Family trusts are popular estate and succession planning
vehicles for good reason: they can be versatile and effective tools
to help manage family wealth and taxes. But many Canadian family
trusts are now well into their second decade and need attention to
avoid significant—even devastating—tax bills
triggered by the Income Tax Act's "21-year
"This rule," says Angela Ross, associate partner, tax
services, PwC, "states in general that any family trust,
whether it is created during someone's lifetime or on the death
of a person, has to treat itself as having disposed of its property
every 21 years."
In Canada, when someone dies, they are seen as having disposed
of their property (except property left to their spouse) at fair
market value and their estate pays taxes on any gains realized on
that property. Any property then acquired by their child will again
be deemed disposed on the death of that child. Were it not for the
"21-year rule," a family trust could hold property for
multiple generations without ever incurring tax on the death of a
So every 21 years in a family trust's "life," the
CRA looks at the property in a trust as if it were the property of
someone who had just died. "When the 21 years are up, if the
trust holds property on that date, it is deemed to have disposed of
the property at its current market value and has to pay taxes on
it. Say the trust owns property that had an original cost of $10
but its value on the 21-year anniversary is $100. That trust will
be deemed to have realized a $90 capital gain."
As we enter 2011, many Canadian family trusts are approaching
the 21st anniversary of their creation and families need to be
aware that in most cases, with proper, advanced planning, steps can
be taken to defer the tax. "A trust can generally transfer its
assets to Canadian resident beneficiaries on a tax-deferred basis
prior to the 21-year anniversary, meaning it can transfer its
assets to beneficiaries without triggering the tax on the
gain," says Ross. "So if the trust owns property with a
cost of $10, and at 20 years, its fair market value is $100, the
trust can transfer the entire asset to its Canadian resident
beneficiaries at its $10 price. The trust disposition would reflect
$10 of proceeds and not the $90 gain. The taxes on the $90 capital
gain can be deferred until that beneficiary sells or
Ross advises family trusts to begin planning for the transfer at
least a year in advance of the 21-year
anniversary—although in more complex cases two or more
years will be needed. Some important points to keep in mind
With the exception of Canadian real estate held in a trust, the
general rule is you can't transfer the trust's assets at
cost to beneficiaries who are not Canadian residents. But even if
you have non-Canadian resident beneficiaries, depending on the
terms of the trust and situation, it may be possible to do some
planning to get the assets out for the benefit of that
non-resident. It can be very complicated, so start early.
If timed properly and you have the right tax scenario, you can
transfer the trust's assets to grandchildren rather than your
children and thus defer the taxes for another generation.
In the case of a family trust owning a business that is
transferring shares to children or grandchildren, it's prudent
to have a shareholders' agreement in place before the children
or grandchildren receive the shares.
Even if your family trust is nowhere near 21 years old, having
it reviewed carefully by an expert now can be a smart move.
"There are a few provisions in the Tax Act that could prevent
you from doing the rollout before 21 years," says Ross.
"Most important is 75(2)—the revocable trust
provision. It applies if the trust received property from any
person who is a capital beneficiary of the trust or is a person who
decides when the trust property is disposed of or to whom it
eventually goes. It's a brutal provision that may prevent the
rollout of any assets to beneficiaries before 21 years and it's
one people need to be aware of." Although there's nothing
that can be done to change it, with enough time, it's possible
to develop strategies to fund the eventual tax liability. "The
sooner you know you have this issue, the better," says Ross.
"Alternative planning may be possible. You could implement a
reorganization at say 10 years to stop the growth in a bad trust
and potentially start the growth in a good trust and minimize the
tax hit that's going to happen at 21 years."
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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