Trusts And Estate Planning

What is a Trust? © 2008 Clarence Byrd Inc.2 SettlorTrusteeBeneficiaries PropertyBenefits Legal Ownership

Legal Vs. Tax  A trust is not a separate legal entity  Income Tax Act views a trust as a separate taxable entity © 2008 Clarence Byrd Inc.3

Trust Vs. Estate  In general, the term “estate” refers to the property and possessions of an individual © 2008 Clarence Byrd Inc.4

Trust Vs. Estate  ITA 104(1) In this Act, a reference to a trust or estate (in this subdivision referred to as a “trust”) shall,...  ITA views “estate” as the property of a deceased individual prior to its distribution  ITA requires a “trust” return for the income of an individual’s estate © 2008 Clarence Byrd Inc.5

Establishing a Trust  Requires three certainties Certainty of intention Certainty of property Certainty of beneficiaries © 2008 Clarence Byrd Inc.6

Establishing a Trust © 2008 Clarence Byrd Inc.7 Who Cares? If a trust is not clearly established, there may be unexpected tax consequences (e.g., income taxed in hands of settlor rather than beneficiaries).

Non-Tax Uses Of Trusts  Administration of assets  Creditor proofing  Privacy (wills require probate, trusts do not)  Avoiding changes in beneficiaries © 2008 Clarence Byrd Inc.8

Classification of Personal Trusts © 2008 Clarence Byrd Inc.9 Testamentary Inter Vivos Spousal or common-law partner Other beneficiariesAlter ego Joint spousal or common-law partner Family

Taxation of Trusts © 2008 Clarence Byrd Inc.10 Settlor Capital Beneficiaries Income Beneficiaries Trust Property Property At FMV Property At Trust’s Cost Trust Income Retained Income (taxed in trust) Distributed Income (beneficiaries taxed)

Rollovers to a Trust  In general: Contributions are a disposition by the settlor at fair market value  Exceptions Spouse or common-law partner trust Alter ego trust Joint spouse or common-law partner trust © 2008 Clarence Byrd Inc.11

Rollovers to a Trust - Spouse or Common-Law Partner © 2008 Clarence Byrd Inc.12 Inter Vivos ITA 73(1.01)(c)(i) The individual's spouse or common-law partner is entitled to receive all of the income of the trust that arises before the spouse's or common-law partner's death and no person except the spouse or common-law partner may, before the spouse's or common-law partner's death, receive or otherwise obtain the use of any of the income or capital of the trust.

Spouse or Common-Law Partner © 2008 Clarence Byrd Inc.13 Testamentary ITA 70(6)(b) A trust, created by the taxpayer's will, that was resident in Canada immediately after the time the property vested indefeasibly in the trust and under which (i) the taxpayer's spouse or common-law partner is entitled to receive all of the income of the trust that arises before the spouse's or common-law partner's death, and (ii) no person except the spouse or common-law partner may, before the spouse's or common-law partner's death, receive or otherwise obtain the use of any of the income or capital of the trust.

Alter Ego © 2008 Clarence Byrd Inc.14 Only Inter Vivos ITA 73(1.01)(c)(ii) The individual is entitled to receive all of the income of the trust that arises before the individual's death and no person except the individual may, before the individual's death, receive or otherwise obtain the use of any of the income or capital of the trust.

Joint Spousal or Common-Law Partner  ITA 73(1.01)(c)(iii) either the individual or the individual's spouse is, in combination with the other, entitled to receive all of the income of the trust that arises before the later of the death of the individual and the death of the spouse and no other person may, before the later of those deaths, receive or otherwise obtain the use of any of the income or capital of the trust, or the individual or the individual's common-law partner is, in combination with the other, entitled to receive all of the income of the trust that arises before the later of the death of the individual and the death of the common-law partner and no other person may, before the later of those deaths, receive or otherwise obtain the use of any of the income or capital of the trust. © 2008 Clarence Byrd Inc.15

Rollovers to a Capital Beneficiary  General Rule: Transfer at trust’s tax cost  Exceptions for transfers out of: Spouse or common-law partner trust Alter ego trust Joint spouse or common-law partner trust © 2008 Clarence Byrd Inc.16

21 Year Deemed Disposition  Deemed disposition/acquisition every 21 years  Limits the deferral of capital gains within the trust © 2008 Clarence Byrd Inc.17

