Canada: Discretionary Family Trusts - The Basics

Last Updated: May 18 2018
Article by Samantha Prasad

Discretionary family trusts can sometimes trigger thoughts of trust fund babies, insane amounts of funds held offshore, or shielding trust assets from creditors or the taxman, all of which are available to the ultra rich. However, family trusts are becoming very common and the norm for many families, even those without yachts! All kidding aside, a family trust is a standard estate and tax planning tool for every family. So, I thought it would be worthwhile to go through the "ABCs" of a discretionary family trust, as well as some of the tax-planning tips and traps to be aware of when forming a family trust.

Beneficiaries – who are they?

A typical family trust is drafted as a discretionary trust for the benefit of a class of beneficiaries. Beneficiaries could include yourself, your spouse and your issue (children, grandchildren, great-grandchildren etc.), and in fact, can include as many family or friends that you would like (subject of course to certain tax issues to consider). People often include a class of secondary beneficiaries, such as further-removed family members or registered charities. These secondary beneficiaries would typically kick in if none of the primary beneficiaries were alive at the time the trust is wound up and the trust assets are distributed.

One tax-planning tool I use is to allow for a corporate beneficiary. This could include a corporation to be incorporated (even at a later date), of which the shares are owned by any one or more of the primary beneficiaries. The use of a corporate beneficiary allows for some tax planning on the eventual distribution out of the trust, for example, if a beneficiary becomes a non-resident of Canada (see discussion below).

If you want to set up a family trust and you also want to contribute property to the family trust, then you cannot be a beneficiary of the trust. There is an attribution rule under the Tax Act which would be triggered if property that is transferred to the trust by an individual could potentially revert back to such individual (i.e. by virtue of you being a beneficiary of the trust). This attribution rule will also kick in if such individual who contributes property to the trust is able to determine how the trust property is to be distributed (i.e., if he or she is the sole trustee or have a veto power as a trustee). In this instance, it does not matter if that individual is a beneficiary or not.

So, the general rule is that if you or someone else contributes or gifts funds or property to a trust, you or that particular person is not allowed to be a beneficiary, or cannot be able to make decisions on their own as to how the trust distributes out the property. And to make matters worse, if this attribution rule is triggered for any moment in time (even if the situation is cured after the rule has applied), a second tax rule jumps in to prevent the distribution of the capital of the trust to a Canadian resident beneficiary without triggering capital gains tax.

There are, of course, certain ways to get around this rule. For example, case law has held that if you were to lend money (even without interest) or sell property to the Trust at fair market value, this attribution rule will not apply. So, if you are gifting funds or property to a trust, be very careful about whether you are included as a beneficiary (or even as a contingent beneficiary) or if you have too much control in determining who gets what out of the trust.

A second event that could trigger capital gains tax on a distribution of capital out of a family trust is if the beneficiary is no longer a Canadian resident. The general rule is that distributions of capital out of a family trust will not trigger any capital gains tax on the increase in value of any trust assets provided that the beneficiary receiving the distribution is a resident of Canada at that time. These days, this problem can arise more often than not, what with kids going to school in the U.S. and staying south of the border. Hence, the use of a corporate beneficiary would allow you to get around this problem: simply incorporate a Canadian resident company of which the non-resident child is a shareholder, and distribute the trust capital to the company. I would mention that it would be important for the non-resident child to get proper tax advice in the country where they live just in case there are other rules triggered under their jurisdiction.

Trustees – Who should they be?

The choice of trustees is usually a personal decision. This is due to the fact that the trustees, who hold the trust property on behalf of the beneficiaries, will have a fairly active role in managing the trust property and determining distributions. A discretionary trust typically gives the trustees "absolute discretion" in respect of distributions to the beneficiaries. They can determine when distributions are to be made, and to whom (and can distribute to any one beneficiary to the exclusion of the others). So, choose your trustees wisely.

I would also typically recommend that three trustees be appointed. It may be that you want to transfer property to the trust; if so, then in order to avoid that attribution rule discussed above, you should be one of three trustees in making any decisions regarding the distribution of that transferred property. If you are one of two trustees, then arguably you have a negative veto (since majority rule is required). Although CanRev has provided some administrative largess where you are one of two trustees, it's better to be prudent and ensure you are one of three trustees so there is no uncertainty.

