On January 1, 2016, new tax rules relating to certain types of
trusts come into force. These new rules will eliminate some of the
advantages of using trusts established by Will
("testamentary trusts") for tax planning
purposes and will impact existing trusts.
Testamentary Trusts to be Taxed at Top Marginal Rates
Currently, income of testamentary trusts is taxed at the same
graduated rates of tax as individuals. Starting January 1,
2016, this income, if not paid out to a beneficiary, will be taxed
at the highest marginal rate of tax (anticipated to be 53.53% in
Ontario as of January 1, 2016). Two exceptions to this rule exist
for: (i) graduated rate estates; and (ii) qualified disability
(i) Graduated Rate Estates
The executors of a deceased's estate can designate the
estate to be a "graduated rate estate"
("GRE") for the first 36 months after
death. By doing so, the estate can:
have estate income taxed at graduated rates for the first 36
months following the date of death;
use certain post-mortem planning techniques to reduce tax, such
as loss carry backs; and
allocate the credits for charitable donations made by the Will
against taxable income of the deceased in the year of death or the
year prior, or allocate such credits against the estate income in
any of the three years during which the estate is a GRE.
(ii) Qualified Disability Trust
Graduated tax rates will also apply to a "qualified
disability trust" ("QDT"), which is
a testamentary trust;
resident in Canada throughout the year;
that names as a beneficiary a person who is eligible for the
federal Disability Tax Credit; and
that, together with the eligible beneficiary, files a joint
election to be a QDT.
An individual can only have one QDT. The benefit of having
a QDT is that any annual income not paid to or for the eligible
beneficiary can be taxed in the trust at graduated rates. However,
the QDT will eventually be required to pay a "recovery
tax" when it is distributed to any beneficiary other than the
eligible beneficiary. Tax will be payable on the accumulated income
on which tax was originally paid at graduated rates, in an amount
equal to the tax which would have been paid had such accumulated
income been taxed at the top marginal rates in the year it was
originally earned. This will apply to payments of accumulated
income to any other beneficiary while the eligible beneficiary is
alive or after the death of the eligible beneficiary. Essentially,
a QDT will only act as a deferral of tax at the top rate for all
income which has not been paid to or used for the benefit of the
Taxation of Spousal Trusts
The new rules provide that a spousal trust (testamentary or
inter vivos), an alter ego trust and a joint partner
trust ("life trusts") are deemed to have
a year-end at the end of the day on which the last person who was
entitled to income for life (the "life
beneficiary") dies. The current rules provide that
the tax liability arising as a result of the deemed disposition of
the capital assets on the death of the life beneficiary rests with
the life trust. Therefore, it is essentially a tax on the assets
which pass to the remaining capital beneficiaries of the life
As of January 1, 2016, the estate of the life beneficiary will
be liable for the tax on the deemed capital gains even though the
estate of the life beneficiary is not entitled to any further
assets out of the life trust. Essentially, the new rules result in
a mismatch between the taxpayer responsible for the tax (the estate
of the life beneficiary) and the taxpayer who owns the assets from
which the tax liability arose (the life trust). The capital
beneficiaries of the life trust will pay no capital gains tax on
the assets they receive, while the beneficiaries of the life
interest beneficiary's estate will pay the capital gains tax on
the assets distributed to the capital beneficiaries of the life
The Department of Finance has issued a letter in which it
suggests that this provision will be amended so that this absurd
result does not occur. In the meantime, it will apply to all
existing life trusts as well as those established after January 1,
Loss of Graduated Rates for Minors
The loss of the graduated rates for trusts means that if a Will
established trusts to protect the inheritance of minor
beneficiaries, only amounts actually paid to or for the benefit of
the minor can be taxed in the minor's hands, and at their
graduated rates. Any income remaining in the trust at the end of
the year will be taxed in the trust at the highest marginal rate.
This also affects testamentary trusts currently being administered
and not just those established after January 1, 2016.
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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On March 31, 2014, BC's new Wills, Estates and Succession Act1 ("WESA") will come into force. WESA introduces new protections for beneficiaries of estates that are in danger of being disputed or deemed ineffective by a court.
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