Changes to Taxation of Trusts

Changes to Taxation of Trusts
Estate Planning Council of Abbotsford
Kim G C Moody FCA, TEP
November 18, 2015

1
Kim G C Moody FCA, TEP, Director, Canadian Tax Advisory is a Chartered Accountant,
Registered Trust and Estate Practitioner and a tax specialist practicing in Calgary with Moodys
Gartner Tax Law LLP. His main area of expertise is tax and estate planning for the owner-
manager of private corporations, executives, professional athletes and other high net worth
individuals. Kim obtained his Bachelor of Management degree from The University of Lethbridge
and his CA designation from The Institute of Chartered Accountants of Alberta.
Kim is the Past Chair and Deputy Chair of the Board, Past Treasurer, as well as Past Chair of the Technical Committee
for the Society of Trust and Estate Practitioners of Canada (“STEP”). In addition, Kim is a past Chair of the Board of
Governors for the Canadian Tax Foundation. He is also a member and Vice Chair of the CBA/CICA Joint Committee on
Taxation and a member of The Canadian Petroleum Tax Society. Kim has a keen interest in planned charitable giving.
He is a past Chair for the Southern Alberta Round Table for the Canadian Association of Gift Planners. Kim is a co-
founder of the Tax Specialist Group – an association of tax specialist firms across Canada. Kim is a recipient of the
Queen Elizabeth II Diamond Jubilee Medal, the Business in Calgary 2012 Leader of Tomorrow Award, and in 2013 was
conferred the Fellow of the Chartered Accountants of Alberta designation. He is also a recipient of the STEP Founders
Award for Outstanding Achievement which was conferred in 2013.
Kim is the author of numerous articles, papers and courses on tax and estate planning and he has lectured extensively
for a number of organizations on tax, estate planning and planned giving, including STEP and the Canadian Tax
Foundation. He is a past instructor for the Certified Financial Planners designation and is a current tax instructor for the
Institute of Chartered Accountants of Alberta’s Professional Development Program.
Kim is married to Vivian and they have four sons – Alexander, Lucas, Jacob and Benjamin.

2
Agenda
1. Trust Taxation – Basic Review
2. What’s New in Trust Taxation?
a) Elimination of graduated rates for testamentary trusts.
b) Subsection 104(13.3).
c) Subsection 104(13.4).
d) Update from the Department of Finance

3
Trust - Definition
A trust is the relationship which arises whenever a person (called the trustee) is
compelled in equity to hold property, whether real or personal, and whether by
legal or equitable title, for the benefit of some persons (of whom he may be one,
and who are termed beneficiaries) or for some object permitted by law, in such a
way that the real benefit of the property accrues, not to the trustees, but to the
beneficiaries or other objects of the trust.
• Ensure you are dealing with a trust and not another legal
relationship (agency, joint venture, partnership, etc.).
• Need three certainties for trust to exist:
1. certainty of intention;
2. certainty of subject matter; and
3. certainty of objects.

Trust Taxation – Basic Review
• section 2 - Canada taxes a “person”
• a trust is not included in the subsection 248(1) definition of a
“person”
• however, subsection 104(2) requires trusts to be treated as
individuals
• subsection 104(2) also includes the multiple trust rule - will treat
multiple trusts as one trust in certain cases.
4

Trust Taxation – Basic Review Cont’d
• inter vivos trusts - taxed at highest marginal rates
• testamentary trusts - taxed at graduated tax rates
• income can be flowed out to the beneficiaries of the trust in
certain cases
• trust gets deduction from trust income for amounts paid to
beneficiaries – paragraph 104(6)(b)
• “paid” - subject to subsection 104(24) - (paid or “payable”)
5

• designations under subsection 104(13.1) (income) and
subsection 104(13.2) (capital gains)
• such designations deem the income paid to a beneficiary not to
have been paid
• result is trust pays the tax
• useful to access additional graduated rates when dealing with
testamentary trusts
• also useful in provincial rate shopping plans
• proliferation of “Alberta trusts”
6

