ALTER EGO TRUSTS/JOINT PARTNER TRUSTS - TIPS, TRAPS & PLANNING*
M.E. Hoffstein**
Introduction
It has now been almost 4 years since the introduction of the concepts of alter ego trusts
and joint partner trusts. This paper will explore some of the benefits of these trusts, identify
some of the pitfalls to be aware of and discuss some estate planning using these trusts in
particular in interprovincial tax planning.
1.
Alter Ego and Joint Partner Trusts - Definitions and Tax Rules
The Income Tax Act1 was amended in 2000 to provide for a number of new types of
trusts.2 Two such trusts are the alter ego trust and the joint spousal or common-law partner trust
(“joint partner trust”).3
In order for a trust to qualify as an alter ego trust or joint partner trust, it must meet
certain conditions.4 In both cases, the trust must be resident in Canada. In addition, the
following conditions apply to an alter ego trust:
(a)
at the time of the trust’s creation, the taxpayer creating the trust was alive,
resident in Canada, and had attained 65 years of age;
(b)
the trust was created after 1999;
* Presented at the Canadian Tax Foundation - 2004 Ontario Tax Conference
** Partner, Fasken Martineau DuMoulin LLP
The author would also like to gratefully acknowledge the following people in their assistance in the preparation of this paper:
Professor Adam Parachin
David Fox, Associate at Fasken Martineau DuMoulin LLP; and
Edward Yanoshita, Student-at-Law at Fasken Martineau DuMoulin LLP
1
2
3
4
Income Tax Act, R.S.C. 1985 c.1 (5 th Supp.) as amended (hereinafter referred to as the “Act”)
The amendments received Royal Assent on June 14, 2001 pursuant to S.C. 2000 c.17
Subsection 248(1) defines alter ego trust to mean a trust to which paragraph 104(4)(a) would apply without
reference to subparagraph 104(4)(a)(iii) and clause 104(4)(a)(iv)(b) and (c). A joint spouse or common law
partner trust is defined in subsection 248(1) to mean a trust to which paragraph 104(4)(a) would apply if that
paragraph were read without reference to subparagraph 104(4)(a)(iii) and clauses 104(4)(a)(iv)(A)
Subsection 73(1), (1.01) and (1.02)
DM_TOR/900039-00001/1100282.1
-2(c)
the taxpayer is entitled to receive all of the income of the trust that arises before
the taxpayer’s death;
(d)
no person except the taxpayer can, before the taxpayer’s death, receive or
otherwise obtain the use of any of the income or capital of the trust; and
(e)
the trust did not make an election referred to in subparagraph 104(4)(a)(ii.1). If
this election is made after any assets are transferred to the trust, then no rollover
will be available on the transfer of the assets into the trust, and the first deemed
disposition of the trust will occur 21 years after the establishment of the trust, and
the first deemed disposition of the trust will occur 21 years after the establishment
of the trust and every 21 years thereafter.
With respect to joint partner trusts, the following additional conditions apply:
(a)
the taxpayer or the taxpayer’s spouse or common-in-law partner5 must, in
combination with the partner6 or taxpayer, as the case may be, be entitled to
receive all of the income of the trust that arose before the later of the death of the
taxpayer and the death of the partner; and
(b)
no other person can, before the later of those deaths, receive or otherwise obtain
the use of any of the income or capital of the trust.
It should be noted that the alter ego trust and joint partner trust provisions of the Act do
not preclude the possibility of there being remainder beneficiaries other than the estate of the
settlor. It is therefore possible for an alter ego and joint partner trust to provide for a gift over
following the death of the settlor, (in the case of an alter ego trust), and the death of the last to
die of the settlor and the partner of the settlor, (in the case of a joint partner trust).7
5
6
7
See definition in subsection 248(i)
The spouse or common-in-law partner will be referred to as “partner”
It should be noted that paragraph 73(1.02)(b)(a) contemplates that an individual under 65 years old can also
establish a trust into which property can be transferred on a rollover basis. In such a case, however, no person
other than the settlor may have an absolute or contingent right as a beneficiary (as defined under 104(1.1) under
the trust. Therefore, the settlor of such a trust cannot provide for a gift over of trust property upon his or her
death. This is different from the rules relating to an alter ego trust, which do permit gift over provisions. The
provisions of subsection 107.4(1) are also of interest. They provide that a transfer of property to a trust, where
the disposition does not result in a change in the beneficial ownership of property, is a qualifying disposition
such that property can be transferred to such trust on a rollover basis. It is interesting to note that while
subsection 73(1.02)(b)(ii) requires the trust to provide that the net income must be paid to the settlor,
subsection 107.4(1) has no such requirement.
DM_TOR/900039-00001/1100282.1
-3A transfer of property to a trust will generally constitute a taxable disposition8. Transfers
to alter ego trusts and joint partner trusts, however, are an exception to this rule and as a result
will occur on a tax deferred basis (subject to the rights of the settlor to elect out of the rollover).9
Subsection 104(4) of the Act provides that a trust is deemed to have disposed of its
property for proceeds equal to its fair market value and to have immediately reacquired such
property for fair market value on the day that is 21 years after the latest of:
(a)
January 1, 1972;
(b)
the date the trust was created; or
(c)
the day determined under paragraphs (a)(a.1) or (a.4) of 104(4) where applicable
and every 21 years thereafter.
Spousal trusts, alter ego trusts and joint partner trusts are an exception to this rule.
With respect to alter ego trusts, a deemed disposition of the assets of the trust will occur
on the death of the settlor and, in the case of a joint partner trust, on the death of the last
surviving spouse. Gains or losses resulting from this deemed disposition will be taxed in the
trust and cannot be taxed in the hands of a beneficiary of the trust. If the trust distributes
property to someone other than the settlor (in the case of an alter ego trust) or the settlor or his or
her partner (in the case of a joint partner trust) while the settlor (or in the case of a joint partner
trust the settler and his/her partner) is alive, a deemed disposition for proceeds equal to the fair
market value will result and again any gains/losses will be taxed in the trust and cannot be
deducted and taxed in the hands of a beneficiary.
It is possible for an alter ego trust to elect to have the 21 year rule apply to the trust. In
such a case the first deemed disposition date will be the 21st anniversary of the date the trust was
established irrespective of whether the settlor dies before that date. If the election to have the 21year deemed disposition rule apply is made by the alter ego trust, subsection 73(1) of the Act will
not apply thus preventing the settlor from transferring property to the trust on a tax-deferred
basis.
8
9
ss248(1) for definition of disposition.
73(1), 73(1.01)(c)(ii) and 73(1.02)
DM_TOR/900039-00001/1100282.1
-4As stated above, any gains or losses arising on the deemed disposition of the trust
property will be taxable to the trust. The deemed disposition under paragraph 104(4)(a) is
deemed to occur at the end of the day on which the settlor dies such that the provisions of
subsection 75(2) will not apply.10 Given that an alter ego trust or joint partner trust must by
definition be created during the lifetime of the settlor it cannot meet the definition of
“testamentary trust”11, and is therefore considered an inter vivos trust. Thus, the capital gain
arising on the deemed disposition resulting from the death of the settlor may bear more tax than
would otherwise have borne in the hands of the deceased.12
In passing, it should be noted that an alter ego trust will be deemed to have disposed of
and reacquired property if it is reasonable to conclude that the property was transferred to the
trust by the settlor in anticipation that the taxpayer would cease to be resident in Canada. In such
a case the deemed disposition would occur on the first day after the transfer when the settlor
ceases to be resident in Canada.13 In addition, if trust property is distributed by an alter ego trust
or joint partner trust to a person other than the life tenant(s) during the life tenant(s)’s lifetime,
the trust will be deemed to have disposed of its property for fair market value.14
Where subsection 70(5) of the Act applies to deem the individual to have disposed of his
or her capital interest in the alter ego trust immediately before death, paragraph 108(1)(a.1) of
the Act provides that the cost amount of the individual’s capital interest is adjusted to take into
account the deemed disposition of the trust’s property under subsection 104(4). This will ensure
that the deceased individual is not subject to tax on the deemed gain that will be subject to tax in
the alter ego trust.
When these trusts were first introduced they were initially considered to be important
tools for the estate planner. While there are a number of advantages, and while in some cases
such trusts offer the only solution, it is important to be aware of the pitfalls in using such trusts.
10
11
12
13
14
Technical Interpretation 2001 - 0114045, July 11, 2002; 1999 - 0013165 May 15, 2000.
Subsection 108(1) of the Act.
This is due to the fact that, as described above, unlike testamentary trusts and individuals, inter vivos trusts are
taxed at the highest marginal rates and therefore do not benefit from the progressive rate structure.
Paragraph 104(4)(a.3). There is an exception to property described in subparagraphs 128.1(4)(b)(i) to (iii) of the
Act that includes such property and capital property used in a business.
Subsection 107(4) of the Act.
DM_TOR/900039-00001/1100282.1
-52.
Advantages
(a)
Probate Tax Savings
A number of techniques have evolved over the past few years to minimize or eliminate
probate tax (or estate administration tax as it is called in Ontario), especially in jurisdictions such
as Ontario and British Columbia, which are the highest probate tax jurisdictions in Canada.15
These include joint ownership of property, beneficiary designations, the use of nominee
corporations to hold property, and the use of multiple wills. While the use of a trust as a will
substitute is not a new concept, it was not often considered in the probate planning process
because of the tax rule that a transfer to a trust is a taxable event for income tax purposes. The
advent of the alter ego trust and joint partner trust means that in certain cases the use of a trust
may be a viable option. The theory is that because property is transferred to a trust inter vivos
and belongs to the trust, the distribution of property on the death of the life tenant(s) will not
trigger probate tax as it does not form part of the deceased’s estate for purposes of the estate
administration tax.
(b)
Centralization of Property and Continuity of Management
Where an individual’s property is situate in multiple jurisdictions and the property forms
part of an individual’s estate passing by Wills in each jurisdiction, multiple concurrent
proceedings with respect to the vesting of such property in estate trustees can be both time
consuming and costly. By transferring property into an alter ego trust or joint partner trust,
complexity, loss of time and cost may be avoided. Through the use of a trust, the ownership of
property is centralized in one jurisdiction under the control of the trustees whose authority to
deal with the assets will not need to be subsequently ratified by a court of any jurisdiction. In
addition, on the death of the settlor, or, in the case of a joint partner trust, the death of the last to
die of the settlor and his or her spouse or common law partner, the trustees will not need to delay
the administration of the trust as they will not need to seek and obtain probate. Thus, the
management of trust property will continue seamlessly despite the death of the settlor or his or
her spouse or common law partner.
15
See Appendix 1
DM_TOR/900039-00001/1100282.1
-6(c)
Alter Ego Or Joint Partner Trust As An Alternative To A Power Of Attorney
Consideration should be given to using alter ego and joint partner trusts in planning for
the protection of a client’s assets in the event of incapacity and perhaps even more importantly,
diminished capacity, from the influence of non-traditional creditors such as caregivers and
second spouses.
The use of such trusts offers several advantages with respect to incapacity planning over
powers of attorney. First, the terms of the trust may be tailored to the specific needs of the client
by providing for specific powers and restrictions. Second, there is greater certainty with respect
to the standard of care owed where a trust is used. Third, a trust allows for the general
recognition by third parties of the trustees’ authority to deal with trust assets across different
jurisdictions, which obviates the necessity of multiple powers of attorney in circumstances where
an individual has assets in several jurisdictions. The trust nevertheless is a more costly option
both in terms of time and expense required on the creation of the trust and for ongoing
administration.
3.
Disadvantages
(a)
Limited Creditor Protection
Trusts have often been considered where the objective is the protection of property from
the claims of future creditors of an individual (including a disgruntled spouse). Generally
speaking, a fully discretionary trust affords the greatest protection in that the right of the
beneficiary is limited to what the trustee determines to distribute to such beneficiary. Until such
time as the trustee exercises his discretion, the only right of the beneficiary is the right to be
considered. A creditor who obtains a judgement against a beneficiary of a fully discretionary
trust has no better claim than the beneficiary. In addition, to maximize the protection against
creditors it is advisable that the beneficiary not be a Trustee unless he or she is one of several
trustees (more than 2) who act by majority. The level of protection afforded by a transfer of
property to an alter ego trust or a joint partner trust will be restricted in that the settlor or his or
her spouse or common law partner must be entitled to receive all of the income of the trust in
order for the rollover rules to apply.
DM_TOR/900039-00001/1100282.1
-7Pursuant to subsection 67(1) of the Bankruptcy and Insolvency Act16 property of the
settlor of an alter ego or joint partner trust may be considered to be “property of a bankrupt”,
which property vests in the bankruptcy trustee. Property is broadly defined in the BIA17 and
property vesting in the bankruptcy trustee includes all property that may be acquired by or
devolve to the settlor of an alter ego or joint partner trust before his or her discharge of
bankruptcy. Such property also includes powers in or over or in respect of the property as might
have been exercised by the bankrupt settlor for his or her own benefit.18 The latter provision
raises a concern that may be addressed by ensuring the settlor is not the sole trustee and does not
have a veto power in any way.
