Pre-Consultation Brush Up on Trust Rules

The March 21, 2013 Budget is proposing major changes to the taxation of trusts in Canada, which will have significant family succession planning implications. Here in the first of two articles, Greer Jacks reviews existing rules, which every tax and financial professional may wish to be aware of before the rules are changed in order to participate in fruitful consultations on the matter.

Alter-Ego / Joint-Spousal Trusts

Under Section 73 of the Income Tax Act (the Act), individuals who are 65 or over can use an inter vivos (in their lifetime) trust as an alternative to a will in order to transfer certain assets free from probate fees. Alter-ego and joint spousal trusts cannot be created by will. Here’s how they operate:

The person who gifts property to the alter-ego trust must be alive and at least 65 years of age, they must be entitled to receive all the income of the trust prior to the death of the person, and they must be the only person able to receive income or capital of the trust prior to the death of the person.

The same basic rules apply to joint spousal trusts except both partners must be entitled to receive all the income of the trust exclusively until their death.

Usually when assets are transferred to a trust that names individuals other than the donor as beneficiaries there is deemed to be a disposition of that property at its fair market value under the Act, thereby triggering income tax at the time of transfer.

A transfer to an alter-ego or joint spousal trust however allows the transferor to make the transfer on a tax-deferred basis, unless the settlor of the trust elects to opt out of the rollover and have the disposition take place at the time, at fair market value.

The most useful way to use these trusts is to have contingent beneficiaries who will receive the income and capital of the trust after the death of the settlor or the surviving partner, whatever the case may be.

When establishing one of these trusts, it is important to re-register the assets that are to be transferred to indicate that the trust, and not the individual, is the new owner. Without taking this step, third parties such as financial institutions might be able to insist on probate before releasing the assets.

It is important to note that alter-ego and joint spousal trusts are not eligible for the capitals gains exemption on the disposition of shares of a qualified business corporation. Therefore, when creating one of these trusts, the prudent taxpayer would be advised to opt out of the roll-out provisions of subsection 73(1) of the Act in order to claim the capital gains exemption at the time of the disposition.

Next time: Which type of trust should you choose?

Greer Jacks is updating jurisprudence in EverGreen Explanatory Notes, an online research library of assistance to tax and financial professionals in working with their clients.