Trust Series – Part II: Planning Opportunities with Trusts

Our first article in the series provided general background information on what a Trust actually is and how it is taxed. In this article, we are focusing on our favorite area – the benefits of a Trust. And if you guessed that this included several tax saving strategies, you would be correct!

Each situation is complex and has many nuances. The topics below are covered at a general level. We are always happy to discuss the details with you directly. Hopefully after reading you might see a situation where you could benefit from your Trust.

Multiplication of the Lifetime Capital Gains Exemption (“LCGE”):

When an individual sells shares of a Canadian Controlled Private Corporation (“CCPC”) or Qualified Farm Property (“QFP”), they may incur a gain on the sale. When certain criteria have been met, it is possible for the tax on this gain to be significantly reduced.

Each individual has a Lifetime Capital Gains Exemption limit of $971,190 as of 2023. If you are in the top tax bracket, the LCGE could save you up to $233,000 of tax.

But what if your gain is more than that limit? And what if you have family members that have not yet used their LCGE? Unless other family members own shares in the CCPC being sold, you cannot use their limits.

But what if a Trust owned the CCPC shares that were being sold? Multiplication magic! The gain on the share sale can be split between all beneficiaries. And each beneficiary can then use their LCGE to offset the gain. If your beneficiaries include yourself, your spouse and two children that could mean up to $3,884,760 of LCGE can be used to offset the tax on a gain.

But be warned, when allocating a gain to a beneficiary of a Trust, they become entitled to that portion of the proceeds.

Loaning funds to a trust to allow for income splitting:

Readers of our articles know that significant limitations on income splitting were introduced in 2018. These Tax on Split Income Rules (“TOSI”) also apply to private corporation dividends received by a Trust and allocated to a non-active shareholder.

However, if a Trust receives funds by way of a prescribed rate loan and then invests those funds, monies earned on those invested funds can be split to the non-active beneficiaries of the Trust without TOSI applying.

Allocating income to non-active beneficiaries can be beneficial as they are often in lower tax brackets. When this can be done with multiple beneficiaries for several years, the tax savings can be significant.

The loan to the Trust must be made at the prescribed interest rate at the time the loan is set up, and payment of the interest must occur by January 30 ever year. The rules are similar to Spousal loans, which you may recall from another of our previous articles.

Due to the increasing interest rate on the prescribed rate loans, this option requires further analysis to support the benefits.

Succession planning - transfer to the next generation:

Another common tax planning situation where a Trust can become involved is as part of an Estate Freeze and passing of a corporation down to the next generation.

The value of a corporation can be “frozen” by exchanging the parent’s common shares for preferred shares. The preferred shares would have a value equal to the fair market value of the corporation at the time of the freeze. These preferred shares could be redeemed over time.

Once the original common shares have been exchanged for preferred shares, the Trust could then subscribe for new common shares of the corporation at a nominal price. Any growth in the value of the company after this time would belong to the shares held by the Trust.

This strategy provides a flexible option if you are unsure about whether your child will take over the business from you or regarding the timing of the transition. Should your child choose to continue in the business, the Trust has the option to roll out the common shares it owns to that individual (providing the preferred shares have all been redeemed). Or the shares can be sold for a gain which can be spread across the family LCGE limits, as noted earlier.

Succession planning - reduce taxes payable at death:

When an individual holds many assets such as investments and various real estate properties at their time of death, these are all deemed to be disposed of at that time. This can result in significant tax owing on the final tax return.

If these assets were transferred to a Trust prior to death, the Trust owns the assets and any gains at that point in time would not automatically be taxable. Assets owned by the Trust are also not subject to probate.

It is important to note that tax could be incurred on the transfer of assets into the Trust, so the implications should be discussed with your advisors before proceeding.

Additionally, there are a number of different types of Trusts that could be implemented. Life Interest Trusts are available when the settlor is at least 65 years of age. Unlike other trusts, the assets can be rolled in tax free and the 21-year deemed disposition timeline is extended until after the settlor’s passing. However, this type of Trust is more costly to set up and maintain.

Protection of assets and confidentiality:

When you put assets in a Trust, you no longer own the assets and therefore your creditors cannot seize the assets. Trust ownership of corporate shares can also be attractive in situations where a child is married but the Trustees do not wish for the shares to be part of divorce proceedings.

Owning high value CCPC shares, real estate or other assets in a Trust is highly beneficial when you wish for the asset to be enjoyed by the beneficiaries, but not for them to be subject to the liabilities of direct ownership.

And finally, Trusts also help to protect the confidentiality of asset ownership.

In the third instalment of our Trusts series, we will be doing a deep dive into the tax traps that may result in adding a Trust. Click here for Part III: Trust Tax Traps.