shares owned by the trust, notwithstanding the discretion on the part of the directors of the corporation to make the payments or refrain from doing so.62  Further, a trust retains its status where an overpayment of income has occurred and the beneficiaries pay the surplus income back in to the trust.63

 

  • Distribution Received From Inter Vivos Trust — If an inter vivos trust is established, naming a testamentary trust among its beneficiaries, and a distribution of income or capital is made to the testamentary trust as a beneficiary.64  The mere fact that the testamentary trust is named as a beneficiary may, at the time the inter vivos trust is established, cause it to lose its status as testamentary if it is construed as having received a gift of a capital or income interest in the inter vivos trust.65

 

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56 M.N.R., Interpretation Bulletin  IT-179R, supra, note 54 at paragraph 2.

57 Paragraph 104(23)(e).

58 Subsection 108(1), definition of “testamentary trust,” at subparagraph (b).

59 Greenberg Estate v. R., [1997] 3 C.T.C. 2859, 97 D.T.C. 1380, 1997 CarswellNat 1007 (T.C.C.).

60 M.N.R., Technical Interpretation 2003-0046171E5, “Contribution to Testamentary Trust” (December 1, 2004).

61 M.N.R., Technical Interpretation 9319185, “Compensation Received by Testamentary Trust” (November 29, 1993) (a contribution of property to a trust generally implies that the trust receives the property without any value being given in return to the contributor, and thus a testamentary trust will not be disqualified by a loan to the trust, or by an asset received into the trust by virtue of a purchase for full face value by the trust, or by a payment into the trust by a trustee in settlement of a claim by the trust against the trustee).

62 M.N.R., 2008 APFF Conference (October 10, 2008) (question 13, “Distribution or payment of dividends to a testamentary trust”).

63 M.N.R., Technical Interpretation 9721035, “Meaning of Contribution” (November 19, 1997).

64 M.N.R., 2008 APFF Conference 2008-0285051C6 (October 10, 2008) (question 13, “Distribution or payment of dividends to testamentary trust”).

65 Ibid.

  • Payment of Expenses — If a beneficiary or some other person pays capital expenses on behalf of the trust.66 

 

  • Payment of Taxes — If a beneficiary of an estate pays income taxes on behalf of the deceased on account of their terminal return that would normally be the obligation of the trustees.67

 

  • Failure to Distribute — If the trustees fail or refuse to make a mandatory capital distribution to a beneficiary of the trust.68

 

  • Variation Restructuring Interests — If the trust is varied in a way that effects a significant restructuring of the income and capital interests of beneficiaries and amounts to the creation of a new trust.69

 

  • Loans From Beneficiaries — Under proposed amendments to the Act discussed earlier, if the trust incurs an obligation to a beneficiary or a person not at arm’s length to a beneficiary.70

 

An error in registering the assets of a testamentary trust, placing them in the name of the beneficiary rather than in the name of the trustee, will not of itself disqualify the trust as testamentary and can be remedied by causing the title to be rectified to show the trustee as the legal owner.71

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56 M.N.R., Interpretation Bulletin  IT-179R, supra, note 54 at paragraph 2.

57 Paragraph 104(23)(e).

58 Subsection 108(1), definition of “testamentary trust,” at subparagraph (b).

59 Greenberg Estate v. R., [1997] 3 C.T.C. 2859, 97 D.T.C. 1380, 1997 CarswellNat 1007 (T.C.C.).

60 M.N.R., Technical Interpretation 2003-0046171E5, “Contribution to Testamentary Trust” (December 1, 2004).

61 M.N.R., Technical Interpretation 9319185, “Compensation Received by Testamentary Trust” (November 29, 1993) (a contribution of property to a trust generally implies that the trust receives the property without any value being given in return to the contributor, and thus a testamentary trust will not be disqualified by a loan to the trust, or by an asset received into the trust by virtue of a purchase for full face value by the trust, or by a payment into the trust by a trustee in settlement of a claim by the trust against the trustee).

62 M.N.R., 2008 APFF Conference (October 10, 2008) (question 13, “Distribution or payment of dividends to a testamentary trust”).

63 M.N.R., Technical Interpretation 9721035, “Meaning of Contribution” (November 19, 1997).

64 M.N.R., 2008 APFF Conference 2008-0285051C6 (October 10, 2008) (question 13, “Distribution or payment of dividends to testamentary trust”).

65 Ibid.

66 M.N.R., Technical Interpretation 2002-0154435, “Payment of Trust Expenses by Beneficiary” (April 17, 2003).

67 M.N.R., Technical Interpretation 9233787, “Election Under 104(13.1) and (13.2)” (January1, 1992).

68 M.N.R., Technical Interpretation 2002-0172475, supra, note 33; also see remarks to that effect set out in the “T3 Guide” published by CRA.

69 M.N.R., Technical Interpretation 2000-0059795, “Testamentary trust variation” (November 8, 2001).

70 M.N.R., Special Release IT 04-01, “Draft Technical Amendments and Explanatory Notes To Amend the Income Tax Act” (February 27, 2004) at clause 45.

71 M.N.R., Technical Interpretation 2006-0218191E5, “Testamentary Trust Administrative Error” (March 7, 2007) (investment accounts placed in name of primary beneficiary by financial advisor rather than in name of trustee, situation rectified by transferring account into name of correct owner).

 

 

 

 

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