Trust – Page 6 – Doug Carroll

Using power of attorney to create a trust for a grantor

At issue

A person may grant power of attorney to one or more others to make decisions about the grantor’s property. Such powers may operate concurrent with the grantor’s own capability to make decisions, and may allow such decisions to be made when the grantor is incapable. Though the terminology and rules vary a bit, each province allows the execution of a legally binding document of this nature.

Generally, attorneys powers fall short of making testamentary dispositions, the clearest sort being the making of a Will on behalf of the grantor. However, the respective province’s legislation must be carefully considered before coming to a conclusion about what that means.

A recent case and follow-up inquiry to the Canada Revenue Agency shed some light on planning possibilities in British Columbia, and may have implications elsewhere.

Power of Attorney Act, RSBC 1996, c 370

Under s.13, an adult may grant to another person the ability to make decisions and act as agent with respect to the person’s property. The attorney will be able to do anything that the granting adult could lawfully do with the property.

However, a specific limitation is provided in s.21, stating that “an attorney must not make or change a will for the adult for whom the attorney is acting.”

Easingwood v. Cockroft, 2013 BCCA 182

In this case, two adult children acting as attorneys create an alter ego trust for their grantor/father. The effect was to transfer a significant portion of the father’s assets into the trust, thereby removing those assets from distribution via the father’s Will and estate, with the intended effect of reducing probate tax and some income tax. The terms of distribution after the father’s death mimicked the terms of the existing Will.

The father’s wife (a later spouse, not the mother of the attorneys) challenged the validity of the trust settlement. She was also pursuing a claim under the BC Wills Variation Act (in force when the events occurred), seeking an altered distribution of the estate.

This appeal court upheld the trial judge’s finding that there is no legal reason why the attorneys could not establish a trust in the course of their administration. And specific to the trust that was created, it did not diverge from the grantor’s “known intentions as reflected both in the will and the marriage agreement” previously validly executed between the spouses.

2014-0523331C6 E – CALU CRA Roundtable

Following from the Easingwood ruling, at the May 2014 meeting of the Conference of Advanced Life Underwriters, the question was posed to the Canada Revenue Agency whether the purported creation of an alter ego trust would result in tax-deferred rollover of the capital property.

The CRA response is a bit roundabout, first providing a summary of the findings in Easingwood, then stating that the focal issue is whether the transfer of the property is “by the individual” and whether the trust has been created “by that individual”.

While not being definitive as to whether the actions of attorneys qualify in this respect, the closing comment suggests that an attorney should seek affirmation from an applicable court that the attorney has appropriate powers and is properly exercising them. Assuming the attorney takes this action, it appears that the CRA would not oppose it.

Practice points

As noted in Easingwood and by the CRA, there is a uniqueness to those facts, in particular that the trust terms effectively mimicked the existing Will. Generally, attorneys will not be able to take actions that lead to a different testamentary outcome.
The particular province’s legislation will have to be consulted to determine whether attorneys elsewhere may undertake this kind of planning.
Comments from the CRA are administrative in nature, without legal effect, and are not even binding on the CRA itself. Still, in a practical sense, there does appear to be a planning avenue after a person becomes incapacitated, so long as the actions comport with the grantor’s existing plans and known intentions.

Trust issues – The end of testamentary trusts?

There was an collective, almost-audible gasp from the estate-planning community when Finance Minister Jim Flaherty announced in the 2013 Federal Budget that testamentary trusts would be placed under the tax microscope. While not technically “the end” for such trusts, the budget brought into question whether the key benefit of graduated tax bracket treatment would remain available to them and to grandfathered pre-1971 inter vivos trusts.

In June 2013, the government published a consultation paper on the issue (the consultation period closed December 2, 2013), soliciting input from all interested individuals and organizations. As proposed, these changes have the potential to:

fundamentally change future estate-planning processes and decisions,
force existing plans to be reconsidered and possibly reconstructed, and
disrupt existing trusts that may have been in place for years or even decades.

Key benefit: Graduated tax brackets

A testamentary trust comes into being on a person’s death, with the trust terms generally provided for in the person’s Will. In fact, an estate itself is a testamentary trust, irrespective of whether a Will exists or what may be stated in it. There’s more on estates below within the summary of proposed changes (see “Challenged to respond”).

A trust is subject to the combined federal-provincial tax rates where it’s determined to be resident. As compared with an inter vivos trust (one created during one’s lifetime) that is taxed at the top marginal tax rate, a testamentary trust is entitled to use graduated tax brackets. Though it cannot claim tax credits available to an actual human being, a testamentary trust can thus experience a tax-rate reduction of 20% or more in some cases.

Proposed changes

Put simply, the proposals would subject these trusts to flat top-rate taxation. In the case of estates, graduated treatment would be allowed for up to 36 months, after which flat top-rate taxation would apply. The measures would apply to existing and new arrangements for the 2016 and later taxation years.