In the case of an alter ego or joint partner trust, consideration should be given to the best
method of protecting the settlor’s assets from being seized by the trustee in bankruptcy to satisfy
the settlor’s obligations to creditors. One method of safeguarding such an interest would be to
ensure the distribution of capital to the settlor is either precluded or is entirely within the
trustees’ discretion.
The measures described above will not however offer any protection to a settlor where
the initial transfer of property into the alter ego or joint partner trust is successfully challenged by
a creditor or by the trustee in bankruptcy and deemed to be void. The most likely basis for such
a challenge would be as a fraudulent conveyance under section 2 of the Fraudulent Conveyances
Act.19 The assets previously transferred to the trust would then be available to satisfy claims by
the settlor’s creditors.
Even if the transfer of assets into an alter ego or joint partner trust withstood such a
challenge, a trustee in bankruptcy may, where an insolvent settlor is a trustee, have the settlor
removed pursuant to subsection 14(2) of the BIA and have another (presumably more
16
17
18
19
R.S.C. 1985, c. B-3 [hereinafter the BIA].
Pursuant to Section 2(1) of the BIA property includes money, goods, things in action, land and every description
of property, whether real or person, legal or equitable, and whether situated in Canada or elsewhere, and includes
obligations, easements and every description of estate, interest and profit, present or future, vested or contingent,
in, arising out of or incident to property.
Paragraphs 67(1)(c) and (d) of the BIA.
R.S.O. 1990, c. F.29. Section 2 provides that every conveyance of real or personal property and every bond, suit,
judgment and execution heretofore or hereafter made with intent to defeat, hinder, delay or defraud creditors or
DM_TOR/900039-00001/1100282.1
-8sympathetic) trustee appointed who will exercise his discretion to distribute capital to the settlor,
such capital then vesting in the bankruptcy trustee and becoming available to creditors. The
bankruptcy trustee may also engage in a “squeeze play”, essentially opposing the settlor’s
discharge unless the trustees exercise their discretion to distribute capital to the settlor.
Essentially, a settlement of assets in trust for oneself will likely be viewed with suspicion
by the courts. Where an individual settles assets in trust for himself or herself, arguably the
courts may have little difficulty in finding that the assets of the trust should be available to pay
the transferor’s obligations.
(b)
Spousal Claims Under the Family Law Act20
Subsections 5(1) and (2) of the Family Law Act provides for the equalization of net
family property upon marriage breakdown and death of a spouse, respectively. Under the Family
Law Act division of property regime, a spouse’s entitlement is not to the property itself but rather
to an equal sharing of the value of property acquired and accumulated throughout the marriage. 21
The equalization regime divides:
(a)
the value of all assets acquired by both spouses during the marriage; and
(b)
the increase in value of the property both spouses brought into the marriage.
The Family Law Act does not expressly prohibit the alienation of assets during marriage
in an effort to minimize a spouse’s equalization claim. Where property is transferred to an alter
ego trust, the circumstances of the transfer may be subject to judicial scrutiny pursuant to a
spouse’s claim that such a transfer was made to defeat his or her right to equalization.
There is case law in Ontario providing that a settlor’s spouse may have creditor status to
attack a transfer of assets as a fraudulent conveyance pursuant to the Fraudulent Conveyances
20
21
others of their just and lawful actions, suits, debts, accounts, damages, penalties or forfeitures are void as against
such persons and their assigns.
R.S.O. 1990, c. F-3.
Property is very broadly defined under subsection 4(1) to include any interest, present or future, vested or
contingent, in real or personal property, including property over which a spouse has, alone or on conjunction
with another person, a power of appointment exercisable in favour of himself or herself and property disposed of
by a spouse over which the spouse has, alone or in conjunction with another person, a power to revoke the
disposition. A spouse’s rights under a vested pension plan are also included.
DM_TOR/900039-00001/1100282.1
-9Act. In Stone v. Stone,22 the plaintiff widow challenged an inter vivos transfer by her husband to
his children of his considerable business assets (worth over $1,000,000), as well as the husband’s
transfer of the matrimonial home to his children without complying with the provisions of
section 21 of the Family Law Act. The transfer took place soon after the husband was advised he
was terminally ill and took place without the knowledge of the plaintiff, his wife of 24 years.
The motivation for the transfer was to ensure the husband’s assets passed to his children from a
previous marriage and not to the plaintiff’s children. In addition, the husband prepared a Will
leaving the plaintiff $250,000 along with a life interest in the matrimonial home. As a result of
these transfers, there was very little in his estate upon his death. Rather than take under the Will,
the plaintiff elected, pursuant to subsection 6(1) of the Family Law Act, to take an equalization
payment and challenged the transfers as fraudulent conveyances.
At trial, it was determined that the plaintiff and her husband had been in a debtor-creditor
relationship vis à vis their Fraudulent Conveyances Act entitlements and obligations. The
transfer of property was set aside by the court as a fraudulent conveyance, and an equalization
payment of over $861,000 ordered in favour of the plaintiff out of the husband’s estate. The
court placed emphasis on Mr. Stone’s knowledge of his impending death, the fact that the
plaintiff’s assets were significantly less than Mr. Stone’s, the secretive nature of the transfers and
Mr. Stone’s acknowledgement prior to death that he anticipated litigation over the provision in
his Will and the transfer of assets to his children.
On appeal, the trial judge’s decision was upheld with the following clarification made
regarding the use of the Fraudulent Conveyances Act in the family law context:
1.
22
Spouses each own their separate property throughout the marriage; however, upon
the happening of one of the five events triggering a valuation date, a spouse is
entitled to equalization of net family property pursuant to subsection 5(1) or 5(2)
of the Family Law Act.
(1999) 46 O.R. (3d) 31 aff’d (2001) 55 O.R. (3d) 491 [hereinafter referred to as Stone]. The concept of a spouse
as a “creditor or other” under the Fraudulent Conveyances Act was reiterated in Jonas v. Jonas, [2002] O.J. No.
3058 online: QL (CJ). In that case the husband, upon separation, orchestrated the transfer of his interest in his
deceased mother’s estate to his children from a previous marriage. This was done subsequent to the
commencement of litigation by the wife with respect to child and spousal support, clearly establishing the wife’s
status as a creditor and was done despite a court order requiring the husband to provide his spouse with full
financial disclosure, including disclosure of the above interest. The court noted that the “badges of fraud” in the
present circumstances more strongly supported a finding of fraudulent conveyance than in Stone.
DM_TOR/900039-00001/1100282.1
- 10 2.
The Family Law Act does not create a debtor-creditor relationship in the form of
“an open running account which becomes a settled account on separation or
death”, but rather a debtor-creditor relationship is created between spouses only as
of the valuation date;
3.
In order for a spouse to qualify as a creditor intended to be protected from
conveyances of property made with the intention of defeating the spouse’s interest
in the equalization of net family property, the spouse must have had an existing
claim against the other spouse at the time the transfers were made. An example in
the family law context where spouses are cohabiting is a spouse’s right under 5(3)
of the Family Law Act to challenge a transfer of assets as an improvident
depletion of net family property and seek an equalization of net family property as
though the spouses were separated with no reasonable prospect of resuming
cohabitation;
4.
The Fraudulent Conveyances Act does not exclude other applicable statutory or
common law remedies that deal with the ownership of property, including the
Fraudulent Conveyances Act. The Family Law Act does not specifically exclude
the Fraudulent Conveyances Act as a means of determining the net family
property of each spouse on the valuation date; and
5.
A spouse cannot, via deliberate non-disclosure of the transfer of assets, deprive
the other spouse of his or her ability to establish himself/herself as a creditor.
In the context of alter ego trusts, if a court determines a settlor has transferred his or her
assets to such a trust for the purpose of reducing his or her net family property, thereby defeating
a spouse’s entitlement to equalization, it appears that such a transfer may be set aside and the
value of the assets included in the calculation of the settlor’s net family property.
(c)
Dependants’ Claims Under the Succession Law Reform Act23
Part V of the Succession Law Reform Act provides a regime under which dependants24
may challenge the adequacy of the support provisions made for them in a deceased’s Will.
Subsection 72(1)(e) provides that the value of certain transactions are deemed to be part of the
deceased’s estate for the purpose of ascertaining the value of the estate and determining what is
available to be charged for payment of a dependant’s claim:
any disposition of property made by the deceased in trust or
otherwise, to the extent that the deceased at the date of his or her
death retained, either alone or in conjunction with another person
23
24
R.S.O. 1990, c. S.26.
As defined in section 57 to mean spouse or same-sex partner, parent, child, and brother or sister of the deceased.
DM_TOR/900039-00001/1100282.1
- 11 or persons by the express provisions of the disposing instrument, a
power to revoke such disposition, or a power to consume, invoke
or dispose of the principal thereof, but this provisions of this clause
do not affect the right of any income beneficiary to the income
accrued and undistributed at the date of the death of the deceased.
Based on the above, property transferred to an alter ego trust might be considered to be
part of the settlor’s estate pursuant to a dependant’s claim under the Succession Law Reform Act.
What is unclear is whether the use of an irrevocable alter ego trust would successfully preclude
such a claim. In Swire v. Swire Estate25, the applicant widow contended that a trust fund her
deceased husband had established for his grandchildren, amounting to approximately $600,000
at the time of the widow’s dependant relief claim, should be considered part of the deceased’s
estate. Although the court determined the trust fund “relevant to the overall picture”, it was not
included in the value of the estate because it was irrevocable. However, the issue was addressed
summarily, given the failure of the applicant to raise the issue of the trust fund in her pleadings
and the judge’s order for directions.
The use of an irrevocable alter ego trust to defeat a Succession Law Reform Act claim
may depend on the interpretation of the wording “or a power to consume, invoke or dispose of
the principal thereof”. While there has been no jurisprudence on the interpretation of these
words, a settlor who is both a capital beneficiary and a trustee may be seen to have retained a
“power to consume”, whereas a settlor who is a capital beneficiary may only be seen to have a
right, but not a power, to consume. It is arguable, however, that a settlor who has only an
income interest has no “power to consume”.
(d)
Claims Under the British Columbia Wills Variation Act26
Section 2 of the Wills Variation Act provides a regime for dependants of a deceased to
claim support from the deceased’s estate where the provisions for support of such dependant in
the deceased’s will are inadequate. The Wills Variation Act is unique among dependant relief
legislation in that a dependant in B.C. does not have to have been financially dependant on the
deceased in order to pursue a claim. The Wills Variation Act, therefore, results in a limitation on
testamentary freedom.
25
(1986) E.T.R. 246; aff’d on other grounds, [1987] O.J. No. 1083 online: QL (CJ).
DM_TOR/900039-00001/1100282.1
- 12 Inter vivos trusts are a common method in B.C. to avoid the application of the Wills
Variation Act. While the effectiveness of such a transaction may be questioned vis a vis spouses
in light of the Stone decision in Ontario, it may continue to be effective to curtail claims of adult
children unless such children have a legal or equitable right.27
(e)
Cost and Complexity
Other factors to consider in transferring property to an alter ego trust or joint partner trust
include the additional costs associated with the implementation and ongoing administration of
such trusts including legal fees, accounting fees, trustee fees, the time required of the trustees in
administering the trust and filing the necessary tax returns, and the settlor’s loss of control over
assets transferred to such trusts.
4.
Some Tax Issues
(a)
Loss of Testamentary Trust Tax Rates
A significant tax issue pertaining to the use of alter ego and joint partner trusts is the loss
of the graduated rates of tax enjoyed by testamentary trusts. It will be recalled that inter vivos
trusts are subject to the top marginal rates of tax while testamentary trusts enjoy the graduated
rates of tax. If it is desired to retain access to the graduated rates of tax by using multiple
testamentary trusts for children and other issue, the use of an alter ego trust or joint partner trust
will not achieve this result.
The term “testamentary trust” is defined in subsection 108(1) of the Income Tax Act as a
trust that arose on or as a consequence of the death of an individual, including a trust referred to
in 248(9.1) other than:
A trust created after November 12, 1981 if, before the end of the
taxation year, property has been contributed to the trust otherwise
than by an individual on or after the individual’s death and as a
consequence thereof …
Clearly, alter ego trusts and joint partner trusts do not qualify as testamentary trusts. The
question, however, is whether a trust can be set up during the lifetime of a person which will
26
R.S.B.C. 1996, c. 490.
DM_TOR/900039-00001/1100282.1
- 13 qualify as a testamentary trust under the Act and which can receive the property of the alter ego
trust following the death of the settlor. In the past, CCRA has accepted that an executory trust
which receives the proceeds of a life insurance policy on the death of an individual will be
viewed as a testamentary trust.28
However, in the case of a transfer of property from an alter ego trust to a trust created
after the death of the settlor of the alter ego trust, CCRA takes the position that this is not a
testamentary transfer from the settlor. This position has been confirmed in a number of technical
interpretations.29
In commenting on the difference between the positions with respect to life insurance
proceeds CCRA notes as follows:30
You referred to CCRA document 9238555, in which we opined
that a trust which is created upon or after the death of an individual
is not disqualified as a testamentary trust solely by reason of
receiving the proceeds from a life insurance policy as a
consequence of the death of that individual. That opinion was
based on the understanding that no amount would be settled on the
insurance trust prior to the receipt of funds from the insurance
policy as a result of the individual’s death, that the individual who
died was the owner of the policy and had designated the trust as
the beneficiary of the insurance policy and that the insurance
designation was a testamentary instrument. Although the terms of
such a trust may be set out before the individual’s death, separate
from the individual’s will, our comments were based on the
understanding that the trust would not be created until such time as
the insurance proceeds were settled upon the trust. It remains our
view that a trust which was settled prior to the individual’s death
remains an inter vivos trust following the death of that individual,
27
28
29
30
Supra note 22.
