Recent Changes In Canada In The Areas Of Trusts And Estates Law

Abstract

This article discusses various types of trust planning currently and historically used by practitioners in Canada for their Canadian resident clients. Additionally, it explores the recent legislative changes to the Canadian trust and taxation laws that impact those types of planning, and the benefits previously associated with those structures. These changes include elimination of preferential tax treatment of testamentary as well as immigration trusts. Considerations of how to deal with these changes are also explored. Finally, an analysis of tax amnesty in Canada, known as the Voluntary Disclosure Program, is discussed.

Executive Summary

Canadian practitioners frequently use trusts to execute tax, personal succession, and business succession planning strategies for their clients. While the laws applicable to the tax and other benefits derived from trust planning at any given point in time will continue to be subject to change based on the government's interest in controlling or curtailing such benefits, trusts continue to have an important and robust role in Canada.

There are a variety of planning strategies, both inter vivos and testamentary in nature, that are used widely. Over the last couple of years, however, there have been changes to the Canadian Income Tax Act (the 'ITA'),1 and developing case law that alters the effectiveness of the use of trusts in certain circumstances.

The two types of trusts, inter vivos and testamentary, are currently subject to different tax regimes in Canada. Until the imposition of the proposed amendments of 2014 Federal Budget to the ITA, testamentary trusts are subject to graduated tax rates, whereas inter vivos trusts are subject to tax at the highest marginal rate. A great deal of testamentary trust planning revolved around the establishment of multiple testamentary trusts created under a Will so that these graduated rates could be enhanced over multiple beneficiaries. The tax-related benefits to this type of planning have been eliminated.

The Canadian rules applying to the taxation of offshore trusts went through multiple iterations starting with the earlier draft revisions in 1999 and becoming law, in 2013 with retroactive effect (subject to limited grandfathering) to taxation years beginning in 2007. These rules continued to allow for certain tax benefits for new immigrants when properly establishing trusts that were commonly referred to as 'immigration trusts'. The 2014 Federal Budget will also eliminate the tax benefits to this type of planning. There are other types of offshore planning that are still available with the right fact pattern that can allow Canadian resident beneficiaries of offshore trusts to enjoy the benefit of trusts that accumulate income offshore tax free, with the tax-paid capital being available for the Canadian resident beneficiaries.

Tax amnesty, referred to in Canada as our Voluntary Disclosure Program (VDP), continues to be very important for Canadian practitioners to understand and to use in appropriate circumstances for their clients. The manner in which the VDP is applied and the concessions made by the government with respect to interest and penalties arising from making disclosures are important to consider along with the consequences of such disclosures. The VDP is another example of Canada's legislative attitude towards finding a balance between fair taxation and providing for tax benefits and breaks in certain circumstances.

In summary, this article will discuss the various types of trust planning currently being used by practitioners for their clients resident in Canada and also the planning with offshore trusts for the benefit of Canadians. It will also review the recent legislative changes that have an impact on the tax or other benefits previously associated with that type of planning. Finally, an analysis of the Canadian VDP will be reviewed.

1. How Robust is Trust Planning in the Region?

   (a)Trusts-Generally2

   All across Canada, both inter vivos and testamentary trusts are widely used for many purposes. They provide an effective vehicle to reduce income tax and also provincial probate fees on death. In Ontario, with the recent changes to the provinces Estate Administration Tax Act, 1998 footnote and its more significant and onerous reporting obligations, we foresee the use of inter vivos trusts as Will substitutes increasing in importance.

   There are also changes to the taxation of testamentary trusts and estates which will impact the use of multiple testamentary trusts for the purposes of income splitting.

   This section of the article will discuss the various types of trusts employed throughout Canada, the use of these trusts in estate and tax planning, and the recent changes to the taxation of trusts relevant to an international audience.

   (b) Alter-Ego Trusts and Joint Spousal or Common Law Trusts

   (i)Generally

   These types of trusts are becoming increasingly popular as an estate planning tool, as they allow taxpayers to transfer property into a trust on a tax-deferred 'rollover' basis, while allowing the taxpayer to retain an interest in the property. These types of trusts also provide planning opportunities with respect to addressing incapacity, reducing or eliminating probate, protecting against claims under dependants' relief legislation, confidentiality, and continuity of management.

   (ii)Conditions to be Met

   For both alter ego and joint spousal trusts, the transferor of the property to the trust must be at least 65 years old at the time of the trust's creation. The transferor, in the case of the alter ego trust, or the transferor and/or his or her spouse3 or common law4 partner, in the case of the joint spousal trust, must be entitled to receive all of the trust's income while alive. No person, with the exception of the transferor or his or her spouse or partner, as the case may be, can receive or otherwise obtain the use of any of the income or capital of the trust before the transferor's death or, in the case of the joint spousal trust, the transferor's spouse's death. It has been questioned whether these conditions must only be met at the time the trust is established or if such conditions must be maintained throughout the trust's existence.5 Moreover, it is not clear whether two spouses or partners can contribute to the same joint spousal trust.6

   On the death of the transferor or his or her spouse, as the case may be, any person can benefit from the trust. It could be required that the trust be wound up and the trust assets distributed as per the terms of the trust deed. Alternatively, the trust deed could provide that the trust is to continue after the death of the transferor or his or her spouse, as the case may be.7 Since it is not a testamentary trust however, any trusts for the remainder beneficiaries will not be entitled to graduated rates of taxation, otherwise applicable, but as will be discussed below, the change to the taxation of testamentary trust status will likely bolster the efficacy and popularity of these trusts.

   (iii)Exception to the 21-Year Rule

   The ITA provides that most personal trusts are deemed to dispose of their capital assets on the trust's 21st anniversary and every 21 years thereafter bringing all accrued capital gains into income.8 Income tax must then be paid. Without an actual disposition, this is often a problem as the trust may lack sufficient liquid assets to pay any tax owing. Often, to defer the application of tax, the assets of the trust are rolled out to the capital beneficiaries prior to the 21st anniversary of the trust.9 The 21-year rule does not apply to alter ego and joint spousal trusts.10 A deemed disposition of the trust's assets will, however, occur on the death of the transferor, in the case of an alter ego trust, and on the death of the last to die of the transferor and his or her spouse or partner, in the case of a joint spousal trust.11 Should the trust continue beyond either of these two triggering events, there will be a deemed disposition of the trust's assets every 21 years thereafter.

   An election can be made by an alter ego trust12 to have the 21-year rule apply to the trust.13 If such an election is made, regardless of when the transferor dies, the trust will be deemed to dispose of its assets for their then fair market value on its...