Qualified disability trusts will also compute federal tax using the graduated tax rates.
Moreover, this could be a sign that those involved in these amendments may not be well versed in trust law, so that a review of the structure for other defects may be advisable. In some situations, it might be argued that the "amendments" are really clarification of the settlor's intention and are therefore part of the original trust; however, whether this argument is tenable may depend on the fact situation.
Perhaps the most telltale situation arises where the trust acquires valuable shares of the corporation for nominal or no consideration. As a simple example, a pre-existing shareholder may hold, say, one hundred common shares of a valuable corporation, but wishes to split dividends with other family members or perhaps multiply the capital gains exemption.
So the trust subscribes to, say, 50 additional common shares for a nominal amount. Assuming that the corporation has at least some value, the result of this is that the trust has received a financial benefit.
The CRA may assert that there has been a transfer taxable disposition of one-third of the shares to the family trust, based on their fair market value, so that a sizable capital gain will result.
Alternatively, the CRA may tax the trust as a shareholder benefit under subsection 15 1 based on the value of the shares. But besides these issues, this could be a warning sign that the structure may have other warts. A similar warning sign relates to so-called exclusionary dividend structures. These are structures which involve more than one class of common-type shares, typically with shares of one class containing sufficient voting rights to control the corporation going to the founder of the business.
The various classes of shares have so-called "exclusionary dividend " features—that is, dividends can be paid on one class to the exclusion of the others. I have mentioned these types of share structures on a number of occasions in recent months. These structures may be implemented in order to provide dividend or capital gain splitting. But the trouble with these structures is that it might be asserted that there is a significant " control premium" attaching to the voting shares, so that the non-voting or limited voting shares have a lower value.
This may undermine an estate freeze or the multiplication of the capital gains exemption. In this context, if an exclusionary dividend structure has overlooked these issues, it could also be another warning sign that further review of the structure is in order—are there other deficiencies?
In some cases, the structure itself may be fine, but the ongoing operation may be flawed or sloppy. This can be very problematic, and in fact is one of the deficiencies that the CRA is looking for in its review of trusts that it is currently undertaking. We generally recommend that, where income is to be allocated and distributed to a particular beneficiary, the cash payments should be paid from the trust's account to a separate bank account for that beneficiary.
Payments out of the bank account should be for the benefit of the particular beneficiary, either for investments or personal expenditures for his or her benefit. In the former case, it should be clear that the investment is for the particular beneficiary, e.
Receipts of personal expenditures for the particular beneficiary should be retained. If payments are made directly from the trust for the benefit of the particular child, experience shows that, unless there is scrupulous record keeping, this can become quite messy; accordingly, the CRA might attack the arrangement as invalid.
It is not sufficient to be able to show that the expenses were incurred for children in general, as opposed to the particular beneficiary. Interest Rate is "Reset" In most cases, income-splitting arrangements with a spouse or minor children will depend on the " prescribed rate loan" exception: The attribution rules will not apply to capital gains or losses of a minor, even if the investment is not funded by a prescribed rate loan.
In some cases, taxpayers may try to take advantage of this by lowering the rate on a loan to a family trust or low-bracket family members to match the prescribed rate.
The proposed changes to the use of donation tax credits for gifts made on or after death were also announced in the federal budget. As of January 1, , testamentary trusts and non-graduated rate estates must select a December 31 year-end and will lose other benefits, including:. The new rules provide that, after January 1, , a deemed year-end will be triggered by the death of a spouse beneficiary in a spousal trust, a settlor in an alter ego trust and the survivor of the settlor and their spouse in a joint partner trust referred to as a life interest trust.
These types of trusts require the payment of trust income to the beneficiary. By filing a designation, it is possible to have income taxed in the trust that was otherwise payable, and thus taxable, to the beneficiary.
Starting in , this designation can only be made if the trust would have no taxable income after making the designation. This means that the designation can only be made in circumstances where the trust has loss carry forwards. However, this result may not have been the intention of the testator or their spouse at the time the trust was created e. However, if the trust transfers funds or makes a loan to the estate to allow it to pay the taxes, this could disqualify the estate as a graduated rate estate.
This loss of status must be carefully considered before making such a transfer or loan. The new changes should not affect post-mortem planning to avoid double tax where the life interest trust owns shares of a private company, other than to add additional compliance filings to this planning.
Qualified Disability Trusts will continue to be eligible for graduated rate taxation. The Qualified Disability Trust must make a joint election with an electing beneficiary to be a Qualified Disability Trust and the electing beneficiary cannot make the same election with any other trust.
To take advantage of the graduated rate of taxation, trust capital must be paid to the disabled beneficiary. If capital is paid to a non-disabled beneficiary, there will be a repayment of the tax savings previously enjoyed. There is no time limit that applies to Qualified Disability Trusts. The trust qualifies provided it meets the required criteria for a particular year.
It is possible that a testamentary trust that does not qualify as a Qualified Disability Trust in one year can qualify in subsequent years. Consider, for example, a testamentary spousal trust where the spouse beneficiary subsequently becomes disabled and is eligible for the disability tax credit.