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Canadian Wealth Management GuideExcerpt: [¶426] “In-Trust Accounts”

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[¶426] “In-Trust Accounts”

[...] There has been a great deal of confusion about the significance of these accounts. They raise several issues:

Issue #1: Are these accounts trusts?

The first issue is whether these “in-trust accounts” are actually trusts for tax purposes. Although some prac-titioners believe that this is the case, recent CRA docu-ments show that, without other supporting documenta-tion, a trust would not likely be established. In order for atrust to exist, the "three certainties" (certainty of inten-tion, property, and objects) must be met. This, of course,is at least in part a question of fact. However, in manycases it is questionable whether there is generally anintention to create a trust. Of course, one of the relevantfactors will be the particulars of the “in-trust” documen-tation, if any, that is signed by the parent/grandparent.(Some financial institutions do not use the word “trust”to begin with, raising the question of whether there is adistinction because the word "trust" is used.)

The following are some recent Technical Interpretationsin these issues:

In Technical Interpretation No. 9717475 (September 22,1997), the CRA showed signs of accepting the proposi-tion that there would typically be no intention to createa trust (although it was indicated that this would dependon the facts of the case). The CRA indicated that wherean "in-trust account" is opened by the parent, in theabsence of a formal trust document, the certainty ofintention to set up a trust arrangement would be a difficult one to prove. As the children involved are most

likely minors, often the arrangement is designed toaccommodate the fact that minors do not have the legalcapacity to enter into legally binding contracts and hencepurchase financial instruments in their own name. Thusthe arrangement may be one akin to agency as opposedto a trust. (A similar statement was made in TechnicalInterpretation No. 9721325, October 27, 1997 and inDocument No. 9829145, April 14, 1999.)

The CRA document No. 9623997 (September 6,1996) deals with the general issue of whether therewould be an inter vivos trust where there is no trustindenture. In that document, the CRA reviewed a number of cases in which it had attacked trusts. It wasindicated that where there is no trust indenture or deedavailable to support a claim that an express inter vivostrust created orally exists, the onus of proof clearlyrests with both the settlor and trustee in establishingthat the three certainties for creating a trust have beenestablished, and that the terms of the verbal agreementcommunicated by the settlor to the trustee have beenadhered to.

The fact that significant tax revenue is at stake is not loston the CRA. In a Technical Interpretation dated April 8th,1999 (No. 9830997), the CRA indicated that it wastheir understanding that the use of in-trust accountswas “widespread” in respect of the acquisition ofmutual funds and the department generally acceptedthat the existence of an “in-trust account” did not, in andby itself, result in the existence of an actual trust. (Thisview was also confirmed in CRA Document No.9911555, dated June 30, 1999.)

CANADIAN WEALTH MANAGEMENT GUIDE

Although the attribution rules do not specifically apply to capital gains made by children or

grandchildren, other tax issues may arise. The most well-publicized of these is the requirement

of many brokerage houses and financial institutions that accounts be set up in the name of a

parent “in-trust” (often without naming the particular child). There has been a great deal

of confusion about the significance of these accounts, particularly whether they are regarded

as trusts by the CRA and the differences between an in-trust account and a full-blown legal

trust. The following example shows how the Canadian Wealth Management Guide quickly

gets you into the heart of these issues, clarifying the confusion surrounding them and

providing an up-to-date summary of the CRA’s views.

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In Technical Interpretation No. 017676A (July 31, 2003), the CRA noted that it “continues to receive a steady flow of enquiries” about the legal status of in-trust accounts.Its position remains unchanged: the question must bedetermined through the application of trust law to thefacts of each given case. The document, in fact, providesa handy summary of the case law on point. The CRAconcludes the document as follows:

The CRA's role is to administer the Income Tax Act andto make sure its provisions are properly applied to thelegal relationships established by taxpayers. Whether atrust exists at law is a factual and legal issue. An indica-tion in an investment account form will not create a trustunless the three certainties are met and can be proven.In light of the variety of circumstances and types of formsthat may exist, the CRA is in no better position than thecourts in making that determination and cannot make ageneral statement with respect to the nature of In Trustaccounts.

Issue #2: What happens if there is a trust?

It is here that there may be the most confusion. As wewill see shortly, non-trust status is not necessarily fatal tocapital gains splitting. In fact, if the “in-trust account” doesconstitute a trust, a number of issues are raised:

• Presumably, trust returns are required. Fortunately if these are "nil returns", the CRA will often be lenient when it comes to late-filing penalties. (This may depend on the amount of income flowing through the trust.)

