Canadian tax rules surrounding trusts are in the midst of a shake-up. This blog summarizes new tax rules applying to testamentary trusts already in effect, and proposed new rules affecting estate donations and spousal and common-law partner trusts.
Graduated Rate Estate
Under new Canadian trust tax rules enacted in 2014, any income earned and retained in a testamentary trust after 1 January 2016, is taxed at the highest federal and provincial personal tax rates, rather than at marginal rates of tax. However, the same rules introduced the concept of the “graduated rate estate” (GRE), the formation of which allows estates to be taxed at the appropriate lower marginal tax rates for up to 36 months, subject to certain conditions. These include that:
- The estate must arise on and as a consequence of the individual’s death;
- The estate must designate itself in its tax return for its first taxation year (or if the estate arose before 2016, for its first taxation year after 2015), as the individual’s graduated rate estate;
- No other estate can be designated as the individual's GRE;
- The estate cannot have come into existence longer than 36 months after the death of the individual, and the estate must have been, at that time, a testamentary trust; and
- The estate must include the individual’s Social Insurance Number in its return of income for each taxation year of the estate that ends after 2015 during the 36-month period after the death of the individual.
Legislative proposals released in draft form by the Canadian Department of Finance on 15 January 2016, provide greater flexibility in the income tax rules for recognizing charitable donations made by an individual, and provide new rules for the tax treatment of capital property transferred to a primary beneficiary upon their death.
The first proposal would modify the rules for donations made by an individual’s GRE to allow concessionary tax arrangements for up to 60 months after the individual’s death.
Currently, donations made by an individual to a registered Canadian charity or other qualified donors are eligible for a Charitable Donation Tax Credit (CDTC), subject to a number of conditions. This can then be applied against the individual's income tax liability. The individual may claim a CDTC for the year in which the donation is made or for any of the five following years.
Trusts (including estates) are subject to the same rules. However, donations made by an individual's estate, while it is the individual's GRE, should be allocated to either:
- the taxation year of the estate in which the donation is made;
- an earlier taxation year of the estate;
- or the last two tax years of the individual.
In addition, if the property donated by the individual’s GRE is a publicly-listed security, or a unit of a mutual fund, that was owned by the individual immediately before the death, the capital gains on the property arising on the individual’s death are exempt from income tax.
The legislative proposals would modify the application of the above rules for donations made by an individual’s GRE by extending the rules to apply to donations made by the GRE, after it ceases to have that status because of expiry of the 36-month period, for up to 60 months after the individual’s death.
Donations made by an individual’s former GRE would be eligible to be allocated among either the taxation year of the estate in which the donation is made, or the last two taxation years of the individual. The capital gains tax exemption will also be available for these donations.
Spousal and Common Law Partner Trusts
Current tax rules permit an individual to transfer, on a tax-deferred basis, capital property to a trust the primary beneficiary of which is the individual’s spouse or common-law partner. These trusts, and certain similar trusts, are then subject to a deemed recognition of capital gains upon the death of the trust's primary beneficiary.
For deaths before 2016, this income was taxed in the trust. For deaths after 2015, these amounts are instead recognized as income in the hands of the primary beneficiary, although any tax liability arising in the primary beneficiary's final tax return will be due, in the first instance, from the trust.
The legislative proposals would modify the tax treatment of spousal and common-law partner trusts and similar trusts, for deaths after 2015, by:
- Taxing in the trust the income deemed to be recognized in the trust on the death of the primary beneficiary (subject to the election described below);
- Permitting a testamentary spousal or common-law partner trust (that arose on and as a consequence of a death before 2017) to jointly elect with the GRE of the trust’s primary beneficiary to have taxed, in the primary beneficiary’s final tax return, the income of the trust for its taxation year in which the primary beneficiary dies; and
- For purposes of computing the trust’s Charitable Donation Tax Credit in respect of a donation made by the trust within 90 days after the end of the calendar year in which the primary beneficiary dies, permitting the trust to allocate the donation to the trust’s taxation year in which the primary beneficiary dies.
The Federal Government is now considering responses to a consultation on the new proposals, which concluded on 15 February 2016, and intends to lay new legislation before parliament in due course.