THORSTEINSSONS LLP TAX LAWYERS

TESTAMENTARY TRUSTS

Shawn W. Tryon and Asif N. Abdulla

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Outline

Testamentary Trusts

Graduated Rate Estates

Spousal Testamentary Trusts

Estate Alternatives

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Testamentary Trusts

“testamentary trust” is defined in ITA 108(1) as: “a trust that arose on and as a consequence of the death of an individual…”

No person other than deceased can contribute assets to a testamentary trust created after November 12, 1981 – result, loses benefits of being a testamentary trust

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Forms of Testamentary Trusts

Types of Testamentary Trusts: The estate of the deceased

Graduated rate estates A trust established under terms of a last will and testament

Spousal testamentary trusts Qualified disability trusts

Trusts established under dependent's relief legislation Insurance trusts, charitable trusts and other special purpose trust

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Losing Testamentary Trust Status

Testamentary trust status is lost where: Property is contributed by someone other than the deceased; Capital obligations of the trust are paid by others, or There is a failure to distribute property to the beneficiaries

A graduate rate estate ceases to be one where it loses testamentary status

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Testamentary Trusts before 2016

Taxed at graduated rates (in perpetuity) – same as an individual

Income attribution rules do not apply – b/c settlor deceased

Multiple testamentary trusts could be established, permitting a degree of income splitting (subject to an anti-avoidance rule)

Not subject to Alternative Minimum Tax

Off-calendar year end permitted

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Testamentary Trusts 2016 Going Forward

New rules apply after 2015 introducing the concept of the “graduated rate estate”

Several conditions are imposed Many special rules which previously applied to “testamentary

trusts” in general are now limited to “graduated rate estates” Why the change:

The estates of most deceased Canadians are finalized and administered in a timely fashion and without inappropriate tax planning. However, some taxpayers are using estates and trusts to obtain unintended tax advantages. Eliminating the tax benefits of graduated rate taxation for trusts and certain estates would ensure increased fairness and neutrality in the federal income tax system. The proposed measures would also address the potential growth in tax planning involving existing rules and the associated impact on the tax base.

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“graduated rate estates”

Applicable to 2016 and subsequent tax years, the new rules permit ONLY “graduated rate estates” to benefit from previous “testamentary trust” treatment under the ITA

Applies top tax rate for all “testamentary trusts” other than “graduated rate estates”, solely for the first 36 months from date of

death; AND “qualified disability trusts”, which are trusts created for the benefit of

an individual entitled to “disability tax credit”

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“graduated rate estates”

New definition for a “graduated rate estate” (subsection 248(1) ITA)Summary:Must be a testamentary trustMust have arose on and as a consequence of an individual’s deathNo more than 36 months after the deathOnly ONE “graduated rate estate” in respect of a deceased individualThe estate must designate itself, in its T3 return of income for its first taxation year as the deceased individual’s graduated rate estateNo other estate can have designated itself as a graduated rate estate of the individualThe estate must include the deceased individual’s Social Insurance Number in its return of income for each taxation year of the estate that ends after 2015.

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“graduated rate estates” changes

Some Examples of ChangesGraduated Rates

Only “graduated rate estates” will be entitled to marginal graduated bracketsIncome tax instalments

Tax instalment rules extended to testamentary trusts unless a “graduated rate estate”Alternative Minimum Tax (AMT)

Eliminate basic $40k AMT exemption unless a “graduated rate estate”Part XII.2 Tax

Extend Part XII.2 Tax to testamentary trusts unless a “graduated rate estate”Taxation year and fiscal period

Extend calendar year end requirement to testamentary trusts unless a “graduated rate estate”

Deemed year-end on lapse of 36 month period (ITA 249(4.1)(a)(ii))

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Trusts versus Estates

Beneficiary of a trust holds “equitable interest” and trustee holds legal title Beneficiary of an estate does not necessarily enjoy a beneficial interest in

the assets while under administration and part of the estate Where a will contemplates creation of trust with some or all of the assets of

the estate, a question can arise as to when the estate terminates and the trust commences. Generally occurs when beneficiaries are ascertained, debts are paid, assets

are gathered in & ascertained, and the final accounts have been passed While in administration, the income of the estate is generally taxed in the

estate and not in the beneficiaries hands UNLESS the executors are intentionally delaying the administration in the estate even though the estate could be distributed

Estate is separate taxpayer under ITA; treated like a trust

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Will Trusts

Will trusts may arise as the result of an individual’s death

Generally created under the will but can arise under a separate declaration

All are treated as testamentary trusts

Testamentary trust status can be lost in a number of ways Most notable way – where property subsequently contributed to the

trust; trust loses testamentary status

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Spousal Testamentary Trusts – Criteria for Rollover

