TRUSTS

The World Wide Legal Information Alliance defines a trust as ‘a legal obligation with respect to property given by a person (donor) to another (trustee) to the advantage of a beneficiary’.

Trusts can be used by individuals and families for a variety of reasons. Trusts can provide tax benefits, can be an effective way of protecting assets from creditors, and can be used to provide benefits to any number of beneficiaries, without the beneficiary having any legal title or claims to the assets providing the benefits.

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Tax benefits

Many business owners use trusts as an effective way of splitting income and ownership of assets. One method which we quite often advise is for the principal business owner to establish a family trust. Some degree of ownership of the family business is then transferred to the family trust, allowing a corporation to declare dividends on the shares held by the trust. The trustee then allocates dividends to beneficiaries, who may be in a lower tax bracket, thereby realizing an absolute tax savings amongst the family unit.

A family trust can be established at the outset of the incorporation of a business, or can be injected to the business structure at a later date. If done in an established business, a valuation of the business is usually required, with that value transferred to the existing shareholders, thereby allowing new shareholders (the family trust) to be introduced for a nominal amount. This is typically referred to as an ‘estate freeze’.

Family trusts cannot be used to split income with indivduals under the age of 18, due to the imposition of the ‘kiddie tax’, which effectively taxes underage individuals at the highest marginal rate. Nonetheless, family trusts can still be useful, as they can be used to finance the education of a family member 18 or over, and can be used to split income with a non-active spouse.

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Creditor proofing

By placing assets in a trust, an individual can benefit from the use of the trust property, or receive an income from the trust property, if the benefits are administered by a trustee who has the discretion to benefit the individual. At the same time, a creditor may be unable to make a claim against the property held by the trust, provided careful planning and drafting of the trust agreement is undertaken. This can be useful where, for example a trust is established to hold the shares of a family corporation for the benefit of the owner’s children, without exposing those shares to matrimonial disputes of the children.

Transferring assets to a trust may give rise to taxes if the assets have appreciated in value since acquired by the transferor. Again, careful planning may be able to reduce or eliminate these taxes altogether. For example, transfers to trusts benefiting the transferor or his spouse may be transferred to an alter-ego, spousal, or joint partner trust free of tax. Another example is by performing an estate freeze, as outlined above.

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Distributions From a Trust

Distributions from a trust become the property of the beneficiary, and can typically be used by the beneficiary to assist with living expenses or to make their own investments. Care must be taken in the administration of a trust to ensure that the income and distributions are properly documented, and that trust funds are not circuited back to the trustee. Distributions from the capital of the trust can typically be made to the beneficiary without adverse tax consequences, since the assets are held ‘in trust’ for the beneficiary.

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Types of trusts

Trusts can be ‘testamentary’ (created through a will) or ‘inter-vivos’ (created during a person’s lifetime). In addition to the type of trusts mentioned above, other recognized forms of inter-vivos trusts are:

• Principal residence trust
• A foundation
• Self-benefit trust
• Offshore trusts
• Disability trusts

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21 Year Rule

Under Canadian Income Tax laws, all trusts are deemed to dispose of their assets after 21 years. This means that tax will become due on the appreciation of assets held by the trust at that time. Carefully planning for this event can result in minimizing or avoiding taxes entirely. A number of methods can be used, including distribution of the assets to the beneficiaries before 21 years is up, establishing a new qualifying trust, or reducing the value of the assets in the trust.

As you can see, trusts can be very useful. Before establishing a trust, you should consult qualified, experienced professionals. Call George van Wensem for a unique approach to your situation.