Trust Planning: Beware Association

When designing a corporate structure involving two or more CCPCs, planners normally seek to avoid association; the objective is to ensure that each corporation has its own $500,000 business limit so that it is eligible for the maximum small business deduction. However, the addition of a trust to this type of structure may inadvertently create association, with a consequent sharing of the $500,000 limit. The examples below show how association can occur through the trust’s beneficiaries, settlor, or trustees.

Association Through the Beneficiaries

Two potential association problems can arise for beneficiaries of any age:
  1. if a trust is discretionary, subparagraph 256(1.2)(f)(ii) deems each beneficiary to own all the shares of a trust; or

  2. if a trust has fixed interests, subparagraph 256(1.2)(f)(iii) deems each beneficiary to own the fixed percentage of the shares that corresponds to the beneficiary’s fixed percentage interest.

In a hybrid situation—that is, if a taxpayer has a discretionary interest in a trust with a maximum cap (for example, 24 percent)—the taxpayer will still be deemed to own 100 percent of the shares (CRA document no. 2003-0052261E5, January 6, 2004).

Consider the situation of a discretionary trust set up to hold more than 50 percent of the shares of a corporation for a beneficiary (Trustco). If the beneficiary is the owner-manager of a different corporation (Beneco) that controls more than 50 percent of the shares, then Trustco and Beneco will become associated by virtue of the rule set out above (because the beneficiary is considered to control both corporations). In a situation such as this, the beneficiary may not even know that a trust is being planned to be put in her name. Further, she may be only one of several beneficiaries, and because the trust is discretionary, she may never derive a benefit out of the trust.

Even more troublesome is the rule in subsection 256(1.3), which provides that if beneficiaries are minor children, then both parents of any minor beneficiaries are deemed to own 100 percent of the shares held in trust for those children, as illustrated in figure 1. This rule gives rise to unexpected consequences because it arises without any cross-shareholdings between Parentco 1 and Parentco 2; in addition, its application is—surprisingly—unaffected by the separation or divorce of the parents (CRA document no. 9923125, December 23, 1999). The result can be avoided only if “it can reasonably be considered that the child manages the business and affairs of the corporation and does so without a significant degree of influence by the parent” (subsection 256(1.3)).

Association Through the Settlor

Subsection 75(2) applies to a particular trust to attribute business income or losses and capital gains or losses to a settlor of a trust when the terms of the trust deed contemplate that a settlor “may” have a reversionary or controlling interest in the trust. If the subsection applies, subparagraph 256(1.2)(f)(iv) will also apply to deem the settlor to own all of the shares held in the trust that were purchased with settlement property or property substituted therefor.

A settlor may settle a trust with nominal consideration that is used to subscribe for shares in a corporation (Trustco). However, if the trust deed is not carefully drafted to ensure that subsection 75(2) does not apply, not only may the trust’s income or losses be attributed to the settlor, but any corporations that the settlor controls may become associated with Trustco pursuant to the deemed ownership rule in subparagraph 256(1.2)(f)(iv).

Association Through a Trustee

Subsection 104(1) provides that a reference to a trust is a reference to its trustee. Thus, as illustrated in figure 2, if a trustee is a shareholder in a corporation and the trustee’s duties will include having a controlling interest in a different corporation, the two corporations will be associated (because the trustee/trust controls both corporations): see CRA document no. 2005-0111731E5 (July 4, 2006). Moreover, if the trust has multiple trustees, each trustee owns 100 percent of all the shares (because trustees own property jointly, and parties who own property jointly each own it 100 percent).

Further consequences follow unless subsection 256(4) (discussed below) applies. If a trustee or co-trustees control two or more corporations under the same trust, these corporations will be associated pursuant to paragraph 256(1)(b). And, more unexpectedly, association will result if a trustee controls two separate corporations under two separate trusts, as depicted in figure 3.

The result described above will occur even if beneficiary 1, beneficiary 2, and the trustee were unrelated before trust 1 and trust 2 are settled and if both Trustco 1 and Trustco 2 were unassociated before being settled under trust 1 and trust 2 (CRA document no. 9510645, June 29, 1995). Association will still arise if the trustees of both trust 1 and trust 2 are an identical group of co-trustees instead of sole trustees (because subsection 104(1) provides that a reference to a trust is a reference to its trustee).

It is possible to avoid association of the type illustrated in figure 3 by having two groups of co-trustees oversee trust 1 and trust 2, so long as those groups are not identical (that is, by having one less person or one more person in one of the two groups)—although if the co-trustees control corporations, then the association problems illustrated in figure 2 may arise.

The only exception to this type of association is in subsection 256(4), which provides that corporations will not be associated solely by their common trustee controller so long as
  1. the trust or trusts are testamentary, and

  2. the corporations were unassociated before the trustee acquired control.

Finally, special issues arise when the trustee is a corporation. Ordinarily, paragraph 256(1)(a) would associate the corporate trustee with a corporation that it controlled. However, subsection 256(5) provides that, in the ordinary course, association will not arise unless the settlor controlled the corporate trustee (or is a member of a related group that controlled the corporate trustee).

Jason R. Pisesky
Felesky Flynn LLP, Edmonton

Canadian Tax Focus
Volume 5, Number 4, November 2015
©2015, Canadian Tax Foundation