This article appears in the Mid-October 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
The federal government’s proposed expansion of trust reporting rules is causing uncertainty and compliance risk for taxpayers who use trusts as part of real estate deals, estate planning and other common financial transactions.
The changes have been underway for years, but proposed legislation still is in the draft stage. However, the rules are supposed to take effect on Dec. 31.
“There’s been a lot of consultation and confusion around the rules,” said Rebecca Hett, vice-president, tax, retirement and estate planning with CI Global Asset Management in Calgary.
The government first proposed stricter rules on trust reporting in the 2018 federal budget as part of its broader effort to combat aggressive tax planning, tax evasion and money laundering. The rules were meant to be effective on Dec. 31, 2021, but the measure never passed into law.
On Feb. 4, 2022, the Department of Finance released draft legislation to implement new proposals, this time including bare trusts within their scope. Bare trusts are arrangements in which a trustee’s only duty is to transfer property to a beneficiary on demand. These trusts are commonly used to facilitate efficient property transfers, to mitigate or avoid provincial land transfer taxes or probate fees, and to ensure privacy. In general, bare trusts aren’t used for income-tax planning.
Finance released revised draft legislation in early August with no significant changes. The consultation period ended Sept. 30. If enacted, the rules would apply for trusts with year-ends on Dec. 31, 2022, and after.
Katherine Ratcliffe, a partner with Lindsey MacCarthy LLP in Calgary, said she “found it disappointing and frustrating” that the government did not address tax practitioner concerns in the revised draft legislation, particularly the inclusion of bare trusts. “It makes the process of consultation seem entirely insincere,” she said in an email to Investment Executive.
If the legislation passes this fall, there will be “a massive amount of stress” for practitioners and taxpayers as they work to identify and prepare tax returns for all existing bare trust arrangements by the filing deadline of March 31, 2023, she said.
“Getting all of the names [of beneficiaries], making sure you have everybody, is going to be an additional cost with no benefit [to clients] whatsoever,” said Keith MacIntyre, tax partner with Grant Thornton LLP in Halifax.
“If [the Canada Revenue Agency (CRA)] had standard forms, and we were able to integrate them today, we could do searches on our database” to help identify clients affected by the proposed new rules, he added.
In response to emailed questions about how the CRA was preparing for the new trust reporting regime, the agency said it would “administer the new reporting and filing requirements once there is supporting legislation that receives royal assent, and we will continue to administer the existing rules for trusts under enacted legislation.”
When asked if the CRA anticipated another postponement in administration of the rules, the agency responded that it would “not be commenting on this legislation while it is in draft form.”
Some clients may not realize they could be caught by the new rules. For example, a bank account opened by a parent for the benefit of a minor child, or one in which an adult child is added as joint owner with a parent, could be considered a bare trust arrangement, and thus a trust return and the associated reporting would have to be filed.
“It certainly seems to me that these types of arrangements are caught now under the definitions of bare trust in the proposed legislation,” Hett said.
The enhanced disclosure rules will have significant implications for the use of trusts for confidentiality purposes, which an individual may want for legitimate non-tax reasons, MacIntyre said. A settlor may not want a family member to know that they’ve been named as a beneficiary of a trust, for example. However, to comply with the new rules, trustees will need to obtain information from individuals involved, thus informing them that they are indeed beneficiaries. “Privacy has now become a very big issue.”
The new rules, if enacted, are likely to change the way trusts are drafted.
Currently, for example, financial advisors often recommend clients create a discretionary family trust for tax and estate planning purposes, naming a broad variety of beneficiaries. Doing so gives trustees a high degree of flexibility in terms of when and to whom distributions can be made.
Should the proposals pass, “there will be a trend toward being much more intentional with who is named as a beneficiary,” Ratcliffe said in an interview.
The new reporting rules also will provide the CRA with more transparency, including an improved capacity to confirm which corporations have failed to report associated corporations in the proper sharing of the $500,000 small business deduction.
The Income Tax Act deems each beneficiary of a discretionary trust to own all of the shares of a corporation owned by that trust for the purposes of the associated corporation rules. If one of these benef iciaries owns a corporation, they may see their ability to access the small business deduction reduced or eliminated if the trust also owns shares of a corporation with taxable capital or passive investment income above threshold amounts.
The enhanced disclosure rules do not represent a legislative change, but to the extent that beneficiaries may not have been aware of the issue, they “can’t stick their heads in the sand anymore,” said Kenneth Keung, director of Canadian tax advisory with Moodys Private Client Law LLP in Calgary. “In that sense, when setting up trusts people will have to pay more attention to who they have listed as a beneficiary.”
The CRA already has information on any income or gains earned on property held in trusts, and beneficiaries would still have to report these amounts on their personal tax returns. However, the expanded reporting rules would provide the government with more detailed information about trusts and beneficiaries.
“There are indeed bad actors out there who are doing aggressive stuff, probably with bare trusts as well, to intentionally hide arrangements,” Keung said.
However, MacIntyre suggested that compliant taxpayers are unfairly and unnecessarily being asked to pay the price for those who may not be deterred by enhanced reporting anyway.
“It’s a huge burden on the taxpayer,” MacIntyre said.
The proposed trust rules in detail
The proposed rules require trusts with taxation years ending on Dec. 31, 2022, or after to annually file a trust income tax return and identify all beneficiaries, trustees, settlors or protectors of the trust, including their addresses, date of birth and taxpayer identification number. Under current legislation, generally only trusts with taxes payable for the year or those that dispose of capital property must file an annual trust return.
Certain trusts are excluded from the scope of the proposed rules. These include mutual fund trusts and registered plans, trusts in existence for less than three months and those with less than $50,000 in asset value — as long as those assets consist only of cash and securities traded on a designated exchange (and other certain assets).
In addition to existing penalties for failure to file a trust return, the proposed reporting rules introduce a new penalty for deliberately not filing or for gross negligence: $2,500 or 5% of the property’s value, whichever is greater.