• character preservation rules (subsections 104(19), 104(21) and
104(22) as examples)
• watch numerous attribution rules (subsections 75(2) and 56(2),
sections 74.1 and 74.2 etc.)
7

“21 Year Deemed Disposition” Rule
Certain exceptions to the application - most notably for “spousal trusts”,
alter ego trusts, joint spousal or common-law partner trusts and so-called
“self benefit trusts”. In these cases, the deemed disposition of the trust
property is deferred until the death of:
• the settlor, in the case of an alter ego or “self benefit” trust;
• the spouse / common law partner in the case of a spousal /common-law
partner trust; and
• the last to die in the case of a joint spousal or common-law partner trust.
Once the trust property is deemed disposed of, any realized taxable
capital gains are included in the trust’s income for its taxation year and
any resulting taxes must be paid.
8

Transfers of Trust Property
• Transfers of trust property to the capital beneficiaries are generally tax
deferred transfers for Canadian resident beneficiaries.
• One often utilized planning tool to avoid the “21 year deemed
disposition” rule for affected trusts is to consider transferring the
property to the capital beneficiaries – subsection 107(2) tax deferred
transfer.
• Such a transfer will occur at FMV to the extent the transfer of the
property is to a non-resident beneficiary or to the extent that the nasty
attribution rule under subsection 75(2) has ever applied with respect to
the trust.
• Very careful planning must be done when transferring property from a
Canadian resident trust to its beneficiaries
9

What’s New in Trust Taxation?
Elimination of Graduated Tax Rates for Testamentary Trusts
• First announced intention to change graduated tax rates for
testamentary trusts in 2013 Federal Budget.
• Department of Finance released consultation paper.
• Many organizations provided comments with many of them
advocating status quo.
• Government announced its intention in 2014 Federal Budget to
proceed with proposals outlined in consultation paper effectively
ignoring all of the submissions made.
• August 29, 2014 draft legislation released.
10

Elimination of Graduated Tax Rates for Testamentary Trusts Cont’d
• Bill C-43 received Royal Assent on December 17, 2014 and is
effective January 1, 2016.
• Contained some surprises – discussed later.
• Legislation contained two exceptions to the elimination:
1. “graduated rate estate” (“GRE”) (defined in subsection 248(1)),
2. “qualified disability trust” (“QDT”) (defined in subsection 122(3)).
11

Elimination of Graduated Tax Rates for Testamentary Trusts Cont’d
12
Subsection 248(1) - “graduated rate estate”, of an individual at any time, means the estate
that arose on and as a consequence of the individual's death if
(a) that time is no more than 36 months after the death,
(b) the estate is at that time a testamentary trust,
(c) the individual's Social Insurance Number (or if the individual had not, before the
death, been assigned a Social Insurance Number, such other information as is
acceptable to the Minister) is provided in the estate's return of income under Part I for
the taxation year that includes that time and for each of its earlier taxation years that
ended after 2015,
(d) the estate designates itself as the graduated rate estate of the individual in its return
of income under Part I for its first taxation year that ends after 2015, and
(e) no other estate designates itself as the graduated rate estate of the individual in a
return of income under Part I for a taxation year that ends after 2015; [emphasis added]

Elimination of Graduated Tax Rates for Testamentary Trusts – GRE’s
• Can only exist for a period of time no longer than 36 months after death.
• For estates being administered beyond that time, any income taxed in the
estate will be subject to non-graduated tax rates.
• In order to be considered a GRE, estate must designate itself as a GRE.
• Most striking is paragraph (e):
• If there can be more than one estate of a deceased individual, then how would
the executors / executrix’s decide which one would be a GRE? And when
could there be multiple estates of a deceased individual? In a multiple will
scenario?
• Better view – one estate.
13
no other estate designates itself as the graduated rate estate of the individual in
a return of income under Part I for a taxation year that ends after 2015;
[emphasis added]

