Defining trusts for tax reporting and compliance

The 2023 tax filing season is upon us, and uncertainty remains about the trust reporting rules. Many Canadians may still be wondering: Do I have a trust and not know it?

 

Caught in these new rules are many types of arrangements that may not appear on their face to be trusts, such as bare trusts. A bare trust is a specific kind of trust arrangement in which the trustee has no obligation other than to deal with the trust property as directly instructed by the beneficiaries, generally with little to no element of trustee discretion. The legal title of the trust property is held by the trustee, but the beneficiaries retain all beneficial ownership of the property.

 

Put another way, unlike a conventional trust where trustees exercise discretion and control pursuant to the trust terms for the benefit of the beneficiaries, a bare trust arrangement is akin to a nominee or principal-agent relationship.

The Canada Revenue Agency (CRA) has acknowledged the inherent uncertainty in identifying bare trusts. The agency is offering penalty relief to bare trusts that file after the April 2 deadline for the 2023 tax year as part of an “education-first approach” to compliance.

 

Common examples of bare trusts include the following:

 

An adult child (or other third party) is added to a property title for no consideration to assist with the parents’ estate planning. The adult child would be the bare trustee (likely alone or potentially as co-trustee with the parents), and the parents would be the beneficiaries, retaining all beneficial ownership and control.

An adult child purchases a home and, to quality for a mortgage or other financing, the parents are also listed as legal owners of the property. The parents would be the bare trustees (either alone or potentially as co-trustees with the child), and the child would be the beneficial owner.

 

A parent opens an in-trust-for account (ITF) for the benefit of a minor child, and it is unclear whether there is a true trust relationship or whether ownership is fully retained by the parent. In these instances, the CRA may consider this a bare trust arrangement, with the parent as the bare trustee and the child as the beneficial owner. While a minor child is not technically a legal person who can direct a trustee as in most bare trust arrangements, the CRA’s view, while fact specific, is that generally the parent is seen as acting as agent for the child.

 

With regard to ITFs, whether or not an ITF constitutes a trust, a bare trust or an account beneficially owned and controlled exclusively by the parent is a fact-specific assessment depending on various factors.

 

For a trust relationship to exist, there must be proof of three certainties:

 

Certainty of intention (intention of the settlor to create a trust)

 

Certainty of subject matter (ascertainable trust property has been transferred to the trustee)

 

Certainty of object (the specific beneficiaries or class of beneficiaries of the trust are ascertainable)

 

Some factors that may influence the determination are how the account is set up, how it has been administered (including how prior returns have been filed), and if there is a governing trust deed in place. The determination should be made with the assistance of qualified legal and tax advisors.

 

It is often the case, where the ITF is acting akin to a trust or bare trust, that a filing requirement would materialize, subject to certain exceptions found in subsection 150(1.2) of the Income Tax Act. Even when it is unclear, filing a trust return with a reporting schedule may be more prudent than ignoring the issue. This may include an ITF governed under a testamentary trust in a will where the minor beneficiary is intended to receive the balance of the trust after they reach the age of majority, or even where there is an unwritten intention by the parents to treat the account as a more formal discretionary trust, with the ability to gift (or not gift) at any time in the future.

 

Further, failure to file carries a significant penalty that would likely eclipse any possible advantage of not filing, if assessed. Under subsection 163(5), a person or partnership is liable to a penalty if they “knowingly or under circumstances amounting to gross negligence” make or participate in making a false statement or omission in a T3 return, fail to file a T3 return, or fail to comply with a demand to file a T3 return (as required in the new subsection 150(2)).

 

The term “gross negligence” is undefined in the Income Tax Act but, based on legal precedent, is generally considered to be a “high degree of negligence sufficient to be characterized as a marked departure from standards, practices and due diligence expected of a reasonable taxpayer”[1] as well as being “akin to burying one’s head in the sand.”[2]  

 

The penalty for contravening subsection 163(5) is the greater of $2,500 or 5% of the highest fair market value of the property held by the trust for the year.

 

For example, if a gross negligence penalty were to be assessed on a bare trust arrangement of $1.5 million in assets, depending on how the value under trusteeship is ultimately determined (as the value under trusteeship or the value of the legal ownership), the penalty may be a minimum of $2,500 or as much as $75,000 per assessed year. This penalty can apply to the accountant who prepares or files the return, so a tax advisor may be understandably hesitant to ignore the existence of a trust relationship or charge a premium to do the extra compliance work or even seek an indemnity to mitigate their risk.

 

It is important to note that in light of these new compliance requirements, the use of bare trusts to hold beneficial ownership may result in a new and unforeseen ongoing expense. This cost could exceed any financial benefit in bypassing probate (legal fees or estate administration tax in many cases).

 

With regard to using ITFs and other bare trust arrangements as a probate-bypass tool, when there are other estate beneficiaries or claimants, there may already be a need to obtain probate and complete a more fulsome estate administration. Also, while certain accounts may appear to bypass an estate, should the estate become the ultimate beneficiary under a bare trust arrangement, assets could be required to re-enter the estate for administration.

An executor should assess these risks with a qualified, experienced lawyer before administering assets. From a planning perspective, this risk assessment now commands much more attention and analysis than in years past, and many long-standing estate plans, as well as preconceived notions, may need to be reviewed.

 

Changes in estate, trust and tax legislation occur frequently. As a result, plans, designations, accounts and trust deeds should be reviewed with qualified professionals on a regular basis to confirm that potential outcomes align with intentions and current laws.

 

Matt Trotta: TAX & ESTATE

Matt Trotta is vice-president, Tax, Retirement and Estate Planning with CI Global Asset Management.