Canada: You Created A Family Trust – Now What (Part 2)?

Family trusts can provide many benefits and are set up for various reasons. They can be effective vehicles for income splitting, estate planning or creditor protection. However, after spending the necessary time to set up the family trust you want and dealing with various advisers, many people soon forget about the trust terms and how the trust should be administered properly.

In a previous edition of Wealth and tax matters we discussed the various tax issues that should be remembered after creating a family trust.¹ This article focuses on the things you need to keep in mind after you have created a trust. Not operating the trust correctly or overstepping your powers under the trust can have adverse effects.

Back to basics

In common law jurisdictions (all Canadian jurisdictions except Quebec) a trust is a relationship. A trust does not have a defined set of articles or structure. It is not governed by corporate law. There is no government directory of Trusts set up in a county, province or country. You won't find it in any official list.

A trust in many cases means you have given something away. It is no longer yours, because you chose to give it to someone else, for absolutely nothing in return. Basically, all trusts entail that:

• you take something of value;
• you give legal title of this asset to someone else (the trustee); and
• the trustee manages the asset for the benefit of other people (typically someone close to you, such as your spouse or children).

Typically, a family trust is created for the benefit of family members. Normally, if you are the one creating the trust (the settlor) or you are the one contributing to the trust, you either won't be a trustee, or are one of several trustees that operate under a majority rule clause. Either way, you must respect your role (or lack thereof) under the trust document. The Canada Revenue Agency (CRA) is focusing on how trusts are being operated to ensure that named trustee(s) actually controls the trust and does not merely act as somebody's agent or puppet.

CRA initiative

If the CRA determines that someone other than the trustee(s) is actually controlling the trust, the following adverse tax implications may occur:

• the province or territory of tax residency of the trust may be changed;
• the country of trust tax residency may be changed;
• the income of the trust may have to be reported by the contributor of trust property on his or her tax return, even if the contributor receives no property from the trust; and/or
• assets of the trust may not be able to be transferred to beneficiaries on a tax deferred basis.

In the past year, the CRA has issued detailed questionnaires to various trusts. These are aimed at determining who controls the trust property and the distributions to beneficiaries. For example, the Aggressive Tax Planning Section of the CRA recently surveyed trustees of trusts being reviewed regarding their residency, asking:

• How were you appointed as the trustee? When were you appointed? Why were you appointed?
• Please provide a list of your duties and responsibilities as trustee.
• How are decisions in relation to the trust property made? Where are the decisions made? Who makes these decisions? Provide copies of all correspondence, emails, memos and notes with respect to all decisions made by you as the trustee.
• Do you have control over the trust's investment portfolio and any other trust assets?

What to do, or rather, what not to do

If you are not a trustee, you should not be taking on the role of trustee. For example, you should not:

• sign documents for the trustee;
• control bank accounts of the trust;
• determine how the trustee votes corporate shares that the trust owns;
• receive the trustee's mail and deliver it to the trustee;
• see the trustee's investment, legal or tax advisers on trust business without the trustee;
• be the one responsible for hiring the advisers (investment adviser, accountant, lawyer) for the trust;
• be receiving questions by the trust's advisers on trust matters;
• review and sign the trust's tax return; and
• take requests for distributions from beneficiaries and relay them to the trustee so that they make distributions to beneficiaries.

If you are one of several trustees, it must be clear that all trustees participate in decisions of the trust and that it is not guided solely by you. You should only be involved to the extent you are contemplated within the trust deed. But it is probably fine to meet the trustee to see how things are going, and in fact you should consider doing so periodically to see if the trustee is doing a good job. When selecting a trustee, ensure that it is someone you can trust and who can make the hard decisions you have made in your life that has made you a success.

A cautionary tale

Canadian courts have had few opportunities to discuss the role of trustees and settlors in trusts, but one recent case - St. Michael Trust Corp. v. the Queen - is particularly interesting, and can help determine whether the trust you have gone out of your way to create is operating appropriately.

The Supreme Court of Canada ruled in the St. Michael case in April 2012. The court agreed with the lower courts and held that the residency of the trust depended on the location of "mind and management" of the trust rather than on the residency of the trustees. This particular trust was considered to be resident in Canada rather than Barbados, where the trustees resided.

In the St. Michael's case the court found that the trustees provided only administrative services and had little responsibility beyond that. The Canadian beneficiaries, on the other hand, were considered to have the central management and control over the trust property, making the trust resident in Canada.

As a result, the trust in question was subject to Canadian tax on approximately $300,000,000 of profits at Canadian tax rates rather than Barbadian tax rates (which were zero).

Final thoughts

Creating a family trust often means you have given something away and you trust another person to manage the property. Many tax and non-tax benefits can result when you create a family trust. But to retain these benefits, you must respect these legal relationships then and in the future.

Footnotes

1. Wealth and Tax Matters, 2011, Issue 1.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.