All trustees need to be aware that trust reporting requirements are changing.
Currently, a trust only needs to file an income tax return in certain circumstances, including if it earns income, disposes of capital property, or makes distributions to beneficiaries during the year. There is no current requirement to identify all of the trust's beneficiaries.
However, the 2018 Federal Budget announced that starting in 2021, except for specifically exempted trusts, trusts resident in Canada and non-resident trusts required to file in Canada will need to:
- file income tax returns annually;
- report all the settlors, trustees and beneficiaries; and
- identify persons who exert control over trustee decisions related to income and capital ("protectors").
Excluded trusts include constructive or resulting trusts (which usually no one knows exist until proclaimed by a judge), lawyer trust funds, trusts that qualify as non-profits or charities, trusts governed by registered plans (which already require significant reporting), and graduated rate estates. Most importantly, many common forms of trusts (such as family trusts and spousal trusts) will not be exempted from this reporting requirement.
There will also be penalties for late filing of up to $2,500, plus a penalty of 5% of the maximum fair market value of the property if the failure to file was made knowingly or due to gross negligence. Given the CRA's willingness to find gross negligence on the part of taxpayers, this is quite alarming.
The purpose of these changes is to help identify aggressive tax planning, tax evasion and money laundering – concerns that have been in the media both nationally and internationally.
However, trustees that have not been responsible for filing tax returns in the past will now have to ensure returns are properly filed, which adds an additional administrative burden.
Further, the new requirement for trusts to report settlors, beneficiaries, trustees and protectors will provide the CRA with substantially more information they can use for audit purposes.
Potentially Big Implications?
While there are a few years before these changes come into effect, it is important trustees know the changes are coming and consider the implications this additional disclosure may have.
Currently, there are many rules dealing with beneficiaries and trusts that are rarely audited because the CRA doesn't know what trusts are out there and who all their beneficiaries are.
For example, in a discretionary trust, pursuant to subparagraph 256(1.2)(f)(ii) of the Income Tax Act, all beneficiaries are considered to own all the shares of corporations owned by the trust in determining whether corporations are associated. The effect of this provision was recently upheld by the Tax Court in Moules Industriels et al v The Queen (2018 CCI 85).
When corporations are associated, they are required to share a single $500,000 business limit for purposes of claiming the small business deduction. Association rules are complex, but the effect is that corporations owned by beneficiaries of a discretionary trust, depending on the various share ownerships, may be associated with any corporations owned by the trust. Further, since two corporations that are associated with a third corporation are in turn associated, corporations owned by two beneficiaries of a trust, with no connection beyond both being owned by someone who is a beneficiary of the trust, may end up being associated. Cousins with completely unrelated corporations may suddenly find themselves sharing a single small business deduction.
While this issue has existed for several years, it has not been a significant concern because the CRA usually did not know who the beneficiaries of a trust were – especially not the beneficiaries of discretionary trusts who owned profitable corporations of their own, as they were less likely to receive distributions and therefore come to the CRA's attention.
All this will change once the first trust returns are filed for 2021. The CRA will suddenly have records of every beneficiary of every trust (except for trusts where the trustees fail to file and are subject to penalties). The CRA will be able to combine this information with their records of all private corporations shareholders. It's far too easy to imagine them putting together an algorithm to identify where associated corporations have not been properly identified in corporate tax returns – not just for 2021 but for previous years as well.
And this is only one potential new audit avenue open to the CRA. Trusts and their beneficiaries are often considered to be related for many purposes and as soon as any of the parties are non-resident there are a whole slew of other potential issues.
With this change on top of other recent changes, such as the taxation of corporations, this is now a very good time for trustees to review the tax implications of their trust's current structure. Especially family trusts owning shares of a private corporation may no longer make sense.
Even if there continues to be valid reasons to have the trust in place, it is more important than ever everyone is properly reporting to the CRA. The chances of getting caught for failing to do so are going up substantially.
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.