What’s New in Trust Taxation Cont’d
Elimination of Graduated Tax Rates for Testamentary Trusts – GRE’s Cont’d
• The Department of Finance, when it released its Technical Notes to the August
29, 2014 draft legislation, had heard plenty about this issue and inserted the
following statement into the Technical Notes:
14
The income tax rules are predicated on the understanding that an individual has
only one estate that arises on the individual’s death. Consistent with this and the
intention that that there be only one graduated rate estate in respect of a
deceased individual, for an estate to be an individual’s graduated rate estate at
any time, a number of other conditions must also be satisfied [Emphasis added]

• Included in August 29, 2014 package of legislative amendments was
previously announced intention to require testamentary trusts to have a
calendar year end.
• New change will be effective for the 2016 calendar year and
onwards.
• Exception for calendar year ends is for GREs which will be able to
have non-calendar year end for the time that is a GRE.
• For testamentary trusts that have non-calendar year ends and that will
be in existence as of December 31, 2015, a deemed year end will
occur at that time.
• Start planning now!
15

Legislation also changed various sections of the Act that will have an
impact on private corporations and their shareholders.
• Common post-mortem planning upon the death of a shareholder of a private
corporation is to utilize the loss carry-back provisions of subsection 164(6) so
as to trigger a loss on the disposition of the shares of the estate, within the first
taxation year of the estate and carryback such loss, to the deceased’s terminal
tax return. This can be very effective planning to eliminate long term double
taxation.
• However, draft legislation will now restrict subsection 164(6) planning to a GRE
rather than just an estate.
• Puzzling restriction.
16

• Another change made by the August 29, 2014 legislation was to
amend the stop-loss rule in subparagraph 112(3.2)(a)(iii) to apply only
to GREs.
• When dealing with corporate owned life insurance proceeds received
upon death of the shareholder, one will have to carefully consider
whether the desired result under subparagraph 112(3.2)(a)(iii) is
achieved now that its application is limited to GREs.
17

Elimination of Graduated Tax Rates for Testamentary Trusts – QDT’s
"qualified disability trust", for a taxation year (in this definition referred to as the "trust year"), means a trust, if
(a) the trust
(i) is, at the end of the trust year, a testamentary trust that arose on and as a consequence of a
particular individual's death,
(ii) is resident in Canada for the trust year, and
(iii) includes in its return of income under this Part for the trust year
(A) an election, made jointly with one or more beneficiaries under the trust in
prescribed form, to be a qualified disability trust for the trust year, and
(B) the Social Insurance Number of each of those beneficiaries;
(b) each of those beneficiaries is an individual, named as a beneficiary by the particular individual in the
instrument under which the trust was created,
(i) in respect of whom paragraphs 118.3(1)(a) to (b) apply for the individual's taxation year (in this
definition referred to as the "beneficiary year") in which the trust year ends, and
(ii) who does not jointly elect with any other trust, for a taxation year of the other trust that ends in the
beneficiary year, to be a qualified disability trust; and
subsection (2) does not apply to the trust for the trust year.
18

What’s New in Trust Taxation Cont’d
Elimination of Graduated Tax Rates for Testamentary Trusts – QDT’s Cont’d
• Effective January 1, 2016 onwards.
• New subsection 122(2) can not apply to the QDT.
• Refers to a new definition of “electing beneficiary” and that is defined in
subsection 122(3) as follows:
• To the extent that all of the above conditions are met, then any income of the
QDT will be at graduated tax rates.
• A “recovery tax” under new paragraph 122(1)(c) will apply to the extent that,
overly simplified, the amount retained by the QDT is ultimately paid out to a
non-electing person of the QDT
19
“electing beneficiary", for a taxation year of a qualified disability trust, means a
beneficiary under the trust that for the year
(a) makes an election described in clause (a)(iii)(A) of the definition "qualified
disability trust" in this subsection; and
(b) is described in paragraph (b) of that definition.

