Trusts (36 questions)

Question 1

How to create a valid trust

Answer 1

In order to create a valid trust, the settler must show a clear intention to create a trust. Clear intention means that the settlor’s property is obviously being transferred to the trustee for the benefit of the intended beneficiaries, not for the absolute benefit of the trustee. This is usually demonstrated through a trust indenture that documents the settlor’s wishes.

If an individual gives the property to another person and is relying on the moral values of that recipient to carry out her wishes, she has created a “precatory trust”, not a valid trust. In the case of a precatory trust, the recipient receives absolute and unrestricted title to the property and can dispose of it in any way he wishes because no true trust has been established.

Question 2

What 3 certainties must a trust meet before it is considered to be a valid trust under the ITA?

Answer 2

1. certainty of intent
   a clear intention to establish a trust, with specified care and control, as opposed to a direct gift
2. The certainty of objects
   what is to be in trust
3. The certainty of beneficiaries
   a clear definition of who it to benefit from the trust

Question 3

Testamentary Trust

Answer 3

Is a trust established upon death, either by express directions set out in a will or other trust indenture, or in accordance with provincial legislation, which specifies that the estate assets must be held “in trust” until they can be disbursed.

Any estate created at death takes the form of a testamentary trust and this trust continues to exist until all estate assets are distributed.

the trust deed that is used to document the family trust provisions can be contained with the Will itself or it can be a separate document.

Although the trust deed may be drafted during the testator’s lifetime, the trust is actually not created until the testator dies.

So the trust deed is not in effect during the life of the testator.

Question 4

Non-discretionary trust

Answer 4

is a trust that have very specific instructions regarding the beneficiaries and the payments and leaves no room for the trustee to use his own judgement. In the absence of any instructions regarding beneficiaries or payments the trustee is governed and bound by provincial legislation.

Question 5

Discretionary trust

Answer 5

gives the trustee a certain amount of discretion regarding the distribution of the trust assets to that chosen beneficiary.

Question 6

Discretionary trust with trust power

Answer 6

is a trust that provides that the trust assets must be divided in some manner among the beneficiaries, but the actual distribution scheme is up to the discretion of the trustee. The trustee can decide how much each beneficiary receives, but he is obligated to distribute the trust assets, and each beneficiary must receive something.

Question 7

Discretionary trust with mere power

Answer 7

allows the trustee to decide which beneficiaries will receive payment, and how much they are to receive, if anything.

Question 8

Taxation on income earned by testamentary trusts

Answer 8

Income that is earned on testamentary trusts is taxable either in the hands of the trust or in the hands of the beneficiaries. If the trust’s terms require the income to be retained by the trust, the trust must include the income in it’s taxable income.

If the terms of the trust require the income to be paid to the beneficiary, it could be taxable either to the trust or the beneficiary. If it is to be taxed at the effective tax rate of the trust, the after-tax amount is distributed to the beneficiary as a capital disbursement. If it is to be taxed at the effective tax rate of the beneficiary, the full amount is distributed as income disbursement, and the full amount is then deductible to the trust and taxable to the beneficiary.

An inter-vivos trust pays tax on its retained income at the top tax of almost 50%. A testamentary trust pays tax on its retained income at the same rate that apply to personal income. The effective tax rates vary from province to province.

For 2014, the combined federal and provincial tax rates are approximately:

• 22% on taxable income up to $44k
• 32% on taxable income between $44k - $88k
• 38% on taxable income between $88k and $136k
• 42% on taxable income over $136k

The application of progressive tax rates makes testamentary trusts attractive form an income splitting point of view.

Question 9

Bill C-43

Answer 9

On December 16 2014, a second Act to implement certain provisions of the budget tabled in Parliament on Feb 11 2014 and other measures received Royal Assent. The Bill eliminated graduated tax rates, and certain income tax rules, for certain trusts or estates.

As of 2016, the retained income of a testamentary trust will be taxed at the top marginal tax rate, not the graduated rates. So creating multiple trusts no longer offers the opportunity for income splitting with a trust. A beneficiary, but not a trust, can claim a tax credit based upon the personal amount.

Graduated tax rates will continue to be available for:

• an individual’s estate, which a testamentary trust arising on the death of the individual, for up to 36 months after the individual’s death; and
• testamentary trusts whose beneficiaries include individuals eligible for the disability tax credit, in recognition of the use of these trusts a tool for preserving access to income tested benefits.

This measure will apply in 2016 and subsequent years.

Question 10

Revokable Trust

Answer 10

Is a trust that the settlor can dissolve. Inter-vivos trusts can be revocable or irrevocable, but a trust indenture is automatically assumed to irrevocable unless it clearly states that the trust is revokable. It is up to the settlor, not the beneficiaries, to specify if the trust is revokable.

Income generated by a revokable trust is always taxed in the hands of the settlor, not the beneficiary or the trust.

So a revocable trust can never be used for income splitting.

Testamentary trusts are always revokable up until the time of death because they are not created until the time of death. Of course, testamentary trusts are irrevocable upon death.

