Many Canadians use inter vivos family trusts to hold assets such as private corporation shares, investments and real property for purposes of family and estate planning, and to access certain tax-planning opportunities. These trusts are generally created by a settlor during their lifetime for the benefit of beneficiaries or classes of beneficiaries.
While these trusts may have fixed entitlements, family trusts are typically discretionary in nature, allowing the trustee to exercise discretion depending on the beneficiaries and the goals of the trust. In some cases, a family trust is used to move certain assets outside of an estate, bypassing probate taxes. In these cases, family trusts may also be structured to trigger entitlements or distribute assets upon the death of a beneficiary in a way that will tie in with the testamentary wishes of that beneficiary.
Recent federal tax legislation has been introduced that may create a chilling effect on trust planning and affect whether these structures are still the appropriate choice for some clients. These changes include:
Capital gains inclusion rate increase
Budget 2024 proposes to increase the capital gains inclusion rate from one-half (50%) to two-thirds (66.7%) for corporations and most trusts, and on the portion of capital gains realized that exceed $250,000 for individuals, graduated rate estates, and qualified disability trusts. This change is intended to be effective for capital gains realized for the year on or after June 25, 2024.
For the average family trust, this means that not only is all income retained in the trust taxed at the highest marginal rate but also all capital gains realized by the trust are taxed at the highest capital gains inclusion rate. This works out to roughly a 10% increase in the rate of tax, and roughly 30% in relative increase in taxation of capital gains, depending on the province or territory. For example, Alberta’s capital gains tax rate increased from 24% to 32%, which is an increase of approximately 33.3%.
One notable exception is cases in which it is possible for the trust property to be transferred out of the trust on a tax-deferred basis to a Canadian resident beneficiary, who then realizes the capital gain. Depending on the property, the terms of the trust deed and the status of the beneficiaries, this may not always be possible.
Increase in alternative minimum tax
The alternative minimum tax (AMT) is a parallel tax calculation that applies where normal calculations would result in little or no tax payable. AMT applies a minimum flat-rate tax after an exempted amount and allows limited access to various credits and deductions.
If the parallel AMT calculation for a tax year exceeds the income taxes otherwise payable under the Income Tax Act (ITA), an individual or certain trusts (including most family trusts considered in this article) would be required to pay the difference. The amount of additional AMT paid in a year under these rules can generally be deducted from tax payable in the following seven taxation years, to the extent the tax otherwise payable in those years exceeds the applicable AMT. AMT becomes permanent if not recovered within this period.
Budget 2023 raised the AMT rate to 20.5% from 15%, and raised the “safe-harbour” exemption (taxable income that is exempt from AMT) for individuals to $173,000 from $40,000. Budget 2024 provided some additional legislative guidance and relief.
Trusts subject to AMT do not benefit from a safe-harbour amount. So, trusts with taxable income would generally have greater exposure to AMT compared with individuals.
For the average family trust, this can be of particular concern, as only 50% of interest expenses can be deducted (which may affect prescribed-rate loan arrangements) and 80% of donation credits can be used for AMT calculation purposes. Having cash on hand to pay the AMT may result in more income being taxed in the trust at the highest marginal rate. Unlike individuals, most trusts are not taxed at graduated rates depending on income. As a result, less income is distributed from the trust to its beneficiaries.
Trust reporting rules
Beginning in the 2023 taxation year, most trusts and trust arrangements with taxation years ending after December 30, 2023, are required to complete a reporting schedule (Schedule 15).
These reporting rules seek information — including name, address, date of birth and taxpayer identification number — identifying the settlors, trustees, beneficiaries and others who can “exert influence” on the trust.
Trusts may be subject to penalties for non-compliance if they provide incomplete schedules or inaccurate information. In certain instances where “gross negligence” is claimed, these penalties can be as high as 5% of the highest fair market value of the trust’s assets in the year. Notably, these penalties can be assessed to both trustees and tax return preparers.
Most family trusts are subject to these rules, unless they meet one of the narrow exceptions found in the ITA.
Information-gathering may be difficult in cases in which beneficiaries are unknown, uncooperative or difficult to ascertain (such as a poorly defined class of beneficiaries).
For the average family trust, this requirement means an increase in annual compliance costs, increased risks to trustees and tax preparers, and a decrease in privacy.
Source: Advisor.ca
