This article discusses the inclusion and use of powers to add and remove beneficiaries in drafting, planning, and establishing family trusts. Due to its length, it is divided into two parts. Part I addresses some of the more straightforward non-tax and tax issues associated with powers to add and remove beneficiaries ("PARBs"). Part II addresses other potential tax issues that PARBs may pose for tax practitioners. Part II will be published in a subsequent edition of Tax Topics.
Lately I've been coming across more trusts with expansive PARBs. In general, PARBs make me feel uncomfortable, particularly when they are included in Canadian discretionary family trusts ("Family Trusts"). My discomfort stems from concerns about the following:
- whether the inclusion of such provisions in a trust could cause a trust to completelyfail in the sense that the trust would not satisfy the "three certainties";1
- that PARBs are extremely potent and if not properly thought out and drafted (and even if properly drafted), might be improperly used—particularly after the freezor in an estate freeze or the settlor in other inter vivos and testamentary circumstances is no longer alive; and
- potential tax issues that adding such clauses might give rise to.
As will be described in this two-part series of articles, my research into these issues has eased my concern about some but not all of these issues. In particular, I remain concerned that if PARBs become standard terms in Family Trust precedents, unlike "chicken soup", they could end up causing more problems than they solve. As a result, I would encourage practitioners to always consider carefully whether or not it is appropriate to use PARBs in trusts that they draft, particularly in Family Trusts.
In this series of articles, I'll focus on the last of the three points noted above. However, before doing so, I'll distill some commentary on PARBs from an excellent recent article by Donovan Waters.2
As Mr. Waters notes, some "questioners" have been concerned that the inclusion of PARBs might cause a trust to fail to come into existence if the PARB clause(s) would be viewed as not creating the necessary certainty to identify beneficiaries of the trust. However, according to Mr. Waters, such concerns
. . . can be put aside. The ability of any person to extend or reduce the number of beneficiaries who may be considered does not create any initial or subsequent uncertainty of objects of the power. In the first place it is important to remember that there is no doctrinal requirement contained in the "three certainties"; they represent elements that allow a court to enforce a trust . . . Certainty is established initially and remains later when additions or deletions are made.3
PARBs, whether direct or even via a power to amend the beneficiary provisions that is less direct, can be extremely potent. Where such provisions are contemplated, Mr. Waters urges that they be tailored to the client's specific situation, which seems like extremely good advice.
Tax Matters — The CRA's Published Views
The Canada Revenue Agency ("CRA") appears to have provided relatively limited commentary regarding its views on the impact of adding beneficiaries to a trust,4 whether through specific trust powers (such as PARBs) or through an amendment to the trust itself,5 and although there have been specific situations in which the CRA has provided positive rulings, for the most part the commentary has not been positive.
In particular, the primary risk seems to be the CRA's view that where a new beneficiary is added to a trust, the existing beneficiaries will generally be deemed under paragraph 69(1)(b) of the Income Tax Act to have disposed of a portion of their interests in the trust equal to each beneficiary's pro rata share of the "fair market value" of the assets of the trust at that time.6 In this regard, where the trust is a Family Trust, the CRA's general view appears to be that each beneficiary's interest would generally be of equal value unless a beneficiary has "a lesser chance" of receiving distribution—in which case adjustments may be required.7
In his article, Mr. Waters makes a number of strong arguments at law as to why the CRA's administrative positions (which have not as of yet been the subject of litigation) are likely wrong at law, and he notes that others have also put forward their own arguments in this regard.8 However, since the CRA continues to maintain those positions, planners who amend trusts to add or delete beneficiaries or employ PARBs in their trusts and who are involved in a later exercise of those powers without the benefit of a CRA advance ruling all continue to be faced with uncertainty as to the tax consequences.9
Having reviewed some of the more conventional non-tax and tax issues associated with PARBs in Part I of this article, Part II will examine some other potential tax issues that PARBs may pose for unsuspecting tax practitioners.
Originally published by Wolters Kluwer Limited.
The author wishes to thank Elie Roth of Davies Ward Phillips & Vineberg as well as a number of other tax and trust specialists who provided comments on earlier versions of this article. Any errors or omissions are the author's sole responsibility.
1 The three certainties are generally referred to as the certainty of intention (to create a trust), the certainty of subject matter (which involves the requirement to be able to identify the property that is to be held for the benefit of the beneficiaries of the trust), and the certainty of objects (which involves determining the person or purpose who is to benefit from the trust—i.e., to provide a means of identifying the beneficiaries).
2 See Donovan Waters, "The Power in a Trust Instrument To Add and Delete Beneficiaries" (2012) 31 E.T.P.J. 173.
3 Ibid., at 187.
4 The CRA has provided positive rulings in connection with non-PARB trust amendments that result in changes to beneficial interests. For example, rulings have been provided in connection with accelerating interests, deferring vesting dates, encroachment powers over capital, and creation of new trusts to hold funds set aside for minor or unascertained beneficiaries. For more on this subject, see page 11 of Elie Roth's portion of a joint presentation with Donovan Waters, "Adding and Deleting a Beneficiary to a Trust—Income Tax Considerations", presented at the June 2013 STEP conference.
5 An additional risk of adding beneficiaries or making other fundamental changes through an amending clause is that under some circumstances the trust may be so fundamentally changed as to cause it to be resettled, giving rise to a deemed disposition of the assets of the trust. For more on this subject, see Sian Matthews, "Enigma Variations", 28 E.T.P.J. (2009) 355 at 379.
6 In this regard, the CRA has been strongly criticized by Waters, Roth, and others for employing concepts of fair market value derived from family law cases such as Sagl v. Sagl, 31 R.F.L. (4th) 405 (Ont. Gen. Div.).
7 For more on the CRA's "standard" position, see CRA Document Nos. 2012-0451791E5, February 11, 2013; 2003-0181465, April 3, 2002; and 2001-0111303, January 1, 2002; among others. See also Roth, supra and David Louis, Samantha Prasad, and Michael Goldberg, Tax and Family Business Succession Planning, 3rd edition at pages 126–130. For an example of a positive ruling by the CRA, see CRA Document No. 2007-255961R3, January 28, 2008, which is discussed in Louis et al. at page 129. See also CRA Document No. 2008-0281411I7, November 20, 2008—but only released on June 12, 2013, which involved the exercise of a PARB in a trust indenture by the sole trustee to add new beneficiaries who were unrelated to the existing trust beneficiaries. In this case, the CRA held that with the exception of the sole trustee, who was also a beneficiary of the trust, none of the other beneficiaries would have been deemed to have disposed of their interests in the trust as a consequence of the exercise of the PARB.
8 For example, see Tim Youdan, "Income Tax Consequences of Trust Variation, Revocable Trusts and Powers of Appointment" (2005) 24 E.T.P.J. 141. It is beyond the scope of this article to describe the criticisms that have been raised by Waters and others.
9 See David Louis, Samantha Prasad, and Michael Goldberg, Tax and Family Business Succession Planning, 3rd edition at pages 129 and 130.
Part I was originally published in Tax Topics No. 2174 on November 7, 2013.
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.