New law would hit trusts

National Post


Earlier this week, the government formally launched a consultation paper that will likely lead to the elimination of the graduated tax rate system for testamentary trusts and estates. the proposed measures would come into play starting in 2016 and would effectively abolish a common estate planning technique used by wealthy Canadians to reduce tax on the investment income earned from their assets, by their beneficiaries, for years after their death.

A testamentary trust is a type of legal arrangement in which one person, typically known as the estate trustee, holds and manages the deceased's property for the benefit of someone else, known as the beneficiary. a testamentary trust also includes an estate, which arises upon death and generally lasts until the executor distributes the assets to the beneficiaries who are inheriting under the will of the deceased.

For tax purposes, both trusts and estates are considered to be individuals and must file returns that require them to pay tax on any taxable income that is not paid to the trust's beneficiaries. testamentary trusts and estates pay tax at graduated tax rates starting at 15% federally for income under $43,561 (in 2013) and ultimately rising to 29% once income reaches about $135,000. each province, other than alberta which has a 10% flat provincial tax, also applies its own set of graduated tax rates to the testamentary trust's income.

Allowing testamentary trusts to pay tax at graduated rates effectively allows the beneficiaries of those trusts to access more than one set of graduated rates - their own and the testamentary trust's. the tax savings can exceed $20,000 annually, depending on the province, when income is taxed in a testamentary trust instead of perhaps in the hands of a high-income beneficiary had they inherited the funds directly and subsequently invested them.

Specifically, the government listed the use of multiple testamentary trusts, tax-motivated delays in completing the administration of estates, and avoidance of the old age security clawback as offensive testamentary trust planning, which "raise questions of fairness, and negatively affect government tax revenues." as a result, the government proposes to change the tax law to apply flat top-rate taxation to testamentary trusts created by will as well as to estates "after a reasonable period of administration" of 36 months.

The government is inviting written comments on the proposed changes until dec. 2