June 26, 2013
If your estate plan includes creating a trust in your will or you are a trust beneficiary or an estate trustee, you may be affected by the federal government’s proposals to tax certain trusts at a top tax rate rather than the lower graduated tax rates that some trusts currently pay, beginning in 2016.
Do the trust proposals affect you?
- Do you have a will?
- Does your will create a testamentary trust or a spousal or common-law partner trust?
- Are you now or will you be a beneficiary of a testamentary or spousal trust?
- Are you a trustee for a testamentary trust?
- Are you an executor of an estate?
If you answered yes to any of these questions, you should contact your KPMG adviser to help you revisit your will and estate planning to reflect upcoming tax changes and to ensure your plans will still accomplish your objectives for minimizing taxes and leaving as much as possible to your beneficiaries.
How are trusts taxed?
Family trusts created by a will or estate have played an important role for many years in Canadians’ plans to pass on business and investment assets to their families.
Currently, estates and other trusts created in a will (testamentary trusts) pay tax on their income at the same graduated rates as individuals. The establishment of a testamentary trust under a will creates a “new taxpayer”, which can provide annual tax savings for the trust’s beneficiaries.
A spousal trust created in a will has another tax advantage — assets can be transferred in a will to this spousal trust without the deceased spouse having to pay tax on any capital gains that would otherwise be deemed to be realized on his or her death. This tax will be deferred until the surviving spouse dies. The principal conditions for a spousal trust are that only the surviving spouse is entitled to receive the trust’s income and no one other than the surviving spouse is entitled to the trust’s capital during his or her lifetime.
On the other hand, a trust that is set up during the settlor’s lifetime, known as an “inter vivos” trust, is treated differently. These trusts pay tax at a flat rate — the top rate of combined federal and provincial tax for individuals. This rate ranges from 39% to 50%, depending on the trust’s province of residence.
Testamentary trusts to pay tax at a top rate
The government announced its intention in the March 2013 federal budget to consult with stakeholders on possible measures to eliminate the tax benefits that arise from taxing testamentary trusts and estates at graduated rates, after a reasonable period of administration for estates.
The Department of Finance announced more detailed proposals in a consultation paper released in June 2013. Among other things, the proposals would subject testamentary trusts to tax at a flat rate equal to the top rate of combined federal and provincial tax for individuals.
Estates would also be subject to this flat top-rate taxation starting immediately after the 36 months that follow the individual’s death (top-rate estates). Estates could therefore retain access to graduated rates for up to the first 36 months of their administration.
These measures would apply to existing and new arrangements for 2016 and later taxation years.
The proposed measures would not change the preferred beneficiary election rules that apply to trusts for disabled beneficiaries or the rules that apply to trusts for certain minor children.
Also, these measures would not change the rollover rules that apply to spousal trusts and common-law partner trusts on the death of the first spouse or common-law partner.
|KPMG observation — Spousal trusts|
Because the consultation paper is generally worded, some details about how the proposed measures would apply are not clear.
For example, it is unclear how spousal trusts or common-law partner trusts will be affected by the proposals. In particular, it is unclear what tax rate will apply to certain capital gains realized by the spousal trust and not paid out to the surviving spouse during his or her lifetime. As well, it is unclear what tax rate will apply to assets deemed disposed of by the spousal trust upon the surviving spouse's death.
Other tax changes for trusts
Along with applying the top tax rate to testamentary trusts and estates after 36 months, Finance proposes to change the way other tax rules apply to trusts.
Income tax instalments
The rules requiring certain taxpayers to pay quarterly instalments would be extended to testamentary trusts and top-rate estates.
|KPMG observation — Instalment rules for trusts |
The law currently requires inter vivos trusts to pay instalments but the CRA’s administrative policy has been not to enforce this rule. Testamentary trusts can currently choose to pay their tax payable within 90 days from the end of their taxation year rather than paying quarterly instalments.
The proposal to require testamentary trusts to pay quarterly instalments may signal a change in the CRA’s administrative policy such that both inter vivos and testamentary trusts could be required to pay quarterly instalments in the future.
Alternative minimum tax
The $40,000 basic exemption from alternative minimum tax (AMT) would not be available to testamentary trusts and top-rate estates.
Taxation year and fiscal period
Testamentary trusts and top-rate estates would be required to use the calendar year as their taxation year. Their fiscal periods would be required to end in the calendar year in which they began.
|KPMG observations — Transition period for estates |
It is unclear how the requirement for a top-rate estate to have a calendar year-end will affect the 36-month transition period, but it appears that an estate can have an off-calendar year-end up to the end of the 36-month period.
For example, if a taxpayer died on July 1, 2016, the 36-month period during which the estate would pay tax at graduated rates would end on June 30, 2019 and the estate would have to start using a calendar year-end in 2019.
As a result, in the calendar year 2019 the estate would pay tax at graduated rates on its income from its first 2019 taxation year (the 12 months from July 1, 2018 to June 30, 2019). It would then begin paying tax at the top rate on its income for its July 1 to December 31, 2019 six-month “stub period”, effectively its second 2019 taxation year.
Consequently, the estate would need to file two tax returns for 2019 — the first one would be due 90 days after the 12-month June 30, 2019 taxation year-end and the second one would be due 90 days after the December 31, 2019 year-end for the six-month stub period.
It is also unclear whether the 36-month transition period, which allows for the use of graduated tax rates, is shortened in cases where the estate could be wound up before the 36-month period ends but continues to be administered so that the estate can take advantage of graduated rates for the full 36-month transition period.
Finally, it remains to be seen whether an estate that is already in administration before 2016 will be entitled to the full 36 months of transitional relief starting from 2016.
Personal trust status
Currently, testamentary trusts automatically qualify as personal trusts but inter vivos trusts only qualify as personal trusts if their beneficiaries do not pay anything for their interest in the trust. The new rules would subject testamentary trusts and top-rate estates to the same conditions that currently apply to inter vivos trusts in determining eligibility as a personal trust.
Unlike commercial trusts, personal trusts are eligible for special treatment — their beneficiaries are eligible for a rollover when they receive certain assets from the personal trust in satisfaction of their capital interest in the trust. As such, the beneficiaries do not pay tax on any capital gain until they dispose of the assets.
Tax administration rules for trusts
Currently, testamentary trusts have access to advantageous administrative tax rules that extend the period:
- During which the CRA may refund an overpayment of tax
- For objecting to a tax assessment
- For filing an agreement to transfer forgiven amounts under the debt forgiveness rules, and
- During which, at the trust’s request, the CRA may reassess or make determinations in respect of certain income tax liabilities.
The proposed measures would limit the relief under these rules to estates that have not yet become top-rate estates.
Grandfathered inter vivos trusts
The proposed changes for testamentary trusts also apply to grandfathered inter vivos trusts, which are trusts that were created before June 18, 1971 that satisfy certain restrictions regarding their activities. These trusts are currently taxed at graduated rates.
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We can help
Your KPMG adviser can help you assess the effect on your estate plans of the proposed changes to the taxation of trusts and point out ways to take advantage of any benefits arising from the changes or help mitigate their impact. For details, contact your KPMG adviser.
Information is current to June 25, 2013. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.
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