In Technical Interpretation 9238555 issued February 4, 1993, dealing with a life insurance policy, Revenue
Canada considered whether a trust which was established during the lifetime of an individual to receive the
proceeds of a life insurance policy on the death of the individual would be a testamentary trust. The issue was
whether the trust would be legally created at the time of the payment of the life insurance death benefit as a
consequence of the death of the individual. Revenue Canada was of the view in that Technical Interpretation that
a trust funded from the proceeds of a life insurance policy available on the death of an individual will be viewed
as a testamentary trust within the meaning of paragraph 108(1)(i), even though the terms of the trust will have
been established by the individual during his life separate from his will.
Technical Interpretation 2000 - 0059755, March 23, 2001; 2000 - 0075375, March 23, 2001; Technical
Interpretation 2000 - 0005135, March 23, 2001; and 2001 - 0079285, November 2, 2001.
Technical Interpretation 2000 - 0059755, March 23, 2001; and 2000 - 0075375 March 23, 2001.
DM_TOR/900039-00001/1100282.1
- 14 even though it may receive the bulk of its capital as a beneficiary
under an insurance policy.
CCRA goes on to note that inter trust transfers between testamentary trusts do not
disqualify the trust from being a testamentary trust:
A trust is not disqualified from being a testamentary trust where as
a consequence of an individual’s death, property is contributed to
the trust, on or after the individual’s death, providing the trust
otherwise qualifies. The definition of a testamentary trust does not
require that the transfer occur at a particular time and a
contribution to a testamentary trust may occur at a later date; for
example, following the death of the individual’s spouse. In this
case, the transfer to the second testamentary trust is from a
testamentary trust, for the benefit of the spouse, through the
direction given in the decedent’s will. Similarly, it is possible for a
contribution to be made to an existing testamentary trust on the
death of an individual. For example, a parent may direct that on
death, a portion of his or her estate would be contributed to a
testamentary trust established by a grandparent. The transfer of
property to an existing trust would be a contribution on or after the
individual’s death and as a consequence thereof.
The position of CCRA is therefore clear: property transferred to an inter vivos trust does
not belong to the settlor of the trust. On the settlor’s death, therefore, the property of the trust
cannot be considered to be a “contribution by the settlor as a consequence of the settlor’s death
to a trust that is created subsequent to the settlor’s death”, i.e., a contribution by the settlor to a
testamentary trust. The impact of this loss of testamentary tax rates must be carefully weighed
against the tax savings that can result from the establishment of alter ego and joint partner trusts,
such as, for example, probate tax savings, in determining the best estate planning strategy for a
particular client.
(b)
Charitable Gifts31
Charitable gifting is a critical estate planning consideration for many individuals. It is
therefore relevant to consider some of the unique charitable gifting issues that are raised by the
establishment of alter ego trusts and joint partner trusts. These issues may be illustrated by
comparing the disparate tax consequences of an individual making a gift to charity in his or her
31
The contribution of Professor Adam Parachin to this portion of the paper is gratefully acknowledged.
DM_TOR/900039-00001/1100282.1
- 15 will versus the establishment of an alter ego or joint partner trust which provides for a transfer of
property from the trust to a charity upon the death of the settlor, in the case of an alter ego trust,
and upon the death of the last to die of the settlor and his or her common law spouse or partner,
in the case of a joint partner trust.
(i)
Gifts Made by Will
There are three key tax advantages for an individual to provide for a gift to charity in his
or her will.
First, subsection 118.1(5) of the Act provides that a gift to charity made by will is deemed
to have been made by the donor immediately prior to his or her death. This is advantageous
because it ensures that the charitable tax credit arising from the gift may be used in the terminal
return of the donor to offset tax liability arising from the deemed disposition upon his or her
death under subsection 70(5) of the Act.32
Second, there is an enhanced donation limit for gifts made in the year of death. The usual
donation limit is seventy-five per cent of the donor’s income for the year,33 but this is increased
to one hundred per cent for gifts made in the year of death.34
Third, to the extent that the charitable tax credit arising from the gift by will is not
exhausted in the donor’s terminal return, there is a one-year carry-back of the credit to the year
proceeding the year of death.35 As with the year of death, the donation limit for the year
preceding death is one hundred per cent of the donor’s income.36
32
33
34
35
36
CCRA has recently revised its position regarding the application of subsection 118.1(5). Formerly, CCRA took
the position that subsection 118.1(5) was applicable only where the will directed the executors to make a gift to a
specific charity or a charity to be selected by the executors out of a list of charities specified in the will. If no
specific charity was mentioned or no list provided, a charitable tax credit was nevertheless available to the estate
under subsection 118.1(3). However, this was less advantageous because the estate is a separate taxpayer to the
deceased and as a result the tax credit available to the estate under subsection 118.1(3) could not be claimed in
the deceased’s terminal return to offset tax liability arising from the deemed disposition on death under ss. 70(5).
In technical interpretation 2001-0090205, dated April 11, 2002, CCRA relaxed its position on this issue so that it
is no longer necessary for the will to name a specific charity or to provide a list of charities in order to qualify for
the credit under subsection 118.1(5) of the Act.
The 75 per cent limit is bumped up to reflect 25 per cent of taxable capital gains and 25 per cent of recapture
arising from gifts to charity in the year. See the definition of “total gifts” in subsection 118.1(1) of the Act..
See the definition of “total gifts” in subsection 118.1(1) of the Act.
Subsection 118.1(4) of the Act.
See the definition of “total gifts” in subsection 118.(1) of the Act.
DM_TOR/900039-00001/1100282.1
- 16 As explained below, these tax advantages may in some ways be preferable to those
available in circumstances where charitable gifting is undertaken through an alter ego or joint
partner trust.
(ii)
Charitable Gifts and Alter Ego/Joint Partner Trusts
As indicated above, the terms of an alter ego trust are required by the Act to provide that
no person other than the settlor is entitled to receive any property of the trust during the settlor’s
lifetime. Similarly, the terms of a joint partner trust must provide that no person other than the
settlor or his or her spouse or common law partner may receive any of the property of the trust
during the settlor’s and his or her spouse’s or common law partner’s lifetime. Thus, while a
beneficiary of one of these trusts may gift to charity any income or capital paid to him or her out
of the trust, a gift to charity directly from the trust may not be made prior to the death of the
settlor, and in the case of a joint partner trust, the settlor’s spouse or common law partner.
The specific tax consequences of a transfer of property from an alter ego or joint partner
trust to a charity upon the death of the settlor (or his or her spouse or common law partner) are
dependent upon the terms of the trust. A critical variable is whether or not the terms of the trust
provide for a power of encroachment during the settlor’s (or his or her spouse’s or common law
partner’s) lifetime.
(iii)
No Power of Encroachment
The Act does not require that the settlor or, in the case of a joint partner trust, the settlor’s
spouse or common law partner, be entitled to capital from the trust during his or her lifetime.
Instead, the Act provides that no person other than the settlor or, in the case of a joint partner
trust, the settlor’s spouse or common law partner, be able to receive or otherwise obtain the use
of any of the capital of the trust during his, her or their lifetime(s). It is therefore not necessary
that an alter ego or joint partner trust contain a power of encroachment.
If an alter ego or joint partner trust provides for a charitable remainderman and does not
contain a power of encroachment in favour of the settlor or the settlor’s spouse or common law
partner, it is possible that the trust may qualify as a charitable remainder trust.
DM_TOR/900039-00001/1100282.1
- 17 A charitable remainder trust is a form of deferred giving by which a charity is gifted an
equitable interest in the capital of the trust. Since the interest given to the charity is a remainder
interest, the charity does not actually receive any property from the trust until the expiration of
all prior life interests. The settlor of a charitable remainder trust, however, is entitled to a
charitable tax credit under subsection 118.1(3) at the time that property is transferred to the trust.
The amount of the tax credit will be equal to the value of the remainder interest given to the
charity.37
There are four key criteria that must be satisfied in order for there to be a charitable
remainder trust. First, as indicated above, the terms of the trust must not provide for a power of
encroachment.
The inclusion of such a power makes it impossible to determine what, if
anything, the charity will ultimately receive from the trust and therefore precludes the issuing of
a charitable gift receipt at the time that the trust is established.
Second, the terms of the trust must provide a charity with a remainder interest in the trust.
This interest must vest in the charity at the time the property is transferred to the trust.38
Third, the trust must be irrevocable.
Fourth, the transfer of property to the trust by the settlor must be voluntary and the settlor
must have no expectation of benefit from the donee charity.39
The unique feature of a charitable remainder trust is that even though the settlor retains
an income interest in the property transferred to the trust he or she does not have to wait until his
or her death, as is the case with a gift by will, to receive a charitable tax credit under
subsection 118.1(3). It may nevertheless be preferable in certain respects for an individual to
make a gift by will to charity than to establish a charitable remainder trust.
37
38
39
Valuing the remainder interest requires an actuarial analysis of the following key factors: the fair market value of
the property transferred to the trust at the time of transfer, current interest rates, anticipated future economic
conditions, the age of the life tenant(s) and mortality tables. A power of encroachment is disallowed because the
inclusion of such a power makes it impossible to determine the value of the remainder interest.
The remainder interest will be considered to have vested in the donee charity if (1) the donee charity is in
existence and ascertained, (2) the size of the beneficiaries’ interests are ascertained and (3) any conditions
attaching to the gift are satisfied.
This correlates with the general requirement articulated in Interpretation Bulletin IT-110R3 that a charitable gift
entails a voluntary transfer of property without valuable consideration.
DM_TOR/900039-00001/1100282.1
- 18 (iv)
Timing of Tax Credit
As indicated above, a gift by will results in the availability of a charitable tax credit at the
time of death of the donor whereas a charitable remainder trust results in the availability of a
charitable tax credit at the time that the trust is established. For many donors, the charitable tax
credit will result in the greatest tax savings if it is available at the time of death, at which time a
significant tax liability will result from the deemed disposition on death under subsection 70(5)
of the Act (except to the extent that the donor has taken advantage of the rollover provisions of
the Act).
The availability of a charitable tax credit to the settlor at the time of establishing a
charitable remainder trust may be less beneficial, since the charitable remainder trust, if it is
structured as an alter ego or joint partner trust, will be established on a rollover basis. 40 In
addition, since the charitable tax credit is received by the settlor at the time of establishment of
the trust, the trust itself will not be entitled to receive a charitable tax credit at the time that it
actually transfers property to the charity. This is significant because this transfer will occur at a
time when the trust will face a significant tax liability due to the deemed realization of capital
gains under subsection 104(4) upon the death of the settlor, in the case of an alter ego trust, and
the death of the last to die of the settlor and the spouse or common law partner of the settlor, in
the case of a joint partner trust.
(v)
Amount of Tax Credit
As indicated above, the ceiling for a gift by will is one hundred per cent of the donor’s
income in the year of death and the year preceding death. Given the significant income inclusion
that may arise from the deemed disposition on death under subsection 70(5) of the Act, the
charitable tax credit available on death can be of significant value.
The ceiling for a gift structured as a charitable remainder trust, however, is lower,
namely, seventy-five per cent of the donor’s income for the year.41 The potential value of the
40
41
The donor could nonetheless carry the credit forward for up to five years to apply against his or her tax liability
in these years.
As indicated in footnote 33, the 75 per cent ceiling is bumped up to reflect 25 per cent of taxable capital gains
and 25 per cent of recapture arising from gifts to charity in the year. If the charitable remainder trust is
DM_TOR/900039-00001/1100282.1
- 19 charitable tax credit arising from the establishment of a charitable remainder trust may therefore
be significantly lower than in the case of a gift by will.
(vi)
Flexibility
A gift by will provides greater flexibility than does a charitable remainder trust. A will is
revocable and may be amended at any time. In addition, as indicated above, it is not necessary
for the donor to name a specific charity in his or her will in order to have been considered to
have made a gift by will under subsection 118.1(5).42 The will can instead leave the selection of
the charity to the discretion of the executors.43 A gift may qualify as a gift by will even if the
charity is not in existence at the time of the donor’s death where the terms of the will direct the
executors to establish the charity upon his or her death.44
In contrast, a charitable remainder trust is required to be irrevocable and must name as
the residuary beneficiary a specific charity in existence at the time that the trust is established.
The donor is therefore unable to change the gift if he or she subsequently decides to support a
different charity.
(vii)
Inclusion of a Power of Encroachment
As a practical matter, many clients will be reluctant to transfer a significant portion of
their assets to an alter ego or joint partner trust where the trust provisions do not include a power
of encroachment. There are a few possibilities for such individuals to consider.