Net Income of a Trust  In general: Follows the ITA 3 rules as applied to an individual  Additional adjustments required © 2008 Clarence Byrd Inc.18

Net Income Adjustments  Deductions available for: Amounts paid or payable to beneficiaries Trustee’s or executor’s fees Amounts paid by the trust on behalf of beneficiaries © 2008 Clarence Byrd Inc.19

Net Income Adjustments  Preferred Beneficiary Election Income retained in trust, taxed in hands of beneficiary Only applicable to beneficiaries ○ Who are eligible for the disability tax credit; or ○ Can be claimed as an infirm dependant over 17 © 2008 Clarence Byrd Inc.20

Net Income Adjustments  Amounts deemed not to be paid A distribution that is taxed in the trust rather than in the hands of the recipient beneficiary Reasons for using ○ Lower rates ○ Avoidance of instalments ○ Use of trust losses © 2008 Clarence Byrd Inc.21

Net Income Adjustments  Amounts retained for a beneficiary under 21 years of age Retained in the trust but taxed in the hands of the beneficiary Beneficiary must be under 21 during the year Amounts must vest irrevocably with the beneficiary. © 2008 Clarence Byrd Inc.22

Taxable Income of a Trust © 2008 Clarence Byrd Inc.23 Net Income of the trust Taxable Income of the trust Same deductions as those available to individuals

Income Allocations to Beneficiaries  To be deductible, amounts must be paid or payable  Not considered payable if: A beneficiary can only enforce payment of an amount of income by forcing the trustee to wind up the trust. The beneficiary’s right to income is subject to the approval of a third party. Payment of income is at the trustee’s discretion. The beneficiary has the power to amend the trust deed and must do so to cause the income to be payable. © 2008 Clarence Byrd Inc.24

Determination of Distributions  Discretionary Amounts at the discretion of trustee Timing at the discretion of trustee  Non-Discretionary Amounts and their timing specified in trust agreement © 2008 Clarence Byrd Inc.25

Flow Through Provisions  Dividends distributed Beneficiary will gross up Beneficiary will get credit  Retained in trust Trust will gross up Trust will get credit  Will retain eligible/non-eligible status © 2008 Clarence Byrd Inc.26

Flow Through Provisions  Capital Gains If distributed ○ One-half taxed ○ One-half tax free If retained ○ One-half taxed ○ One-half becomes part of trust’s capital © 2008 Clarence Byrd Inc.27

Flow Through Provisions  Tax on split income A tax on specified types of income (see Chapter 10) Applicable to those under 18  If specified income earned in trust: It will be subject to this tax if beneficiary is under 18 © 2008 Clarence Byrd Inc.28

Flow Through Provisions  Business Income Must be calculated at trust level Will include CCA, recapture, and terminal losses © 2008 Clarence Byrd Inc.29

Flow Through Provisions  Principal Residence Exemption Owned by trust Ordinarily inhabited by beneficiary Exemption available © 2008 Clarence Byrd Inc.30

Trust Tax Payable Testamentary Trusts  Taxed using the progressive rates applicable to individuals  Multiple testamentary trusts If same beneficiaries may be taxed as one trust  Tainting May lose testamentary status if contributions by living person © 2008 Clarence Byrd Inc.31

Trust Tax Payable Inter Vivos Trusts  Undistributed income taxed at maximum rate of 29 percent © 2008 Clarence Byrd Inc.32

Tax Credits  Many not available (e.g., medical expenses)  Available Donation tax credits Dividend tax credits (eligible and non-eligible) Foreign tax credits Investment tax credits © 2008 Clarence Byrd Inc.33

Alternative Minimum Tax  Applicable To Trusts  The $40,000 exemption is only available to testamentary trusts © 2008 Clarence Byrd Inc.34

Income Attribution  Applicable to spouses, common-law partners and related minors  Applicable to transfers to a trust where the beneficiary is a spouse, common- law partner, or related minor  Occurs when income is allocated to such individuals © 2008 Clarence Byrd Inc.35

Reversionary Trusts  Attribution to settlor: If the transferred property can revert to settlor If the settlor can determine the persons that will receive the transferred property The transferred property cannot be disposed of except with transferor’s consent © 2008 Clarence Byrd Inc.36

