Family Trusts
Family trusts offer particular legal and tax benefits that may provide significant advantages to you and your family, especially if you are a business owner.
The following article explains what family trusts are, how they are created, and the most common roles that trusts play in wealth management.
What is a trust?
A trust is a fiduciary relationship recognized by law in which property is held by a trustee for the interest of a beneficiary. A trust can have multiple trustees and multiple beneficiaries. Unlike a corporation, a trust is not a legal person. The trustee is the legal representative of the trust and carries on all legal actions on behalf of the trust. The trustee is also the legal owner of all trust property – despite the fact that a trust’s beneficiaries maintain a beneficial interest in such property.
While the term “family trust” is commonly used to describe a trust created for the benefit of family members, this term has no specific legal meaning. Family trusts fulfill a variety of functions, making them a particularly flexible legal tool.
How is a trust established?
While trusts can be established in a variety of ways including upon death (testamentary trusts) or by operation of the law (constructive trusts), family trusts are typically created by the execution of a trust instrument signed by the original holder of the property (the settlor) and a person tasked with controlling such property (the trustee). This is known as an inter vivos trust (living trust).
The trust instrument (usually in the form of a deed) is the controlling document of the trust. It identifies the trustee, the beneficiaries, and sets out the various rights and obligations of the trustee in respect of the trust property and the beneficiaries.
Why are family trusts established?
Estate Planning – The allocation of property into a family trusts can be an effective way of mitigating the effect of the Estate Administration Tax. This tax is charged on the total value of an estate as set out in a will submitted for probate. Ontario currently charges some of the highest probate taxes in the country at 1.5%. However, as trust property is not considered part of an estate, it is excluded from the calculation of this tax.
Income Splitting – A family trust can also be an effective vehicle for income splitting; the practice of allocating taxable income over anumber of persons with low marginal tax rates and thereby reducing the total amount of tax paid. For this strategy, shares in a family business are typically transferred to a family trust. Dividends are then paid up to the trust by the business and distributed to the trust beneficiaries. Business owners with children turning 18 in the applicable taxation year may benefit from income splitting. The period during which children are completing post-secondary education is often a popular time to implement an income splitting strategy.
Jurisdictional Arbitrage – In Canada, trusts are taxed in the province in which they are domiciled. Establishing a trust in a provincial jurisdiction with a lower tax rate may be an effective way of reducing taxes. In Canada, Alberta trusts are commonly used for this purpose. However, for this strategy to be effective, an Alberta resident trustee must be vested with full discretion in terms of the management and control of the trust.
Estate Freeze – Family trusts are typically used in estate freezes as a vehicle for a departing business owner to control the future ownership of the business through the exercise of discretionary powers afforded to the business owner as trustee of the family trust.
Minor or Disabled Children – A trust can also be useful for maintaining control and allocating distributions of trust property in respect of minor and disabled children.
Asset Protection – A beneficiary’s interest in an irrevocable, fully-discretionary trust is generally protected from creditors of the beneficiary. While a beneficiary’s creditors may step into the shoes of the beneficiary and exercise any rights of the beneficiary, by definition, the rights of a beneficiary of a discretionary trust are inherently limited. A trustee of such a trust has extensive powers and discretion to choose both the timing and allocation of distributions. Thus, where a beneficiary’s interest in a trust is threatened by such beneficiary’s creditors, the trustee may simply refuse to make any distributions to that particular beneficiary. This can effectively block creditor claims. However, a trust offers no protection to a beneficiary where property is transferred to a trust with the intention of defrauding creditors (a fraudulent conveyance).
Confidentiality – Another benefit of a family trust is confidentiality. Unlike a will, which may be required to be submitted before a court for probate, a trust is a private document. Assuming that no dispute arises, none of the parties involved in the creation of a trust (settlor, trustee, beneficiary) are obliged to acknowledge the relationship. The only reporting requirement of a trust is the filing of a T-3 Return with the Canada Revenue Agency. Confidentiality is thus an added advantage of trusts where discretion is sought.
While family trusts can provide an efficient vehicle for tax planning and other purposes, a qualified legal advisor should always be retained. If you have any further questions on the use of trusts, feel free to contact Michael Otto or another member of Loopstra Nixon’s Wealth Management Practice.