Question 11

Transferring an asset to an intervivos trust

Answer 11

intervivos trust provide limited tax advantages.

When a property is first transferred to an intervivos trust (other than a spousal trust of certain rollover trusts), the settlor realizes a deemed disposition at the FMV for tax purposes, and this could result in taxable capital gain for the settlor at the time of the transfer.

This FMV becomes the ACB of the property for the trust. if that property is ultimately transferred into the control of a beneficiary, it is transferred at this ACB, and no deemed disposition occurs for tax purposes until the beneficiary chooses to dispose of the property.
So an intervivos trust can be used to defer income tax on capital appreciation.

If the property earns income while it is being held by the trust, that income can either be distributed to the beneficiaries, or it can be retained by the trust. If it is distributed to the beneficiaries, it is taxed in their hands at their ETR (unless it is subject to income attribution rules, which could attribute the income to the settlor).

However, if the income is retained by the trust, it will be taxed at the top marginal tax rate. Therefore inter vivos trusts do not provide opportunities for income tax splitting.

Question 12

Intervivos trusts - creditors

Answer 12

Assets that are transferred to a trust are controlled by the trustee, and are not in direct control of either the beneficiary or the settlor. They can only be distributed according to the terms of the trust. This means that the assets are protected from creditors of both the beneficiary and the settlor.

Question 13

Inter vivos trusts: Year end and taxable payable

Answer 13

Year end is calendar year - December 31

Taxes owing must be paid within 90 days.

Question 14

Trusts:
When are two trusts considered a single entity
When are two trusts considered two separate entities

Answer 14

If a single settlor establishes two trusts, each with different beneficiaries, they will be considered two separate entities for tax purposes.

If a settlor establishes two trusts, each with the same beneficiaries, those trusts will be considered to be a single trust for tax purposes, and their taxable income will be combined on a single tax return.

Question 15

Income earned in an intervivos trust:

Answer 15

Income earned by an intervivos trust is taxed at the top income tax rate unless:

• it is distributed to a beneficiary according to the trust deed, in which case it is taxable to the beneficiary at their ETR.
• it is attributed to the settlor under the income attribution rules, in which case it is taxable to the settlor at his ETR

If a settlor transfers income-producing property to an inter vivos trust that names his minor children as the beneficiaries, the income will be taxable to the settlor under income attribution rules, regardless if the income is retained by the trust or distributed to the beneficiaries. For the year in which the child reaches 18 years of age, the income attribution rules cease to apply.

Question 16

21 year rule

Answer 16

To prevent trusts from using their capital appreciation indefinately, the ITA requires trusts to report a deemed disposition of capital property at FMV on the first deemed disposition date, and every 21 years thereafter. This is referred to as the 21 year rule, and it means that a trust could realize a taxable capital gain on trust assets even if it has not actually disposed of the property.

The first deemed disposition date depends on the type of trust, as follows:

• for spousal and common law partner, intervivos trust or testamentary trust, it is the date of the beneficiary’s death.
• For alter ego trusts, it is the date of the settlor’s death
• for joint spousal or common law, it is the alter date of the settlor’s death or the death of his spouse or common law
• for all other testamentary trusts, it is the later of Jan 1 1993 and the date that is 21 years after the day the trust was created.

To avoid the application of the 21 year rule, the trust deed could specify that the trust property is to be transferred to the beneficiaries before the expiry of the 21 year period. In this way, the trust property is transferred to the beneficiaries at the ACB of the trust, and no capital gain will be realized until the beneficiary chooses to dispose of the property.

Question 17

When must a trust file a T3 trust tax return

Answer 17

The trustee of an inter vivos trust is required to file a T3 Trust tax return on behalf of the trust if any of the following situations apply:

• a trust has tax payable
• the trust has a taxable capital gain
• the trust has provided a benefit of more than $100 to a beneficiary for the upkeep or maintenance of trust property that is being used by the beneficiary
• The trust has gross income of more than $500
• The trust allocates or pays income of more than $100 to any single beneficiary
• the trust allocates income to a non-resident beneficiary
• the trust sells some or all of its assets

Question 18

Valid spousal trust

Answer 18

is a trust that provides is a trust that provides the settlor’s spouse receives all of the trust income during her lifetime and is the only person who has access to the trust income or trust capital during her lifetime. If anyone other than the surviving spouse it entitled to use or receive trust income or capital while the surviving spouse is still alive, the trust will be tainted and the spousal rollover will not be available.
Note that the ITA treats legally married spouses and common law partners equally, so that same rollover provisions apply to valid common law partner trusts and surviving common law partners.

Question 19

Joint Spousal trust or Joint Common Law trust, which conditions must be met

Answer 19

These trusts allow spouses and common law partners to rollover capital property into a trust that jointly names both spouses or common law partners as beneficiaries. These trusts provide several advantages, including property protection and probate avoidance. They can also fulfill some of the functions of a will or POA.

