Twenty-One-Year Planning: Consider Broadening Trust Beneficiaries

A recent CRA technical interpretation (2017-0683021I7, June 8, 2018) concerned a trust with individual non-resident beneficiaries and the planning apparently undertaken to avoid the deemed disposition of assets related to the trust's 21st anniversary. The beneficiaries transferred their capital interests in the trust to a newly incorporated unlimited liability corporation (ULC). However, the CRA concluded that the ULC was not a beneficiary of the trust, and therefore undesirable tax results follow. This TI serves as a reminder that taxpayers and their advisers should plan proactively when a family trust is involved and consider broadening trust beneficiaries to include corporations wholly owned by beneficiaries of the trust.

The trust held shares of a private corporation (Holdco). As part of the planning, Holdco increased the stated capital of its common shares, resulting in deemed taxable dividends, which were allocated to the trust. Subsequent to the stated capital increase, the trust distributed the Holdco shares to the non-resident beneficiaries. After that, the non-resident beneficiaries assigned their capital interests in the trust to the newly incorporated ULC on a tax-deferred basis under subsection 85(1). The trust allocated the dividend to the ULC on its T3 tax return on the basis that the ULC became a beneficiary of the trust as a result of the transfer of the beneficial interest.

The problem with this plan is that the trust settlement agreement limited its beneficiaries to natural persons. Because of this, the ULC could not be a beneficiary of the trust and dividends could not be allocated to it. Therefore, the dividends were included in the income of the non-resident beneficiaries pursuant to subsection 104(13), and the dividends were also subject to non-resident withholding tax. (Furthermore, regardless of whether the ULC is a beneficiary, the CRA found that subsection 56(2), which prevents tax minimization by directing payments to another person, would apply to attribute the dividend income to the non-residents, making it subject to withholding taxes.) In addition, subsection 105(1) would apply such that a benefit would have been conferred on the ULC, resulting in an income inclusion for the ULC. Finally, because the non-residents were the trust beneficiaries (and not the ULC), the trust was not able to distribute the Holdco shares on a rollover basis pursuant to subsection 107(2) (since this section applies only on the distribution of property from a trust to Canadian-resident beneficiaries). As a result, the trust must have distributed the Holdco shares to the non-resident beneficiaries at FMV.

Given the CRA's position, taxpayers and advisers should exercise caution when transferring beneficial interests in trusts to corporations that are not beneficiaries of such trusts. Also, it would be prudent to ensure that corporations wholly owned or controlled by beneficiaries of the trust are included as beneficiaries in the trust settlement agreement. This flexibility in the trust settlement agreement might have avoided the adverse tax results that arose in this scenario.

Jin Wen
Grant Thornton LLP, Toronto

Canadian Tax Focus
Volume 9, Number 3, August 2019
©2019, Canadian Tax Foundation