In my blog titled
'Using an Estate Freeze to Transition Your Business', I
considered a transition of a company to the next generation. In
that blog, the shares were held directly by the child. Oftentimes,
families who are considering implementing an estate freeze are
looking for the benefits of that tactic, but are not ready to make
the decision of who will be the ultimate owner of the shares. Many
families ultimately find that a family trust will provide them with
more benefits than having their children acquire the shares
A family trust is an excellent tool to assist in family and
estate planning. In a trust relationship, a trustee holds legal
title and controls the assets of the trust, but they are held for
the beneficiaries. The separation of beneficial ownership from
legal ownership makes a discretionary family trust an effective
tool for protecting assets from claims of creditors, income
splitting and wealth transfer. It is commonly understood that the
trust property is generally not matrimonial property; however, B.C.
recently enacted new legislation (Family Law Act), which
specifically deals with how to allocate property in a family trust
for matrimonial asset purposes.
When setting up a family trust as part of a business structure,
the shareholders should be aware of how a family trust is different
than owning shares directly.
Separation of beneficial ownership from legal
As the trustees hold legal title of the assets held by the
family trust, they maintain control over the assets until they
desire to transfer property to the beneficiaries. The trustees also
have discretion to treat the beneficiaries differently from one
another. In contrast, if the shares were held outright, all
shareholders of a class are entitled to the same treatment, whereas
if they are beneficiaries of a trust, the trustees can decide
whether or not they receive any income. The trustees have a
fiduciary duty to the beneficiaries to hold the assets for
As the trustees have discretion to act in a manner that they
choose, they have the flexibility to make decisions regarding
allocation of income and capital of the trust.
Separation of income from capital
The trustees of the family trust can decide to allocate income
differently than the eventual allocation of capital (i.e. shares).
For instance, one beneficiary of a family trust can receive
dividends for education purposes, but the shares may eventually be
transferred to a different beneficiary. This is quite different
than an outright ownership of shares, where the income and capital
cannot be separated.
Flow through entity
From a tax perspective, a family trust is a conduit for income -
dividends can be paid on the common shares and the trustees have
discretion on the allocation of the dividend amongst the
beneficiaries. If the trust retains the income, it will be taxable
at the highest marginal tax rates. If the trust allocates the
income to the beneficiaries, the income will be taxed in the hands
of the beneficiary at their personal marginal tax rates.
In addition, the dividends and capital gains that flow through a
trust will maintain their character. As such, if a family trust
sells shares that qualify for the capital gain deduction, the
capital gains deduction can be used by the beneficiary to shelter
the income from tax.
21 Years Deemed Disposal
Whenever a family trust is settled, it is important to remember
there will be tax consequences down the road. Every 21 years, the
family trust is deemed to dispose of its assets for fair market
value proceeds. If the trust still holds shares of the company,
taxes will be incurred on the appreciation on the value of the
shares since the trust acquired them. However, in advance of the
21st anniversary, the trust can transfer the assets to any of the
beneficiaries (referred to as a 'rollout') as desired by
the trustees and wind up. If there is a rollout of trust assets,
the beneficiaries will receive the assets at the adjusted cost base
to the trust.
Whether you're planning to transition your business in the
short term or well into the future, the time to start building a
comprehensive succession strategy is now.
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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