Elimination of Graduated Tax Rates for Testamentary Trusts – QDT’s Cont’d
• QDT’s are complex.
• However, to the extent that the lawyer engages in planning for families
that have disabled beneficiaries, then consideration should be given to
their utilization.
• Obviously, specialized tax assistance will be needed.
• If income splitting is still an objective in conjunction with reserving
assets for a minor, one might want to consider the use of a subsection
104(18) trust.
20

Subsection 104(13.3)
• Introduced as part of the August 29, 2014 draft legislation, to be
effective January 1, 2016, and was part of Bill C-43 that received Royal
Assent on December 17, 2014.
• Its introduction was one of the surprises mentioned earlier.
• New subsection 104(13.3) is brief and reads as follows:
• Subsection 104(13.3) is narrow in scope but will limit some common
graduated tax rate and provincial rate shopping plans.
• Advisors who deal with trusts will need to be aware of this new rule
starting 2016 forward.
21
Any designation made under subsection (13.1) or (13.2) by a trust in its return of
income under this Part for a taxation year is invalid if the trust's taxable income
for the year, determined without reference to this subsection, is greater than nil.

Subsection 104(13.4) Cont’d
• Since its surprise introduction, it has been the subject of a lot of
writings, discussion and controversy.
• There are certain exceptions to the application of the “21 year deemed
disposition rule” for “spousal trusts”, alter ego trusts, joint spousal or
common-law partner trusts and so-called “self benefit trusts”. In these
cases, the deemed disposition of the trust property is deferred until the
death of:
a) the settlor, in the case of an alter ego or “self benefit” trust;
b) the spouse / common law partner in the case of a spousal
/common-law partner trust; and
c) the last to die in the case of a joint spousal or common-law partner
trust.
22

• Once the trust property is deemed disposed of, any realized taxable
capital gains are included in the trust’s income for its taxation year and
any resulting taxes must be paid by encroaching on trust property.
• New subsection 104(13.4) will change the landscape effective January
1, 2016 forward.
23

• Two basic changes arise from new subsection:
1. Upon the death of the applicable person in the case of an alter ego trust,
self benefit trust, spousal trust or joint spousal or common-law partner
trust, the trust is deemed to have a taxation year end at the end of that
day.
2. Income of the trust that will arise as a result of the deemed disposition of
the trust assets will be deemed to be included in the hands of the
deceased individual.
24

Subsection 104(13.4) - EXAMPLE
• Mr. and Mr. Apple both Canadian resident and not U.S. citizens
• Mr. Apple died a number of years ago. Much of his assets were
transferred to a testamentary trust for the benefit of Mrs. Apple.
• Trust was conditioned so as to ensure that there was a “rollover” of the
assets into the trust (generally meaning that no income taxes would be
triggered as a result of Mr. Apple’s death).
• The conditions for rollover, under subsection 70(6) of the Act, are that:
i. the trust must be created by the taxpayer’s will (this condition would be met since the spousal trust for Mrs.
Apple would be created by terms set out in Mr. Apple’s will);
ii. the trust was resident in Canada immediately after the time the property vested indefeasibly in the trust;
iii. Mrs. Apple must be entitled to receive all of the income of the trust that arises before her death; and
iv. no person except Mrs. Apple may, before her death, receive or otherwise obtain the use of any of the income or
capital of the trust.
• Trustee of the spousal trust for Mrs. Apple is Canada resident lawyer
friend of Mr. Apple’s and was appointed pursuant to the terms of Mr.
Apple’s will.
25

Subsection 104(13.4) - EXAMPLE Cont’d
• Beneficiaries of the spousal trust are Mr. and Mrs. Apple’s three
children.
• Former law, spousal trust would have a deemed disposition of its
assets at FMV on the day of the death of Mrs. Apple under subsection
104(4) of the Act.
• Spousal trust would then include any gain or loss as a result of such a
deemed disposition in the taxation year of the trust that included the
date of death.
• Assets would then be used to pay for the resulting tax liability.
26

What’s New in Trust Taxation
• Now, subsection 104(13.4) will require the trust’s otherwise
income inclusion to the date of death to be included in Mrs.
Apple’s hands for deaths that occur after 2015
27

• A significant consequence of this new rule. Mrs. Apple
remarried two years after the death of Mr. Apple to Mr. Banana
two years after the death of Mr. Apple and built up additional
assets during their marriage.
• Mr. Banana and Mrs. Apple effected standard “mirror” wills
whereby each of them would receive the other’s assets upon the
first death and then to charity upon the last death.
• The surviving spouse would be the executor or executrix of the
estate of the first to die spouse. Structured this way, there
should be “rollovers” to the surviving spouse upon the first death
under subsection 70(6) of the Act.
28

