Estate Lawyer
Joanna Ringrose

TESTAMENTARY TRUSTS



GENERAL COMMENTS REGARDING POTENTIAL BENEFITS

A “trust” is an interest in property held legally by one person (the trustee) for the benefit of another (the beneficiary). A “testamentary trust”, is a trust established by the terms of a “last will and testament” - thus the term “testamentary trust”.

A testamentary trust is an arrangement set up in a Will directing the executor (“estate trustee” in Ontario) of the Will to hold certain estate assets for the benefit of certain individuals or to transfer certain assets to a separate trustee who will do so. The executor or separate trustee is then directed to pay out the income (interest, dividends, etc.) and eventually the assets (or the proceeds of their sale) over a period of time. Provided the trust is properly structured, such an arrangement can provide a number of benefits, including the following:
  1. Potential creditor protection for the beneficiary;
  2. Potential protection against a Family Law Act claim against a beneficiary (in the event of a marriage breakdown);
  3. Potential annual income splitting tax benefits (resulting from accessing the graduated marginal tax rates available to individuals) when there are multiple family member beneficiaries (e.g. children, grandchildren, etc.), some of whom are in a lower income tax bracket;
  4. Potential protection against inherited assets passing to unintended beneficiaries; (e.g. when a married child inherits assets from a parent [the “testator”] and then dies, leaving those assets to their spouse, that surviving spouse could remarry and pass the inherited assets on to a new spouse, rather than the testator’s grandchildren); and
  5. The avoidance of additional Ontario Estate Administration Taxes (“probate taxes”) on the trust assets on the death of the lifetime beneficiary of the trust.
Additional income splitting tax benefits of such trusts were available in Canada for more than 25 years, allowing trustees to tax income in the trust starting at the lowest marginal rates. Because the Canadian government became concerned with the growth in the tax-motivated use of testamentary trusts, it announced its intention in the 2013 Federal Budget to review and consult on possible measures aimed at eliminating these special tax benefits. Following a consultation period, the 2014 Federal Budget reaffirmed the government’s intention to proceed with these measures and on December 17, 2014, the new rules received royal assent. Under the new rules, which became effective January 1, 2016, testamentary trusts (with the exception of certain “Graduated Rate Estates” and “Qualified Disability Trusts”) became subject to tax at the top federal tax rate. (The Department of Finance released further draft legislative changes on the “Tax Rules for Certain Trusts and Their Beneficiaries” on January 15, 2016, to address some problematic provisions contained in the original legislation.) The combined top marginal federal/provincial rates can range as high as 53%, depending on the trust’s province of residence.

The two exceptions to the new tax rules consist of the following:
  1. “Graduated Rate Estates” - Graduated rates will continue to apply for the first 36 months of an estate that qualifies as a “testamentary trust” under the Income Tax Act; i.e. it is a trust that arises on and as a consequence of an individual’s death. The 2014 Tax Measures Supplementary Information states that “this recognizes that estates require a period of administration and that estates are generally administered within their first 36 months. If the estate remains in existence more than 36 months after the death, it will become subject to flat top-rate taxation at the end of that 36-month period.” To qualify as a “graduated rate estate” (GRE) the estate must designate itself as the deceased individual’s GRE in its trust tax return in its first taxation year that ends after 2015. (The estate will be deemed to have a year-end when it ceases to be a graduated rate estate [at the end of the 36 months] and it is then required to select a December 31 taxation year-end.)
  2. “Qualified Disability Trusts” - A second exception to the new rules applies to trusts having as their beneficiaries individuals who are eligible for the federal Disability Tax Credit. Such trusts (which may include “Henson Trusts”) will continue to receive the benefit of graduated rate taxation as long as the beneficiary continues to qualify. The existing graduated rate taxation of testamentary trusts for the benefit of disabled individuals has been an important tool in preserving access by these individuals to income-tested benefits, in particular provincial assistance benefits, such as Ontario Disability Support Program payments.
Despite these legislative changes, testamentary trusts continue to provide many families with estate planning benefits. Potential creditor protection for beneficiaries and potential protection against a Family Law Act claim, for example, are unaffected by the legislative changes. As noted above, income splitting opportunities (e.g. among each adult child’s own family members) can continue to exist with respect to properly drafted and properly administered testamentary family trusts created in Wills.


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(Important note: The above commentary is of a general nature only. It is not legal or tax advice and does not provide an exhaustive list of changes to the taxation of testamentary trusts. It is recommended that the reader obtain legal advice and/or tax advice specific to any particular situation.)



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