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Tax Law

Family trusts may be used for used for numerous tax and non-tax related reasons. Several practical applications of inter vivos family trusts include:

1. Confidentiality.

Trusts are private documents and do not have to be filed with a Court.  A will has to be filed with a Court and becomes a public record that anyone can obtain.  There are no other annual or specific filing requirements with respect to the creation or ongoing operation of the trust other than to file an annual T3 trust income tax return. There is no requirement to disclose publicly what assets are held in the trust or to disclose the beneficiaries.

2. Retention of Control.

Family trusts are an effective tool for parents to set aside property for children’s use and enjoyment without relinquishing control of the property because of the separation of beneficial ownership from legal control.

3. Creditor-Proofing.

The separation of legal and beneficial ownership of property of a trust might provide significant protection from creditors without drastically altering control over and use of property transferred to the trust. Quite often, creditor proofing issues arise in the following contexts:

(a) matrimonial breakdown of parents or children;
(b) avoiding claims against the settlor’s estate; and
(c) protecting future corporate growth, corporate surplus and non-active business assets.

Provided that a settlor or transferor does not contravene the Bankruptcy and Insolvency Act or provincial fraudulent conveyances legislation, property transferred to a trust would probably not be exigible by creditors of the settlor or transferor. Further, beneficiaries of the trust are normally protected from the claims of creditors if the family trust is irrevocable, the trustees have full discretion over the trust property and the beneficiaries do not exercise control over or obtain vested rights to receive the trust property.

4. Making Provision for Minors, Disabled Adults and Financially Irresponsible Children.

Minor children and adults who are mentally disabled do not have the legal capacity to deal with property.  Further, financially irresponsible beneficiaries (e.g., irresponsible by nature or because of an addiction) cannot squander the trust fund of a well-drafted trust.

5. Avoidance of Probate Fees.

Transferring property to a family trust allows an individual to avoid probate fees since the transferred property does not form part of the transferor’s estate at death.

6. Income Splitting.

Canada’s progressive tax rate structure and high marginal tax rates provide incentive for taxpayers to distribute income to members of their family to minimize the overall amount of the family’s tax liability. A family trust can result in tax savings where income, otherwise taxable in the hands of parents or at the trust level, is taxed in the hands of beneficiaries who pay tax at a lower marginal tax rate. However, caution is necessary when family trusts are used to achieve income splitting objectives. The tax on split income and the attribution rules in the Act have broad application.

7. Splitting the Lifetime Capital Gains Exemption for “Qualified Small Business Corporation Shares”.

With proper planning, the $800,000 capital gains exemption on dispositions of qualified small business corporation shares can be multiplied among the beneficiaries of a family trust. Further, family trusts can be used to “purify” the assets of a small business corporation to ensure that shares of the corporation meet the criteria of “qualified small business corporation shares”. This is normally accomplished by ensuring a corporation is a beneficiary of the family trust.

Trusts and Income Splitting

One purpose of setting up the trust is to split the income between you and each of your respective family members. Another purpose of the family trust would be to take advantage of the lifetime Capital Gains Exemption on Qualified Small Business Corporation Shares which is currently $800,000.  This can mean tens of thousands of dollars in tax savings.

The effect of the Exemption is that upon a sale of the shares of the company, either an arm’s length sale, or a transfer to the next generation, the first $1,600,000.00 of capital gain ($800,000 of taxable capital gain) per shareholder will be free of tax.  If a husband and wife each own shares, this could mean $3,200,000.00 of tax-free capital gains.  If children are added as shareholders, directly or through a family trust, each of them will also be entitled to the Exemption.  Even if one has no thought of selling the shares of the company, there are situations where the Income Tax Act will treat assets as having been sold for proceeds equal to the fair market value (referred to as a “deemed disposition”).  Foremost among these situations are non-arm’s length gifts, and death.

Establishing a Trust

In order to create a trust, we would need a settlor, trustees and beneficiaries. Ideally, a settlor should be someone who is arms-length and who will not be a beneficiary, contingent or otherwise, or a trustee of the family trust.  However, a settlor may also be a trustee.  There is normally one settlor and he or she is normally at arms-length to the beneficiary.

A trustee is someone who will administer the trust and there are normally three trustees. It is recommended that the individuals who are trustees of the trust make decisions that would benefit the beneficiaries.  A spouse may be a trustee as well.  A parent or another individual who is considered to be arms-length to the trust may be trustees, and it is also important that the trust deed specify that the decisions of the trustees are to be taken by a majority vote.

The beneficiary is the person for whose benefit the trustee holds the trust property.  In a family trust, the beneficiaries may be the spouse, children, grandparents etc. The beneficiaries are the individuals who qualify may for the Exemption, provided that the conditions above have been met. It should, however, be noted that the beneficiaries of the trust should not have a controlling interest in another company.