Consultation to Eliminate Graduate Rate Taxation of Trusts and Estates Ends December 2

Budget 2013 included an announcement that the government would be looking into measures to improve the integrity of Canada’s tax system relating to testamentary trusts.

It has now announced that consultations on the matter will now be accepted. To give your input on the proposals, e-mail trusts-fiducies@fin.gc.ca. The closing date for comments is December 2, 2013. 

For estate purposes, a flat top-rate of tax is proposed to commence after a reasonable administration period (36 months) following the person’s death. Therefore, graduated rates will still be accessible for these trusts for that 36 month period. These measures would apply to existing and new arrangements for the 2016 and later taxation years. There are also proposals pertaining to trusts for disabled and minor children, as well as spousal and common-law partner trusts. Background follows:

Trusts and estates are treated as taxpayers under the Income Tax Act (“the Act”) and are therefore liable to pay tax on their taxable income. In computing their income for the year, most trusts are permitted to deduct the income paid to their beneficiaries in the year. Therefore, the trust does not pay any tax on this income and the income is passed to the individual, who is then taxed at a graduated rate.

The graduated rate taxation rules that pertain to individuals contain four brackets for which different rates of tax apply depending on the level of taxable income. For 2013, the rates are 15% on the first $43,561 of taxable income, 22% on the next $43,562 of taxable income (on the portion of taxable income over $43,561 up to $87,123), 26% on the next $47,931 of taxable income (on the portion of taxable income over $87,123 up to $135,054), and 29% on taxable income over $135,054.

If the trust recognizes the income it made during the year for tax purposes and not the beneficiaries, then generally the trust must pay the tax. The rate of tax to be applied currently depends on the type of trust though, and this distinction is the perceived unfairness in the current system.

Certain types of trusts, specifically “grandfathered inter vivos trusts” (inter vivos refers to a trust that is created during the taxpayer’s lifetime, as opposed to a testamentary trust which is created following the death of a taxpayer) are entitled to special tax rules which the government has identified as being potentially unfair because they enable tax to be applied at a graduated rate as well, thus allowing the beneficiaries of those trusts to access more than one set of graduated rates.

Grandfathered inter vivos trusts are Canadian resident trusts created before June 18, 1971 and satisfy certain restrictions regarding their activities. The 1972 tax reform introduced high flat-rate taxation for inter vivos trusts. Prior to that, trusts generally had full access to the graduated rates applicable to ordinary individuals.

Currently, testamentary trusts and grandfathered inter vivos trusts compute federal tax using the graduated tax rates available to individuals, while other trusts such as ordinary inter vivos trusts pay tax at the top federal marginal tax rate applicable to individuals, currently 29%.

It is now proposed that a flat rate of tax be applied to all trusts, including grandfathered inter vivos trusts and estates.