Introduction of Trusts
Introduction and Definitions
A trust consists of four major components: The settlor, the trustees, the beneficiaries, and the trust property.
1. Settlor
The settlor is the person who creates the trust by contributing property to the trust. Because the settlor must gift (or settle) property, this property should usually be of a type that does not generate income. The settlor of the trust cannot be a beneficiary of the trust. A family member or friend could be the settlor of this trust. If the settlor is a family member, attribution rules must be considered.
2. Trustees
The trust is administered by persons called trustees. The responsibilities of trustees are set out in the trust document. These include, but are not limited to, managing the affairs of the trust, selecting the investments that the trust will make, determining the distribution of the income of the trust and the distribution of the capital of the trust.
For a discretionary trust, the responsibilities of trustees and the purpose of the trust should be drafted as broadly as possible to allow for payments by the trust for the welfare and advancement of the beneficiaries. They should also allow the trust to invest in virtually anything.
3. Beneficiaries
The beneficiaries of the trust are persons who are entitled to share the income and capital of the trust. Generally, children would be described as a class. Additionally, any income or capital distributed by the trust to the beneficiaries would belong to the beneficiaries. The funds are not available for personal use of the trustees or anyone who is not a beneficiary.
4. Trust Property
The trust property will initially be that contributed by the settlor.
Other Important Points
1. Rule in Saunders v. Vautier
There is an established principle of trust law (referred to as the rule of Saunders v. Vautier) which can apply where all of the beneficiaries of the trust are individuals of the age of majority, have full legal capacity, are of one mind, and have interests in the trust which are vested and irrevocable. If so, then in some instances, the trust may be modified or terminated by the beneficiaries prior to its termination date and without regard to the wishes of the settlor and the trustees. This will not apply to the trusts if the trusts have a corporation (which is not an individual) as a beneficiary.
2. Irrevocability
For a trust to serve its purpose, the trust must be irrevocable. As a result, it is challenging to amend the terms of a trust at a later date. However, the trustees do have the ability to decide, from year to year, which beneficiaries will receive how much money and when, if the trust is discretionary.
3. Attribution Rules
Where a parent or grandparent loans or transfers property directly or indirectly (i.e. through a trust) to a minor child, then any income from the property will be attributed to and taxed in the hands of the parent or grandparent. Certain capital gains, however, will not be attributed.
Corporate Attribution rules may also apply to attribute income to the parents. This can be mitigated by paying the minimum dividend on the frozen shares.
4. Income Distribution
There are two main ways in which income of a trust can be distributed. It can be paid out to the beneficiaries, or it can be made payable to them on their demand. Therefore, income will have to be paid or payable to the beneficiaries, for it to be taxed in the hands of the beneficiaries. This income will belong to the beneficiaries. It is recommended that a separate bank account be kept for the trust and that proper records be kept for reimbursements of expenses paid on behalf of any beneficiaries.
5. Deemed Disposition
A trust is not designed to last forever, and there are legal rules to prevent a trust from being of indefinite duration. As well, the Income Tax Act provides for a deemed disposition of the trust's capital property every 21 years. This means that for tax purposes, the trust will be considered to have sold all of its capital property at fair market value every 21 years. To avoid the operation of this rule, the trust property can be transferred to the beneficiaries who are Canadian tax residents within 21 years on a tax-free basis.
6. Common Types of Trusts
There two main types of trusts: testamentary trusts and inter vivos trusts.
A testamentary trust is a trust or estate generally created on and as a result of the death of the person. The terms of a testamentary trust are based on the Will of the deceased person or the court order.
An inter vivos trust is a trust that is not a testamentary trust. Here are some common inter vivos trusts: alter-ego trust, joint spousal or common-law partner trust, and so on. If you would like to find out more about the types of inter vivos trusts and how you can utilize them to fit your financial goal, please do not hesitate to contact us.