First, an alter ego or joint partner trust could be structured as a charitable remainder trust,
i.e., no power of encroachment, with the settlor transferring only a portion of his or her assets to
the trust. The settlor could in the future transfer additional portions of his or her property to the
trust as he or she becomes more comfortable doing so. Unfortunately, however, it is the current
42
43
44
established as an alter ego or joint partner trust, however, these additional amounts (assuming no other charitable
gifts have been made in the year) will not be available since the trust will be established on a rollover basis
See footnote 32.
The will must, however, not leave the decision of whether to make a gift to charity to the executors in order to
qualify for a gift by will under subsection 118.1(5). In addition, the will must specify the dollar amount of the
gift or the percentage of the residue of the estate to be gifted to charity. Technical interpretation 2001-0090205,
dated April 11, 2002.
Technical interpretation 2000-0005187, dated March 6, 2001. The charity must in fact constitute a qualified
donee at the time that money is transferred to it by the executors.
DM_TOR/900039-00001/1100282.1
- 20 practice of CCRA to disallow a charitable tax credit for such additional contributions to a
charitable remainder trust.45
Second, an alter ego or joint partner trust could be structured to provide for a charitable
remainderman subject to a power of encroachment during the lifetime of the settlor, and in the
case of a joint partner trust, his or her spouse or common law partner. This precludes the
availability of a charitable tax credit to the settlor at the time that the trust is established. The
power of encroachment, however, provides assurance to the settlor that he or she, and in the case
of a joint partner trust, his or her spouse or common law partner, may access the capital of the
trust if this should prove necessary prior to death.
If the trust is structured in this manner, the remainder interest to charity will not become
relevant for tax purposes until property is actually transferred from the trust to the charitable
remainderman.46 There are three possible tax results at this time.
(viii)
Charitable Tax Credit Under Subsection 118.1(3)
The transfer of property from the trust to the charitable remainderman may be treated as a
charitable gift made by the trust. If this occurs, the trust will be entitled to a charitable tax credit
under subsection 118.1(3). The trust may use this charitable tax credit to offset the tax liability
of the trust arising as a result of the deemed realization of capital gains by the trust under
subsection 104(4) upon the death of the settlor, in the case of an alter ego trust, and upon the
death of the last to die of the settlor and his or her spouse or common law partner, in the case of a
joint partner trust. This will only be the case, however, if the “gift” is made by the trust to the
charitable remainderman in the taxation year in which such death occurs. The reason for this is
that, as indicated above, unlike the charitable tax credit available under subsection 118.1(5) in
45
46
In technical interpretation 2001-0101845, dated January 14, 2002, CCRA takes the position that the property
gifted to charity upon the establishment of a charitable remainder trust is an equitable interest in the trust rather
than the capital of the trust. Accordingly, it is the position of CCRA that when additional capital is transferred to
the trust there is no new gift made to charity for which a charitable tax credit is available. It is submitted that
CCRA’s reasoning in this regard draws something of an artificial distinction between the equitable interest gifted
to charity upon the establishment of a charitable remainder trust and the capital of the charitable remainder trust.
The equitable interest gifted to charity is an equitable interest in the capital of the trust. To the extent that
additional contributions of capital enhance the value of this interest an additional gift has arguably been made to
the charity for which a gift receipt should be available.
This will not occur until, in the case of an alter ego trust, the death of the settlor, and in the case of a joint partner
trust, the death of the last to die of the settlor and his or her spouse or common law partner.
DM_TOR/900039-00001/1100282.1
- 21 respect of a gift by will, the charitable tax credit available under subsection 118.1(3) cannot be
carried back (it can only be carried forward for a period of five years).
(ix)
Deduction Under Paragraph 104(6)(b)
The transfer of property from the trust to the charitable remainderman may be treated as a
distribution in satisfaction of the charity’s income interest in the trust. If this occurs, the trust
will be entitled under paragraph 104(6)(b) to deduct the amount distributed to the charity from its
income for the year of transfer. However, for purposes of determining the amount that the trust
will be able to deduct under paragraph 104(6)(b), the income of the trust will be calculated
without regard to income arising from the deemed realization of capital gains in the trust under
subsection 104(4). This characterization of the transfer from the trust to the charity, even if such
transfer occurs in the taxation year in which the deemed realization occurs, will not therefore
provide relief against the tax liability arising from this deemed realization.
(x)
Rollout Under Subsection 107(2)
The transfer of property from the trust to the charitable remainderman may be treated as a
distribution in satisfaction of the charity’s capital interest in the trust.
If this occurs,
subsection 107(2) will allow the property to be transferred from the trust to the charity on a
rollover basis. Subsection 107(2) will therefore operate to trump subsection 69(1), which, but
for subsection 107(2), would deem the trust to have received from the charity proceeds of
disposition equal to the fair market value of the property transferred to the charity. Since a
deemed realization of capital gains will in any event occur under subsection 104(4) prior to the
transfer of property to the charity, the rollover under subsection 107(2) will be of minimal to no
benefit to the trust.
Which of these three possibilities is most likely to occur?
Generally, where a gift is made out of a testamentary trust’s income to a charity, the trust
is administratively permitted to choose whether to treat the charity for that year as an income
beneficiary or to claim a charitable tax credit for the gift. CCRA has stated, however, that this
DM_TOR/900039-00001/1100282.1
- 22 administrative practice is restricted to testamentary trusts and therefore does not apply to alter
ego or joint partner trusts.47
CCRA has stated that it is ultimately a question of fact as to whether a transfer to a
charity is appropriately characterized as a charitable gift or a distribution in satisfaction of the
charity’s beneficial interest in the trust. In particular, in technical interpretation 9918215,48
CCRA stated that:
With respect to inter-vivos trust arrangements, your letter raised
questions as to the application of subsections 118.1(3) and 107(2)
on the distribution of capital property of the trust to the
discretionary capital beneficiaries. Again, we assume that the
terms of the trust provide the trustees with the discretion to make
charitable gifts. Based on this assumption, and as indicated above,
with respect to the application of subsections 118.1(3) and 104(6),
on the distribution of income from a trust to a charity at the
discretion of the trustees of the trust, this is a question of fact which
depends upon the specific wording of the trust agreement and the
intentions of the trustees in making the distribution to the charity.
[Emphasis added.]
There is therefore no “bright line” test to determine whether a transfer from an alter ego
or a joint partner trust to a charity will result in a charitable tax credit under subsection 118.1(3)
being available to the trust. However, it appears as though the availability of such a credit
requires that the transfer be capable of being characterized as voluntary. This is consistent with
the definition of a charitable gift provided in Interpretation Bulletin IT-110R3 as a “voluntary
transfer of property without valuable consideration.”
What is required in order for a transfer from a trust to a charity to be characterized as
voluntary? It is arguable that where the terms of the trust provide for a power of encroachment
in favour of the life tenant with a remainder interest to charity the eventual transfer of property to
the charity is necessarily voluntary.
47
48
This rationale was adopted by CCRA in technical
Technical interpretation 2000-0056625, dated April 4, 2001.
Although technical interpretation 9918215, dated December 1, 1999, did not deal with alter ego trusts or joint
partner trusts, CCRA stated in technical interpretation 2000-0056625 that the principles articulated in that
technical interpretation apply to alter ego trusts (which, by logical extension, means they should also apply to
joint partner trusts).
DM_TOR/900039-00001/1100282.1
- 23 interpretation 9811782 in the context of a spousal trust.49
The terms of the trust under
consideration in this technical interpretation provided for a power to encroach on capital in
favour of the life tenant with the remainder of the trust property to charity upon the death of the
life tenant. CCRA determined that the trust would be entitled to a charitable tax credit at the
time that it transferred property to the charity reasoning as follows:
The distribution by the trust to the charity constitutes a “voluntary
transfer” as the power to encroach on capital gives the trustees
discretion not to distribute any of the trust assets to any charity.
However, it is not entirely clear that a transfer from an alter ego or joint partner trust will
necessarily be treated as a charitable gift simply because the inclusion of a power of
encroachment arguably renders the transfer to the charity discretionary.
In technical
interpretation 2000-0056625, CCRA commented that:
Where the trust agreement empowers the trustees to make a gift
and the trustees exercise this power, it would be appropriate for
subsection 118.1(3) to apply. On the other hand, where the charity
is an income beneficiary and a distribution is made out of the
trust’s income, subsection 104(6) would be the relevant provision.
The difficulty with having articulated the issue in these terms is that it seems to pose as
mutually exclusive the possibility of the charity being a mere donee of a charitable gift from the
trust and the possibility of the charity being a beneficiary of the trust. These are not, however,
mutually exclusive possibilities. As a matter of trust law, no transfer may be made from a trust
to a charity unless the charity is a beneficiary of the trust. Moreover, the mere fact that a transfer
to charity is as a result of the exercise of discretion by the trustees does not lead inexorably to the
conclusion that the charity is a mere donee of a charitable gift from the trust as opposed to a
beneficiary of the trust. The definition of beneficiary contained in the Act, for example, is broad
enough to encompass persons who are discretionary income or capital beneficiaries of a trust.50
There is therefore some uncertainty with respect to what the specific tax result will be
where property is transferred to charity from an alter ego trust following the death of the settlor
49
The Department of Finance commented in the Revised Explanatory Notes issued in June 2000 that the income tax
regime for alter ego and joint partner trusts would parallel that of spousal trusts.
DM_TOR/900039-00001/1100282.1
- 24 or from a joint partner trust following the death of the last to die of the settlor and his or her
spouse or common law partner. Even assuming, however, that a charitable tax credit would be
available to the trust in respect of such a transfer it may still be preferable for the donor to
undertake charitable gifting in his or her will rather than through an alter ego or joint partner
trust.
(xi)
Timing of Tax Credit
As indicated above, the charitable tax credit arising from a gift by will is necessarily
available to offset the donor’s tax liability arising from the deemed disposition on death under
subsection 70(5). As also indicated above, however, the charitable tax credit available to the
trust (assuming that one will be available) will only offset the tax liability resulting from the
deemed realization of capital gains in the trust under subsection 104(4) if the transfer to the
charity is made in the same taxation year as the death of the settlor, in the case of an alter ego
trust, or the death of the last to die of the settlor and his or her spouse or common law partner, in
the case of an alter ego trust.
(xii)
Amount of Tax Credit
As indicated above, the ceiling for a gift by will under subsection 118.1(5) is higher than
is the case for a gift made by a trust under subsection 118.1(3). The charitable tax credit arising
from a gift made to charity under the terms of a will is therefore potentially more valuable than is
the case with respect to a charitable gift made by a trust.
(xiii)
Flexibility
As indicated above, it is not necessary for a will to name a specific charity in order for a
gift under the will to qualify for the charitable tax credit under subsection 118.1(5). Unless the
intent is to create a charitable remainder trust as defined above, there is similarly no requirement
for the terms of an alter ego trust or joint partner trust to name a specific charity as the
remainderman. Both of these gifting arrangements are therefore equally flexible in this regard.
However, since a will may at any time prior to death be revoked or amended with ease, a gift
made by will may nevertheless be said to offer greater flexibility.
50
See the definition of “beneficiary” contained in subsection 108(1) and the definition of “beneficially interested”
DM_TOR/900039-00001/1100282.1
- 25 (c)
Canada - U.S. Tax Convention Issue
The use of an alter ego trust may not be an attractive estate planning tool for a Canadian
resident who is a U.S. citizen. It would appear that the transfer of property to such a trust would
be a non-recognition transaction for U.S. tax purposes, since the trust should qualify as a grantor
trust. However, there may be an element of double tax if, for example, the grantor (settlor in
Canadian terms) is taxed in the U.S. on the income and capital gains arising in the grantor trust
while in Canada, the settlor would not necessarily be taxed on capital gains arising in the trust.
In addition, the Canada-U.S. Tax Convention appears to create a double tax situation.
Article XXIX-B deals with taxes imposed by reason of death. Article XXIX-B6 provides that in
determining Canadian tax payable by an individual who immediately before death was a resident
in Canada, the amount of inheritance tax payable in the U.S. shall be allowed as a deduction
against Canadian tax on the total income profit and gains of the individual in the U.S. in that
year. The provision does not operate seamlessly with an alter ego trust and consequently,
Canada could deny the credit for U.S. estate taxes payable with respect to U.S. situs assets.
Paragraph 7 of Article XXIX-B is the companion provision to paragraph 6, and provides
that in determining U.S. estate tax imposed on the estate of an individual who is a citizen of the
U.S., a credit shall be allowed against such tax imposed in respect of property situated outside
the U.S. for taxes payable in Canada by reason of the death of the individual. This particular
provision is more generic in scope and appears to potentially encompass the situation, which I
have posited above.
It will be recalled that from a Canadian perspective, on the death of a life tenant of an
alter ego trust, capital gains arising from the deemed disposition on death rules, are taxed in the
trust. From the U.S. perspective, it is the individual who is taxed and who obtains the credit.
(d)
Capital Losses
The provisions of subsection 164(6) of the Act permit the personal representatives of the
estate of a deceased person to elect to have losses incurred in the first taxation year of the estate
be deemed to be losses of the deceased in the last taxation year of the deceased person. There is
contained in subsection 248(25) of the Act.