Deemed dispositions on death (ITA 70(5) and (6)) Deceased must be a resident of Canada before death Spouse must be a resident of Canada immediately prior to

testator’s death, OR if property passes to spouse trust, trust must be resident in Canada immediately after property vests ie. spouse individual need not be resident in Canada at that time

Property must pass as a consequence of death Spouse trust must specifically be created by the testator’s will ITA 248(8) provides expanded definition for circumstances deemed to

be “as a consequence of death” – eg. by court order

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Testamentary Spousal Trust Rollovers

Property must vest indefeasibly within 36 months from date of death Can be no other contingent event which may prevent trust from

obtaining or receiving absolute ownership over property

The spouse or common-law partner must be entitled to all income of the trust

No person (other than the beneficiary spouse) can be entitled to any capital of the trust during the spouse’s lifetime

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Testamentary Spousal Trust Advantages

Complete rollover and tax deferral on property transferred to the trust until the death of surviving spouse

Control over assets/capital

No attribution – b/c transferor dead

Ideal for second marriage concerns

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Tax Planning for Property Settled

Access to unused net capital or non-capital losses of the testator elect out of rollover under ITA 70(6.2)

Availability of the Lifetime Capital Gains Exemption elect out of rollover under ITA 70(6.2) to use deceased’s exemption

Donation tax credits elect out of rollover under ITA 70(6.2)

Maximizing use of deductions and medical expense tax credits elect out of rollover under ITA 70(6.2)

Impact of the 21-year rule if qualified spouse trust, 1st deemed disposition occurs at date of death of

surviving spouse and then every 21 years thereafter

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Electing out of the Rollover

ITA 70(6.2) Property by property election

On-Off “switch” – no ability to trigger partial gains on a particular property

Strategy works with “identical properties” election is on a property by property basis, therefore can elect out of

rollover on one property and not another or on 1 share and not on another share (i.e. elect out of rollover to utilize deceased’s LCGE while rolling remainder of shares)

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Property Contributed to a Trust

Type of Testamentary Trust Beneficiary Tax Treatment of Property Inserted

Qualifying Spousal or Common-Law Partner Trust

Spouse or Common-Law Partner

Generally a ITA 70(6) Rollover (However opting-out possible under ITA 70(6.2)) – can rollout ONLY to spouse

Tainted Spousal or Common-Law Partner Trust

Spouse or Common-Law Partner

ITA 70(5) applies. Disposition at FMV- Can rollout to beneficiaries including spouse

Other Testamentary Trust Child, Grandchild or Other Person

ITA 70(5) applies. Disposition at FMV (exceptions for qualified farm and fishing property) - Can rollout to beneficiaries including spouse

Charitable Remainder Trust

Charitable Organization

Amount elected under ITA 118.1(6), not greater than FMV and not less than ACB of property.- Can choose amount of gain and amount of donation tax credit

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Testamentary Planning - Pitfalls

Failing to fund the trust

Tainting a spousal trust

Failing to plan for property with accrued capital gains

Under utilizing exemptions, deductions and losses

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Estate Alternatives

Joint Ownership: Property of deceased owned jointly with other persons Property passes to surviving joint tenant by operation of law (ie. does

not pass through the estate of the deceased Direct Beneficiary Designations:

Property passes directly by beneficiary designations and therefore does not form part of the deceased’s estate

eg. RRSP and insurance designations Alternative Testamentary Instruments:

Property contributed to inter-vivos trust during deceased’s lifetime 65+ years: alter-ego / joint-spousal (common-law partner) trusts Inter-vivos discretionary family trusts

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Alter Ego & Joint Spousal Trusts

Requirements: Inter-vivos trust created after 1999 Settlor(s) must be 65 years of age or older Settlor/spouse/partner must be entitled to all trust income before the

death of the survivor No person other than settlor/spouse/partner may be entitled to capital

before the death of the survivor Rollover on Contribution of Assets:

Available only to the creator(s) of the trust Taxation:

Income/gains/losses attributed to settlor(s) during lifetime (ITA 75(2)) Deemed disposition of capital assets at time of settlor/survivor’s death

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Key Benefits of Alter Ego & Joint Spousal Trusts

Privacy: No public disclosure on distribution of assets

Avoidance of Probate Fees: Probate in BC: 1.4% of estate value ($28K on $2M asset value) Graduated rates in a GRE (up to $30K on $200k income for 3 years)

Certainty: Not subject to variation under WESA (formerly, WVA) Particularly useful in split families / multiple marriages

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QUESTIONS

Shawn W. Tryon Asif N. Abdulla604-602-4298 604-602-4255swtryon@thor.ca anabdulla@thor.ca