• Mrs. Apple dies before Mr. Banana in 2017.
• Upon Mrs. Apple’s death, the spousal trust would be deemed to have disposed
of its assets but the income inclusion would be in the terminal return of Mrs.
Apple.
• Mr. Banana, as executor of Mrs. Apple’s estate, would report the spousal
trust’s income in Mrs. Apple’s final income tax return pursuant to new
subsection 104(13.4).
• How will Mr. Banana get the funds to pay the resulting tax liability? Simple
answer is the spousal trust, of course.
• What if the lawyer friend trustee of the spousal trust refuses to transfer assets
to Mrs. Apple’s estate to pay the tax?
• Will Mr. Banana be out of pocket to fund the tax liability out of assets that
should have been transferred to him on a rollover basis? Perhaps.
• Any remedies to the above possibility? Unfortunately, no.
29

• Department of Finance obviously thought about this example and
introduced new subsection 160(1.4) of the Act.
• Subsection 160(1.4) hardly solves the problem, but certainly protects
the Government’s interest.
• Worst case scenario, Mr. Banana would be out of pocket while the
newly sprung beneficiaries of the spousal trust, the three Apple
children, would be enriched.
30
If subsection 104(13.4) deems an amount to have become payable in a taxation year of a
trust to an individual, the individual and the trust are jointly and severally, or solidarily, liable
for the tax payable by the individual under this Part for the individual's taxation year that
includes the day on which the individual dies to the extent that that tax payable is greater
than it would have been if the amount were not included in computing the individual's
income under this Part for the taxation year.

• Department of Finance has been aware of the above possibility and,
reacting to many comments that it received on the subject and
included the following statement when it later released its Technical
Notes on subsection 160(1.4):
31
Subsection 160(1.4) provides that the trust and the particular beneficiary are jointly and
severally, or solidarily, liable for the portion of the particular beneficiary's tax payable under
Part I because of the inclusion in that income of the amounts described in paragraph
104(13.4)(b). Existing subsection 160(2) empowers the Minister of National Revenue to
assess the liability that arises under subsection 160(1.4) against the trust at any time, and it
is intended that that the Minister apply subsection 160(2), in respect of an amount owing
under subsection 160(1.4), as though the trust were liable in the first instance for that amount
[emphasis added].

• Many practitioners not convinced that the CRA, when administering
new subsection 160(1.4) will collect tax first from the trust
notwithstanding the above direction given by the Department of
Finance.
32

• No mechanism available, such as a subsection 164(6), to carry back
any losses realized by the trust after the death of the spousal
beneficiary to be utilized in the deceased’s terminal return.
33

So why did the Department of Finance introduce this surprise into the
August 29, 2014 draft legislation?
• It appears that subsection 104(13.4) was introduced as an intent to be
relieving by enabling the trust and the deceased to utilize any
remaining graduated tax rates that might be available.
• There also appears to be a policy intent to try to simplify subsection
104(6), eliminate certain Old Age Security clawback planning,
eliminate provincial rate shopping on death and simplify capital gains
deduction access for spousal trusts.
34

• “misplaced tax liability” concern is very real and needs to be planned
for very carefully by lawyers and other advisors who will continue to
use life interest trusts in estate planning.
• One suggestion is that careful drafting of the trust conditions should
make it very clear that that the trust tax liability resulting from the
deemed disposition must be paid using trust assets.
• Are there other consequences that will arise as a result of the
introduction of subsection 104(13.4)? Certainly.
35

