The use of trusts by a business owner for tax or estate planning is still misunderstood. The comments most frequently heard are the following:
"If I hold real estate through a trust, I can avoid paying tax when I sell it; if I transfer my property to a trust, I can avoid it being included in a bankruptcy; the Canada Revenue Agency recently announced that it would investigate tax planning involving a trust; I don't need a trust to hold my company's assets—my children are too young and my business is not for sale; setting up a trust is too expensive and difficult to manage."
As a business owner, it is important to study the different aspects of a trust to determine whether it could be the appropriate vehicle to hold some of your assets. For example:
- Property held by a trust forms part of patrimony separate from that of the settlor, the trustees and the beneficiaries, and therefore provides protection against the creditors of those people.
- Death does not automatically put an end to a trust. It allows the deferral of tax resulting from the increase in value of property held by the trust which is payable at the time of death.
- It is possible to use the $750,000 capital gains exemption of more than one beneficiary (even a minor) when shares are sold by the trust.
- A trust allows dividends received to be allocated to the beneficiaries , allowing for income splitting and the protection of the excess cash of the operating company.
The tax and other advantages that come from setting up a trust should be considered as a whole with a mid to long-term perspective. In order to benefit fully from these advantages, we recommend obtaining the advice of an expert as early as possible in the corporate life of your business. This advice should not be limited to the stage of the creation of a trust, considering its use becomes even more relevant as your business grows, is sold, purchases assets or in the event of a death. We will now attempt to respond to and clarify the concerns mentioned above, which are very common.
If I hold real estate through a trust, I can avoid paying tax when I sell it?
Although this statement may seem naïve for some, it is a comment frequently made by people who have created a trust and purchased real estate through it. The trust allows income to be split between various beneficiaries but it does not make a capital gain non-taxable (except in the case of a sale of shares when certain conditions are met).
It is also important to be aware of the potential application of the "attribution rules". If an individual transfers cash to a trust of which he is the beneficiary and the trust is used to purchase real estate, all the resulting income will automatically be attributed to the individual, even if the trust attributes it to another beneficiary.
Depending on the number of properties held, it may be advisable for them to be held by a company which is in turn held by a trust. That way, the income would be taxed at a lower rate, but this strategy would only be useful if the investor does not need the cash generated by the properties to meet his or her personal needs.
If I transfer my property to a trust, can I avoid it being included in a bankruptcy?
We often meet business owners in an insolvency situation who want to transfer assets to a trust to protect themselves against bankruptcy. Both the Civil Code of Québec and the Bankruptcy and Insolvency Act contain provisions allowing such transfers to be contested and reversed. Also, in divorce proceedings, a judge might be inclined not to recognize transfers made to a trust to protect a person from an impending divorce. It is therefore important to plan in advance and to ensure that one's assets are protected by a trust at the right time so a transfer will not be invalidated.
The Canada Revenue Agency recently announced that it would investigate tax planning involving a trust.
It is true that the Canada Revenue Agency is auditing trusts and beneficiaries' tax returns more often. The situations looked at most closely are those involving income splitting when the trust beneficiary fails to declare the amount received. Other audits are carried out to ensure that shares issued to a trust have in fact been paid for and that the money used by the trust to pay for them does not come from a trust beneficiary. It is therefore very important for someone with questions in this regard to consult an expert as soon as possible, before it's too late.
I don't need a trust to hold my company's assets - my children are too young and my business is not for sale.
It is important to remember that, although dividends received by a trust cannot be attributed to minor children without the dividend being taxed in the hands of the parents, the same does not apply to a capital gain, which can be attributed to any person, regardless their age. This can be a very interesting way to maximize the use of the $750,000 capital gains exemption. And for those who think they'll never sell their company, that may be true, but it is important to remember that an individual's death has the same effect as a sale to a third party. One might never sell, but death is inevitable…
Setting up a trust is too expensive and difficult to manage.
Contrary to a company, a trust does not have to be registered with the Enterprise Registrar or file annual declarations. Also, a tax return is only required if more than $500 of income was earned during a year or if property has been disposed of.
Misunderstanding about this tool is mainly due to the fact that a trust is a vehicle half way between a company and an individual and its use stems from both tax reasons and civil law. Given the extent and complexity of the advantages a trust can offer for a business owner, it is important to take the time to find out more about it before eliminating the possibility of using it.