The Canada Revenue Agency (CRA) issued a technical interpretation on the tax treatment of trust income where there was a distribution from the trust to beneficiaries who weren’t entitled to the distribution in the first place.
The trust was established for the benefit of children who were minors at the time of the trust distribution. The trust agreement forbid the trustee(s) from making distributions to minor beneficiaries presumably to avoid the application of the corporate attribution rule. Well, the trustee(s) made the distributions to the kids anyway.
When determining the taxable income of the trust, one may deduct distributions that were either paid or payable in the year. In this case the CRA said the distribution could neither be paid or payable since the trustee(s) did not have the authority to make the payments. So far so good – while the trust was not entitled to a deduction for the payment the beneficiaries were not required to include the distribution in their income. However, the CRA relied on another tax rule to tax the beneficiaries on the income anyway as a taxable benefit – double tax, once in the trust and again to the beneficiaries – no relief in sight!
A well written trust agreement will include restrictions on making payments to minors so as to avoid attribution rules. Trustees must respect the agreement else risk a double tax on income.