Canada: Trust Year-End Administration

There are several types of trusts contemplated in the Income Tax Act, each with specific opportunities, rules and restrictions. One type, often referred to as a discretionary family trust ("Trust"), is used extensively in tax, family and succession planning, as it affords enormous flexibility for ownership structures of Canadian private corporations in achieving income splitting, multiplying capital gains exemptions, deferring deemed dispositions occurring on the death of an entrepreneur, reducing probate fees, and reducing risk by insulating assets from business risks and other potential creditors.

The Trustees have administrative duties, which should be properly discharged to ensure the Trust achieves its tax, and other, objectives. In particular, the satisfaction of those duties should be evidenced with supporting documentation in a manner similar to what one might anticipate with respect to the operations of a corporation, including:

Annually:

  • Preparation of accurate bookkeeping and accounting records for all receipts, expenditures, amounts receivable, and obligations of the Trust.
  • Preparation of minutes of Trustee meetings. Major decisions should also be evidenced with executed Trustee resolutions. At a minimum, the Trustees should meet annually to review the affairs of the Trust and to make appropriate decisions.
  • Generally, the Trustees have the discretion to allocate all or a part of the income of the Trust to one or more beneficiaries. Each year, those decisions on the allocation and payment of income must be made and implemented by the end of that year. Amounts that are paid in the year, or become payable, to a beneficiary are not taxed in the Trust. While these amounts are initially included in computing the income of the Trust, they are allowed as a deduction so that the Trust pays tax only on the unallocated income.

    In order to receive a deduction:

    • For amounts paid, the Trust must actually make the payment to the beneficiary(s) in the year for which it claims a deduction.
    • For amounts not actually paid, the amount must be payable to the beneficiary(s) at the end of the year for which the Trust claims a deduction. In order for the "payable" condition to be satisfied, there must be a legal obligation for the Trust to make the payment after the year, the beneficiary(s) must have a legal right to enforce the payment, and the beneficiary(s) must be aware of the amount payable to them. One common way of proving that these conditions are met is for the Trust to issue, and deliver to the beneficiary(s), a promissory note in favour of the beneficiary(s) before the Trust year-end. Instead of determining an exact amount, the Trustees need only set out a percentage of trust income to be allocated to a particular beneficiary(s), as long as the decision is made, and evidenced, as discussed above by the end of the Trust taxation year in question.
  • Trustees can make payments to third parties on behalf of a beneficiary, and these payment amounts would be deductible in computing the income of the Trust, and would be included in the beneficiary's income. However, the decisions to pay amounts to third parties on behalf of a particular beneficiary should be documented in the manner discussed above. As well, receipts for payments made to these third parties, or to the parents or guardians of minor-aged beneficiaries as reimbursement for expenditures, should be retained in the Trust records.
  • T3 Income Tax and Information returns must be filed with the CRA. These returns are due within 90 days of the Trust year-end. T3 slips must also be sent to beneficiaries by this date.

Permanently:

  • Retention of a copy of the original signed Trust agreement and the property used to settle the trust (for example, a $10 bill is sometimes used). Usually, the original Trust deed and the settled property are kept at the office of the Trust's legal counsel, but if not, the Trustees must make sure these documents are safe and secure.
  • Retention of annual records discussed above, in the event the CRA wishes to conduct an audit of the Trust's accounts.

One common practice is to retroactively record Trust income allocations through the T3 Income Tax and Information Return or through journal entries. This should be avoided. Even amounts paid directly to beneficiaries of the Trust, and subsequently recorded with journal entries, should be avoided. The CRA and the Ministry of Finance have stated in the past in various court cases1 and in various technical publications2 that a journal entry's function is to describe and record a transaction, not to make it legally effective. Justice Bowman, in VanNieuwkerk3 stated "It has been said on many occasions in this Court that accounting entries do not create reality. They simply reflect reality. There must be an underlying reality that exists independently of the accounting entries." The concept that journal entries can be used to create a payable, or to effect payment of an amount already payable, has been consistently invalidated by the courts and therefore, Trustees must be wary of relying on journal entries to record the creation of the promissory note payable that is necessary for the Trust to claim a deduction for an amount payable to a beneficiary.

Footnotes

1 (VanNieuwkerk v. The Queen, [2003 UDTC 240], Hillier v. The Queen [2009 DTC 1015], Merchant v. The Queen [2009 DTC 1054], and Rudolph v. The Queen [2009 DTC 1295])

2 (Technical interpretations JL91_048, 2011-0415161E5 and 2013-0515761E5 and Income Tax Technical News #14)

3 VanNieuwkerk v. The Queen, [2003 UDTC 240] at paragraph 6.

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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