Transfers of property to a trust generally constitute a disposition of the property at fair market value (1). The disposition triggers the realization of any accrued capital gains, which results in income taxes becoming payable. The current exception to this rule is the rollover of property to a trust for the benefit of a spouse (2).
On December 17th, 1999 the Department of Finance released draft legislation which created two new types of trust, an alter ego and a joint partner trust (3). This has now been passed into law and transfers of capital property to these new types of trusts will not result in an immediate disposition for tax purposes. The disposition will be deferred until the death of the transferor (in the case of an alter ego trust) or until the death of the surviving spouse (in the case of a joint partner trust). In essence, a tax free rollover is created on the transfer of property to these types of trusts. These trusts open up significant new planning opportunities and bring Canada up to speed with the very popular revocable living trusts which have been widely used in the United States for many years.
This article will review the proposals concerning alter ego and joint partner trusts and their impact on estate planning strategies.
Under Subsections 73(1) and (1.02) of the Act, an alter ego trust is one created after 1999 by an individual (the “Settlor”) age 65 years of age or older which is for the exclusive benefit of the Settlor during his or her lifetime. The trust must provide that no person other than the Settlor can have any absolute or contingent interest as beneficiary under the trust. In other words, as long as the Settlor is alive, no other person may receive income or capital from the trust. A joint partner trust is also one created after 1999 by a Settlor age 65 or older, but is for the exclusive benefit of the Settlor and his or her spouse (which now includes a common law spouse and same sex partners) during their joint lives.
Under both types of trusts, as long as the Settlor had reached age 65 at the time the trust was settled, other beneficiaries can be named to receive trust property after the death of the Settlor (in the case of an alter ego trust) or after the death of the survivor of the Settlor and his or her spouse (in the case of a joint partner trust).
Both of these trusts are created while an individual is alive and would be established under a trust agreement signed by the Settlor and the trustees. The Settlor could have complete discretion over the selection of trustees. For example, the Settlor could act as sole trustee or could be one of two or three trustees. If the trust is a joint partner trust, the Settlor and his or her partner could act as trustees. The key aspect of such trusts is that the Settlor would maintain control over trust assets while he or she is alive.
The trust agreement would provide for the appointment of new or replacement trustees upon the incapacity or death of the original trustee or trustees.
As stated previously, no disposition is created at the time the property is transferred into the trust.
All income earned by an alter ego or joint partner trust will be attributed to and taxed in the hands of the Settlor for as long as the Settlor is alive (4).
On the death of the Settlor (in the case of an alter ego trust) or his or her partner (in the the case of a joint partner trust) a deemed disposition will occur within the trust and, because this will be considered an inter vivos trust, tax will be payable at the top marginal rate (5).
The normal 21 year deemed disposition rule will be suspended until the death of the Settlor (in the case of an alter ego trust) or the death of the surviving partner (in the case of a joint partner trust) at which time a deemed disposition will occur.
With the exception of potential extension of the 21 deemed disposition rule, these new trusts create no income tax savings or tax deferrals beyond those already available.
The main planning opportunities relating to these new trusts are as follows:
(a) Because property has been transferred into the trust while an individual is alive, the property ceases to form part of the individual’s estate for probate purposes. In other words, upon the death of the Settlor (in the case of an alter ego trust) or upon the death of the surviving partner (in the case of a joint partner trust), the property would pass directly to the beneficiaries designated by the Settlor and would not fall into and form part of the estate. The practical result being that the property is removed from challenge pursuant to provincial Wills Variation legislation or otherwise.
(b) Given that the property does not form part of the individual’s estate, probate fees or taxes are avoided. In recent years probate fees have increased dramatically in Ontario (300%) and in B.C. (130%) and such fees represent a direct tax on the gross value of a person’s estate.
(c) To the extent that property falls into and forms a part of a person’s estate and as such is subject to probate, there is the requirement of full and complete public disclosure of all assets and liabilities. By avoiding probate, confidentiality is maintained.
(d) Alter ego and joint partner trusts are very flexible planning instruments. For example, the trust document could be drafted in a way that allows some or all of the trust capital to revert to the Settlor at any time. In other words, should the Settlor ever wish to reverse the transfer of assets into the trust that can be done at any point in the future without any adverse income tax consequences.
(e) To the extent that property is transferred into an alter ego or joint partner trust, death becomes a relatively insignificant event from a financial perspective. In other words, there is nothing to do with regards to distribution or transfer of assets to an estate. The whole issue of devolution of property is thus significantly simplified.
(f) Through the ability to appoint alternate trustees in the event of incapacity, alter ego and joint partner trusts are also powerful tools for dealing with incapacity. To the extent assets are held inside such trusts, the need for Representation Agreements or an Enduring Powers of Attorney would be obviated.
Issues to Consider
Notwithstanding the apparent advantages of Alter Ego and Joint Spousal trusts, the following issues should be kept in mind:
Alter ego and joint partner trusts represent the dawn of a new planning era for Canadians. The trusts can be used to avoid the significant disadvantages associated with will based planning and probate. This is a luxury which has been enjoyed by our U.S. counterparts for many years. It remains to be seen how quickly Canadians will embrace this new realm of possibility.
1. The definition of “disposition” in Section 54 of the Act included a transfer of property to a trust.
2. Subsections 70(6) and 73(1).
3. A Notice of Ways and Means Motion tabled on June 2, 2000 to implement the December 17, 1999 legislation, with certain revisions. Most of the rules covering these trusts will be found in new Subsections 73(1)-(1.02)
4. Subsection 75(2).
5. Subsection 122(1).