Trust Distributions May Have Adverse Tax Results Where Trust Has Sole Trustee
A discretionary family trust is a common estate and tax planning tool, particularly for shareholders of private companies. A business owner can utilize a trust to split income among his or her family members. Subject to the attribution rules in the Income Tax Act and certain other rules, including “kiddie tax”, distributions made via a trust can create tax efficiencies by using the lower marginal tax rates of lower-income family members.
CRA Position Creates Uncertainty
One anti-avoidance rule that may hamper income-splitting is subsection 56(2). In broad terms, subsection 56(2) may apply to so-called “indirect transfers”, where there is a payment or transfer of property at the direction of the taxpayer for another person’s benefit.
In the recent British Columbia tax conference of the Canadian Tax Foundation, the Canada Revenue Agency (CRA) was asked to confirm that subsection 56(2) will not apply to situations where a sole trustee, who is also a beneficiary, makes distributions to himself or herself to the exclusion of other beneficiaries. The genesis of the question to the CRA was case law regarding subsection 56(2) that is favourable to the taxpayer, including the Supreme Court of Canada decision in McClurg v. The Queen.
The CRA declined to confirm that subsection 56(2) would not apply. The CRA expressed the view that McClurg case is distinguishable from circumstances where a sole trustee who is also a beneficiary makes distributions to other beneficiaries without making a similar distribution to himself or herself. The CRA stated that the finding in McClurg is not directly transferrable to the trust situation, and whether subsection 56(2) applies would depend on the facts and circumstances. The CRA did not provide any examples of fact situations were subsection 56(2) would apply, so it is difficult for taxpayers to speculate where the CRA may assess on the basis of that anti-avoidance rule. If the CRA were to assess, the result for the sole trustee could be a full taxable income inclusion of distributions made to the other beneficiaries.
Eliminate Risk By Having Multiple Trustees
The CRA has not been particularly successful in having subsection 56(2) assessments sustained in court, in the McClurg case and several others. However, prudent taxpayers may prefer to appoint multiple trustees to eliminate the risk of a reassessment that may occur where there is a sole trustee.
Typically (but not invariably), we recommend appointing more than one trustee for a discretionary family trust for tax reasons as well as other reasons. In light of the CRA’s views regarding subsection 56(2), it would be wise for sole trustees of discretionary family trusts to consider the appointment of additional trustees.
Invitation for Discussion:
If you are a sole trustee and would like to discuss your options, please contact a member of our Tax & Estate Planning team at Nerland Lindsey LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.