FAMILY TRUST WORKS AS SUCCESSION PLANNING TOOL

Originally published on July 17, 2008

 

A family trust is becoming an increasingly popular way to safeguard assets and split income.

As Saskatoon tax lawyer Beaty Beaubier puts it, "a family trust is for those individuals who want to share wealth but not necessarily control."

A family trust is not a legal entity like a corporation.  However, for income tax purposes, the trust is considered to be an "individual" and must file an annual trust return (Form T3) to the Canada Revenue Agency within 90 days of the trust's fiscal year-end.

Typically, one or both of the parents act as trustees, who have fiduciary duties to the beneficiaries.  In their simplest form, these fiduciary duties can be described as duties of loyalty, care and impartiality.

Setting up a family trust to hold common shares of a farming corporation has advantages:

  • An ability to split income among children because business income can be distributed as dividends to lower-bracket adult family members.

  • A family trust can be "discretionary," which allows the trustee to decide in what proportion or amount income or property will be distributed to beneficiaries.  For example, if one child is running the farm business and financing the retirement of the parents, the parents may choose to allocate a higher proportion or all of the shares held by the trust to that child.

 

  • Discretionary trusts may in certain circumstances provide a means of safe-guarding assets from matrimonial division or seizure by creditors because the allocation of income and property is up to the discretion of the trustee.

  • A family trust provides a means of "spinning out" non-business assets to a corporate beneficiary of the trust.  To qualify for the capital gains exemption, at least 90 percent of the company's assets must be devoted to qualifying Canadian business activities.  Also, the majority of the company's assets must be devoted to such activities throughout the two years before a disposition.  Non-business assets, such as portfolio investments and rental properties, will put taxpayers "off-side" of small business corporation status.

  • A family trust is essentially a private arrangement, the details of which are not generally subject to public disclosure.

However, a family trust also has disadvantages:

  • For certain income tax purposes, all beneficiaries are deemed to control all of the shares of a corporation that is owned by a discretionary trust.  This means that if one of the beneficiaries controls another small business corporation, that corporation will be "associated" and forced to share the $400,000 small business limit with a farming corporation that is controlled by a discretionary trust.
    The corporate tax rate is lower for businesses with profits of $400,000 or less.  Corporations with larger profits face higher tax rates.

  • By creating an "inter vivos trust," which means it is created in your lifetime, taxpayers lose the advantage of creating a "testamentary trust" upon their death.  Income generated in a testamentary trust is taxed at progressive tax rates while income taxed in an inter vivos trust is taxed at the highest personal rate.

It should be noted that a trust is deemed to have disposed of its holdings after 21 years.  This 21-year rule triggers a capital gain on a deemed disposition of the farm corporation shares.

Because these shares would normally qualify for the capital gains exemption, no tax should be triggered provided that the capital gain can be allocated and distributed to Canadian residents who are eligible to claim the capital gains exemption.

The biggest problem with succession planning and the potential use of a family trust is leaving it until it is too late.  Seek professional help and get started, even if succession is many years down the road.

 

Allyn Tastad, certified general accountant, is a partner in the accounting firm of Hounjet Tastad Harpham in Saskatoon at 306-653-5100, e-mail at allyn@hth-accountants.ca or website www.hth-accountants.ca. He is also involved in the family farm near Loreburn, Saskatchewan.  The opinions expressed in this column are for information only.