Canada: The Testamentary Trust Amendments: No Fairness For Most Disabled Canadians

Despite the objections of The Canadian Bar Association (CBA), the Chartered Professional Accountants of Canada (CPAC) and the Society of Trust and Estate Practitioners (STEP), the 2014 Federal Budget introduced legislation to eliminate the graduated rate of taxation for testamentary trusts. Exception is made only for ongoing trusts of individuals who suffer from mental or physical impairment and qualify for the disability tax credit (DTC).

The CBA, CPAC and STEP submissions highlighted that these changes will negatively affect seniors, small business owners, middle class families, and perhaps most importantly individuals with disabilities who do not qualify for the DTC.

Top rate taxation of trusts for disabled individuals

The 2014 Budget confirmed that graduated rate taxation will be eliminated after 2015, except for estates for the first three years after death. Income of a testamentary trust will now be taxed at top marginal rates of taxation. The current rate of 20 per cent will increase to almost 50 per cent in Ontario.

DTC-eligible individuals protected

Testamentary trusts for those who qualify for the DTC will continue with graduated taxation. The Income Tax Act (the Act) is structured to ensure tax fairness for various groups of disabled individuals and their families. First, the DTC applies to those who have a severe and prolonged impairment to physical or mental functions, which significantly restricts that individual's ability to perform a basic activity of daily living (the DTC Group). This DTC Group is estimated to include from 498,000 to 745,000 individuals, or about 1.5 to 2 per cent of the Canadian population.

Other disabled Canadians get no protection

Many other Canadians suffer from mental and physical impairment but do not qualify for the DTC (the Non-DTC Group). The Act reflects this reality and there are several tax credits and deductions to assist some of the individuals in this Non-DTC Group. Examples include the Infirm Dependant Credit, the Caregiver Credit, the Eligible Dependant Credit and RRSP rollovers.

As it is estimated that 3.8 to 4.4 million Canadians suffer from a mental or physical impairment (11 to 14 per cent), the Non-DTC Group includes some 3.1 to 3.9 million people. This speaks to those who have a mental or physical impairment, a learning disability, or an inability to manage their affairs. Many cannot earn a living or adequately care for themselves.

The long-standing fiscal policy in Canada is to use testamentary trusts, often referred to as "Henson Trusts," to ensure the well being of the DTC and Non-DTC Groups. To date, these provided long-term stability to individuals while protecting their families' savings, and allowed individuals to continue to qualify for provincial and federal benefits.

50 per cent tax rate or loss of disability pensions and other benefits

Effective 2015, all of the trust income applicable to this Non-DTC Group will be taxed at top marginal tax rates (about 45 to 50 per cent in Ontario).

The option for a trustee will be to distribute and tax that income in the disabled individual's hands, resulting in the loss of important benefits for the disabled individual. Examples of benefits affected are:

  • dollar-for-dollar loss of disability benefits such as the Ontario Disability Support Program (ODSP)
  • increases in "rent-geared-to-income," which in Ontario (for example) is 30 per cent of taxable income
  • clawback of tax benefits for the individuals and family members (e.g., refundable medical expense supplement, working income tax benefit, HST credit, Ontario Trillium benefits, child tax benefits), which can in many cases range from 30 per cent to as high as 110 per cent of the income inclusion

The preferred beneficiary election generally will be of no assistance. It allows income to be taxed in the beneficiary's hands without any entitlement to that income. If applicable, the income arguably should not affect provincial benefits. This election will not apply to the vast majority of circumstances, and in any event it results in the clawback of all tax benefits.

The changes will therefore cause serious harm to the Non-DTC Group. Families will face either paying tax at almost 50 per cent or the loss of benefits that in some cases will far exceed the income in question.

These results are neither reasonable nor fair. We hope the federal Department of Finance and the provincial authorities will review the submission of the CBA, CPAC and STEP and reconsider these amendments to the testamentary trust rules so that they better reflect the needs of the Non-DTC Group. Contact your Collins Barrow advisor for more information. 

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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