New reporting rules for trusts

CRA wants to know who’s who in a trust

Proposed changes in the March 2018 federal budget included new reporting requirements for trusts. The new measures relate to filing T3 returns and disclosure that will be required on trustees, beneficiaries, and settlors starting in 2021. Here’s a look at the impact of the new rules.

Trusts are not technically legal entities. Rather, it’s the trustees, acting on behalf of the trust, who have legal capacity. In fact, when I draft documents to which a trust is a party, the contracting person is actually the trustee of the trust, and not the trust itself. Yet, under the Tax Act in Canada, a trust is a separate taxable entity, which means that it is a taxpayer in its own right and has to report any income and pay taxes on that income (to the extent it has not allocated any income out in the same taxation year to a beneficiary). This means a trust has to also file a tax return.

Trusts are like individuals in that they must have a calendar year end. In order to ensure that a trust is able to allocate its income to its beneficiaries so that income is taxed in the beneficiaries’ hands and not in the trust, allocations and trustee resolutions evidencing the allocations must be done by the end of the day on December 31.

The problem is that if a trust happens to hold an investment account, the trustees won’t actually know what the income for the full year will be until after December 31. So we normally advise trustees to document the allocation as a percentage of the total net income for the year, even though they don’t have the actual numbers.

Filing a return

Another anomaly with trusts is that unlike individuals, a trust has a much shorter period in which it has to file a return (known as a T1). You and I have until April 30 of the following year to file our tax returns. However, a trust must file its tax return within 90 days of its year-end, meaning March 30. Why is that? Your guess is as good as mine.

Currently, filing a T3 has not been too taxing (pun intended). For those who value privacy, the information to be disclosed as it relates to the trust (other than its income) was relatively simple. The trustee, name of the trust, and address had to be disclosed. If the trust distributed any assets, the beneficiary that received the asset had to be listed. If there was a change to the beneficiaries, that had to be disclosed and the name of the new beneficiary had to be listed. But otherwise, the information disclosed was not too onerous.

The new rules

However, earlier this year, the federal government announced new measures relating to T3 filing and transparency. For 2021 and subsequent tax years, additional information will be required on trust T3 filings (for both domestic and non-resident trusts that are deemed resident).

Specifically, disclosure is to be made for all trustees, beneficiaries, and settlors (including anyone who is able to exert control over trustee decisions in relation to allocations of trust income or capital, such as a Protector). Certain trusts are excluded, including graduated rate estates, qualified disability trusts, nonprofit trusts, and registered charities or trusts that are less than three months old or that generally hold less than $50,000 worth of assets throughout the year (provided that the assets do not include shares of a private company or real estate).

However, if you have a typical discretionary family trust that holds value worth more than $50,000, then you no longer have the privilege of complete privacy.

Knowing who’s who

So if you formed a discretionary trust where you included everyone but the family dog as a discretionary beneficiary, the disclosure requirements may well cause a large headache for you. What if your class of beneficiaries includes contingent beneficiaries? How do you determine who needs to be part of the disclosure? The proposed rules provide that the requirement to disclose will be met if the required information is provided for each beneficiary whose identity is known or ascertained with reasonable effort by the person who is filing the return for the trust.

Under the existing rules, a trust may not be required to file a return in certain circumstances, including if there is no trust income payable for the year. However, under the new rules, a trust will be required to file a T3 each year; this requirement is in respect of “express trusts.”

So what is an “express trust”? Although the Tax Act does not actually provide a definition for an express trust, it appears that based on common law and legal textbooks, an express trust would be one that is deliberately created. So this would seem to capture all discretionary family trusts. So the long and short of it is that every discretionary family trust will be required to file a T3 every year, even if there is no income for the year.

Putting the stick about

To reinforce these rules, new penalties will be introduced for failure to file a T3 with the proper disclosure information ($25 a day with a minimum of $100 and a maximum of $2,500). If the failure to file was made knowingly or due to gross negligence, there is an additional penalty of 5% of the maximum fair market value of the property held (with a minimum penalty of $2,500). This latter penalty can end up being quite punitive if a family trust is sitting on shares of a company that has significant value.

When I advise clients on whether to put a family trust in place, I always remind them that the trust should file a T3 each year. But this will now be a much deeper conversation. Previously, filing a nil return for a trust would not make for a large project. However, even a nil return will require a lot more thorough work into ensuring the proper disclosure is made every year.

Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-author of Tax and Family Business Succession Planning, 3^rd Edition. She is also co-editor of various Wolters Kluwer Ltd. tax publications. Portions of this article first appeared in The TaxLetter, © 2018 by MPL Communications Ltd. Used with permission.

Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.