TOSI and Valuing a Discretionary Interest in a Trust

Consider a common corporate structure that entails shares of Opco being wholly owned by a discretionary family trust with beneficiaries who are all related to one another. Dividends paid by the corporation to the trust and allocated to beneficiaries who have attained the age of 17 years before the year starts may be subject to TOSI unless the dividends are not derived directly or indirectly from a related business. Practitioners may be surprised that it is unclear whether a related business exists in this circumstance. The answer may depend in part on whether a discretionary interest in a trust has a nominal value. It is hoped that the CRA will provide guidance on this question.

A related business, in the context of a corporation, may exist if a source individual is actively engaged on a regular basis in the activities of the corporation (subparagraph 120.4(1)(a)(ii)). If that is not the case, such as for a corporation with only passive investments, a related business might still exist. One must make the determination using a further two-part test under which both parts must be satisfied for TOSI to apply (paragraph 120.4(1)(c)).

Part 1

This part of the test is satisfied where a source individual owns either

  1. shares of the capital stock of the corporation; or

  2. property that derives, directly or indirectly, all or part of its fair market value from shares of the capital stock of the corporation.

Where the corporation is wholly owned by a trust, condition (1) cannot be satisfied since trusts are specifically excluded from the definition of "source individual." However, condition (2) may be satisfied if the beneficiaries are considered to hold property that derives, directly or indirectly, all or part of its FMV from the underlying property of the trust.

The CRA's view is that a discretionary interest in a trust is property (APFF CRA round table, question 10, October 5, 2018) and thus condition (2) is satisfied. This argument is particularly persuasive if the trust assets consist only of shares of the corporation; in that case, there are no other assets that would contribute to the value of the discretionary interest.

Part 2

The second part of the test is satisfied where the FMV of a source individual's discretionary interest in the trust constitutes at least 10 percent of the FMV of all of the issued and outstanding shares of the corporation. However, a difficult exercise must be undertaken to ascertain the FMV of a discretionary interest in a trust. If a nominal valuation is supported, this condition will not be met. The CRA takes no position on this point in the APFF round table, noting only that the valuation of a discretionary interest in a trust is a question of fact. However, in a different context, the CRA has taken issue with the nominal valuation and supported instead an even-handed principle (CRA ruling 2001-0111303, 2002), which would allow this condition to be met:
It would be unreasonable to conclude that the FMV of an interest [in] a discretionary trust holding property with significant value has no value simply because it is difficult to measure. In absence of any term of the trust that would direct the trustees to favour one beneficiary over another, the even handed principle would suggest that value of each beneficiary's interest was approximately equal.

Martin Lee

Kakkar CPA Professional Corporation, Vaughan, ON
[email protected]

Canadian Tax Focus
Volume 9, Number 1, February 2019
©2019, Canadian Tax Foundation