2 July 2013 T.I. 2013-0488381E5 - 107(2) distribution
Principal Issues: 1. Property transferred to beneficiary in satisfaction of capital interest with debt owing by the trust to that beneficiary eliminated.
Position: 1. Property transferred represents partial 107(2) distribution & partial payment of debt outstanding-"in kind".
Reasons: 1. Debt must be settled for face value = fmv or tax consequences of debt forgiveness may result; gain may occur on portion of the property disposed of by the trust in payment of debt.
XXXXXXXXXX
2013-048838
Lena Holloway, CA
July 2, 2013
Attention: XXXXXXXXXX
Re: Interpretation Request regarding subsection 107(2) of the Income Tax Act (the "Act")
This is in reply to your submission of May 2, 2013 in which you requested a technical interpretation of the applicability of subsection 107(2) of the Act in a hypothetical situation with the following assumed facts and assumptions:
(i) the only property owned by a testamentary trust is land with a cost of $100;
(ii) the trust does not hold any cash;
(iii) improvements to the land in the amount of $30 were made to the land and funded by the sole beneficiary;
(iv) immediately before the land is distributed to the beneficiary the fair market value of the land is $200; and
(v) subsection 75(2) of the Act has never applied to the trust.
You wish to determine whether the distribution of the real property to the beneficiary will occur on a rollover basis pursuant to subsection 107(2).
Our Comments
Written confirmation of the tax implications inherent in actual proposed transactions is given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, entitled Advance Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency publications can be accessed on our website at http://www.cra-arc.gc.ca. Your request was not submitted as an advance income tax ruling request, however, as stated in paragraph 22 of IC 70-6R5, we do provide written opinions on general enquiries and we are prepared to provide you with the following comments.
Where property is distributed by a trust to a beneficiary in satisfaction of their capital interest in that trust, subsection 107(2) should apply provided that the preconditions for application are met. Under this subsection, the trust is deemed to dispose of the distributed property for its cost amount and the beneficiary is generally deemed to have acquired the property at the same cost amount. The trust therefore recognizes no capital gain or loss in respect of property distributed pursuant to this subsection. Where a debt owing by the trust to the beneficiary is settled by the transfer of property to the beneficiary, section 80 will apply only if the debt is a "commercial debt obligation" (as that term is defined in subsection 80(1)) and if the value of the property transferred is less than the debt outstanding.
Paragraph 107(1)(a) provides special rules that apply in determining the capital gain that may arise on the disposition by a beneficiary of part or all of the beneficiary's capital interest in a personal or prescribed trust. Generally, it provides that for the purposes of computing the capital gain, if any, from the disposition, the beneficiary's adjusted cost base of the interest or part thereof is deemed to be the greater of its adjusted cost base otherwise determined and its cost amount. Where money or other property of the trust is distributed by a trust in satisfaction of all or part of a beneficiary's capital interest in a trust subsection 108(1) provides that the cost amount of that capital interest will be equal to the total of the beneficiary's proportionate share of both the money and the cost amount to the trust of the property so distributed. Furthermore, where the disposition of the interest is effectively made to the trust, for example, where property of the trust is distributed to the beneficiary in satisfaction of the beneficiary's interest in the trust, paragraph 107(1)(a), in conjunction with paragraph 107(2)(c), ensures that the disposition of the interest will not result in a capital gain and normally not a capital loss (although a capital loss may result under certain circumstances).
In the example outlined in your correspondence, although a single property will be transferred to the beneficiary, the transfer represents in part a "payment in kind" of the debt and in part a distribution in satisfaction of the beneficiary's capital interest in the trust. Under paragraph 107(2)(a) the trust shall be deemed to have disposed of the portion of the property distributed in partial or total satisfaction of the beneficiary's interest for proceeds equal to its cost amount to the trust immediately before that time. In order to retire the $30 debt, the portion of the fair market value of the property required to settle the debt is $30. This would leave $170 of the fair market value of the property, available to be distributed under subsection 107(2). This fraction translates to a cost amount of $110.50 ((100+30) x 170/200) of the property distributed under subsection 107(2) to the beneficiary. If the beneficiary were to sell the property at a subsequent date for the fair market value of $200, the gain on disposition would be equal to $59.50 ($200-($110.50 + $30)). Given that the $30 debt was settled with a portion of an asset with an inherent cost of $19.50 ($30/$200 x $130), the trust would recognize a gain of $10.50 (proceeds of $30 less cost of $19.50) on the disposition of the portion of the asset required to settle the debt. The total gain realized by the trust and the beneficiary would be equal to $70 ($59.50 + $10.50).
The tax result in this situation is appropriate given the increase in the value of the property.
We trust the above comments will be of some assistance.
Yours truly,
Phillip Kohnen
Manager
Trusts Section I
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch