Family trusts not just for the rich and famous - Part 2
While discretionary family trusts have come to be associated only with the very wealthy, they can be a useful estate and tax planning tool for every family. In a previous article I looked at how these trusts work and how using a corporate beneficiary can help get around the non-resident tax trap, particularly useful for those with family members who have taken up residence abroad. This time, I want to explore the importance of choosing the right trustee and making sure the trust is formed correctly.
Choice of trustee
The choice of trustees is usually a personal decision. This is because trustees, who hold the trust property on behalf of the beneficiaries, will have a fairly active role in managing the trust property and determining distributions. A discretionary trust typically gives the trustees “absolute discretion” in respect of distributions to the beneficiaries. They can determine when distributions are to be made and to whom (and can distribute to any one beneficiary to the exclusion of the others). So choose your trustees wisely.
I would also typically recommend that three trustees be appointed. It may be that you want to transfer property to the trust. If so, you need to avoid falling afoul of the attribution rule, which is triggered if property that is transferred to the trust by an individual could potentially revert back to the individual, i.e., by virtue of your being a beneficiary of the trust – see my previous article. To do this, you should be one of three trustees in making any decisions regarding the distribution of that transferred property. If you are one of two trustees, then arguably you have a negative veto (since majority rule is required). Although the Canada Revenue Agency (CRA) has provided some administrative largesse where you are one of two trustees, it’s better to be prudent and ensure you are one of three trustees, so there is no uncertainty.
To the extent that the trustees make any decisions regarding the trust property or distributions, it is important that they document their decisions in writing. In addition, if any income or other monies are distributed from the trust to the beneficiaries, the trustees must ensure that those monies are actually paid out to the appropriate beneficiaries, and not scooped by the parents. This is an issue that has apparently been targeted by the CRA on audits, so it’s important to ensure that the flow of funds matches the trustees’ decisions.
Is the trust properly formed?
The “settlor” plays an important role in establishing the family trust. He or she is the person who formally establishes the trust by “settling” the trust with property (i.e., cash or a gold coin has been typically used) to clearly indicate the intention to form the trust. It is important that this property, known as the “settlement instrument,” be properly safeguarded by the trustees, as the CRA has been known to ask for proof of the initial instrument’s existence. You might, for example, tape or attach the settlement instrument to the original trust agreement, so it doesn’t get lost.
But the settlor’s role is not as simple as handing over a gold coin. He or she must actually intend to form the trust and should understand the terms of the trust agreement. The settlor cannot be a beneficiary of the trust, or else the attribution rule will kick in. However, he or she should be the person who instructs the advisor preparing the trust deed, or because that may not always be practical at the very least review and confirm the terms of the trust prior to its finalization and execution. The settlor’s role also includes the confirmation of the trustees. So, the settlor should not always be a choice of convenience.
Once the settlor has formally formed the trust deed, his or her role is generally done, as the settlor has no further ongoing duties in respect of the trust. That is the trustees’ duty.
Creating a trust is not as cut and dried as it might appear, with a number of formal steps required to establish it and ensure that it is legal and not open to challenge by the CRA. It’s important to get proper legal and tax advice if you’re contemplating setting up a trust.
Previously published in The Fund Library on July 26, 2018 by tax and estate planning lawyer, Samantha Prasad.