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Federal Tax - Trusts. Canada v. Vefghi Holding Corporation
In Canada v. Vefghi Holding Corporation (Fed CA, 2025) the Federal Court of Appeal allowed an income tax appeal and dismissed a cross-appeal - here involving issues that were "raised in an application under Rule 58 [SS: 'Question of Law, Fact or Mixed Law and Fact' (preliminary resolution of issue)] of the Tax Court of Canada Rules (General Procedure), SOR/90-688a".
Here the court considers a trust taxable dividend issue [under ITA 104(19): 'SUBDIVISION K - Trusts and their Beneficiaries - Designation in respect of taxable dividends']:[1] This is an appeal and a cross-appeal from the Order of the Tax Court of Canada answering a question that was raised in an application under Rule 58 of the Tax Court of Canada Rules (General Procedure), SOR/90-688a. The question that was posed to the Tax Court was:Where a trust designates a portion of a taxable dividend (the "Amount") received on a share of the capital stock of a taxable Canadian corporation (the "Issuer"), pursuant to subsection 104(19) of the federal Income Tax Act (the "Act"), such that the Amount is deemed to have been received by a beneficiary (the "Beneficiary"), when is it determined whether the Issuer is connected with the Beneficiary for purposes of paragraph 186(1)(a) of the Act? [2] The Tax Court Judge provided the following answer (2023 TCC 135):Where a trust designates a portion of a taxable dividend (the "Amount") received on a share of the capital stock of a taxable Canadian corporation (the "Issuer"), pursuant to subsection 104(19) of the federal Income Tax Act (the "Act"), such that the Amount is deemed to have been received by a beneficiary (the "Beneficiary"), the determination of whether the Issuer is connected with the Beneficiary is made at the time that the taxable dividend was, as a question of fact, received by the trust provided that the Beneficiary is deemed under subsection 104(19) to have received the Amount in the same taxation year as the taxable dividend was, as a question of fact, received by the trust.
However, if the Beneficiary is deemed under subsection 104(19) to have received the Amount in a taxation year that is subsequent to its taxation year in which the taxable dividend was, as a question of fact, received by the trust, then the determination of whether the Issuer is connected with the Beneficiary is made in the subsequent taxation year of the Beneficiary. [3] The Crown appealed this Order. The Crown’s proposed answer to the Rule 58 question was refined between the filing of the notice of appeal and the filing of the Crown’s memorandum. The refined response as proposed by the Crown is:Where a trust designates the Amount pursuant to s. 104(19), such that the Amount is deemed to have been received by the Beneficiary, the determination of whether the Issuer is connected with the Beneficiary for purposes of s. 186(1)(a) is made when the deemed dividend takes effect, being when the Amount is designated by the trust at the end of the particular taxation year of the trust in which the trust received the dividend from the Issuer. [4] Vefghi Holding Corporation (Vefghi Holding) and S.O.N.S. Environmental Ltd. (S.O.N.S.) filed a cross-appeal. They also refined their proposed response between the filing of the cross-appeal and the filing of their memorandum. Their refined proposed response is:Where a trust designates a portion of a taxable dividend (the “Amount”) received on a share of the capital stock of a taxable Canadian corporation (the “Issuer”), pursuant to subsection 104(19) of the federal Income Tax Act (the “Act”), such that the Amount is deemed to have been received by a beneficiary (the “Beneficiary”), the time at which it is to be determined whether the Issuer is connected with the Beneficiary for purposes of paragraph 186(1)(a) of the Act is the time at which the dividend is declared or paid.
Or, alternatively
Where a trust designates a portion of a taxable dividend (the “Amount”) received on a share of the capital stock of a taxable Canadian corporation (the “Issuer”), pursuant to subsection 104(19) of the federal Income Tax Act (the “Act”), such that the Amount is deemed to have been received by a beneficiary (the “Beneficiary”), the time at which it is to be determined whether the Issuer is connected with the Beneficiary for purposes of paragraph 186(1)(a) of the Act is the time at which the dividend is actually received by the trust. [5] For the reasons that follow, I would allow the appeal with a clarification to the response as proposed by the Crown and dismiss the cross-appeal. In these reasons there are references to a number of provisions of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the Act). The full text of the current version of the provisions that are relevant in answering the Rule 58 question is set out in the Appendix attached to these Reasons. The only provision that was amended after 2014 was paragraph 186(1)(a) of the Act. The amendment only changed the amount set out in paragraph 186(1)(a) of the Act (from 1/3 to 38 1/3%) and therefore does not impact the response to the Rule 58 question.
