Tax Planning and Trusts

Changes in how we undertake tax planning for corporate structures could make the use of a family trust more important than ever, so we thought this would be a good time to explain what a trust is and how it works.

There are several different kinds of trusts, though here we will focus on two common types: family trusts and holding trusts. All trusts have similar aspects. A trust is an agreement among a group of people whereby the “trustees” agree to hold property for the “beneficiaries” as set out in the trust agreement, which is established when the trust is set up. The trustees are the people who make decisions about what the beneficiaries receive (i.e., what dividends they will receive to achieve income splitting objectives). Consideration should be given to naming more than one trustee as there can be issues related to matrimonial property that should be considered. Beneficiaries are the people who can receive a benefit from the trust and are usually named by relationship (spouse, children, etc.) as opposed to by specific name. It is difficult to add beneficiaries in the future, so we recommend naming those people who you may wish to income split with when the trust is established. Note that there may be adverse tax consequences if any of the beneficiaries have U.S. connections (U.S. citizen, green-card holder, etc.), are a beneficiary of another family trust, or have their own company.

A family (or income splitting) trust is often established to facilitate income splitting and is perhaps the most common type of trust. Regular income from a corporate structure, usually paid out as dividends, can be paid to beneficiaries over the age of 18. The sale of a small business could result in significant capital gains, and a family trust allows for these gains to be spread across multiple beneficiaries, thus significantly reducing the capital gains taxes payable by the primary business owner. Family trusts file a tax return each year and, if taxable, pay the highest rate of tax. As such, they are used only as a means of removing money from a corporation and not for retaining cash.

A holding trust is different from other trusts in that it does not pay tax and is not required to file a tax return. A holding trust is usually created to protect assets (usually real estate held within the trust) from personal liability by essentially forming an invisible layer between the assets and the beneficiaries. Income earned on the trust property continues to be taxed in the personal returns, as it was before the transfer to the trust. There is usually no deed transfer tax to move a property to a holding trust. However, banks may not look favourably on trusts, and a property that is mortgaged might be difficult to move to a trust as the bank may perceive that it hurts the bank’s first charge on the property. Personal guarantees are usually required for mortgaged properties held in trust.

In conclusion, a properly planned trust can help achieve effective income splitting and asset protection. Each situation is unique, and consideration should be given to the costs compared to the benefits of a trust. Trusts often cost around $2,500 or more to set up but may be able to save thousands in tax when used properly in a corporate structure. We would be happy to explain how a trust might assist your business with tax planning.

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