As part of a crackdown on planning using testamentary trusts to
obtain the benefit of multiple graduated tax rates, the Federal
Government recently enacted a number of amendments to the
Income Tax Act. These address circumstances where a
testamentary trust (including an estate) incurs a debt or
obligation to a beneficiary or any other person with whom a
beneficiary of the trust does not deal at arm's length. In
these circumstances, the trust could lose its status as a
"testamentary trust", and with it, the graduated tax
rates afforded to testamentary trusts.
The real worry for estate planners are debts arising from
innocuous payments, such as funeral expenses paid by a beneficiary
of an estate where the estate's assets are tied up in illiquid
form (such as private company shares or land). Unless one of the
exceptions apply, such a payment could very well cause an estate to
lose its status as a "testamentary trust" and with it,
the trust's graduated tax rates.
Fret bad debt
There are four types of obligations which are exceptions to this
provision, and if one wants to avoid the loss of testamentary trust
status, these requirements should be followed stringently.
The first exception is an obligation incurred in satisfaction of
the beneficiary's interest in the trust, namely one incurred by
the trust in satisfaction of the beneficiary's right under the
trust to enforce payment of an amount of the trust's income or
capital gains payable by the trust to the beneficiary, or to
otherwise receive any part of the capital of the trust.
The second obligation is one owed to the beneficiary, if the
debt or other obligation arose because of a service (which will not
include any transfer or loan of property) rendered by the
beneficiary to, for or on behalf of the trust. This could include,
among other things, administration fees paid to a trustee who was
also a beneficiary.
The next may potentially save the beneficiary paying the funeral
expenses for a deceased individual. The test is that there must be
an obligation owed to the beneficiary:
which arose because of a payment made by the beneficiary for or
on behalf of the trust;
the debt is repaid by the trust within 12 months, or such
longer period as the minister allows; and
it is reasonable to conclude that the beneficiary would have
been willing to make the payment if the beneficiary dealt at
arm's length with the trust,
except that the third (arm's length) requirement is
not necessary if the trust was an individual's
estate and the payment was made within the first 12 months after
the individual's death (with provision made for an extension of
this period on application to the minister).
Thus, the payment of funeral expenses, if paid by the
beneficiary within 12 months of the death of the individual and
repaid in full by the trust within 12 months of payment, shall not
cause the trust to cease to be a "testamentary trust"
within the meaning of that term in subsection 108(1).
There is also a saving provision that grandfathers debts
incurred before October 24, 2012 if which are repaid within 12
months after the day on which the Technical Tax Amendments Act,
2012 received royal assent, or such longer period as the
My whole tax year ruined
One further consequence of a testamentary trust losing its
status as such, aside from the loss of graduated tax rates, is a
deemed taxation year end for the trust at the moment that the
exclusion in the definition of "testamentary trust"
applies, and a deemed new taxation year for that trust, beginning
at that moment.
The real issue here is that once the testamentary trust has lost
its status as such, capital losses incurred by the estate after the
deemed year end created by the loss of testamentary trust status
cannot be carried back to the deceased's final tax return under
subsection 164(6), as capital losses may only be carried back which
are incurred during the first taxation year of the estate.
Thus, along with a high rate on income taxed in the trust, losses
may potentially be rendered completely unusable.
Beneficiaries and trustees should thus tread lightly. Unless the
obligation clearly fits within one of the exceptions, a
testamentary trust should not incur obligations from its
beneficiaries or persons related to these beneficiaries. If debt
arises because of a payment made by a beneficiary on behalf of the
trust, the debt should always be repaid, and promptly. And unless
the payment is made after the first 12 months after the death of
the individual whose estate is at issue, the terms of the payment
made by the beneficiary should be such that he or she would have
been willing to pay if he or she and the trust were dealing at
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.
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
On September 30, 2016, the VAT authorities confirmed that VAT shall apply to directors' fees.
Some comments from our readers… “The articles are extremely timely and highly applicable” “I often find critical information not available elsewhere” “As in-house counsel, Mondaq’s service is of great value”
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).