A number of further implications flow from this change:

Tax instalments – Instead of being allowed to pay taxes at year-end, quarterly tax instalments would be required
Alternative minimum tax calculation – As is the case for existing inter vivos trusts, the $40,000 exemption would no longer apply
Year-end – Rather than being able to choose its year-end, such trusts would be subject to a calendar year-end
Distributions to non-residents – The exemption from part XII-2 distribution tax would no longer apply
Tax-deferred distributions – Rather than being automatically a “personal trust” that may transfer assets at cost base to beneficiaries, conditions would attach to such characterization
Investment tax credits – These credits would no longer be allowed to be transferred to beneficiaries, and therefore could only be used to calculate the trust’s own income
Tax administration – Extended time periods for certain refunds, assessments and filings would no longer be available

The proposals would not affect capital property rollover rules for spousal and common-law partner trusts, but otherwise the changes would apply to the operation of these trusts.

For disabled and minor-age beneficiaries, income would still be able to be taxed to qualified beneficiaries while being retained in the trust, though the trust itself would be subject to flat top-rate taxation.

The fallout

The government’s stated concern is that beneficiaries of these impugned trusts may access more than one set of graduated tax rates, raising questions of “tax fairness and neutrality.” With respect to grandfathered pre-1971 inter vivos trusts, I agree that tax planning undertaken almost half a century ago should not continue to provide tax benefits indefinitely. However, in the case of testamentary trusts – where you must die for the wheels to be set in motion – we need to tread far more carefully.

Accepting that the system may be open to abuse by some, there is a much broader swath of the population who, by no fault of their own, find themselves in a vulnerable position due to the death of a key household provider. Juxtaposed with “tax fairness,” life itself has not been fair to these widows or widowers, orphans and other dependants. There are valid personal and public policy reasons for the “neutrality” of the tax system to give way in such circumstances.

Challenged to respond

Wills prepared under the prevailing rules may need to be redrafted, and other planning avenues may need to be considered. Apart from the confusion and complication this could introduce, there is also a cost. Practically, inaction may be the default result; or if a testator is now incapable, no corrective action would be possible anyway.

Surrounding estate-planning measures would also be affected. For example, the quantum of life insurance may now be out of sync — whether those proceeds are intended to flow through a testamentary trust or directly to a beneficiary — on the assumption of existing tax treatment applying to other assets flowing through a testamentary trust. As with wills, there is the potential for confusion and complication, and a very real possibility that insurability would limit or eliminate manoeuvring options.

Trusts and small business corporations – Flexibility in family wealth management

The trust has existed under common law for centuries and can be devoted to a wide variety of purposes. In essence, a trust structure separates legal ownership of property from beneficial ownership. In the hands of a business owner, a trust may likewise be applied for many purposes, but the focus is often on tax results.

For that business owner, the property in question consists of shares of a business corporation, with the trust beneficiaries being a combination of spouse, children and possibly extended family members. The business owner would generally be cast in the role of trustee – often with one or more other trustees – having the ability to legally manage the shares on an ongoing basis.

Though not exhaustive, summarized below are a number of key benefits of this arrangement. Circumstances will dictate whether and to what extent this may impact a particular individual or business, and therefore, consultation with qualified tax and legal professionals is a must before acting upon any of this information.

From an income perspective:

Shares may be structured in such a way so dividends can be paid to the trust as a shareholder. In turn, the trustees will have the power to manage the distribution of dividends to the trust beneficiaries. As a flow-through from the trust, beneficiaries receiving dividends will generally be entitled to the dividend gross-up and tax credit.

The effective tax rate on Canadian dividends is less than it is for regular income (e.g., interest and registered plan income), and can even be lower than the rate for capital gains, particularly for those individuals not in the top income tax bracket. There is actually a level where a taxpayer will pay no tax on the dividends if that person has no other income. For ineligible dividends (where the prior corporate income benefited from the small business deduction), the ‘tax-free’ dividend level ranges from a low of $7,000 to about $35,000, depending on the province.

Note that an anti-avoidance measure (known colloquially as the “kiddie tax”) effectively negates the preferential tax treatment of such dividends paid to minors related to the business owner, whether directly or via a trust. This measure may also apply to capital gains if dividend payments have been withheld on the shares.

From an ownership perspective:

Generally, capital gains on business corporation shares will be realized on disposition at the business owner’s initiative, or possibly deemed so upon that person’s death. One or more trusts are often components of an estate-freezing exercise whereby eventual capital gains on these shares are sought to be pushed to younger generations. The freeze can be implemented by changes in beneficial ownership that may involve absolute transfers or may instead make use of intermediate vehicles, such as further corporations and/or trusts.

In addition to the capital-gains-freeze aspect, the concurrent purpose of this exercise is to multiply access to the lifetime capital gains exemption on qualifying small business corporation shares. The exemption (proposed to increase from $750,000 to $800,000 pursuant to the 2013 Federal Budget) is a per-person entitlement and can be structured using one or more trusts so the tax benefits can be achieved without the business owner losing control of the enterprise.

From a protection and control perspective:

Subject to share provisions and/or a shareholders’ agreement, direct share owners generally have full ownership rights. Even when in a minority position, securities legislation may entitle a shareholder to require a corporation to take actions contrary to the controlling majority’s wishes. By separating beneficial from legal ownership, a trust can help the business owner achieve wealth- and estate-planning ends while muting business complications that might otherwise arise.

In addition to being subject to attack from others, property owned directly by an individual is exposed to the individual’s own frailties. A trust can provide a greater degree of insulation against present and future risks and uncertainties, such as creditor claims, matrimonial disputes, mental incapacity or the death of that individual.