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Trust in the System

Updated: Aug 2

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. Needless to say, the expenses associated with supporting Mr. B’s children are high – approximately $35,000 per child, per year (tuition, cars, phones, etc.).


Based on the above, Mr. B will require approximately $100,000 to support his children in 2016 (the “Support Funds”). If Mr. B extracts the Support Funds from his corporation (whether via dividend or salary/bonus), he will be left with a lot less than the $100,000 he requires for the support, since a large chunk of that will be required to satisfy the tax bill that results from the extraction. Mr. B would actually have to extract significantly more than $100,000 from the Corporation in order to be left with the $100,000 of Support Funds that he requires.


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. There are various options available to Mr. B, but in this article I will explore one particular option: the “Discretionary Family Trust” (a “Family Trust”).


Firstly, what is a trust? In law, a “trust” is not a separate legal entity (as is a corporation), rather, it is a relationship between (i) the “settlor” of the trust, being the person who contributes the initial property to the trust, (ii) the trustees of the trust, who hold and deal with the property for the benefit of the beneficiaries (in accordance with the terms of the trust indenture), and (iii) the beneficiaries of the trust, who are entitled to the property of the trust (in accordance with the terms of the trust indenture). Although not a separate legal entity, the Trust is a separate taxpayer under the rules contained in the Income Tax Act (Canada) (the “ITA”).


How can a trust save Mr. B a lot of tax dollars? If Mr. B’s shares of the Corporation are owned by a Family Trust (instead of by Mr. B personally), of which Mr. B’s three children were beneficiaries, the Corporation can declare a dividend payable to the Family Trust (i.e., the shareholder), in the amount of $100,000. The trustee of the trust (who would be Mr. B himself) would then allocate (in accordance with the discretion provided to the trustee in the trust indenture) one-third of the dividend to each of his three children (as beneficiaries of the Family Trust). Assuming the children had no other income in the year, each child could receive his/her dividend and pay very little (if any) tax thereon. As the trustee of the Family Trust, Mr. B can use the money from the dividend allocated to each child, for that child’s benefit – paying for his/her tuition, car, phone bill, etc.


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.


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.

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