While discretionary family trusts have come to be associated only with the very wealthy, they can be a useful estate and tax planning tool for every family. In a I looked at how these trusts work and how using a corporate beneficiary can help get around the non-resident tax trap, particularly useful for those with family members who have taken up residence abroad. This time, I want to explore the importance of choosing the right trustee and making sure the trust is formed correctly.
Choice of trustee
The choice of trustees is usually a personal decision. This is because trustees, who hold the trust property on behalf of the beneficiaries, will have a fairly active role in managing the trust property and determining distributions. A discretionary trust typically gives the trustees 鈥渁bsolute discretion鈥� in respect of distributions to the beneficiaries. They can determine when distributions are to be made and to whom (and can distribute to any one beneficiary to the exclusion of the others). So choose your trustees wisely.
I would also typically recommend that three trustees be appointed. It may be that you want to transfer property to the trust. If so, you need to avoid falling afoul of the attribution rule, which is triggered if property that is transferred to the trust by an individual could potentially revert back to the individual, i.e., by virtue of your being a beneficiary of the trust 鈥� see my . To do this, you should be one of three trustees in making any decisions regarding the distribution of that transferred property. If you are one of two trustees, then arguably you have a negative veto (since majority rule is required). Although the Canada Revenue Agency (CRA) has provided some administrative largesse where you are one of two trustees, it鈥檚 better to be prudent and ensure you are one of three trustees, so there is no uncertainty.
To the extent that the trustees make any decisions regarding the trust property or distributions, it is important that they document their decisions in writing. In addition, if any income or other monies are distributed from the trust to the beneficiaries, the trustees must ensure that those monies are actually paid out to the appropriate beneficiaries, and not scooped by the parents. This is an issue that has apparently been targeted by the CRA on audits, so it鈥檚 important to ensure that the flow of funds matches the trustees鈥� decisions.
Is the trust properly formed?
The 鈥渟ettlor鈥� plays an important role in establishing the family trust. He or she is the person who formally establishes the trust by 鈥渟ettling鈥� the trust with property (i.e., cash or a gold coin has been typically used) to clearly indicate the intention to form the trust. It is important that this property, known as the 鈥渟ettlement instrument,鈥� be properly safeguarded by the trustees, as the CRA has been known to ask for proof of the initial instrument鈥檚 existence. You might, for example, tape or attach the settlement instrument to the original trust agreement, so it doesn鈥檛 get lost.
But the settlor鈥檚 role is not as simple as handing over a gold coin. He or she must actually intend to form the trust and should understand the terms of the trust agreement. The settlor cannot be a beneficiary of the trust, or else the attribution rule will kick in. However, he or she should be the person who instructs the advisor preparing the trust deed, or because that may not always be practical at the very least review and confirm the terms of the trust prior to its finalization and execution. The settlor鈥檚 role also includes the confirmation of the trustees. So, the settlor should not always be a choice of convenience.
Once the settlor has formally formed the trust deed, his or her role is generally done, as the settlor has no further ongoing duties in respect of the trust. That is the trustees鈥� duty.
Creating a trust is not as cut and dried as it might appear, with a number of formal steps required to establish it and ensure that it is legal and not open to challenge by the CRA. It鈥檚 important to get proper legal and tax advice if you鈥檙e contemplating setting up a trust.
Courtesy Fundata Canada Inc. 漏2018. is Tax Partner with Toronto law firm . Portions of this article appeared in The TaxLetter, published by MPL Communications Ltd. Used with permission.
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