Canada Revenue Agency and Income Splitting Trusts

Volume No. 10-03

“The CRA has decided to actively audit domestic inter vivos trusts.”

It seems that the Canada Revenue Agency (the CRA) has decided to actively audit domestic inter vivos trusts (trusts created by a living person, as opposed to ones created on death in one’s will). While trusts are commonly used in estate planning, they are also established to facilitate income splitting with lower-income spouses and children. These income-splitting trusts seem to be the CRA’s primary target.

This initiative coincides with court cases challenging the effectiveness of “income splitting” trusts as well as the CRA’s audit of the “kiddie tax” (income-splitting tax). We have always advised clients to ensure not only that their trusts are created properly, but also that they are administered diligently. Some of the compliance practices that should generally be in place for inter vivos trusts include:

  1. In order for trust income to be taxed in a beneficiary’s hands the income must normally be either paid out to, or made payable to, the beneficiary before the trust’s year-end (an exception applies for beneficiaries with disabilities). If an amount is “made payable to” the beneficiary, the obligation must be clearly and legally enforceable in order to avoid tax in the trust at high rates.
     
  2. Funds allocated to a beneficiary for tax purposes must be used for the benefit of that beneficiary. Any funds withdrawn from the trust for the benefit of someone other than the specific beneficiary (e.g. the trustees, who are often the parents of the beneficiary or for another beneficiary) are not deductible to the trust, and could also trigger a taxable benefit to the recipient.
     
  3. Where the trust reimburses a parent for expenses paid relating to a beneficiary, receipts for those expenses and a clear link to the beneficiary must exist.
     
  4. In addition to being properly established, the Trust must be properly maintained. Recommendations for proper record-keeping include:
    • Ensuring that the trust arrangement is properly documented and that the property that was used to settle (create) the trust is available (or a proper trail of how the property was used exists);
    • Maintaining appropriate bank and investment accounts for the trust ;
    • Maintaining annual trustee minutes to document the decisions of the trustees;
    • Making payments to or for the benefit of beneficiaries with cheques, and ensuring that invoices are retained to support any amounts paid by the trust on behalf of beneficiaries; and
    • If the trust was funded with a loan and income attribution could apply, ensuring that interest, generally at the CRA’s prescribed rate at the time the loan was made, is paid within 30 days after the end of each calendar year.

A properly constituted and administered inter vivos trust is still an acceptable and effective tax planning vehicle. However, ignoring the compliance and administrative requirements can jeopardize the tax effectiveness of these trusts.


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