DM_TOR/900039-00001/1100282.1
- 26 no provision similar to subsection 164(6) with respect to losses that arise on the death of the
settlor in the case of an alter ego trust or the settlor and his or her spouse or common law partner
in the case of a joint partner trust.
The Act does provide for a three-year carryback of capital losses against capital gains in
paragraph 111(1)(b) of the Act. However, this provision will only be available if the loss arises
in the same tax entity as the gain. It has been argued that a trust terminates on the death of the
life tenant if the provisions of the trust provide for an outright distribution to beneficiaries
following the death of the life tenant or for the distribution of the trust property to trusts for the
benefit of some or all of the beneficiaries.
In order to provide for the possibility that losses that arise in the three years after death of
the life tenant(s) are available for carryback against capital gains of the alter ego trust or joint
partner trust (arising on the death of the life tenant(s)), consideration should be given to drafting
the trust to allow for the possibility that the distribution of the capital to the reaminderman on the
death of the life tenant(s) be delayed for a period of up to three years. If this is done, it may be
possible for losses occurring within that three year period to be carried back against capital gains
arising at the death of the life tenant, since the gains and losses will arise in the same entity, i.e.,
the trust.
(e)
Private Corporations and the Double Tax Issue
An individual who owns shares of a Canadian controlled private corporation should
consider the potential for double tax in respect of such shares upon his or her death and make
provision for the steps that may be required to minimize such exposure.
Alternative tax
strategies have been devised to deal with this issue and include use of a capital dividend account,
paying tax on a deemed dividend in the estate rather than capital gains tax in the terminal return
or vice versa (having regard to different effective tax rates and the desire to take advantage of a
dividend refund in the corporation) or bumping up the cost base of some of the assets held in the
corporation. The introduction of alter ego trusts and joint partner trusts has added an extra layer
of complexities to an already complex topic. It is beyond the scope of this paper to delve into the
DM_TOR/900039-00001/1100282.1
- 27 complexities of this area and the following discussion is necessarily simply a cursory review for
the purpose of alerting the reader to some of the issues.51
A common technique to eliminate the double tax problem arising on death has in the past
been to fund the corporate repurchase of the shares of a deceased shareholder with proceeds of
life insurance. The capital gains tax arising in the hands of the deceased shareholder as a result
of the deemed disposition on death would be eliminated by a carry back of the capital loss
created on the share redemption so long as the redemption occurred in the first fiscal period of
the estate (subsection. 164(6) of the Act) and the tax which would otherwise arise in the estate on
the deemed dividend arising on the redemption of the shares would be eliminated by the
corporation electing to declare the dividend out of the capital dividend account.
Changes to the dividend stop loss rules first introduced in April 1995 have had a
significant impact on share redemption strategies funded by corporate owned life insurance.
These rules are found in subsections 112(3) to (7) of the Act. Subsection 112(3.2) provides that a
loss otherwise available to be carried back to the deceased’s terminal return under the provisions
of subsection 164(6) will be reduced if there is a payment from the capital dividend account to
the estate.. To the extent that the capital dividend exceeds 50% of the lesser of the gain realized
on death and the actual loss generated on the disposition of the shares, the loss is reduced by the
excess capital dividend amount.
The stop loss rules contain grandfathering rules for plans or arrangements that existed on
April 26, 1995. These rules can be summarized as follows:
(1) the pre-existing agreement rule, where the shares are disposed
of pursuant to an agreement in writing executed before April 27,
1996. To qualify the agreement must not be altered or modified in
any way; and
(2) the pre-existing insurance rule which provides that where the
corporation was the beneficiary of a life insurance policy on April
25, 1995, where the life insurance policy insured the life of the
shareholder or spouse of the shareholder and “ it was reasonable to
51
For excellent discussion and analysis see the paper by Jim Barnett, Peter Everett, Chris Ireland and Shelagh
Rinald, “Post Mortem Planning for Private Company Shares – The New Regime” (2002 Ontario Tax
Conference, Canadian Tax Foundation, October 28-29, 2002).
DM_TOR/900039-00001/1100282.1
- 28 conclude that a main purpose of the life insurance policy was to
fund, directly or indirectly, in whole or in part a redemption,
acquisition or cancellation of the shares.
The question which arises is to what extent the 50% relieving provisions are available
when shares are held by an alter ego trust or joint partner trust. The relevant sections are
subsections 112(3.2), 112(3.3) and their interaction with the provisions of subsection 104(4). A
review of these provisions indicate that the 50% relieving provisions will continue to have
application in the context of alter ego trusts and joint partner trusts. It is less clear whether the
grandfathering provisions apply and thus, in circumstances to which the grandfathering rules
apply, a careful review of these provisions is recommended before such shares are transferred to
an alter ego trust or joint partner trust.
(f)
GST
The settlement of property on a trust constitutes a supply for GST purposes and thus the
issue of whether GST will apply to the transfer of property will depend on the usual
considerations under the Excise Tax Act.52 If one is contemplating the transfer of corporate
shares or certain used residential complexes, these transactions are exempt supplies. It should
also be noted that if a transfer is taxable, section 268 of the Excise Tax Act bases GST on the
value of the consideration, which is the proceeds of disposition of the property for purposes of
the Income Tax Act. Thus, if there is a rollover of property to the trust, there will be no GST. If
there is an election made to opt out of the rollover provisions, GST may apply.
(g)
Trust Transfers And Land Transfer Tax
Land transfer tax is paid on the “value of the consideration” when there is a
“conveyance” of real property. The definition of “value of the consideration” in the Land
Transfer Tax Act53 has several subsections, but the main provision states that it:
includes the gross sale price or the amount expressed in money of
any consideration given or to be given for the conveyance by or on
behalf of the transferee and the value expressed in money of any
liability assumed or undertaken by or on behalf of the transferee as
part of the arrangement relating to the conveyance and the value
52
53
R.S. 1985, c. E-15.
R.S.O. 1990, c. L.6.
DM_TOR/900039-00001/1100282.1
- 29 expressed in money of any benefit of whatsoever kind conferred
directly or indirectly by the transferee on any person as part of the
arrangement relating to the conveyance.
It must be remembered that there is no exemption from land transfer tax for conveyances
involving trusts. Where there is truly no value of the consideration for such transfers, however,
the land transfer tax payable will be nil as the tax rate will be applied against a zero base. The
key question is: what is the transferee giving as consideration (regardless of the fair market value
of the land)?
In the case of a conveyance of land from a beneficial owner to trustees of an inter vivos
trust, consider the following: if the transferee pays no consideration for the conveyance, is there
an outstanding mortgage? If so, who is responsible for assuming the mortgage indebtedness
after the conveyance? If the same beneficial owner remains responsible for funding payments,
no tax should be payable. If there is an outstanding mortgage, the trustees must be holding the
land in trust for the same beneficial owner or, alternatively, for the same beneficial owner and
that person’s spouse. (There is a land transfer tax exemption for conveyances between spouses
even where there is an outstanding mortgage.) If after the conveyance, someone other than the
former beneficial owner or the person’s spouse intends to assume the mortgage obligation, the
payment of land transfer tax can be avoided by paying off the existing mortgage immediately
prior to the conveyance and then refinancing immediately after the conveyance.
If the inter vivos trust provides that the beneficial owner is the only beneficiary of the
trust during his lifetime (i.e. no encroachment for the benefit of anyone else and no assumption
of liability by anyone else), no tax should be payable. On the death of the beneficial owner, the
inter vivos trust will provide for a change in the beneficial ownership of the land. The trustees
will either be holding the land for (a) different beneficial owner(s) or the trustees will convey the
land to (a) different beneficial owner(s). At that time, tax would be payable if the new beneficial
owner(s) pay(s) any value of consideration or assume(s) any outstanding indebtedness.
Do the trustees have any beneficial interest in the land or are they simply holding the land
in trust? If they are simply holding the land in trust, even if they have some duties to perform in
their capacity as trustees, no tax should be payable.
DM_TOR/900039-00001/1100282.1
- 30 (h)
Principal Residence Exemption54
A principal residence can generally be transferred into an alter ego trust or joint partner
trust without losing the eligibility for principal residence exemption.
The definition “principal residence” in section 54 of the Act55 permits a personal trust to
designate a property as a principal residence if:
(a)
The trust’s housing unit is ordinarily inhabited in the calendar year ending in the
trust year by a specified beneficiary56 of the trust for the year or by the spouse or
former spouse of such beneficiary or by a child of such beneficiary;
(b)
There are no corporations (except registered charities) or partnerships beneficially
interested in the trust at any time in the year; and
(c)
No other property is designated as a principal residence by a specified
beneficiary, a specified beneficiary’s spouse (other than one from whom the
taxpayer was legally separated throughout the year), a specified beneficiary’s
unmarried child who is less than 18 at the calendar year ending in the trust year,
or, if the specified beneficiary is unmarried and less than 18 at the calendar yearend, by the beneficiary’s mother, father, or unmarried brother or sister who is less
than 18 at calendar year-end.
Since alter ego trusts and joint partner trusts qualify as personal trusts, the principal
residence exemption can be claimed in respect of an actual or deemed disposition of a principal
residence.
Subsection 40(4) applies when a principal residence has been transferred between
spouses and subsections 70(6) or 73(1) applied to the transfer. If property is transferred to an
alter ego or joint partner trust and the trust subsequently disposes of the property,
subsection 40(4) can apply with respect to the principal residence exemption claimed by the trust
and the trust is deemed to have owned the property throughout the period the settlor owned it and
54
55
56
See IT-120R2 for a discussion of the application of the principal residence exemption for personal trusts.
See paragraph 54(c.1)(ii) of the Act for the definition of “principal residence”.
Subsection 248(25) of the Act defines a “specified beneficiary” as an individual who, for the calendar year ending
in the trust year, is beneficially in the trust and who ordinarily inhabited the housing unit or has a spouse, former
spouse, or child who ordinarily inhabited the housing unit in the year for the purpose of the calculations in
subsection 40(2)(b) and 40(2)(c).
DM_TOR/900039-00001/1100282.1
- 31 the property is deemed to be the principal residence of the trust for each taxation year for which
it was the principal residence of the settlor.57
Prior to 1982 a family could have more than one principal residence allowing an
individual and his or her spouse to make principal residence designations with respect to two
different properties. As of 1981, a taxpayer can have only one principal residence and no other
property may be so designated by another member of the taxpayer’s family unit. As a result,
where one of the properties is transferred to an alter ego trust, the trust and the settlor can have
different principal residences for years prior to 1982. If the settlor acquires the property from his
or her spouse in circumstances to where subsection 70(6) or 73(1) applied, and then transfers it
to an alter ego trust, the property will be the principal residence of the trust for each year it is
deemed to be the principal residence of the settlor under subsection 40(4)(b), even if the settlor
designated another property as a principal residence for years prior to 1982.58
Subsection 40(4) ensures that an alter ego trust is not precluded from claiming the
principal residence exemption notwithstanding the rollover treatment of subsection 73(1).
Nevertheless, if there is a large accrued gain at the time the property is transferred to the alter
ego trust, consideration should be given to electing out of the subsection 73(1) rollover,
triggering the gain and claiming the principal residence exemption. The alter ego trust or joint
partner trust would acquire the principal residence at its fair market value at the time of the
transfer.
(i)
Capital Gains Exemption
Subsections 110.6(2) and (2.1) of the Act provide a $500,000 capital gains exemption on
the disposition of qualified farm property and qualified small business corporations shares.59
Thus, where an individual owns such property at the time of death, he or she can use the
exemption to shelter up to $500,000 of capital gains from tax.
Where such property is
transferred to an alter ego or joint partner trust, the issue arises as to whether this exemption is
57
58
59
In Technical Interpretation 2000 - 012416 dated June 19, 2000 and 2002 - 0126685 dated June 18, 2002, CCRA
considers a fact situation which contemplates inter spousal transfers and the subsequent transfer of the property
by one of the spouse to an alter ego trust.
Supra note 4.
As defined in subsection 110.6(1) of the Act.
DM_TOR/900039-00001/1100282.1
- 32 available on the deemed disposition, which occurs at the trust level on the death of the life tenant
or life tenants (in the case of a joint partner trust).
Subsection 110.6(12) provides that certain spouse trusts can access the unused capital
gains exemption of the beneficiary spouse for the taxation year in which the beneficiary spouse
dies. Since alter ego trusts and joint partner trusts are not included in the provision, in order for
the capital gains exemption to be available it would be necessary for the trust to designate to the
extent possible the deemed capital gains as taxable capital gains of the beneficiaries under
subsections 104(21) and (21.2).
Subsection 104(21) provides that in order to access this
designation, however, the taxable capital gains must be included as income of the beneficiary by
virtue of subsection 104(13), 104(14) or section 105 of the Act. The deemed capital gain arising
on the death of the settlor cannot be so allocated and is therefore taxable in the hands of the trust.
The $500,000 capital gains exemption is therefore not available to shelter the deemed capital
gains arising on the deemed disposition of qualified farm property or qualified small business
corporation shares on the death of the settlor, in the case of an alter ego trust, and on the death of
the last to die of the settlor and his or her spouse or common law partner, in the case of a joint
partner trust.
