Settlement Code

A set of statutory provisions under which income arising from property that has been gifted is taxed as if it were income of the donor and not of the donee.
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Understanding the Settlement Code

The Settlement Code comprises a set of statutory provisions governing the taxation of income generated from property that has been gifted. According to these provisions, such income is taxed as if it were the income of the donor (the person who gives the gift) rather than the donee (the person who receives the gift). This regulation broadly covers any situations where it is possible for either income or capital to revert to the donor at some point. This means it applies to both outright gifts and gifts into trust.

Objectives of the Settlement Code

The Settlement Code serves three primary purposes:

  1. Preventing Tax Avoidance Through Trusts: Ensure that a trust cannot be used merely as a tax-saving vehicle, which would allow income to be taxed at a lower rate than applies to the settlor, while still benefiting the settlor eventually.
  2. Restricting Income Splitting Opportunities: Limit the ability of parents to split income amongst family members, particularly minor children, to reduce overall tax liability.
  3. Preventing Assignment of Income: Restrict the assignment of income to individuals subject to lower tax rates.

Examples of Settlement Code Application

  1. Family Trusts: A parent sets up a trust in a child’s name with the intention of the trust’s income benefiting the child. The Settlement Code ensures that as long as the income may revert back to the parent, it will be taxed as the parent’s income.
  2. Outright Gifts: An individual gifts a large sum of money to a relative but maintains indirect control over how the income from this money is used. Under the Settlement Code, any income-generating activities from this sum would be taxable to the donor.
  3. Income Assignment: A business owner attempts to reduce personal tax liability by assigning business income to a family member in a lower tax bracket. The Settlement Code would treat the income as if it belonged to the business owner for tax purposes.

Frequently Asked Questions (FAQs)

Q1: Does the Settlement Code apply to all types of gifts?

A1: Yes, the Settlement Code can apply to all types of gifts where there is potential for income or capital to eventually benefit the donor, directly or indirectly.

Q2: Are there any exceptions to the Settlement Code?

A2: Yes, some exceptions include outright gifts to individuals who are capable of managing the property and income independently without indirect control from the donor, especially if they are not minor children.

Q3: What is the difference between an outright gift and a gift into trust under the Settlement Code?**

A3: An outright gift is a direct transfer of property without an intermediary, while a gift into trust involves transferring property to a trust where it is managed by trustees. Both are subject to the Settlement Code if income or capital can revert to the donor.

Q4: How does the Settlement Code impact tax planning for families?

A4: The Settlement Code restricts opportunities for income splitting within families, particularly by preventing parents from transferring income to minor children to take advantage of their lower tax rates.

  • Trust: A fiduciary relationship in which one party, known as a trustee, holds property for the benefit of another party, known as a beneficiary.
  • Income Splitting: The division of income among different entities or family members to reduce the overall tax burden.
  • Settlor: An individual who creates a trust by placing assets under the control of a trustee for the benefit of beneficiaries.
  • Donee: A person who receives a gift.
  • Donor: A person who gives a gift.

Online Resources for Further Reading

Suggested Books for Further Studies

  • “Planning and Administration of Offshore and Onshore Trusts” by William A. Bischoff and Richard A. Bridge
  • “Trusts and Equity” by Richard Edwards and Nigel Stockwell
  • “Federal Income Taxation of Trusts and Estates” by Mark L. Ascher

Accounting Basics: “Settlement Code” Fundamentals Quiz

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