Known as in-trust, in-trust-for, or simply ITF, parents may often hold investment accounts earmarked for a minor child’s needs. While historically these trust accounts have been most commonly associated with education planning, they need not be constrained to that purpose alone. In particular, there are tax benefits that may be gained.
However, to take effective advantage in this broader sense, greater formality is necessary. By carefully documenting and monitoring the arrangement, a family will be better able to calculate the tax benefits and obtain more certainty that those benefits will indeed be realized.
An informal trust?
Parents may view an ITF as an informal way to isolate savings, but there must truly be a trust relationship in order for the tax benefits to be realized. To paraphrase Yoda of Star Wars fame, a trust either “is or is not,” so the use of the term “informal trust” is something of a misnomer. Thus, it must be clear what the property is, who will benefit from that property, and that there is a discernible intention to transfer ownership of that property into this new relationship.
The principal benefit to be gained is to have as much of the income as possible taxed in the child’s low tax bracket. Absent the trust, all income will generally be taxed in the parent’s hands. With the trust in place
- interest and dividends will still be attributed back and taxed to the parent,
- income-on-income (so-called second-generation income) will be taxed to the child, and
- realized capital gains will be taxed to the child.
Follow the money
It is important to understand that a taxpayer must be able to prove entitlement to a tax benefit, not for the Canada Revenue Agency (CRA) to disprove it. Logistically, this presents some challenges when an ITF is employed.
In the classic ITF, all income is initially reported as that of the parent, being that it is that person’s Social Insurance Number that is on file with the investment company. In order to transfer taxation into the child’s hands, a note will have to be attached with the parent’s annual income tax return. In turn, a tax return should be filed on behalf of the child. Often there will be no tax due from the child given the basic personal exemption, but it is a good idea to nonetheless file the return to demonstrate you are in compliance with CRA filing rules.
Likewise, good recordkeeping is critical to being able to distinguish the types of income generated, in order to allocate the tax liability to the correct party. This can be especially complicated if the investment account is a combination of parent-sourced funds and the child’s own money, the latter being included because investment companies will not generally enter into contracts with minors. To the extent that these are commingled, it may become difficult – if not impossible as rebalancing and second-generation income come into play – to know what is whose, recalling once more that the onus is on the taxpayer vis-à-vis the CRA.
It may be preferable to use at least two accounts, both of which will be ITFs in form, though in substance their source funds differ. The first account will be the child’s own money; for example, from the Canada Child Tax Benefit, the Universal Child Care Benefit or an inheritance. The ITF format is an administrative convenience, and all income of whatever sort is to be taxed to the child.
The second account will be the true trust arrangement whereby the parent-sourced funds are gifted from the parent to be invested for the child. The above-mentioned tax-filing procedure would apply to this account. Ideally, each year the second-generation income would be shuttled over to the first account, thereafter completely clear of being attributed back to the parent..
A role for corporate class
This is a situation where corporate class mutual funds may offer some value. Such funds do not distribute interest and foreign income, two of the income types that are subject to immediate attribution. Of the two types of income that are distributed, Canadian-eligible dividends will still be attributable (at first generation) to a parent under an ITF, but capital gains distributions will be taxed to the child.