Based on the above, consideration should be given to having the settlor transfer the
qualified farm property or qualified small business shares at fair market value by electing out of
the rollover provisions of subsection 73(1) of the Act. Such an election would trigger a capital
gain in the hands of the settlor, who can then utilize the exemption under 110.6(2) or (2.1) of the
Act. A partial rollover to the alter ego or joint partner trust may also be considered where only a
portion of the capital gain can be so sheltered.
5.
Some Estate Planning Uses of Alter Ego Trusts & Joint Partner Trusts
(a)
Planning to Avoid Wills Variation Act (B.C.)
As was noted earlier in this paper, claims under the Wills Variation Act of British
Columbia may, in certain cases, be rewarded through the use of an alter ego trust to replace a
will.
DM_TOR/900039-00001/1100282.1
- 33 (b)
Probate Planning
It was noted earlier that alter ego trusts/joint partner trusts can be utilized to reduce or
eliminate probate tax and should be considered as an alternative to the other methods.
There will be circumstances where the ability to engage in probate planning through the
use of beneficiary designations and/or multiple wills is not available because the client is
incapable and one of the only alternatives to avoid or reduce probate taxes is to consider a
transfer to an alter ego trust or joint partner trust by use of a power of attorney. In these
circumstances the question arises as to whether it is possible for persons acting under a power of
attorney to engage in such estate planning. The common law imposes general limitations on the
powers that can be delegated to an attorney. These include the following:60
(a)
An attorney is a fiduciary who may not exercise the power of attorney for
personal benefit unless authorized to do so by the document or unless the attorney
acts with the full knowledge and consent of his or her principal.
(b)
A principal cannot do by an attorney an act where the competency to do the act
arises by virtue of some duty of a personal nature requiring skill or discretion for
its exercise. For example, an attorney cannot swear a verifying affidavit on behalf
of his or her principal, or exercise on behalf of that principal discretionary powers
arising by virtue of the principal’s role as a fiduciary (i.e., act as a director or as a
trustee in the place of the principal). However, once a principal who is a fiduciary
has exercised his or her discretion, the signing authority to carry the act into effect
may be validly delegated.
(c)
An attorney cannot make, change or revoke a will on behalf of the donor.
(d)
Unless the instrument provides otherwise, an attorney cannot assign or delegate
his or her authority to another person.
(e)
An attorney must not allow personal interests to conflict with those of the donor
of the power of attorney. This restriction reflects item (a) above.
The common law provides that a person cannot delegate the power to make a will.61
60
61
Thériault Powers of Attorney, Some Fundamental Issues, [1999] 18 Estates, Trusts & Pensions Journal 229 at
230-231.
For an excellent discussion on the doctrine of delegation of will-making power, see D.M. Gordon, “Delegation
of Will-Making Power” (1953) 69 The Law Quarterly Review 334 and see Chichester Diocesan Fund and Board
of Finance (Incorp.) v. Simpson [1944] A.C. 341 at 371 (H.L.). For a discussion of this case and further
comments on the topic, see Frederick D. Baker, “Are Wills Draftsmen Misusing Discretionary Powers?” (197374) 1 Estates and Trusts Quarterly 172-81. A wide variety of well-recognized and well-accepted testamentary
DM_TOR/900039-00001/1100282.1
- 34 This common law rule is codified in s. 7(2) of the Substitute Decisions Act
(Ontario)(“SDA”), which provides that a continuing power of attorney may authorize the person
named as attorney to do on the grantor’s behalf anything in respect of property that the grantor
could do if capable, except make a will.
What does it mean, to “make a will”? Subsection 1(1) of the SDA provides that “will”
has the same meaning as that provided in the Succession Law Reform Act.62 In turn, subsection
1(1) of the Succession Law Reform Act defines a will as including any “testamentary
disposition”. The restriction that an attorney may not make a will on behalf of a donor is
therefore a restriction, which prohibits attorneys from making any testamentary disposition on
behalf of donors. The question thus becomes: What constitutes a testamentary disposition?
It is absolutely clear that a gift made under a will or a codicil [read an amendment to a
will] constitutes a testamentary disposition. It is therefore certain that attorneys are prohibited
from executing wills or codicils on behalf of donors. What is less apparent, however, is how far
the definition of testamentary disposition extends.
Does it extend to the designation of
beneficiaries on behalf of a donor under a life insurance policy, RRSP, RRIF or other pension
plan? Such beneficiary designations bode testamentary implications insofar as they alter the
62
provisions appear to offend the rule. Powers of appointment both specific and general, discretionary provisions
in favour of charities, powers of encroachment and discretionary provisions that enable trustees to discriminate
among beneficiaries all appear to be acceptable.
There have been legislative enactments to change the application of this doctrine, however. The genesis of this
change appears to be the English Mental Health Act (U.K.), 1983, c. 20. Subsection 96(1) of that Act reads in
part as follows:
96(1) Without prejudice to the generality of section 95 above, the judge shall have power to make such orders
and give such directions and authorities as he thinks fit for the purpose of that section and in particular may
for these purposes make orders or give directions or authorities for …
(e) the execution for the patient of a will…
New Brunswick passed legislation, the Infirm Persons Act, which states the following:
3(4) The jurisdiction and authority of the court under this Act includes the power to make, amend or revoke a
will in the name of and on behalf of a mentally incompetent person.
11.1(1) The power of the court to make, amend or revoke a will in the name of and on behalf of a mentally
incompetent person shall be exercisable in the discretion of the court where the court believes that, if it
does not exercise that power, a result will occur on the death of the mentally incompetent person that the
mentally incompetent person, if competent and making a will at the time the court exercises its power,
would not have wanted.
These provisions were considered at length in Re M. (Committee of) (1988), 27 E.T.R. (2d) 68 (N.B. Q.B.)
where the court created a will for a mentally incompetent person. Ontario has no such legislation.
R.S.O. 1990, c. S. 26.
DM_TOR/900039-00001/1100282.1
- 35 makeup of a donor’s estate. Are attorney therefore prohibited from making such designations on
behalf of donors? The answer to this question would appear to be “yes”63.
Are attorneys also precluded from engaging in other estate planning activities on behalf
of donors? It will, for example, be desirable in many instances for an attorney, on behalf of an
incompetent person, to engage in inter vivos estate planning to reduce or avoid the incidence of
probate tax (in Ontario referred to as an estate administration tax), capital gains tax or U.S. estate
tax on death, to avoid a distribution on intestacy or to advance a testamentary bequest.64 Are
these estate planning activities permissible for an attorney?
A trilogy of recent British Columbia cases, Re Goodman,65 Re Bradley66 and O’Hagan v.
O’Hagan,67 explore the extent to which the courts will permit rearrangement of an estate by inter
63
64
65
66
See Re Poottcher Estate [1990] B.C.J. 1659 (BCSC) Re MacInnes [1935] 1 D.L.R 401 (SCC) Kologinski v.
Kologinski Estate [1988] MJ No 328 (Man Q.B.) Tamblyn v. Leach (1981) 10 ETR 178 (Man Q.B.) Re Rogers,
Rogers v. Rogers (1963) 39 D.L.R. (2d) 141 (BCCA) Fontana v. Fontana [1987] B.C.J. No 425 for a more
detailed discussion of the law with respect to RRSP and Insurance policy designations see H.E. Hoffstein Tips &
Traps, Issues in Estate Planning, Estates & Trusts Forum 2000; Ralph E. Scane Non Insurance Beneficiary
Designations (1993) 72 Can. Bar. Rev. 178.
For further discussion on these points see Jennifer Pfuetzner, Law Society of Upper Canada, Second Annual
Estate and Trusts Forum, Nov. 24, 1999.
(1998), 24 E.T.R. (2d) 194 (B.C. S.C.). In Re Goodman, a son was appointed the committee of his mentally
incompetent mother’s estate (which had a value of approximately $600,000). The estate consisted of two real
estate properties and some investments. In his capacity as committee, the son sought judicial authorization of a
proposed transfer of one of the properties to himself and the other to his sister. Counsel for the applicant raised
two bases on which the transfers were sought:
(a) The Estate was large enough, absent the two properties, to permit the advancement of the patient’s
intention that her two children should receive these two properties as a part of their inheritance; and
(b) The gifting at this time, whether on the basis of the alleged expression of intention or on the basis of estate
planning, made good sense for the proper, honest and prudent management of the patient’s Estate.
It was conceded that there was no need, on behalf of either of the children of the patient, for the transfer of these
properties.
Mr. Justice Taylor refused to authorize the transfer of the properties. There were three bases for his refusal:
(a) There was no clear evidence that the mother had intended to transfer the properties as proposed. Therefore
the properties could not be transferred on this basis.
(b) Any resultant savings in probate fees or capital gains tax could not be said to constitute a benefit to the
estate, but was instead a benefit for the beneficiaries under the estate. Therefore the properties could not be
transferred on this basis.
(c) In any event, the transfer of assets by a committee can only be undertaken where it is necessary to do so,
such as in circumstances where the proposed transfer is necessary to satisfy the incompetent person’s
obligation to support others. Since the transfer of the properties was not necessary in this sense, they could
not be transferred on this basis.
[2000] B.C.J. No. 205 (B.C.C.A.). Similar to Re Goodman, the court in Re Bradley declined to allow a
committee to engage in estate planning on behalf of the donor who was the committee’s mentally incompetent
wife. The donor in this case was a U.S. citizen who owned substantial real and personal property that would be
DM_TOR/900039-00001/1100282.1
- 36 vivos estate planning after the owner of the estate has become incompetent. These cases reveal
that there is a reluctance on the part of courts to allow attorneys/committees to engage in such
estate planning activities.
67
liable to U.S. estate taxes upon her death. The committee sought permission to effect certain transactions with
the donor’s property. These transactions were recommended to him by U.S. tax attorneys as a means of reducing
tax liability on the death of the donor. They entailed the making of annual gifts out of the donor’s estate to her
husband, the committee, in the amount of $100,000 and to her children and grandchildren in the amount of
$10,000. The idea was to reduce the size of the donor’s estate during her lifetime so as to lessen the estate taxes
that would be payable on her death.
The British Columbia Supreme Court granted the application. On appeal, however, the British Columbia Court
of Appeal overruled the lower court’s decision to grant the application. The Public Trustee urged the Court of
Appeal to adopt the position similar to that taken in Re Bradley, i.e., that where there is no evidence that an
incompetent person possessed, prior to the onset of their incompetency, an intention to carry out a particular
transaction, court approval for a committee to carry out this transaction should be granted only where the
necessity of the transaction can be demonstrated. Writing for a unanimous court, Newbury J.A. rejected this
argument of the Public Trustee. In particular, Newbury J.A. held that the appropriate test in applications of this
sort was:
…whether a reasonable and prudent business person would think that the proposal in question
would be of benefit to the [donor] and his family, in light of the circumstances known at the time
and that might arise in the future, and giving paramount importance to the [donor’s] own interest,
present and future.
The court held that even though the proposed transactions were desirable insofar as they would save tax they
nevertheless could not satisfy this test. Of particular concern to the court was the fact that the transactions would
significantly reduce the size of the donor’s estate and thereby had the potential to comprise the best interests of
the donor.
Another consideration for the court was the fact that granting approval to the transactions would have
significantly altered how the donor’s property would be transferred relative to how it would otherwise be
transferred on her death. Since the donor did not have a will, her estate would on her death pass pursuant to
intestacy legislation, i.e., one third to her husband and two thirds to her children. Contrary to this statutory
scheme of distribution, the proposed transactions significantly favoured the husband. Even though the donor’s
children consented to the proposed transaction, the court held that this was a consideration, albeit a minor one,
militating against granting approval.
[2000] B.C.J. No. 204 (B.C.C.A.). O’Hagan is the lone case in this trilogy in which court approval was granted
to a committee to engage in estate planning on behalf of the donor. At issue in O’Hagan was an estate freeze
proposed by a committee on behalf of his father, who was an 89 year old man afflicted with Alzheimer’s disease.
The estate consisted of property worth more than $7,000,000. The intended purpose of the proposed estate
freeze was to minimize the capital gains tax liability that would arise on the death of Mr. O’Hagan.
The British Columbia Supreme Court denied the application. The British Columbia Court of Appeal, however,
overruled this denial. Applying the aforementioned test (i.e., would a reasonable and prudent businessperson
think that the transaction or transfer in question would be beneficial to the donor and his family, given the
circumstances that are known at the time and the possibilities that might arise in the future), the British Columbia
Court of Appeal granted authorization to the committee to effect the proposed estate freeze. The court was
convinced that this test was met because of the unique set of circumstances that were in question. In particular,
the court placed great weight on the fact that unlike the proposed transaction in Re Bradley, the proposed estate
freeze here did not involve a diminution of the donor’s estate. The proposed estate freeze simply involved the
reorganization of the donor’s company in such a manner as to effect a tax savings without posing any downsides
whatsoever to the donor. The court was therefore convinced that it was in the best interests of the donor.
