The decision contained in the 2006 Budget to fully exempt scholarships was one that has been greatly appreciated among students, parents and the academic world.

But as is always the case with a potential tax-free source of income, there are those who want to use the scheme in ways not contemplated by the government.

For example, we recently were asked whether payments made to the children of an owner-manager of a private company and referred to as scholarships would qualify. We had to opine that it was highly unlikely.

But there are occasionally more fundamental issue about whether a particular payment will qualify for the exemption. While the vast majority of cases where scholarships are given for post-secondary (and sometimes even secondary) schools, there are always grey areas.

A recent CRA ruling dealt with this sort of issue and demonstrates the technical problems that can arise.

The letter was in respect of a query as to whether the full amount of a post-doctoral fellowship is exempt from income tax under subsection 56(3)of the Act, “the scholarship exemption.” As a a post-doctoral fellow at foreign university, the student is primarily involved in research, although he also takes some courses.

The student does not pay tuition and the position as a postdoctoral fellow does not lead to a degree.

Paragraph 56(3)(a) applies to fully exempt income received as a “scholarship, fellowship or bursary” (as those terms are used for purposes of the Act), where the income is connected to the individual’s enrolment in an educational program that is eligible for the education tax credit described in subsection 118.6(2) of the Act (the “ETC”).

The ETC is available where an individual is enrolled in a “qualifying educational program” or a “specified educational program” at a “designated educational institution”, as those terms are defined in subsection 118.6(1) of the Act.

For the sake of the letter, the CRA assumed (without ruling on the matter) that the amount the student received from was a “fellowship” for purposes of the Act (as opposed to employment income or a research grant), and that the individual was in fact “enrolled” in an educational program.

Thus the key point of the discussion revolved around whether a post-doctoral fellow at a university outside Canada is eligible for the ETC and, in particular, to whether a university outside Canada can be considered a “designated educational institution” for such an individual.

For a university outside Canada to be a “designated educational institution,” the CRA ruled, it must be “a university … at which the individual … was enrolled in a course, of not less than 13 consecutive weeks duration, leading to a degree” as set out in paragraph (b) of the definition of “designated educational institution” in subsection 118.6(1) of the Act.

The letter concludes:

“It is our understanding that the nature of a post-doctoral fellowship is such that, although a post-doctoral fellow might be “enrolled in a course,” such a course would not usually lead to a degree (even though the same course might lead to a degree for a Masters or PhD student).

“Consequently, we are of the view that, generally, a post-doctoral fellow at a university outside Canada will not be eligible for the ETC and, therefore, a full exemption under paragraph 56(3)(a) of the Act would not be available for the amount of any related fellowship income.

“However, a limited scholarship exemption may be available under paragraph 56(3)(c) of the Act, equal to the lesser of $500, and the amount otherwise included in the fellow’s income under paragraph 56(1)(n).”

We don’t quibble with the analysis of the ruling but merely note that the result is unfortunate. It also highlights the kind of technical impediments that particularly gifted students may run into in trying to take advantage of the governments educational incentives.

— - Arthur Drache, CM, QC, is an Ottawa-based lawyer at Drache Associates LLP and is associate counsel to Miller Thomson LLP.

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