Purchase or Sale of an Interest in a Trust  Income Interest Cost usually nil Gain will be property income  Capital Interest May have a cost Gain or loss will be capital © 2008 Clarence Byrd Inc.37

Tax Planning Family Trust  Trust established for family members  Can be used to enforce behaviour (e.g., showing up for family dinners)  Can be used for income splitting © 2008 Clarence Byrd Inc.38

Tax Planning Spousal Trusts  Can provide for management of assets  Can ensure appropriate distribution of assets subsequent to death of spouse (settlor’s children in the event of spouse re-marriage ) © 2008 Clarence Byrd Inc.39

Tax Planning Alter Ego and Joint  Avoidance of Probate Costly Time consuming Multiple jurisdictions Probate in public domain  Establishment in low tax jurisdiction (e.g., Alberta) © 2008 Clarence Byrd Inc.40

Estate Planning  Non-Tax Considerations Intent of testator Preparation of final will Preparation of living will Ensuring liquidity Avoiding family disputes Expediting the transition © 2008 Clarence Byrd Inc.41

Estate Planning  Tax considerations Pre-death planning Planning in the year of death Income splitting Foreign jurisdictions Administration © 2008 Clarence Byrd Inc.42

Estate Freeze  Objectives Transfer income to low tax beneficiaries Freeze value of assets Avoid immediate taxation Transfer future growth Retain control of assets  Not always possible to achieve all of these goals © 2008 Clarence Byrd Inc.43

Estate Freeze Techniques  Gifts Transfers growth and income Generates current income unless transferee is a spouse or common-law partner Attribution rules could apply Tax on split income could apply Transferor loses control over assets © 2008 Clarence Byrd Inc.44

Estate Freeze Techniques  Instalment sales Could use capital gains reserves Would require payment at FMV to avoid attribution Loss of control © 2008 Clarence Byrd Inc.45

Estate Freeze Techniques  Establishing an inter vivos trust Transfers income and future growth Will attract immediate taxation unless it is a spousal trust Can result in income attribution and tax on split income © 2008 Clarence Byrd Inc.46

Estate Freeze Techniques  Holding company Can accomplish most objectives Without rollover, will result in immediate taxation on transfer © 2008 Clarence Byrd Inc.47

Estate Freeze Techniques  Rollover under ITA 85 or ITA 86 Can accomplish all objectives ITA 86 requires an existing corporation ITA 86 is simpler in that is does not require an election © 2008 Clarence Byrd Inc.48

Specified Investment Flow Through Entities (SIFTs)  SIFT Partnership Canadian resident Securities publicly traded Holds non-portfolio properties  SIFT Trust Canadian resident Securities publicly traded Holds non-portfolio properties © 2008 Clarence Byrd Inc.49

Specified Investment Flow Through Entities (SIFTs)  The problem High tax rates on publicly traded corporations ○ Integration doesn’t work ○ Makes flow through income attractive Non-residents and tax exempt entities ○ Non-residents pay low rates ○ Tax exempts pay no tax ○ Makes flow through income attractive © 2008 Clarence Byrd Inc.50

Specified Investment Flow Through Entities (SIFTs)  The solution Tax income from non-portfolio properties Non-portfolio ○ Securities Greater than 10 percent of equity of investee Greater than 50 percent of the equity of the SIFT ○ Real and resource properties (more than 50 percent of the SIFT’s equity) ○ Property used to carry on a business © 2008 Clarence Byrd Inc.51

Specified Investment Flow Through Entities (SIFTs) © 2008 Clarence Byrd Inc.52 Applicable Rate Basic Rate38.0% Abatement(10.0%) General Rate Reduction( 8.5%) Provincial SIFT Factor13.0% Total32.5%

Specified Investment Flow Through Entities (SIFTs)  Mechanics Of Tax – Partnerships Part IX.1 tax on earnings of non- portfolio properties After tax amount is deemed to be a dividend received from a taxable Canadian Corporation Can be allocated to partners as dividends (generally eligible) © 2008 Clarence Byrd Inc.53

Specified Investment Flow Through Entities (SIFTs)  Mechanics Of Tax – Trusts Earnings from non-portfolio properties taxed at 32.5% When after tax amount is distributed, it is deemed to be a dividend (generally eligible) © 2008 Clarence Byrd Inc.54

© 2008 Clarence Byrd Inc.55