Subsection 104(13.4) - EXAMPLE
Here is another one. Let us consider the following facts:
1. Mr. and Mrs. Orange are married and both are Canadian residents for income tax
purposes.
2. Mrs. Orange is a U.S. citizen and Mr. Orange is not. Since Mrs. Orange is a U.S.
citizen, her death will trigger US estate taxes to the extent that the value of her assets
exceeds her applicable exclusion amount under I.R.C. § 2010(c)(2) (which is
generally US $5.43M for 2014).
3. The combined net worth of the Oranges is US $20M split equally amongst them.
4. Mrs. Orange will die in 2017.
5. Mrs. Orange’s applicable exclusion amount for U.S. estate tax purposes for 2017 is
assumed to be US $6M (which in reality, we do not know what this amount will be in
2017).
In above familiar fact pattern, it would be common to have the will of Mrs. Orange
provide for a spousal trust for the benefit of Mr. Orange if she died first. Such a
trust would meet all of the conditions of subsection 70(6) so that a “rollover” for
Canadian tax purposes would occur on her death.
36

37
• If planning was completed properly, Mrs. Orange’s will would provide that such
a spousal trust could qualify as a “qualified domestic trust” (“QDOT”) for U.S.
estate tax purposes and would rely on the provisions of paragraph 5 of Article
XXIX-B of the Canada-US Tax Convention (the “Treaty”) to enable a rollover of
certain property into that trust for the benefit of Mr. Orange.
• Normally, the only amount that would be transferred into the trust would be the
portion of Mrs. Orange’s estate exceeding her applicable exclusion amount
(which in our example would be US $10M less US $6.0 = US $4M).
• Transferring the assets in this way will enable a deferral of the payment of both
Canadian income taxes and US estate taxes upon Mrs. Orange’s death.
• If Mr. Orange was to ever receive any of the capital of the spousal trust /
QDOT during his lifetime, a portion of the capital would need to be paid to the
US government that reflects the U.S. estate tax that would have otherwise
been paid upon Mrs. Orange’s death.

38
• Upon Mr. Orange’s death, the spousal trust will have a deemed disposition of
its trust assets pursuant to subsection 104(4) of the Act.
• Income resulting from the trust’s deemed disposition will now need to be
included in his terminal income tax return pursuant to the provisions of new
subsection 104(13.4). In addition, U.S. estate tax must be paid.
• How will the new rules under subsection 104(13.4) interplay with Article XXIX-
B of the Treaty? Good question.
• Many cross-border practitioners are working through the implications of this
and most, including me, do not have a conclusive answer yet. However my
initial review of the rules and the Treaty have concluded that it is not all bad but
ultimately VERY careful planning will need to be done. Suffice it to say that it is
complicated.

39
• Given the above, are life interest trusts still useful? Yes.
• Notwithstanding that the study and practice of tax is exciting and challenging, good
tax practitioners will often reflect on a good plan and ensure that the tax planning is
not “wagging the tail of the dog”.
• While the use of spousal testamentary trusts were often used to income split upon
death and the subsequent death of the spouse (by transferring the residual assets
of the spousal trust to additional trusts for the benefit of the next generation) by
accessing additional graduated tax rates, the non-tax benefits were often more
important in the overall estate plan (planning for spendthrifts, second marriage
considerations, protection of assets from children spouses, probate avoidance,
etc.).
• To not use life interest trusts because of the above noted changes in trust taxation
is likely letting the tax tail wag the dog.
• Good trust and estate lawyers / accountants / planners will carefully consider the
tax issues and plan accordingly.

Subsection 104(13.4) – Update From the Dept of Finance
• Joint Committee, STEP and CALU have been actively working
together to communicate and present alternatives / solutions regarding
subsection 104(13.4).
• November 16, 2015 letter to Joint Committee, STEP and CALU – good
news!
• Very generally, proposed amendment would return affected trusts and
their beneficiaries to a regime that corresponds to the 2015 and earlier
regime subject to certain narrow elective exceptions.
• No guarantee that proposed amendment will ever see the light of day
but fingers crossed!
• JC will continue to work with Finance on proposed changes.
40

Concluding Comments
41
As the ancient Greek philosopher Heraclitus stated: “There is nothing permanent
except change”.
Embrace change for the benefit of your clients.

Canada
Calgary, AB
Edmonton, AB
Vancouver, BC
USA
Buffalo, NY
moodysgartner.com
D 403.693.5102
kmoody@moodysgartner.com
D 403.693.5102
kmoody@moodysgartner.com

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