Ottawa increases scrutiny of family trust arrangements
By Brian Wilson
The family trust has traditionally been regarded as an important tool in succession planning within families.
The trust is often used as a vehicle to pass on future growth to children, split income among family members or multiply the capital gains exemption. Since there is nothing inherently offensive to the Canada Revenue Agency (CRA) about proper succession planning, the use of family trusts has generally been regarded as a low-audit risk.
All too often, the trust deed ends up in a drawer, and advisers who have been retained to set up the trust structure are not asked to monitor ongoing trust activities
One result is that some clients and advisors have not paid a lot of attention to dotting the “I’s” and crossing the “T’s” in this type of arrangement.
This is all about to change. In 201, the CRA has launched a program throughout Ontario to review existing family trust arrangements. As well as the relevant provisions of the Income Tax Act. CRA is focusing on the documentary support for the various activities of the trust. For example:
- Was the trust properly settled?
- Where is the original trust property?
- Have the trustees acted as fiduciaries?
- Are there trustee minutes of meetings or resolutions to approve transactions involving the purchase and sale of assets by the trust?
- Have any loans been properly documented?
- Was interest paid on those loans in a timely manner?
- Are there minutes of meetings or resolutions of the trustees to support the distribution of income and capital and the designation of income as dividends and capital gains?
- Has the flow through of the capital gain and the use of the capital gains deduction by the beneficiaries been executed properly?
All too often, once a family trust is established, there is no ongoing maintenance. The trust deed ends up in a drawer, and advisers who have been retained to set up the trust structure are not asked to monitor ongoing trust activities. The result is the only time that the trust is looked at again is when a significant event occurs, such as the sale of assets by the trust or the 21-year deemed disposition date.
In light of this new CRA program, more attention will have to be paid to the creation of the trust and the details of ongoing trust activity.
At the time the trust is created, the trust deed and the property that was used to initially settle the trust should be kept in a safe place. It is important to be able to produce or trace the settled funds to later prove the trust was actually created. Otherwise CRA may allege the whole arrangement is a sham.
It is also important to choose reliable trustees; individuals who will take the position seriously and actively participate in the trust’s decisions.
Only then can they demonstrate they were acting as trustees in the event the CRA should allege one trustee controlled the trust. That could result in adverse tax consequences to the trust and its beneficiaries.
Each year, the activities of the trust should be documented by written resolution or minutes of meetings signed by the trustees. If the sale of assets and the distribution of income of the trust to beneficiaries are not properly approved by the trustees, this will give the CRA the opportunity to characterize the transaction in a way that has adverse tax consequences for the trust and/or the beneficiaries.
Finally, it is also important to establish who is going to be responsible for ensuring the trust activities are monitored. Will it be a trustee, the accountant for the family, the lawyer who set up the trust? Whoever it is, that should be made clear in an engagement letter.
These steps will minimize the risk of adverse tax consequences from the rigors of a CRA audit under this new program.
Brian Wilson is a lawyer specializing in domestic and international tax planning for individuals and businesses. He is a partner with Wilson Vukelich LLP in Toronto. He is the co-author of several publications for the Canadian Institute of Chartered Accountants.
This article first appeared in the LEON FRAZER QUARTERLY REVIEW, Q1 2011