Recent tax legislation has introduced some significant changes that have impacted how family trusts are taxed in Canada. These changes have had a significant impact on existing Canadian family trusts with the bulk of these changes impacting many renowned and influential private family businesses.
Many are still trying to assess the impact of these changes on their businesses and some are even questioning whether family trusts are beneficial anymore or serve any purpose at all.
What Is A Family Trust?
A trust is an arrangement where a settlor transfers property to a trustee (only in the title) in order for the trustee to manage such property for the benefit of a beneficiary.
Unlike a company, a trust isn’t a legal entity, but rather the formalization and personification of a commercial relationship between individuals. The trust is governed by a trust deed or agreement, which outlines the powers and rights of the trustee and the beneficiary.
The trust deed also outlines how the property or assets of the trust are to be managed. Under British Columbia law, trusts can last for a total of 80 years, subject to a 21-year disposition rule, but that’s something you could understand better after speaking to a wealth management expert.
A family trust would allow one individual in the family, for example, the father, to hold property in trust with an asset management company or some other individual, for the benefit of his children to have a fixed income even while they’re studying at college.
How Are Family Trusts Taxed In Canada?
While most seem to be confused about the taxation of trusts, it’s not that difficult. Simply put, trusts are required to report their yearly income and expenses on what’s known as a ‘Trust Income Tax and Information Return’, commonly known as a T3 return.
Subsequently, the trust will need to pay income tax if the income from the trust has not been paid yet. If the income has already been distributed throughout the year to the beneficiaries, then it should be with a deduction.
The trust will need to file the required T3 slips to report such distributions throughout the year. Also, the beneficiaries must mention such income on their own tax returns.
It should be noted that the T3 return filing obligation is for every taxation year, even if the trust has no income or gains to report.
Recent Legislative Changes Impacting Family Trusts In Canada
Trusts no longer enjoy income-splitting benefits. This was a key change that was implemented with the introduction of the tax on split income (TOSI) rules in 2018.
Before, there was an allowance under the law for private corporations owned by trusts to pay income to the trust and allocate that income to family members. Doing so is not possible anymore.
The 2018 federal budget brought with it some new disclosure requirements that also applied to trusts. These requirements came into effect in 2021 and now the law requires that the personal details of all taxpayers connected to trusts be disclosed to the CRA.
These disclosures can be made on a schedule on the T3 return and the individuals whose details must be disclosed include settlers, trustees, beneficiaries, and any individuals who have control over the decisions of the trust related to income or capital distribution (such as fund managers).
Details to be disclosed include names, addresses, the jurisdiction of residence, taxpayer identification number, and, possibly for corporations, statutory documentation evidencing valid registration and standing of the company.
In the event you fail to file your T3 return, including the schedules disclosing information about individuals connected to the trust, you would be subject to a penalty of $25 per day, with a minimum of $100 and a maximum of $2,500.
In the event the authorities find that non-compliance is out of gross negligence, then further penalties could also apply. These penalties can amount to $2,500 or 5% of the maximum FMV of the property held in the trust in the year, whichever is greater.
It's possible that trustees could also face penalties in their personal capacity, but legislation is silent on the specifics of this particular matter.
The Benefits Of Family Trusts - Why Are They Important?
Trusts can be effective in helping a family corporation multiply the lifetime capital gains exemption. This is because trusts are allowed to sell shares of corporations that qualify for the Qualified Small Business Corporation exemption.
Since the gain may be shared between the beneficiaries of the trust, the tax payable is notably minimized.
Trusts also play a key role in succession, as families can use them to transfer wealth in a tax-efficient manner. Such mechanisms of transferring wealth can also result in a deferral of capital gains.
You could speak to financial advisors to see the exact mechanisms that would achieve this, but rest assured trusts allow you to maintain wealth within the family in an efficient manner and within the purview of the law.
When one hears the word “trust”, negative connotations of tax evasion come into play. The truth is that trusts are a legal way of protecting one’s wealth and benefiting from other protections and exemptions granted by law.
Probate fees are payable based on the value of the deceased individual’s estate. Such fees can sometimes be as high as 1.4%.
If assets of the estate are held in a trust, then one is exempted from having to pay any probate fees.
Since trusts are considered to be separate from the people connected to them, they protect beneficiaries and their assets in the event creditors are to make any claims against said beneficiaries.
Properties held in trust are always ensured of confidentiality!
In contrast, once a will is through probate it becomes a public document and is accessible to anyone who is willing to apply to the courts to view it. The same can’t be done with trusts.
It’s understandable if a family would want to maintain their confidentiality, especially when it comes to a matter such as inheritance. Trusts allow families to do just that and do so by staying within the ambit of the law.
Considering A Path For Succession Planning? - Consult With An Expert Near You!
Understanding how family trusts work and what tax implications they can have for your family or business is essential in order to determine whether a Family Trust is in your best interest.
As such, it is always recommended to consult with a financial advisor or wealth management expert before making a final decision.
At Eastport Financial Group Inc, we specialize in all types of financial advisory and consultancy services and have helped thousands of Canadian families and businesses with their taxes, estate planning, insurance, retirement, and investments.
Our Nova Scotian flare, honesty, and trust are what sets us apart and have made us one of the most sought-after financial advisory firms in the Atlantic Provinces. Give us a call today to learn more!