In 2001 Canada introduced two new trusts; the alter ego and joint partner trust. Essentially both trusts allow a settlor of an inter vivos trust to transfer capital assets into a trust on a tax deferred basis if the following conditions are met:
- The settlor must be at least 65 at the time the trust was created
- The trust is created after 1999
- In the case of an alter ego trust the settlor must be entitled to receive all the income of the trust that arises before his or her death. In the case of a joint partner trust the settlor or his or her partner, in combination with one another are entitled to all income of the trust that arises prior to the death of the survivor of them
- No person expect the settlor (and his or her spouse in a joint partner trust) may, before the settlor’s death (or the survivor’s death in a joint partner situation) may receive or otherwise obtain the use of any income or capital of the trust
- A majority of the trustees must be Canadian
These trusts have a series of advantages, including probate savings and confidentiality which will be discussed in another article. This article will discuss some of the potential traps or downsides to using such a trust.
All trusts should be professionally drafted and with professional drafting will be professional fees. Alter ego and a joint partner trusts are no exception. In fact, due to the technical requirements associated with the trusts it is even more paramount to ensure professional care is taken in the drafting. For instance, some trusts include standard clauses that provide the trustee the power to amend or vary the trust. However, a clause such as this may mean the trust no longer complies with the requirement that only the settlor and/ or their spouse could benefit. The term may therefore result in an immediate deemed disposition.
The immediate cost associated with creating the trust needs to be carefully compared to the future probate and tax savings associated with these trusts. Legal costs will vary depending on the complexity of the trust.
Potential US tax exposure
If at death there is US estate exposure there is a risk of double taxation. The United States estate tax would be applied against the settlor as the United States in certain circumstances reads through these trusts whereas Canada regards the trust as a separate taxpayer. There is no tax treaty relief in these situations.
Limitation of Capital gains exemption
These trusts do not benefit from the $848,252 (2018) capital gains exemption on the sale of qualifying CCPC shares or for shares held in a CCPC or qualified farm or fishing property ($1M for 2018). Therefore, sophisticated planning is normally required to gain access to the exemption. One option might be to opt out of the tax-deferred rollover on transfer of property to the trust.
Family Law Considerations
Conveying assets to a trust may reduce assets available for division in the case of a marriage breakdown. If the court one of the reasons for the was to reduce net family property the transfer may be viewed as fraudulent.
Charitable Planning considerations
Charitable gifts in a Will or through an insurance or registered plan are deemed to be gifts by an estate and as such carry a lot of advantages. For instance a charitable gift in a Will can be used as a tax credit in the year of death on the terminal return or in the estate and the credit available is in respect of 100% of net income in the terminal year and the year prior compared to the normal rule of 75%. Assets held outside of AET and JT partner trusts also allow for flexibility in donating during the settlor’s lifetime However, these advantages are not available to an inter vivos trust as they are not deemed to be a gift by an estate. Also, because alter ego and joint partner trusts are prohibited from distributing any of its income or capital to anyone other than the settlor (or spouse in the case of a joint partner trust) during the settlor (or spouse’s) lifetime, the settlor will not be able to use trust assets to achieve charitable objectives during his or her lifetime. Income or capital received from the trust, however, can be donated.
Where the gift to charity is structured to occur on death of the settlor (or spouse or common-law partner in the case of a joint partner trust), the trust can normally claim the resulting tax credit, which can offset tax payable at the trust level for the year of death.
Since the trust is a separate taxpayer from the settlor or his or her spouse gains in the trust cannot be offset by losses realized by the settlor or vice versa.
Future Trust Planning
If after the death of the individual or the joint partners the trust is to continue, for instance the funds are to be held in trust for a child or grandchild, the funds are deemed to be from an inter vivos trust and carry with it a tax disadvantage. If the funds had passed through the parent or grandparent’s estate the estate would have enjoyed up to three years of graduated tax rates. Any income taxed in the hands of the inter vivos trust, on the other hand, is taxed at the highest marginal rate and does not benefit from this three year graduated rate period.
Ongoing administrative planning
A trust is required to file an annual tax return and the reporting obligations are about to become cumbersome. The 2018 federal budget proposed a new reporting requirement applicable for returns to be filed for 2021 and subsequent taxation years for certain “express trusts” which are resident in Canada and for non-resident trusts which are required to file a T3 income tax return. Express trusts are defined in the budget as a trust created with the settlor’s express intent, as opposed to resulting or constructive trusts which arise as a matter of law.
Many trusts will be exempt from the requirements, most notably a graduated rate estate, a qualified disability trust, trusts in existence for less than three months or trusts with a value of less than $50,000 provided the trust only holds deposits, government debt or listed securities.
The announcement is hardly surprising as it is consistent with the disclosure rules in other countries and for corporations. The form for reporting has not been provided and many questions are left unanswered; such as how much of an administrative chore will this be, and will the form state that only classes will need to be reported or actual individuals?
For Canadians using an inter vivos trust structure as part of their wealth or estate planning; including alter ego trust or joint partner trust commencing in 2021, they will now face a new filing requirement whether or not the trust is earning reportable income. At the least this will be an additional administrative step for those administering trusts.
In my next article we will discuss some of the benefits of an alter ego or joint partner trust. For now, it is important to remember that the trust is not a suitable solution for everyone and the above concerns should be kept in mind before the trust is recommended.