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Written by: Bryan Hubbell, CPA, CGA
Canadian family trusts are a common tool used in estate planning for family business owners. With good family trust planning you can enjoy a number of benefits including:
- Simplified management of the business – While the business is owned by the family trust, the trustee retains control of the business. The trustee has a fiduciary obligation to manage the business in the best interests of the trust’s beneficiaries.
- Flexibility – A discretionary family trust usually provides the trustee with the ability to distribute income or capital to one or more beneficiaries to the exclusion of others. This allows the trustee to consider the specific needs and circumstance of individual beneficiaries when making distributions.
- Asset protection – The assets held by the family trust are not owned directly by the trust beneficiaries. As a result, it is more difficult for creditors of a beneficiary to attack business assets owned by the trust.
- Estate planning – The future value of assets held by a family trust accrues to the benefit of the trust beneficiaries. This can allow business owners to fix their future estate tax liability through an estate freeze and transfer future business value to the beneficiaries of the trust.
The family trust trustee’s ability to make distributions to the beneficiaries is governed by the trust deed. Rules in the Income Tax Act provide for the trust to deduct amounts of income that are either paid or made payable to the beneficiaries from the trust’s taxable income. In this way, the family trust’s income that is distributed to the beneficiaries is taxed in the hands of the beneficiaries and not in the trust.
A recent CRA technical interpretation highlights the importance of understanding the terms of the trust deed and the negative consequences that can result when those terms are not complied with.
In the situation considered by the CRA, a family trust had been established for the benefit of the business founder’s children. In order to avoid the application of specific corporate income attribution rules to the business founder, the trust deed prohibited the distribution of income or capital to beneficiaries that were under the age of 18.
Despite this prohibition, the trustee had paid a portion of the trust’s income to beneficiaries that were under the age of 18. Unsurprisingly, the CRA determined that the payments made to the under age beneficiaries was not deductible by the family trust. Consequently, these amounts were taxable in the trust at the top personal tax rate.
In addition, the CRA determined that the under age beneficiaries had received a benefit from the family trust. Accordingly, the payments received by the under age beneficiaries from the trust were also included in their personal income and subject to tax at their marginal tax rates.
Family trusts can provide a number of benefits for family business owners. However, failing to understand and comply with the terms of the trust deed can have significant negative tax consequences.
In the situation considered by the CRA this resulted in double taxation, with the same income being taxed in the family trust and in the hands of the beneficiaries – a costly lesson.
You might also like our related Manning Elliott blog article entitled, “How a Holding Company or Family Trust Could Benefit You.”
Bryan Hubbell, CPA, CGA is a Senior Tax Manager with Manning Elliott LLP. To contact Bryan for more information about how the new Specified Corporate Income rules may limit your ability to claim the small business deduction, please call him at 1-604-557-5759 or email him at firstname.lastname@example.org
The above content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent changes. Professional tax advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.