Subsection 104(13.3) and Charitable Donations by a Testamentary Trust

On January 1, 2016, new rules relating to the taxation of trusts came into force in the form of subsections 104(13.3) and (13.4) of the Income Tax Act (Canada) (the “Act”). We have previously discussed the effect of subsection 104(13.4) (which, due to January 2016 legislative proposals, will “live only in the tax history books after 2016”), but have not yet commented on the tax implications of subsection 104(13.3) on charitable gifting by testamentary trusts.

Most testamentary trusts that arise on and as a consequence of an individual’s death provide trustees/executors with little to no discretion regarding the distribution of income and capital to beneficiaries.  Where the income of a testamentary trust becomes payable to a beneficiary, the Act requires the income to be taxed in the hands of the beneficiary, and the trust may deduct a corresponding amount from its income. According to subsection 104(24), an amount is payable to a beneficiary in a year if the amount was paid to the beneficiary in the year or if the beneficiary was entitled in the year to enforce payment.

Prior to 2016, subsections 104(13.1) and (13.2) enabled a trust to designate distributed income and taxable capital gains as being taxable in the trust, rather than in the hands of the beneficiaries. This could prove useful where a trust had losses that could be used to offset income or taxable capital gains, or if a trust had made a charitable donation and could claim the resulting tax credit under subsection 118.1(3).

However, new subsection 104(13.3) provides that these designations will be invalid where a trust’s income in a year is greater than nil (i.e., income paid or payable to a beneficiary can only be taxed in the trust to offset losses). One effect of this new provision is that a trust can only take advantage of a charitable donation tax credit in a year where its income is not considered payable to its beneficiaries. Under common law principles, a beneficiary is generally only not entitled to enforce payment of an amount during the initial 12-month period of a testamentary trust, which is referred to as the “executor’s year”. The CRA acknowledges in its interpretation bulletin IT-286R2 the existence of the common law executor’s year and has stated the following:

Under common law rules, the initial 12-month period for a testamentary trust, commencing with the date of the settlor’s death, is referred to as the “executor’s year” and the right to income of the trust is, during the executor’s year, unenforceable by a beneficiary of the trust.

Thus, it appears that for a non-discretionary testamentary trust, the only period during which the trust’s income beneficiaries would not be entitled to enforce payment of the trust’s income would be the initial 12-month period following the death of the testator. This is consequently the only period during which such a trust could have income for tax purposes against which a charitable donation tax credit could be claimed.

As a result, subsection 104(13.3) significantly limits the ability of non-discretionary testamentary trusts to use charitable tax credits to offset taxes payable. The effect of this new rule should be kept in mind when planning for charitable donations to be made upon, or subsequent to, the death of an individual.