7. Tax Treatments of Trusts
T3 trust tax returns must be filed for both testamentary trust or inter vivos trust if income from the trust property is subject to tax, and in the tax year, the trust:
Has tax payable
Is requested to file
Is a deemed resident trust
Is a resident in Canada and has either disposed of or is deemed to have disposed of, a capital property that has a taxable capital gain
Is a non-resident throughout the year, and has a taxable capital gain or has disposed of taxable Canadian property
Similar to corporations, depending on the types of the amount allocated by the trust, it may have to issue tax slips such as T4 slips, T3 slips, T4A slips, and NR4.
It was proposed in the 2017 federal budget, and effective for the 2018 and subsequent taxation years, T5 information returns must be made in respect of interest payments on account of money on loan to, money on deposit with, or property of any kind deposited or placed with a trust. Accordingly, a family trust will now be required to report the amount of interest paid on the prescribed rate loan annually on a T5 return (and issue the related T5 slips) on or before the last day of February, in respect of the preceding year.
Filing Deadlines
Similar to T2 corporate tax returns, the T3 return deadline depends on the trust’s taxation year-end. A T3 return and the related T3 slips, NR4 slips and T3 and NR 4 summaries must be filed within 90 days after the year-end. Any balance owing must be paid within 90 days after the year-end to avoid interests and penalties. The above deadline also applies to final returns.
Penalties and Interests
If the T3 return is filed past the due date, a late-filing penalty will apply. The penalty is 5% of the unpaid tax plus 1% of the unpaid tax for each full month that the return is late, to a maximum of 12 months. The trust may be charged of the late-filing penalty, although there is no tax owing. In this case, the penalty is $25/day for each day the return is late, range from $100 to $2,500. If a T3 return filing is requested by CRA and the return is filed late, the late-filing penalty will be higher, and CRA will assess a late-filing penalty for any of the three previous years’ returns. The penalty may be 10% of the balance owing, plus 2% of the current year balance owing for each full month that the return is late, to a maximum of 20 months. Any unpaid amounts AND the total amount of penalties assessed is subject to interests. Interest is compounded daily at a prescribed rate from the date the unpaid amount was due until the date of its payment. Please note that repeated failure to report income will also result in penalties, and the amount will be much higher.
To avoid any legal consequences and penalties and interest, a trust and/or its representative are responsible for filing the trust return and all related schedules and statements promptly and adequately.
Payment Options
T3 payments can be made through CRA’s My Payment service using Visa Debit, MasterCard Debit, or Interac Online card from a participating Canadian financial institution. Cheques or money order can be mailed to the Receiver General with the front of the return. Please make sure that the trust name and the trust account number are correct, as indicated on the front of the trust return.
If the trust and/or the representative does not have a bank account at a Canadian financial institution, the following methods can be used to make payments:
Wire transfer
An international money order drawn in Canadian dollars
A bank draft in Canadian dollars from a Canadian bank
To ensure that the payment is applied to the correct account, please make sure that the trust name, trust account number and the taxation year are all correct and attached to the payment.
If you have any questions or comments about this blog post, please feel free to contact us.
Disclosure
This article provides a general summary of trusts. The material is based on current laws and regulations as of the writing date of this article, January 10, 2020.
All comments are for education purposes only, and the following information is not intended to provide legal or tax advice. The article may outline strategies or suggestions, not all of which will apply to your particular facts and circumstances. To ensure that your facts and circumstances have been properly considered and that action is taken based on the latest information available, you should obtain professional advice from a qualified legal and/or tax advisor before acting on any of the information in this article. The publisher of this article has no responsibility to any person. Under no circumstances, including, but not limited to negligence, shall we be liable for any direct, indirect, special, consequential or other damages that result from the use of, or the inability to use, the information contained in this handout. To the fullest extent permitted by applicable law, we disclaim all warranties, expressed or implied, including, but not limited to, implied warranties of merchantability and fitness for a particular purpose, with respect to any materials provided or obtained from or via us.
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