Recent changes in tax legislation have affected the way that trusts can be used, as well as the information they are required to report. Many have speculated that these changes have limited the usefulness of trusts as a tool for holding assets, but there are still many advantages to setting up a trust.
What has changed?
Limits on income splitting
The extension of the income splitting rules that came into effect on January 1, 2018 has made certain business owners question their current corporate structure. This is because the manner in which shares are held (i.e. through a holding company or through a trust) will affect whether the income received will be subject to tax on split income (TOSI), which imposes tax at the highest marginal rate on certain types of income.
For example, where shares of a private corporation (meeting the definition of a “related business” for the purposes of TOSI) are held by a family trust, and an inactive spouse and inactive adult children are beneficiaries of the trust, none of the family members will be able to exempt themselves from TOSI through the use of the “excluded shares” exemption (which may be available to taxpayers owning shares with at least 10 percent of the votes and value of a corporation). That’s because this exemption requires that the shares be held by the individual directly. As a result, taxpayers who own shares of a private corporation through a family trust will need to look to the other TOSI exclusions to alleviate the potential tax burden.
For some taxpayers this is an undesirable result, as the remaining exclusions typically require a certain level of involvement within the business, either through labour or capital contribution, while the “excluded shares” exemption allows individuals to receive income from a corporation simply on the basis of share ownership.
New reporting requirements
Another way that the advantages of using a trust may be limited in the future is through the new reporting requirements that will come into effect in 2021. These new rules will require that certain types of trusts file a T3 return more frequently and provide more personal identification information relating to beneficiaries, settlors and protectors of the trust.
The impact here is that by increasing these reporting requirements, the government will now have more information at its disposal regarding Canadian property and those who are entitled to it.
For example, where property is owned by a trust, the trust will now be required to file an annual T3 return that will notify the government when beneficiaries of the trust—in other words, those who are entitled to the property—change. This increased information is likely to form the basis for future tax changes. At the very least, it is sure to lead to additional scrutiny of taxpayers.
Advantages to using a trust
While these changes mean that some of the advantages to using a trust may be limited, there are still multiple tax and non-tax advantages to using a trust.
Multiplication of the Lifetime Capital Gains Exemption (LCGE)
From a tax perspective, one of the major remaining benefits of using a trust—when it comes to holding shares of a private corporation in particular—is that by having multiple beneficiaries to the trust, it is possible to effectively multiply the LCGE on the disposition of shares of a qualified small business corporation (QSBC).
Multiplying the LCGE will allow each family member that is a beneficiary to the trust to shelter from tax $848,252 (in 2018) of any gain that has been allocated to them on the sale. A family of four would therefore be able to jointly shelter $3.39 million in gains from tax through the use of a trust, which provides a significant tax advantage.
Maintaining QSBC status of shares
In light of the new income splitting rules, it is helpful to ensure that your private corporation meets the criteria for being considered a QSBC. This is due to the fact that taxable capital gains on the disposition of QSBC shares are exempt from TOSI. Where a private corporation is not considered a QSBC (as a result of holding a large value of passive assets), a trust can be a helpful tool for purifying the corporation to meet the definition.
For example, a trust with a corporate beneficiary could be introduced (through a reorganization) as a shareholder of an operating company (Opco). Opco could then pay dividends to the trust, which would then allocate the income to the corporate beneficiary, thus allowing for constant purification of Opco using inter-corporate dividends.