On December 17, 2014, Bill C-43 received Royal Assent, ushering in a new era of estate planning with proposed changes to the Income Tax Act (the "Tax Act"). Included in the bill are changes which will have profound implications on planning using spousal trusts, alter ego trusts, joint spousal or common law partner trusts (referred to herein as "life interest trusts"). The new rules will apply as of January 1, 2016.


Starting in 2016, life interest trusts will undergo a deemed disposition triggered at the end of the date of the death of the last surviving life interest beneficiary, which will either be the settlor or the spouse, depending on the nature of the life interest trust. All of the trust's income for the tax year, including capital gains arising on the deemed disposition of assets triggered by the death of the life interest beneficiary, will be deemed to have been made payable to the life interest beneficiary and will be included in his or her terminal tax return.

Although this deemed payable mechanism may address concerns with having the trust income taxed in the life interest trust at the highest marginal rate, it may create significant financial hardship in certain circumstances where trusts are commonly used to retain control over the distribution of income or capital from a trust. This hardship is illustrated by the following example:

A spousal trust is established in John's Will to provide for his second wife, Jane. On Jane's death the capital of the spousal trust is to be left to John's children of his first marriage. Under Jane's Will, her own estate is left to her children from her first marriage. If John dies first, his assets will pass to the spousal trust. On Jane's death, the spousal trust will undergo a deemed disposition of its assets, and under the new rules, all income will be deemed payable to Jane, with the tax reported in Jane's terminal return and borne by Jane's estate. As Jane's beneficiaries (her children) are different than the remainder beneficiaries of the spousal trust (John's children), and her children will not receive any of the assets of the spousal trust, they will effectively bear the tax burden of the spousal trust, without benefiting from any of its assets. This results in a windfall for John's beneficiaries to the detriment of Jane's beneficiaries.


The new rules provide that the life interest trust (i.e. John's spousal trust) will be jointly and severally liable with the life interest beneficiary's (i.e. Jane's) estate for the tax liability.

In response to concerns about the fairness of these new rules, especially in circumstances where the ultimate beneficiaries are different as in the above example, the Department of Finance ("Finance") released revised explanatory notes on the liability provisions, stating that "it is intended that that the Minister [of Revenue assess the trust], in respect of an amount owing... as though the trust were liable in the first instance for that amount." However, given that the new rules are clear that the life interest beneficiary (i.e. Jane's estate) is primarily liable for the tax, and that the administrative practice of the Canada Revenue Agency ("CRA") is to assess and initiate collection proceedings against the primary taxpayer and only initiate proceedings against other taxpayers as a last resort, it is unclear if the provisions can or will be administered as suggested by the Department of Finance.

Further, even if the CRA exercises its discretion to enforce against the trust assets, it will not necessarily forgo its rights against the life interest beneficiary to the extent that the trust assets are (i) illiquid or (ii) insufficient to fund the tax. The CRA has not commented on the new rules or whether it intends to enforce them as suggested by Finance.

Although the potential financial hardship is clearly problematic, the new rules may have other unexpected results. Given the uncertainty of which taxpayer will ultimately bear the tax burden, and the fact that the tax liability will not be determined until after the life interest beneficiary's terminal tax return is filed and assessed, it may be difficult for the trustees and executors to ensure timely payment of the tax, even in circumstances in which all parties are co-operating.

To the extent the taxes are collected against the trust rather than the estate of the life interest beneficiary, as is intended by the Finance, the trustees of the trust may be obliged by virtue of their fiduciary duties to litigate to recover taxes from the estate of the life interest beneficiary. Further, a reimbursement by the life interest trust to the beneficiary's estate of the taxes triggered may cause the estate to lose its status as a testamentary trust which may have significant adverse implications on other planning, such as loss of status of the beneficiary's estate as a Graduated Rate Estate.


These new rules represent a significant change for taxpayers and their advisors. Everyone should be encouraged to review their estate planning before 2016 to ensure that it is still appropriate and will achieve the intended objectives. Arrangements involving spousal trusts, alter ego trusts, and joint spousal and common-law trusts may give rise to unexpected, and potentially adverse, tax consequences.

For those with irrevocable arrangements that are already in place (i.e. spousal trusts already created under a deceased's Will, etc.) or for individuals who are mentally incapable and unable to amend their existing testamentary planning, it may be difficult or impossible to deal with the negative impact of the new rules. Hopefully Finance will address these practical concerns in an amendment before the January 1, 2016 implementation date.

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