To the extent that the trustees make any decisions regarding the trust property, or distributions, it is important that they document their decisions in writing. In addition, if any income / funds are distributed out of the trust to the beneficiaries, the trustees must ensure that the funds are actually paid out to the appropriate beneficiaries, and not scooped by the parents. This is an issue that has apparently been targeted by the CRA on audits, so it's important to ensure that the flow of funds matches the trustees' decisions.

Is the Trust Properly Formed?

The "Settlor" plays an important role in establishing the family trust. He or she formally establishes the trust by "settling" the trust with property (i.e. cash or a gold coin has been typically used). It is important that this property, knows as the "settlement instrument" be properly held on to by the trustees as CanRev has also been known to ask for proof of the initial instrument's existence – one tip might be to tape or attach the settlement instrument to the original trust agreement so it doesn't get lost.

But the settlor's role is not as simple as handing over a gold coin. He or she must actually intend to form the trust and should understand the terms of the trust agreement. The settlor cannot be a beneficiary of the trust, or else the attribution rule discussed above will kick in. However, he or she should be the person who instructs the advisor preparing the trust deed, or at the very least (as that may not always be practical), review and confirm the terms of the trust prior to its finalization and execution. The settlor's role also includes the confirmation of the trustees. So, the Settlor should not always be a choice of convenience.

Once the Settlor has formally formed the trust deed, his or her role is generally done, as the Settlor has no ongoing duties in respect of the Trust. That is the Trustees' duty.

Tax Considerations

The various roles discussed above are not the only considerations when establishing a family trust. Tax planning is very important when drafting the trust agreement. In addition to the attribution rule discussed above, there are some additional attribution rules which may apply in certain circumstances. If you transfer / gift property to the trust for no consideration, and that property throws off income, any such income that is to be allocated to your spouse or your minor kids through the trust could be attributed back to you. There are exceptions to the application of these attribution rules, such as the prescribed loan strategy that I have written about before, or ensuring that the trust agreement contains the appropriate anti-attribution clause, which would prevent distributions of income to your spouse or minor child. It is important to speak to your tax advisor to ensure that the proper steps are taken or included in the trust agreement at the time that the trust is formed. I would highly stress that you speak to your advisor before you finalize the trust agreement as it is very difficult to amend a trust agreement. And in some instances, simply fixing the problem after the fact won't save you from a tax problem.

Lastly, an important tax rule to remember with a discretionary family trust is that they only have a tax shelf life of 21 years. That's because under the Tax Act, a discretionary family trust is deemed to have sold all of its assets on its 21st anniversary (and every 21st anniversary thereafter). So, if the discretionary trust owns assets with a large pregnant gain, it could be stuck with a huge tax bill if nothing is done. So, the rule of thumb with discretionary family trusts is to ensure that the trustees distribute the trust capital to the beneficiaries just prior to the trust's 21st birthday.

Why a Discretionary Family Trust?

There are many potential answers to this question. But I thought I would provide a few of them that tend to tie to estate & tax planning.

For tax purposes, a family trust can allow for income splitting with minors. If you were to simply gift funds to your minor children, any interest income would be taxed in your hands. However, if you were to lend the funds at the prescribed rate (currently 2 per cent as of April 1, 2018), then such income can be taxed in your minor children's hands at low rates. However, legally, a minor child cannot borrow funds. Hence, a family trust can provide the vehicle by which a loan at the prescribed rate can be made for the benefit of your minor children.

Another benefit of a trust is that if you are not yet sure how certain property is to be held among your family members, then having a family trust hold such property in the meantime gives you the ability to control how the property is managed, and at least 21 years before you need to decide how the assets get hold by your family members.

Again, as noted above, there are many more reasons why a family trust can provide some benefit to you and your family. So, I would suggest that the next time you speak to your financial, estate or tax advisor. You just might be interested in one of the answers that might be relevant to your particular situation.

Originally published by The TaxLetter, May 2018.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Samantha Prasad
Similar Articles
Relevancy Powered by MondaqAI
Moodys Gartner Tax Law LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Moodys Gartner Tax Law LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions