It’s not uncommon for a trust or an estate to have a non-resident beneficiary. When such a situation arises, trustees should consider whether Part XII.2 tax applies. Essentially, Part XII.2 imposes a 40% tax on the non-resident beneficiary if the trust or estate earns designated income that would, if earned directly by a non-resident, be taxed under Part I of the Income Tax Act (the “Act“). Its purpose is to prevent a non-resident beneficiary from paying a lower rate of Canadian tax on specific income earned in Canada.

Part XII.2 applies if the trust or estate has designated income and has one or more designated beneficiaries.[1] The term “Designated Income” is a defined term that can be summarized as a trust or estate that generates taxable capital gains from the sale of taxable Canadian property,[2] rental income, or Canadian business income which has been distributed to a beneficiary and the estate has a non-resident beneficiary.[3] The term “designated beneficiary” is also a defined term and, for the purpose of this blog, includes a non-resident beneficiary.[4]

It’s worth noting that there is no Part XII.2 tax payable by a trust that was throughout the year:

• A graduated rate estate,
• A mutual fund trust,
• Exempt from tax under Part I because of subsection 149(1),
• A trust to which paragraph (a), (a.1), or (c) of the definition of trust in subsection 108(1) applies, or,
• A non-resident trust.[5]

Part XII.2 Tax Calculation

The calculation of Part XII.2 tax is complex. A trust must pay Part XII.2 tax for a taxation year of 40% of the least of:

• Its designated income for the tax year,
• The amount that would be the income of the estate for the year if no amount were deducted under subsection 104(6) in computing the estate income in respect of amounts that became payable in the year to a beneficiary or in respect of tax paid by the estate for the year under Part XII.2, and
• 100/60[6] of the amount deducted by the estate under paragraph 104(6)(b), an amount that became payable in the year to a beneficiary or that were included in a beneficiary’s income for the year by reason of subsection 105(2), in computing the income of the estate for the year.[7]

It’s important to appreciate that Part XII.2 tax will only apply to a trust or estate in a year where a portion of its income was distributed or became payable in the year to beneficiaries and the 40% tax applies on its designated income for that taxation year.

It’s the responsibility of the estate (i.e. its trustees) to pay Part XII.2 tax but the tax paid is deductible in computing the trust or estate’s income for that year.[8] In other words, the estate may treat Part XII.2 as if it was distributed to beneficiaries. The Canadian beneficiaries of the trust or estate may claim a Part XII.2 refundable tax credit for Part XII.2 tax that is attributed to them.

Part XII.2 is complex. Advisors should appreciate that when an estate has a non-resident beneficiary, there’s a possibility that Part XII.2 tax of 40% may apply and if so, the trustees must be mindful of their responsibility in complying with this tax.

[1] ss. 210(1).

[2] Defined in ss. 248(1).

[3] Under subsection 210.3(1), Part XII.2 tax is only applicable if the trust has a designated beneficiary.

[4] The definition of “designated beneficiary” is broad and should be reviewed in its entirety but for the purpose of this blog, it will focus on non-resident beneficiary.

[5]  ss. 210(2).

[6] 167%.

[7]  ss. 210.2(1).

[8] ss. 104(30).