DM_TOR/900039-00001/1100282.1
- 37 There do not appear to be any cases in Ontario which deal with these issues, although in
her paper Ms. Pfuetzner cites the unreported case of Re Macken68as an example of a situation
where an Ontario court allowed a committee of both a husband and wife who were incompetent
to effect inter vivos estate planning to avoid the incidence of U.S. estate tax. (The wife was a
U.S. citizen). In respect of the wife, the court approved inter vivos gifts to the husband and
relatives and in respect of the husband, permitted the transfer of his estate to a trust in which he
had a life interest to his wife and, on the death of both, a distribution to the residuary
beneficiaries.
The extent to which an attorney can effect estate planning is unclear. However, it is
arguable that the test articulated in Re Bradley and O’Hagan regarding when a proposed
transaction will constitute a benefit to the estate should govern the actions of an attorney. Since
the attorney owes a duty of care to the donor, he or she must ultimately act in the best interests of
the estate rather than of the beneficiaries. The courts seem concerned to ensure that any such
transaction not permanently reduce the donor’s estate and ensure the donor’s estate can meet
his/her debts and testamentary gifts.
In addition to the above savings, the use of alter ego and joint partner trusts to distribute
property on death also shields the settlor and his or her family from the public nature of the
probate process.
The probate application, disclosing the value of the deceased’s real and
personal property, is a matter of public record.
The avoidance of probate tax alone may provide incentive to clients with substantial
assets to use alter ego or joint partner trusts as estate planning tools. However, the avoidance of
probate tax should be carefully weighed against the potential long-term consequences for higher
tax rates within the trust and for trusts that receive property of alter ego or joint partner trusts on
the death of the settlor.
68
Nov. 18/96 Ct. File # 05-00039/96 (Ont. Gen. Div.) and see re Banton (1998) 154 D.L.R. (4th) 176 (Ont. Gen.
Div.) where in a different context, Mr. Justice Cullity seemed to accept that persons acting under a power of
attorney have power to create a trust and transfer assets of their principal to such trust.
DM_TOR/900039-00001/1100282.1
- 38 (c)
Tax Reduction - Inter-provincial Tax Planning69
In addition to the benefit of centralization of assets in one jurisdiction, the use of an alter
ego trust or joint partner trust provides an opportunity to consider the ability to access the tax
rates of a province whose tax rates are lower than those of the province in which an individual is
resident. Essentially, the taxpayer who is resident in a high tax province will establish a trust
resident in a lower tax jurisdiction and transfer assets to that trust. Alternately an existing trust
could be migrated out of a high tax jurisdiction to a province with lower tax rates.
Because of its lower tax rates Alberta has been a popular province to consider as the
residence of a trust in interprovincial tax planning.
The following table compares the top marginal tax rates for an individual (including a
trust) in Alberta versus other provinces for 2004
BC
Alta
Ont
Quebec
Interest and ordinary income
43.7
39
46.41
48.22
Capital gain
21.85
19.5
23.20
24.11
Dividends
31.58
24.08
31.34
32.81
As will be noted there is less tax across the board between Alberta and Ontario.
Subsequent tax savings can therefore result if dividends, for example, are paid to an Alberta
resident trust as opposed to a taxpayer resident in Ontario.
(i)
Residence
Clearly, it is key if one is considering the use of a trust to access Alberta tax rates, care
must be taken to ensure that the trust is resident in Alberta.
The Act does not provide any rules for determining the residence of a trust for tax
purposes. The residence of a trust or an estate is a question of fact. Generally speaking, the
69
For a more fulsome discussion of Inter-provincial Tax Planning see:
Craig M. Jones, Alberta Trusts in Tax & Estate Planning 2002, Prairie Provinces Tax Conference.
Fowlis and MacRae, Inter-provincial planning, STEP Calgary, Jan 16, 2002
Martin Rochwerg, Using Trusts as an Income Splitting Tool, Canadian Tax Conference 2003
David H. Sohmer “Fundamental Issues in Shifting Income to Low Tax Provinces” (2003) Vol. 22, no. 2,
Estates, Trusts & Pension Journal, 127-39
DM_TOR/900039-00001/1100282.1
- 39 residence of a majority of the trustees will establish the tax residence of the trust. 70 However,
other factors may also be taken into account in determining residence including location of the
assets, whether the trustees or some one other than the trustees manage or control the trust assets,
and the extent of the authority of the trustees over certain decisions. CCRA is of the opinion that
management and control of a trust rests with the person who has most or all of the following
powers or responsibilities:
(a)
(b)
(c)
(d)
(e)
(f)
control over changes in investments;
responsibility for management of business or property of the trust;
responsibility for banking and financial arrangements for the trusts;
control over other trust assets;
responsibility for preparation of accounts and reporting to the beneficiaries; and
power to contract and to deal with advisors.
These comments are in line with the decision in the Federal Court Trial Division in
Thibodeau Family Trust v. The Queen.71 Thus, in provincial tax planning, it is essential that the
trustees of the trust or at least a majority must reside in the lower tax jurisdiction and must
exercise control over and management of the trust assets in that jurisdiction.
It would also be important that the settler of the trust or a person other than the trustees
does not control the decisions of the trustees nor exercise dominion over the trust assets. The
same is true with respect to the trust beneficiaries. The trustees should not be seen to be the
agents of the beneficiaries. No one residing outside of Alberta should have a veto power or
power of appointment over the trust assets.
The following steps have been suggested to ensure that a trust is resident in Alberta.
70
71
1.
Establishing a new trust is generally preferable to moving an existing trust;
2.
The trustees should be individuals and they should all reside in the Province of
Alberta;
3.
If not all of the trustees reside in Alberta, a majority should reside here;
Interpretation Bulletin IT-447 entitled “Residence of a Trust or Estates”.
[1978] DTC 6376.
DM_TOR/900039-00001/1100282.1
- 40 4.
No trustee who resides outside Alberta should have any power to veto the actions
of the trustees, nor should that trustee have power to remove and/or appoint
trustees;
5.
The trustees should be responsible for administrative matters, including
investment management, tax return preparation, custody of assets and reporting to
beneficiaries;
6.
If the trust is an existing trust which is being moved to Alberta, and if the trust
terms provide that the trust will be governed by the laws of another jurisdiction,
the trust should be varied to provide that Alberta law is the governing
administration;
7.
No one, such as a protector, resident outside of Alberta, should have the ability to
veto trustee decisions;
8.
Bank and investment accounts should be established with a financial institution in
Alberta;
9.
Meetings of trustees should be held in Alberta;
10.
The trust should provide for the deemed cessation of trusteeship if a trustee ceases
to reside in Alberta;
11.
T3 returns should be prepared by an accountant resident in Alberta and mailed to
the Canada Customs and Revenue Agency from an Alberta address; and
12.
Accounts of the trustee’s administration should be passed periodically before the
Court of Queen’s Bench of Alberta.
(ii)
Possible Application of Subsection 75(2)
If access to the lower tax rates of a different province is one of the objectives of transfer
of property to an alter ego trust or joint partner trust it is important that the provisions of
subsection 75(2) do not apply to that trust.72 Subsection 75(2) will apply where property of a
72
Subsection 75(2) provides as follows:
Where, by a trust created in any manner whatever since 1934, property is held on condition
(a)
that it or property substituted therefor may
(b)
(i) revert to the person from whom the property or property for which it was substituted was
directly or indirectly received (in this subsection referred to as “the person”), or
(ii) pass to persons to be determined by the person at a time subsequent to the creation of the trust,
or
that, during the lifetime of the person, the property shall not be disposed of except with the
person’s consent or in accordance with the person’s direction,
DM_TOR/900039-00001/1100282.1
- 41 trust is held on any of the following conditions: (i) that the property may revert to the person
from whom the property was received or (ii) pass to persons to be determined by such person at a
time subsequent to the creation of the trust, or (iii) that, during the lifetime of such person, the
property shall not be disposed of except with the consent of that person. It would appear that this
section applies even if property is transferred to the trust at fair market value.73
If the section applies, then any income or loss, capital gains or losses from the property
will be attributed to the person from whom the property or substituted property was received
while such person is resident in Canada. It should be noted that while the literature on this
section refers to these powers in relation to the settlor, the section applies to any transfer of
property to a trust by any person.
The terms of subsection 75(2) are not precise and the limits of the provision are far from
certain. There has been little, if any, jurisprudence, which would assist in interpreting the
provisions of the section. The most often asked questions with respect to ss. 75(2) relate to:
(i) what is a “condition” that creates a reversion, and (ii) what constitutes a “determination”,
“consent” or “direction” by the settlor or transferor.
(iii)
Reversion
With respect to what constitutes a reversion of property for purposes of subsection 75(2),
the provision will presumably cover revocable trusts notwithstanding “that the term “revert” is
normally used to refer to a property interest rather than to a revocation under a reserved
power”.74
Where the trust indenture contains a provision that would allow the settlor or other person
who contributed property to a trust to reacquire the property, (as for example if the Settlor was a
potential capital beneficiary), even if the ability to reacquire the property were remote,
subsection 75(2) would apply. Where, however, the contributor could reacquire the property by
any income or loss from the property or from property substituted therefor, any taxable capital gain or allowable
capital loss from the disposition of the property or of property substituted therefor, shall, during the lifetime of the
person while the person is resident in Canada be deemed to be income or a loss, as the case may be, or a taxable
capital gain or allowable capital loss, as the case may be, of the person.
73
Tax Window File #9332575, January 27, 1994
74
Cullity & Brown, Taxation & Estate Planning 3d edition, p. 664
DM_TOR/900039-00001/1100282.1
- 42 operation of law, such as the total failure of the trust for lack of beneficiaries, subsection 75(2)
would not apply.75 Accordingly, a contributor of property to the trust, whether as settlor or
otherwise, should not be a capital beneficiary. If a settlor/contributor is an income beneficiary,
subsection 75(2) does not appear to have application.
It is clear, therefore, that if it is desirable to avoid the application of subsection 75(2), the
trust should be irrevocable and under no circumstances should it be possible for the property to
revert to the Settlor other than by operation of law on the failure of the trust.
It appears that subsection 75(2) will not apply where property is loaned to a trust since, in
these circumstances, the transfer of property back to the person from whom it was received
would not be a reversion of the property pursuant to the terms of the trust.76 CCRA has
indicated, however, that the loan must be a genuine loan made to a trust outside and independent
of the terms of the trusts.77
(iv)
“Determination”, “Consent”, “Direction” 78
75
Tax Window File #9332575, January, 1994; Tax Window File #9304585, May 19, 1993
Annual Conference of the Canadian Tax Foundation, Toronto, November, 1991, Question 7, Access to Canadian
Income Tax, para. C56-124. See also Question 46 at the 1986 Annual Conference where it was stated that the
making or repayment of a loan does not constitute a reversion within the meaning of subsection 75(2) of the Act;
and see IT-369R
77
CCRA has expressed its view on what it considers to be a genuine loan in paragraph 8 of Interpretation Bulletin
IT-258R2 dealing with “Transfers of Property to a Spouse” and paragraph 3 of IT-260R entitled “Transfers of
Property to a Minor”. Generally speaking, CCRA will accept a loan as “genuine” where there has been a written
and signed acknowledgment of the loan by the borrower and an agreement to repay it within a reasonable time.
Consequently, a promissory note, or other such document, should be executed by the trustees of the trust
evidencing the indebtedness.
78
In a number of technical interpretations, CCRA has clarified that subsection 75(2) will apply on a contribution of
property to a trust in the following circumstances:
if the contributor is the sole trustee (Tax Window File #9202455, February 27, 1992);
(a)
if the contributor is one of two trustees (Tax Window File #9213965, August 11, 1992; Tax
Window File #9407905, June 6, 1994);
(b)
even if the contributor is one of three or more trustee:
(i)
if the trust indenture provides for the unanimous consent of the trustees to make
decisions (Tax Window File #9317655, December 17, 1993);
(ii)
and even if the trust provides for decision-making by majority vote, if the contributor
must form part of the majority or if in fact at any time there are only two trustees (Tax
Window File #9407905, June 6, 1994. See also Tax Window File #9514275, August 21,
1995 for comments about the interplay between ss. 75(2) and 107(4.1); Tax Window File
#9717815, November 19, 1997).
One concession that has been made is found in Tax Window File #9213965, dated August 11, 1992 which provides
as follows:
76
DM_TOR/900039-00001/1100282.1
- 43 -
“When the person from whom the property was received by the trust cannot determine
the identity of the beneficiaries but can only determine the quantum of the trust property
to be distributed to the beneficiaries which have already been identified by the trust
documents, we are of the opinion that subparagraph 75(2)(a)(ii) and paragraph 75(2)(b)
of the Act may not be applicable.
However, if the possibility to determine the quantum of the trust property is such that it
results in the possibility to determine the beneficiaries to whom the property will pass, it
is our view that subparagraph 75(2)(a)(I) and paragraph 75(2)(b) of the Act could apply.
This situation may occur, among others, if the settlor retains the possibility to identify
which property can be distributed to a beneficiary or if he retains the possibility to fix the
quantum (for example, in allocating nothing to a beneficiary) so that he has retained the
possibility to identify the beneficiary.”
