Mr. B is a businessman who carries on business through his corporation, 1234567 Ontario Inc. (the “Corporation”). Mr. B supports 3 children above the age of 18, who are all in university full-time. Supporting Mr. B’s children is expensive. Each child requires roughly $35,000 annually for tuition, cars, and phones.

Based on the above, Mr. B will require approximately $100,000 to support his children in 2016 (the “Support Funds”). If Mr. B withdraws the Support Funds as a dividend or salary, he will receive much less than $100,000. This happens because the resulting tax bill consumes a large portion of the withdrawal. To keep a full $100,000, Mr. B must actually extract a much higher amount from the Corporation.

Is there a better way for Mr. B to obtain the Support Funds? The answer is yes. Mr. B can structure the Corporation in a more tax-efficient manner. Mr. B has several options. This article explores one specific solution: the “Discretionary Family Trust” (a “Family Trust”).

What is a trust?

In law, a “trust” is not a separate legal entity like a corporation. Instead, it is a relationship between three parties: the “settlor,” the trustees, and the beneficiaries. The settlor contributes the initial property. The trustees hold and manage that property for the beneficiaries’ benefit according to the trust indenture. Finally, the beneficiaries hold the entitlement to the trust property. Although not a separate legal entity, the Trust acts as a separate taxpayer under the Income Tax Act (Canada) (the “ITA”).

How can a trust save Mr. B tax dollars? If a Family Trust owns Mr. B’s corporate shares, the Corporation can declare a $100,000 dividend payable to that Trust. Mr. B, acting as trustee, would then allocate one-third of the dividend to each of his three children. Assuming the children have no other income, each could receive their share while paying very little tax. As the trustee, Mr. B uses these funds for the child’s benefit, such as paying for tuition, cars, or phone bills.

The foregoing is one form of “income splitting”, and is only one of various benefits of using a Family Trust. Other benefits include potential multiplication of the “lifetime capital gains exemption” (i.e., the $800,000 shelter available (currently) to every Canadian resident individual who sells shares of a company that meet the definition of “qualified small business corporation shares” (section 110.6 of the ITA) – which I will discuss in a future article), and creditor proofing.

Implementing a Family Trust for Existing Corporations

A very common question that arises in the above-described scenario is whether someone who already owns the shares of his/her company in his/her own name can obtain the benefits of a Family Trust as described above. The short answer is yes – although various limitations apply. To obtain such a structure, some form of “freeze” transaction would be required (using either section 85 or section 86 of the ITA).

The rules in the ITA dealing with trusts are very tricky. One must be wary of (among other things) the “attribution” rules (which can cause income to be attributed to a different taxpayer than the taxpayer in whose name the income is reported), as well as subsection 75(2) of the ITA, which can remove the ability to roll out trust property at cost (a very important feature of the Family Trust).

Taxpayers should always consider the most tax-efficient way to structure their affairs. The Canadian courts have indicated that taxpayers are entitled to plan their affairs in the manner that is most tax-efficient. Taxpayers ought to take advantage of the many rules provided by the ITA that allow them to keep more cash in their pockets.

Ready to protect your family’s future? A Discretionary Family Trust is just one piece of a robust financial strategy. Explore our comprehensive tax and estate planning to ensure your assets are protected for the next generation.