• Are the capital gains taxable to the child or to the trust?More specifically, pursuant to the “in-trust account”arrangement, is this type of income “paid or payable” to the child? This is required in order to tax the capitalgain in the hands of the child; otherwise, the capitalgains would be taxable to the trust. Does it matter ifthese amounts are actually paid in the year to anotheraccount for the children? If this account is also an “in-trust account”, do we have yet another trust (so thata high rate of tax would still apply) and so on? Oneprovision that might be relevant is subsection 104(18),which abrogates the “paid or payable” requirement ifthe property is held in-trust for an individual under 21,the right to the property “vested” (otherwise than bythe exercise of the discretionary power) and the right isnot subject to any future condition (other than a condi-tion that the individual survived to an age not exceed-ing 40 years. In an in-trust account situation which is

basically undocumented, it may be difficult to establishthat subsection 104(18) applies because it obviouslyimplies specific terms.

• Do the reversionary trust rules in subsection 75(2)apply, so as to tax the capital gains in the hands of thefunding parent/grandparent, after all? Loosely speaking,the reversionary trust rules will apply to a trust if thetrust property may revert to the person from whom theproperty was received, is passed to persons determinedby the person, or if the person maintains a veto overthe disposition of the property. One fairly simple anti-dote to the reversionary trust rules that has been sug-gested is to ensure that the person named in the trustaccount differs from the funding parent/grandparent.(See ¶2142 for further discussion of the reversionarytrust rules.)

If “in-trust accounts” are not trusts, what is the effect oncapital gains splitting? As stated previously, it is oftenassumed that if trust status is unsuccessful, capital gainssplitting will fail. However, to obtain capital gains splittingadvantages with children, a trust is not necessarilyrequired — what is necessary is a transfer of beneficialownership of the investment to a child. Besides a trust,this can be documented as a gift and/or a declarationthat the arrangement is a bare trustee.

These documents, which are considerably simpler than afull-blown trust, should be considered, especially where asubstantial investment is involved. At time of writing, it isnot at all clear that, as a matter of actual assessing prac-tice, the CRA is actively inclined to disrupt capital-gainssplitting using “in-trust accounts”. Even so, it is possiblethat, without supporting evidence, the CRA could takethe position that there was no transfer ownership of the investment. An individual's tax position in this regardmay depend on what financial institution documentation(if any) is signed when he or she sets up the “in-trustaccount”: some documentation might be helpful, somenot. This risk would, of course, be accentuated if the individual acted in a manner that is inconsistent withsuch a transfer (for example he or she simply took themoney back or gave it to another child). GAAR gives theCRA broad powers to nullify the benefits of tax-motivatedtransactions. When GAAR was introduced, it was statedthat where an income splitting manoeuvre involves thetransfer of assets to a family member, and it is apparentthat the family member was never really supposed tobenefit from the transfer, GAAR might apply — e.g., when a gift is made to an adult child who sells the property and simply gives the proceeds back to his or

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her parents. The CRA later published an InformationCircular on GAAR but did not repeat this warning in theCircular. (See section 245.)

Issue #3: Protective aspects

The main reason a funding individual may want a trust is for non-tax reasons, because of the protection over the investment asset. This is especially the case if a largeinvestment is involved. An outright transfer probablymeans the individual is giving the asset away, “no stringsattached”. For example, it has been observed that withouta trust, the child may be entitled to the “in-trust account”,the account would be subject to marital and creditorclaims against the child, and so on. These are legitimateconcerns, which, of course, are endemic to a transfer ofownership.

A properly drafted trust, on the other hand, can protectthe asset and provide flexibility. For example, a so-calleddiscretionary trust can allow the individual to shift incomeand capital between beneficiaries, and so on. However,this also means the trustees will have to file annual trustreturns, and possibly prepare promissory notes (to evi-dence the fact that the capital gains are payable to thechild every year, i.e., if they are not actually paid out tothe beneficiary during the year), and so on. However, afull-blown trust is generally advisable if relatively largeinvestment is involved.

Apart from the foregoing, a number of practical considerations arise in respect of “in-trust accounts”:

• It is recommended that an “in-trust account” be established for each child rather than establishing one “in-trust account” for a number of children.

• The “in-trust account” should be established with the child's social insurance number, rather than the parent's. Otherwise, a computer cross-check of the account could attribute the income to the parent.

• It is desirable that the child be named — e.g., “David Louis, in trust for Alyssa Louis”. In some cases, the financial institution will decline to do this but persistence will often result in a change of policy.

The commentary on this topic is current as of January 2nd, 2005.

Feature: Focus on investors.

Benefit: The information is aimed to give advice on generating and maximizing one’s wealth, for individuals, private corporations, and public corporations.

Feature: Written in a non-technical manner.

Benefit: Information in the service can be transmitted directly to clients or incorporated into correspondence.

Feature: Practical rather than theoretical.

Benefit:Readers can see how the law applies to them currently in any given situation.

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