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VII. Conclusion
[66] As a result, I substantially agree with the response to the Rule 58 question as proposed by the Crown. However, as noted above, the ambiguity in the Crown’s proposed response should be corrected. Since the earliest time the trust could satisfy the condition that it be resident in Canada "“throughout the particular taxation year”" is when its year end is concluded, the time for the determination should be the end of trust’s taxation year.
[67] I would therefore allow the appeal and dismiss the cross-appeal. I would set aside the Order issued by the Tax Court and I would answer the Rule 58 question as follows:Where the conditions of subsection 104(19) of the Act are satisfied and a trust designates the Amount pursuant to s. 104(19), such that the Amount is deemed to have been a dividend received by the Beneficiary, the determination of whether the Issuer is connected with the Beneficiary for purposes of s. 186(1)(a) is made at the end of the particular taxation year of the trust in which the trust received the dividend from the Issuer. At paras 11-65 the court explains their reasoning in detail.
. Magren Holdings Ltd v. Canada
In Magren Holdings Ltd v. Canada (Fed CA, 2024) the Federal Court of Appeal dismissed a appeal, this from a dismissed Tax Court appeal, this from a Ministerial assessment "imposing tax on the basis that all of the capital dividends those corporations paid in 2006 were excess dividends", and "where a corporation pays a capital dividend in excess of the balance of its capital dividend account, the corporation is liable for tax":
Here the court summarizes some trust-as-taxpayer law:(1) Taxation of trusts and their beneficiaries
[12] A trust is a taxpayer and therefore must compute its income and taxable income. However, a trust may avoid a tax liability on its income by paying an equal amount to its beneficiaries, who then must include the payment in their income: ss. 104(6)(b), 104(13). The same is not true of losses. Where a trust realizes a loss, it cannot pass that loss out to its beneficiaries; only the trust may use its losses.
[13] Where a trust pays its income to its beneficiaries, any liability for tax on the trust’s income is determined based on the beneficiary’s circumstances. If the beneficiary is a registered retirement savings plan, or other tax-exempt plan, no tax is payable until the income is withdrawn from the plan, typically many years later. If the beneficiary is itself a trust, it in turn may pay the income to its beneficiaries so it becomes their income rather than income of the trust.
[14] With few exceptions, the character of the trust’s income is not maintained when paid to a beneficiary; rather, the beneficiary has income from a property that is an interest in a trust: s. 108(5)(a). Capital gains are one exception to that general principle relevant to this appeal.
[15] Where a trust realizes a capital gain, and distributes an equal amount to a beneficiary, the trust may make a designation so that one-half of the distribution is deemed to be a taxable capital gain realized by the beneficiary: s. 104(21). The other portion of the distribution—reflecting the non-taxable portion of the trust’s capital gain—is not included in the beneficiary’s income. Moreover, the distribution does not affect the beneficiary’s tax cost—the adjusted cost base (ACB)—of their interest as beneficiary in the trust: s. 53(2)(h)(i.1)(A) and (B). That ACB remains unchanged regardless of the distribution’s effect on the value of that interest.
[16] In this way, provided the appropriate designation is made, the trust’s capital gain is taxed as if the beneficiary had realized it directly.
[17] When a trust purchases for cancellation (redeems) a beneficiary’s interest in the trust, the trust may choose to treat part of the amount it pays for that interest as a distribution of its income, rather than an amount paid to acquire the interest. In that circumstance, only the amount in excess of the income distribution will be proceeds of disposition for the beneficiary’s interest. Consequently, whether the beneficiary has a capital gain (or capital loss) depends on whether those reduced proceeds exceed (or are less than) the beneficiary’s ACB of the repurchased (redeemed) interest.
[18] If the trust’s income includes taxable capital gains, the trust may choose to treat part of the amount it pays on the redemption as a distribution of a capital gain, designating 50 percent as a taxable capital gain. While the distributed capital gain reduces the beneficiary’s proceeds of disposition for the interest in the trust as described in the preceding paragraph, the beneficiary’s overall capital gain (or capital loss) should be the same, albeit comprised of two amounts.
[19] In particular, the capital gain distributed by the trust would reduce the proceeds of disposition for the redeemed trust interest, and would require the beneficiary to include 50 percent as a taxable capital gain in income. The beneficiary would also have a capital gain (or capital loss) on the trust interest redeemed, depending on whether the reduced proceeds of disposition (reflecting the distributed capital gain) exceed (or are less than) the beneficiary’s ACB of the redeemed trust interest. Any resulting allowable capital loss would be deductible against the distributed taxable capital gain.
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