In two recent Technical Interpretations:(Document #2000-0042505, April 30, 2001; and Document #2001-0067955,
January 3, 2002) CCRA considered the application of subsection 75(2) to an irrevocable discretionary trust that
originally had three trustees, one of whom was the settlor. The terms of each of the trusts provided that, among
other things, each of the settlor’s children were to be the beneficiaries of their respective trusts and that the decisions
of the trustees were to be made unanimously (cf Estate Freeze from Hell, update 2002).
Document No. 2001-0067955 provides in part as follows:
"Where the beneficiaries under a trust are named in the trust indenture and cannot be modified (i.e., the
person from whom the property was received by the trust cannot select additional beneficiaries after the
creation of the trust), subparagraph 75(2)(a)(ii) is generally not considered applicable. This is true even
though the person from whom the property was transferred to the trust may be able to determine the
amount of the trust property that is to be distributed to beneficiaries already identified in the trust
documents. However, subparagraph 75(2)(a)(ii) is worded broadly and there could be exceptions to this
general position depending on the situation.
With respect to paragraph 75(2)(b), it is our view that the condition in paragraph 75(2)(b) might not be met
in respect of property which is contributed to the trust by a person who is one of two or more co-trustees
acting in a fiduciary capacity in administering the trust property where the property is subject to standard
terms ordinarily found in trust indentures and there are no specific terms outlining how the trust property is
to be dealt with. However, a determination of whether this condition is met in respect of any particular
property can only be made on a case by case basis following a review of all the facts and circumstances
surrounding a particular situation."
In informal discussions with CCRA, it was noted that in a situation involving a single trustee, CCRA would likely
continue to apply subsection 75(2). In addition, in another Technical Interpretation (Document #2002-0116535,
February 19, 2002) which dealt with subsection 75(2) in the context of “common disaster” or “fall back” clauses, the
CCRA was asked to comment on the application of subsection 75(2) in four scenarios: two which contemplated that
in the event of there being no identifiable beneficiaries of a trust the trust assets were to be distributed in accordance
with the terms of the settlor’s spouse’s will; and the other two which contemplated that in the event of there being no
identifiable beneficiaries of a trust the trust assets were to be distributed in accordance with the settlor’s will. The
CCRA applied section 75(2) in all four scenarios on the basis that the property could revert back to the settlor (with
respect to distributions in accordance with the terms of the settlor’s spouse’s will). With respect to distributions
made in accordance with the terms of the settlor’s will, the CCRA indicated that it would apply subparagraph
75(2)(a)(ii) on the basis that by retaining this power the settlor had effectively retained a general power to determine
to whom the property would pass after the creation of the trust.
However, in a later commentary, #2002-0139205 (July 22, 2002), in commenting again on scenarios 1 and 2, CRA
noted that it had reconsidered its position and indicated that ss. 75(2) would not apply because if the property
devolved back to the transferor spouse it would do so as a result of the terms of a will and not the terms of the trust
as required by ss. 75(2).
In order to avoid the application of subsection 75(2), if the Settlor or other contributor to the trust is to be a trustee,
he or she should be capable of being outvoted on every issue relating to the determination of which beneficiary will
DM_TOR/900039-00001/1100282.1
- 44 At first it was considered that an individual who may have contributed property in a
personal capacity took on a different role as a trustee. To be on the safe side it was suggested
that there be more than one trustee, although initially there did not appear to be a technical
reason to do so. Clarification by CCRA over the past few years has confirmed that a contributor
of property to a trust should not act as a trustee who has sole or veto power as a trustee.
It should be noted that subsection 75(2) differs from the personal and corporate
attribution rules contained in section 74.1 in that it is any income or loss from the property or
property substituted therefor, or capital gains or capital losses realized from dispositions of the
property or property substituted therefor, that are attributed to the transferor. In the case of the
other attribution rules, it is only the income, loss, capital gains or capital losses allocated to (i.e.,
paid or made payable to) the beneficiaries of the trust that are attributed to the transferor. In
addition, CCRA takes the position that if a trust has a capital gain on property that is subject to
subsection 75(2) attribution, the attributed capital gain is not eligible for the capital gains
exemption. This is because subsection 75(2) contains no provision similar to subsection 74.2(2)
to deem the person to have disposed of the property for purposes of the exemption. The
application of subsection 75(2) to any of the property held by a trust at any time will also restrict
the ability of the trust to distribute property on a rollover basis to any persons other than the
person from whom the trust received the property or the spouse of such person. (See Subsection
107(4.1)).
Thus, in order to avoid the application of ss. 75(2), the settler should not be a capital
beneficiary and should not be the sole or one of two trustees, nor have a veto power. In addition,
benefit and to what extent. The easiest way to ensure that this happens is to require a minimum of three trustees at
all times with decision-making by majority. The trust indenture should not provide that the settlor/contributor must
form part of the majority and should provide that, if at any time there are two trustees of whom the
contributor/settlor is one, the trustees are constrained from making decisions concerning distribution to beneficiaries
until a third trustee is appointed. Similarly, the settlor or transferor should not be given any right to veto
distributions to beneficiaries (Tax Window File #9514275, August 21, 1995; Tax Window Files #9213965, August
11, 1992; #9514275, August 21, 1995; #9717815, November 19, 1997).
An even more disconcerting administrative position was advanced by CCRA with respect to appointment and
removal of trustees (Tax Window File #9407905, June 6, 1994). In the Minister’s opinion, where “the settlor/trustee
has the power to appoint, remove or replace any trustee”, “it is a question of fact whether the property held by the
trust could only be disposed of with the consent of the settlor/trustee”. Thus, where a settlor/contributor also desires
to be a trustee, one must compare the risk of subsection 75(2) applying against the benefit of conferring such a
power on the settlor.
DM_TOR/900039-00001/1100282.1
- 45 where the terms of the trust require that the income of the trust must be paid to the settler, the
trust may make an election under subsection 104(13.1) and 104(13.2) of the Act to cause the
income to be taxed at the trust level.
It should also be noted that some provinces such as Quebec have enacted anti-avoidance
provisions to curtail the use of Alberta trusts to avoid income splitting.
(v)
Inter-provincial Planning Using Alter Ego Trusts
It is possible to engage in interprovincial planning without the use of an alter ego trust.
For example a simple strategy would be for a trust to be created in Alberta and have a taxpayer
who is resident in a high tax province make a loan to the trust. That loan must be genuine 79 and
care must be taken to ensure that the provisions of ss. 75(2) and ss 56(4.1) do not apply.80
An Alberta resident alter ego trust can be used to minimize tax on dividends paid to
obtain a refund of refundable dividend tax on hand (RDTOH). For example an Alberta resident
trust that qualifies as an alter ego trust can be established by the shareholder of a corporation that
has significant RDTOH. The shareholder may transfer some portion of her shares to the trust.
Subsequent to the transfer the corporation can purchase the shares for cancellation giving rise to
a deemed dividend. For tax purposes this would be income of the trust. For trust law purposes
the receipt of the deemed dividend would be considered to be capital. This is important in the
context of an alter ego trust as it will be recalled that pursuant to the terms of an alter ego trust,
all of the income must be paid to the income beneficiary. The proceeds of cancellation can be
invested in the trust and taxed in the trust at Alberta rates so long as an election is filed pursuant
to the provisions of ss. 104(13.1). The trust can also make loans to the corporation at the
prescribed rate.
One variation of this theme involves the declaration of a stock dividend on existing
shares and the transfer of the new shares to an Alberta alter ego trust on a tax free basis. The
stock dividend would be new shares with a low paid up capital and high redemption amount.
After the transfer the trust would redeem the shares triggering a deemed dividend and utilization
of the RDTOH account balance. This variation avoids the requirement of a valuation that may
79
IT-369R
DM_TOR/900039-00001/1100282.1
- 46 create difficulties in the first scenario if it is desired to transfer only some of the shares held by a
shareholder to the trust.
It should be noted that in order to avoid the application of ss. 75(2) and ensure that the
income can be taxed in the trust and enjoy the Alberta tax rates, the settlor can only be an income
beneficiary but not a capital beneficiary. Thus one disadvantage of this planning is that the
proceeds of purchase for cancellation can never be returned to the shareholder.
In order to ensure that the stock dividend is treated as capital of the trust for trust law
purposes in the second scenario, the trust instrument could provide that the shareholder cannot
receive the proceeds from redemption or purchase for cancellation of shares of the corporation.
Another variation on these scenarios is for a shareholder to transfer his shares to the trust
following which a dividend would be declared in order to use the RDTOH balance. A subsection
104(13.1) election would be filed to cause the income to be taxed in the trust. Concern has been
expressed that ss. 75(2) would apply as pursuant to the terms of the trust, the income must be
paid to the shareholder and it is not clear whether ss. 104(13.1) would override ss. 75(2) and thus
this option may not be the preferred approach.
(vi)
Inter-provincial Planning Using Spousal Trusts
If the alter ego trust is not available because the shareholder has not attained the age of 65
years or because there is concern about the loss of ability to access the capital in the future, the
use of a spousal trust can be considered. Shares could be gifted or sold to the spousal trust,
which would be resident in Alberta. The sale proceeds could be satisfied by the issuance of a
promissory note.81 The proceeds of disposition to the transferor spouse from the disposition of
all of the shares would be equal to the ACB of the shares pursuant to subsection 73(1) such that
no capital gains or loss will be realized. Subsequent to the transfer, the corporation could
purchase for cancellation the shares held by the trust. As the amounts received by the trust on
the purchase for cancellation is considered capital for trust law purposes, they can be used to pay
or partially pay down any promissory note taken back on the sale of the shares to the trust.. The
80
81
See Craig Jones, supra.
See CCRA document no 2000-0012557 and CCRA document 1999-0001435
DM_TOR/900039-00001/1100282.1
- 47 provisions of subsection 74.1 might be avoided if a subsection 104(13.1) election is filed.82 The
transferor spouse cannot be an income or capital beneficiary of the trust during his or her lifetime
but can be an income beneficiary of the trust after the death of the beneficiary spouse (but not a
capital beneficiary as this would attract the provisions of ss. 75(2)). It would appear that if the
terms of the trust provide that the capital is to devolve to the estate of the beneficiary spouse on
his or her death and be dealt with in accordance with the terms of his or her will, the provisions
of subsection 75(2) would not be met.83 In order to avoid the application of probate tax on the
value of the trust capital distributed to the estate of the deceased beneficiary spouse,
consideration should be given to drafting the terms of the trust and the wills to ensure that such
capital forms part of the estate of the deceased beneficiary spouse that will not be subject to
probate tax.
82
83
It is noted that ss. 74.5(1) could not be relied on thus it would be important to make the 104(13.1) or 104(13.2)
election.
In Technical Interpretation 2002-0116535 (Feb. 19, 2002). CRA commented on four hypothetical scenarios
involving spousal trusts. In two of the scenarios, the assets of the spousal trust devolved to the estate of the
spouse on her death and the other two scenarios, the assets devolved to the estate of the spouse who had
originally transferred the assets to the trust. CRA concluded that in all four scenarios, the provisions of ss. 75(2)
would apply to the spousal trust because in the first two scenarios, there was a possibility that the transferor
spouse might through the spouse’s will reacquire the trust property and because in the other two scenarios, the
transferor spouse retained a power of distribution exercisable by will.
DM_TOR/900039-00001/1100282.1
TABLE OF CONTENTS
Page
ALTER EGO AND JOINT PARTNER TRUSTS - DEFINITIONS
AND TAX RULES ......................................................................................... 1
ADVANTAGES.............................................................................................. 5
Probate Tax Savings ........................................................................................ 5
Centralization of Property and Continuity of Management ............................. 5
Alter Ego Or Joint Partner Trust As An Alternative To A Power Of
Attorney ........................................................................................................... 6
DISADVANTAGES ....................................................................................... 6
Limited Creditor Protection ............................................................................. 6
Spousal Claims Under the Family Law Act .................................................... 8
Dependants’ Claims Under the Succession Law Reform Act ....................... 10
Claims Under the British Columbia Wills Variation Act .............................. 11
Cost and Complexity...................................................................................... 12
SOME TAX ISSUES.................................................................................... 12
Loss of Testamentary Trust Tax Rates .......................................................... 12
Charitable Gifts .............................................................................................. 14
Canada - U.S. Tax Convention Issue ............................................................. 25
Capital Losses ................................................................................................ 25
Private Corporations and the Double Tax Issue ............................................ 26
GST ................................................................................................................ 28
Trust Transfers And Land Transfer Tax ........................................................ 28
Principal Residence Exemption ..................................................................... 30
Capital Gains Exemption ……………………………………………………31
SOME ESTATE PLANNING USES OF ALTER EGO TRUSTS
& JOINT PARTNER TRUSTS .................................................................. 32
Planning to Avoid Wills Variation Act (B.C.) ............................................... 32
Probate Planning ............................................................................................ 33
Tax Reduction - Inter-provincial Tax Planning ............................................. 38
• Residence ................................................................................................ 38
• Possible Application of Subsection 75(2) .............................................. 40
• Inter-provincial Planning Using Alter Ego Trusts.................................. 45
• Inter-provincial Planning Using Spousal Trusts..................................... 46
DM_TOR/900039-00001/1100282.1
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