Christy L. SandlesScotia Private Client Group

Tax Treatment of Testamentary and Inter Vivos Trusts

Current Situation

• Testamentary trusts are deemed to be an individual in respect of trust property and are therefore taxed as an individual (s. 104(2) of the Income Tax Act)– Benefit is that they are able to access graduated rates of individuals

• Inter vivos trusts are taxed at the highest combined marginal rates for individuals (between 39% and 50%, depending on the jurisdiction)– Pre-June 1971 inter vivos trusts are grandfathered and can access

graduated rates

Proposed Changes

• Budget 2013 set out a consultation process for the following suggested changes:– Testamentary trusts to be taxed at the highest marginal rate (the

“flat-top” rate)– Will not be grandfathered – ie. will apply to existing and future trusts

– Estates will be taxed at the highest marginal rate after 36 months

– Grandfathered inter vivos trusts will be taxed at the flat-top rate

Related Administrative Changes

• All trusts will move to a calendar taxation year

• Requirement to remit tax payments on an instalment basis

• No access to exemptions for Alternative Minimum Tax or Part XII.2 tax

• No longer automatically a personal trust under the ITA– Would be subject to criteria to determine eligibility

• Various other administrative changes

Effect of Proposed Changes on Other Provisions

• Will not change the rules that apply to trusts for minor children– Income can be taxed in their hands while remaining in trust

• Will not change the preferred beneficiary election rules

• Will not change the roll-over rules that apply on the death of a spouse or common-law partner

Rationale?

• Promote fairness and neutrality in the tax system, and eliminate the “extent” of this planning– Now considered to give too great an advantage over inter vivos

– Would be beneficial to re-visit the reason for introducing the graduated rates

• Estates are being kept open to take advantage of the graduated rates

• Avoidance of the Old Age Security Recovery Tax– Individuals are leaving funds in trust to maximize OAS benefits and avoid

clawback

Implications?• Loss of income splitting

– Could penalize surviving spouses who will end up paying more tax after the death of a spouse

• Detrimental to those who might use a trust for other purposes– Beneficiaries with disabilities

– Spousal protection

– Spendthrifts

• Penalizes complex or delayed estates

• Highlights the need for flexible planning– Ensure trust addresses payment of income

– If trust is solely for tax purposes, ensure it can be collapsed

Revisiting Inter Vivos Trusts

• Inter Vivos Trusts– Income is taxed at highest marginal rate

– Likely will be income tax implications (ie. capital gains) as a result of transferring assets into the trust

• Alter Ego / Joint Partner Trusts– A type of inter vivos trust available to individuals over the age of 65

– Assets can be transferred in without triggering gains (you cannot transfer an RRSP or RRIF)

– For the lifetime of the settlor, assets and income therefrom are only for the benefit of the settlor (or spouse, in certain circumstances)

Inter Vivos / Alter Ego Trusts• Benefits:

– Can avoid Testators Family Maintenance Act claims

– Privacy

– Avoids probate

– Ease and speed of administration– Sometimes considered a power of attorney substitute for these assets

• Drawbacks:– More costly and labour-intensive to set up

– No probate

– Appreciating assets will be taxed at highest rate on death, rather than at marginal rates

– Cannot access graduated rates of testamentary trusts

Planning Opportunities

• Still many uses for testamentary trusts to address issues other than tax planning– While change would have impact on tax benefits, should not

outweigh other uses

– Tax implications can be minimized through careful planning

• Consider using alter ego trusts now that loss of testamentary trust status is not a concern

Consultation Process

• Input can be given until December 2, 2013

• Changes to take effect in 2016

Questions?