In order to create a joint spousal trust, the following conditions must be met:

• the spouses must be entitled to the trust income during their lifetime
• the only individuals who cane have any access to the trust’s capital during the settlor’s lifetime are the settlor and his spouse.
• no person other than the surviving spouse is entitled to the capital of the trust after the settlor’s death, during the remainder of the surviving spouse’s lifetime
• the settlor’s must be at least 65 years of age when the trust is created (the age of the spouse is not taken into consideration); and
• the trust must be created after 1999

These rules also apply to common law partners and joint common law partner trusts.

Question 20

Alter ego trust

Answer 20

An alter ego trust is an inter vivos trust that names the settlor as beneficiary, and which names a trusted friend, relative, or professional party as the trustee. A taxpayer can rollover capital assets into an alter ego trust. The settlor must be at least 65 years of age when the trust is created.

While an alter ego trust does not provide any tax advantages, an alter ego trust does provide many estate planning opportunities.

An alter ego trust allows the taxpayer to place his assets in a protected trust during his lifetime, giving them full access to the assets, but ensuring that he is not manipulated by other family members into handing them over.

An alter ego trust can minimize probate fees because the trust assets are not estate assets, and will be distributed according to the terms of the trust deed, not a will.

An alter ego trust provides confidentiality because there is no need to pass the assets through the public probate process.

An alter ego trust can reduce the potential for court challenges because the assets do not base through the estate and cannot be subject to a challenge of the will.

Question 21

Transferring capital property to an alter ego trust

Answer 21

When a taxpayer transfers capital property to an alter ego trust, the taxpayer is deemed to have received proceeds equal to his ACB, and the trust is deemed to have acquire the property at this same amount. The trust is deemed to have disposed of the property for FMV at the time of the settlor’s death.

The settlor cannot use an alter ego trust to implement an estate freeze.

Question 22

What happens to assets inside an alter ego trust at the time of the settlor’s death

Answer 22

The settlor of an alter ego trust would name someone other than the settlor as the income and/or capital beneficiaries after the settlor’s death. The assets of an alter ego trust would not revert to the settlor’s estate upon death. The assets held in the trust go to the beneficiaries directly and do not form part of the deceased’s estate (by passing probate.)

Question 23

Alter ego trust function as POA or will

Answer 23

An alter ego trust can function both as POA and as a will. An alter ego trust would normally name someone other than the settlor as the income and capital beneficiaries up the settlor’s death. The trust assets would not revert the settlor’s estate upon death. As a result, the assets would bypass the estate and be managed or distributed in accordance with the trust deed, and this can effectively take the place of a will. While the settlor is still alive, he can benefit from the assets held in trust, but a trustee is responsible for managing those assets, similar to POA, in the case of incapacity.

Question 24

Protective Trusts

Answer 24

are the predecessors of alter ego trusts, and they can be established by the settlor at any age. Provided that the settlor is the only person who can benefit from the trust during his lifetime, then assets can be rolled over into the trust.

While the assets are in trust, the trustee fulfills a role similar to that of a POA. However, a protective trust must terminate upon death of the settlor, and the assets must revert to his estate, to be distributed in accordance with his will.

So a protective trust can fulfill the function of a POA, but not the function of a will.

Question 25

Prudent investor principal

Answer 25

Provincial trustee legislation provides default rules that govern the duties and powers of a trustee in the event that a trust deed does not exist or, if it does exist, it fails to address these issues. With respect to investment powers, the trustee legislation of some provinces relies on the prudent investor principal, which allows the trustee to invest trust capital in any type of property, as long as the investment is one that any prudent person might make when investing on behalf of others.

A prudent person investing on behalf of others would consider things such as:

• general economic conditions
• the possible effects of inflation
• the expected tax consequences of investment decisions or strategies
• the rules that each investment or strategy plays within the trust’s overall portfolio
• the expected total return of the investment, considering both income and capital appreciation
• the trust’s needs for liquidity, regularity or income, and preservation of capital; and
• the special value of any single asset to the purpose of the trust or to a beneficiary

Provinces that due not use the prudent investor principal tend to specify a list of permitted investments, which is often referred to as the “legal list”. This list is quite conservative and, in some cases, even precludes mutual funds.

Question 26

Saunders v Vautier rule

Answer 26

If the beneficiaries are of the age of majority and of full mental capacity, and they are absolutely entitled to all of the property, the can demand immediate payment from the trustee (even if the settlor had specified that the property was not to be distributed until a much later date).

Making a trust discretionary and making a child and a charity as beneficiary would then ensure the trust does not fall under the Saunders Vs Vautier rule.

Question 27

Intervivos family trust

Answer 27

Is a trust that is established for family members as beneficiaries while the settlor is still alive. And inter vivos trust is not a rollover trust. Once an inter vivos trust is established, it continues to be an inter vivos trust for tax purposes even after the death of the settlor.

Question 28

Joint spousal trust

Answer 28

is an intervivos rollover trust that you and your spouse would establish for you and your spouse’s benefit.

All of the following conditions must be met:

• The transferor must be at least 65 years of age
• the transferor and his spouse are entitled to all of the trust income; and
• no other person is entitled to the capital of the trust during the transferor or the spouse’s lifetime