Save tax by using a family discretionary trust *

As previously mentioned, there are several advantages to setting up a family discretionary trust from tax, legal and personal perspectives. For one, managers can achieve a key objective: protecting personal assets from potential recourse by creditors. In today’s business climate, new regulations applicable to public companies (designed to increase public protection) require chief executive officers and chief financial officers to assume greater liability over the accuracy of financial information published by their corporations. They must personally certify the corporation’s financial statements, thereby exposing themselves to higher risk. Given these circumstances, setting up a family discretionary trust becomes an attractive way for such executives to ensure greater protection of their personal assets, as assets transferred to a trust constitute a distinct estate.

What is a family discretionary trust?

A family discretionary trust is an inter vivos trust created by and for the members of the same family. The inter vivos trust is a legal vehicle created through a contract (the trust deed) in which a person (the settlor) transfers assets to one or more persons (the trustees) to control those assets for the benefit of other persons (the beneficiaries). Settlors may transfer a variety of assets into the trust, including investment portfolios, shares from a family company, rental properties, a principal residence, etc. Then, according to the level of discretion described in the trust deed, the trustee may allocate trust revenues or capital to one or more of the beneficiaries. Beneficiaries might include the settlor’s spouse, children or grandchildren, or, subject to certain tax rules, the settlor himself.

Tax planning considerations

Before creating a family discretionary trust, one must examine any applicable asset transfer rules or attribution rules. From a tax perspective, transferring the settlor’s assets to a family discretionary trust results in a fair market value disposition of these assets, unless you satisfy specific conditions. Once transferred to the trust, the income generated by these assets will again be taxable at the highest marginal rate, which ranges from 46% in Ontario to almost 49% in Newfoundland and Labrador.

However, one can reduce this tax liability by attributing income to certain beneficiaries because revenues thus attributed are deducted from the revenues earned by the trust and taxable in the hands of the beneficiaries, to the extent that the attribution rules are not applicable. In effect, during the settlor’s lifetime, trust income attributed to a spouse, as well as trust income (except for capital gains) attributed to minor children, is taxable in the hands of the settlor because of attribution rules.

Thus, by attributing, during the settlor’s lifetime, the trust’s income to children of majority, or capital gains to minor children, it is possible to lower a family’s tax burden. For example, by attributing income generated from trust assets to a child of majority to pay for his or her university tuition, the family’s overall tax burden will be reduced, since the child of majority will be personally taxed on this income at a marginal rate that would likely be lower than the marginal rate of the parent. In such instances, to prevent tax authorities from questioning the attribution of income, it would be important to keep adequate records showing that the income was paid or payable to the beneficiaries.

To summarize, setting up a family discretionary trust provides many advantages. To make sure that such a strategy meets all your objectives, it’s wise to consult experienced tax and legal advisors.

please do not hesitate to contact me should you have any questions regarding the above.

* This article was prepared by Danielle Lacasse, a Deloitte partner in Montreal, in collaboration with Cindy Harvey.