Tax Updates

Restrictions on discretionary trust’s dividend allocation powers

May 20, 2020

Authored by RSM Canada LLP

Cleo L. Melanson, CPA, CA, CMA, shared this article


The word ‘discretionary’ means ‘unrestricted’ or ‘unregulated’. However, discretionary trusts may not always enjoy unfettered decision-making from a tax perspective. For instance, tax authorities can regulate a discretionary trust’s dividend allocation powers.

In technical interpretation 2019-0833061E5, the Canada Revenue Agency (CRA) considered whether a discretionary trust could allocate a portion of a dividend, supported by safe income, to a corporate beneficiary and the remaining portion, not supported by safe income, to an individual beneficiary.

Primer on technical terms

A discretionary trust is a trust that provides trustees the decision making power in respect of distributions to the beneficiaries, rather than being confined to the terms of the trust agreement. By contrast, a “fixed interest” trust is one where the trustee has no discretion in making distributions of the income or capital of the trust and must follow the distribution instructions provided in the trust instrument.

A trust is taxable on the income it earns during the year. However, the Income Tax Act (“Act”) provides that if an amount becomes payable by a trust to its beneficiaries, the beneficiaries, and not the trust, will be liable for the tax obligation in respect of that amount. That is, a trust can deduct this amount from its total taxable income. Further, the amount paid by a trust to a beneficiary will generally lose its character and will be re-characterized as income from property. However, certain designations are available in the Act to ensure that certain types of income retain their character. As a result of this flow-through treatment, the provisions for the dividend gross-up, dividend tax credit, intercorporate dividend deduction, or Part IV or IV.1 tax can apply to the beneficiary, depending on the case. For example, subsection 104(19) of the Act allows a Canadian resident trust to designate a taxable dividend received from a taxable Canadian corporation as having been received directly by the beneficiary. This enables (i) an individual beneficiary, who is a resident in Canada, to claim the gross-up and dividend tax credit and (ii) a corporate beneficiary to receive a tax-free intercorporate dividend under subsection 112(1) of the Act.

As explained in RSM Canada’s Tax Alert on safe income, subsection 112(1) of the Act provides that a Canadian corporation can generally pay dividends to another Canadian corporation tax-free. However, subject to certain conditions and exceptions, the Act limits tax-free inter-corporate dividends to the payer corporation’s safe income on hand that reasonably contributes to the capital gain that could be realized on a disposition of the share on which the dividend is received.

CRA view 2019-0833061E5

The relevant facts were:

  1. A holding corporation (Holdco) and an individual (Mr. A) are the beneficiaries of a discretionary trust (the Trust) that holds the shares of an operating corporation (Opco) that were issued following an estate freeze.
  2. The safe income on hand associated with the shares held by the Trust in Opco is $1,000.
  3. Opco pays a dividend of $2,500 to the Trust.
  4. The Trust makes a subsection 104(19) designation so that Holdco is deemed to receive a portion of the dividend that is equal to Opco’s safe income of $1,000 and the remainder of the dividend is deemed to have been received by Mr. A.


The principal issue before the CRA was whether a trustee can exercise its discretion to allocate (i) the portion of a dividend associated with safe income to Holdco such that the dividend will benefit from the safe income exception in paragraph 55(2.1)(c) of the Act, and therefore, be a tax-free intercorporate dividend to Holdco, and (ii) the remaining portion to Mr. A.

Dividend allocation on a pro-rata basis

The CRA confirmed that a trust can designate under subsection 104(19) that a taxable dividend received from a taxable Canadian corporation be deemed to be received directly by the beneficiary. However, the CRA determined that subsection 104(19)  does not allow a trustee of a discretionary trust to exercise its discretionary powers to allocate the safe income portion of the dividend entirely to a corporate beneficiary, and the remaining portion to an individual beneficiary. Therefore, the corporate beneficiary will not benefit from the safe income exception in paragraph 55(2.1)(c) of the Act for the entire amount of dividend received and cannot claim the dividend tax-free under subsection 112(1). Rather, the safe income on hand portion of the total dividend designated by a trust should be allocated between the corporate beneficiary and the individual beneficiary on a pro-rata basis as illustrated below:

Total dividend designated by Trust



Safe income on hand portion



Dividend designated to Holdco



Dividend designated to Mr. A



Proportion of dividend designated to Holdco

$1,000/ $2,500 = 40%

E = C/A

Proportion of dividend designated to Mr. A

$1,500/ $2,500 = 60%

F = D/A

Proportion of safe income on hand that can be designated to Holdco

40% of $1,000 = $400

G = E*B

Proportion of safe income on hand that can be designated to Mr. A

60% of $1,000 = $600

H = F*B


Discretionary trust’s powers are also regulated

The CRA’s technical interpretation demonstrates that a trustee of a discretionary trust may have the powers to decide which beneficiary will receive dividends and how much, but it cannot use its discretionary powers to allocate tax attributes to the beneficiaries. An alternative planning strategy may be possible:

  1. Opco pays a dividend of $1,000 to the Trust in year 1, up to its safe income on hand.
  2. Trust designates this dividend under subsection 104(19) to Holdco such that Holdco will benefit from the safe income exception in paragraph 55(2.1)(c) of the Act.
  3. Opco pays an additional dividend of $1,500 to the Trust in year 2. The dividend exceeds Opco’s safe income on hand.
  4. Trust designates the entire dividend received in year 2 under subsection 104(19) to Mr. A.

Based on the guidance in the recent technical interpretation, the Trust’s subsection 104(19) designation would enable Holdco to claim the entire $1,000 dividend as tax-free inter-corporate dividend under subsection 112(1) of the Act.  Whether this series of transactions could be viewed as abusive would need to be further considered.

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This article was written by Nakul Kohli and originally appeared on 2020-05-20 RSM Canada, and is available online at

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