“Exercise Your Discretion”

1. “Exercise Your Discretion” The Ins and Outs of Family Trusts Kevin J. Kilgour, CPA, CGA November 19, 2013

2. Agenda • 1. What is a “family trust”? • 2. How are they created? • 3. Why do we use them? • 4. How are they taxed? • 5. What are the common pitfalls? • 6. Family Law issues • 7. Examples and planning opportunities

3. What is a family trust? • Non-commercial (i.e. personal) inter vivostrust settled for the benefit of a group of family members • Settlement property is a gift • Nothing is paid for a beneficial interest in the trust

4. How are they created? • Trust is a relationship, not a legal person (the trustee is) • Settlor: Must have a natural interest in benefitting the family (i.e. family friend or other family member) – NOT A BENEFICIARY AND IDEALLY NOT A TRUSTEE – avoid 75(2) • Settlement property: Usually a silver coin or other property from which significant income will not arise – avoid attribution issues

5. How are they created? (cont.) • Trustee(s): Usually one or both parents, but can include third parties • Beneficiaries: Can be any member of the family (including spouses), and may also include corporations controlled by the family • Protector: Optional person who may appoint trustees, or otherwise control actions of the trustees after settlement of the trust

6. Why do we use them? • Income splitting • Separate control from ownership (i.e. trustee versus beneficiary) • Discretion to allocate income and capital • Privacy (assets of the trust are not subject to reporting as with an estate) • Asset protection • Estate tax planning by minimizing death taxes (capital gains and probate fees)

7. How are they taxed? • Taxed as an individual – top marginal tax rate in province of residence • Can allocate income and capital gains to beneficiaries • Deductions from income for amounts allocated and taxed in beneficiaries’ hands • Must file an income tax return for each calendar year • Must file an information return for each calendar year if allocating income or capital gains

8. How are they taxed? (cont.) • Due date for returns is 90 days after the end of each calendar year • Deemed to dispose of and reacquire all of its capital property on the 21st anniversary of its settlement date for proceeds equal to its fair market value at that time • Property cannot be transferred into a family trust on a tax-deferred basis, but it may be able to be transferred out to the beneficiaries on a tax-deferred basis

9. What are the common pitfalls? • Make sure trust is validly constituted (i.e. three certainties of intent, object, and subject matter) • Make sure that income allocated to beneficiaries is paid or made payable to them or the trust may not be entitled to a deduction from its income

10. What are the common pitfalls? • Carefully review powers of appointment as they may have unintended income tax results – may result in disposition of trust property for income tax purposes (i.e. treatment as a new trust) – CRA’s view is that an addition of a beneficiary is not a change in the terms of the trust if contemplated in the trust indenture, but may result in disposition of interest of beneficiaries who are also trustees (value?) – consider a separate Appointer

11. What are the common pitfalls? (cont.) • Watch for association issues for income tax purposes, especially with minor children – consider excluding minors as beneficiaries if capital gains splitting is not a goal • Watch for attribution issues, especially corporate attribution if used in an estate freeze – consider excluding spouses and minor children (i.e. “designated persons”) if necessary, or use a method that does not trigger attribution (such as a stock dividend freeze) – avoid use of cash to settle the trust – borrow from an arm’s length party to acquire additional trust property (i.e. private company shares)

12. What are the common pitfalls? (cont.) • 75(2) attribution: Ensure that the trust is irrevocable and that the settlor cannot receive the settlement property (or substituted property) , determine its distribution, or prevent its distribution through a lack of consent – carefully review powers if settlor is also Protector or exclude them completely - Sommerer and Brent Kern re transfers to a trust at FMV • Ensure that the taxable portion of capital gains and deemed income are included in income of the trust so that it can be allocated as such and taxed in the beneficiaries’ hands if necessary – these are not income under ordinary trust law so must be characterized as such in the trust indenture

13. What are the common pitfalls? (cont.) • Ensure that the 21st anniversary date does not arrive without appropriate planning being considered to transfer assets out of the trust and avoid the capital gains tax that may be triggered – consider building an automatic distribution into the trust indenture if concerned • Ensure that the prescribed rate of interest is charged on any related party loans to the trust and paid within 30 days of the end of each calendar year (i.e. 56(4.1) avoidance), and also that the loan is properly documented and genuine (i.e. 75(2) avoidance)

14. What are the common pitfalls? (cont.) • When using corporate beneficiaries, ensure that the rules regarding connected corporations are considered so that Part IV tax does not apply unexpectedly • Ensure that central management and control resides in the correct jurisdiction in order to get the income tax regime you desire for the trust (Alberta?) – Thibodeau and Garron

15. What are the common pitfalls? (cont.) • Ensure that residency of beneficiaries is monitored and withholding taxes are appropriate • Confirm citizenship status of beneficiaries – significant U.S. reporting obligations for U.S. citizens

16. Family law issues • New Family Law Act of BC (in effect on March 18, 2013) includes a discretionary interest in a trust as an “excluded property” for purposes of property division on separation • Value of interest in the family trust is deemed to be equal to the value of ALL property of the trust, even if interest is discretionary • The growth in value of excluded property during the marriage or common-law relationship is considered to be family property and is generally required to be shared equally amongst the departing spouses

17. Family law issues • Problem is that the beneficiary spouse is not entitled, and certainly may never receive, 100% of the growth in value of the assets of the trust during the marriage/relationship, but must still compensate the departing spouse for 50% of that amount • May result in a loss of other property that would not have otherwise been required to be shared with the departing spouse – likely an unintended result • Consider including spouses as beneficiaries of the family trust to mitigate the issue since both spouses will then have identical claims with respect to their interests in the trust

18. Family law issues • Valuations will be important, particularly at the time of commencement of marriage or common-law relationship, in order to avoid ambiguity regarding the amount of growth in the relevant asset values • Spousal agreements will be even more important under the new rules – allows spouses to opt out of the standard treatment • Need to ensure spouses are treated fairly (i.e. not “significantly unfair”) or agreement will likely not be enforceable

19. Examples and planning opportunities • Common organizational structure X Family of X Holdco Beneficiaries FT Trustee Controlling interest Opco

20. Examples and planning opportunities • On January 1, 2014 X Family of X Beneficiaries FT #1 Trustee Settlement date: January 1, 2014 Holdco

21. Examples and planning opportunities • On January 3, 2014 X Family of X Beneficiaries FT #2 FT #1 Trustee Settlement date: January 3, 2014 Settlement date: January 1, 2014 Beneficiary Opco Holdco

22. Examples and planning opportunities • On January 2, 2035 X Family of X Beneficiaries Trustee FT #1 Settlement date: January 1, 2014 Holdco Opco

23. Questions?