Tax Strategy
To Trust or Not to Trust
A trust can have an impact on whether or not corporations are associated.
FROM: MAR-APR 2004 ISSUE | BY FRANCINE ST-ONGE
In personal and family tax planning, trusts are increasingly used to hold shares of family corporations, mainly because they are a flexible tool. When a discretionary trust holds shares, dividend income and capital gains on the eventual sale of the shares can be attributed in such a way as to reduce the overall tax burden on the family, although, of course, attribution rules and the tax on split income must be taken into account where applicable. It is also possible to postpone identifying the beneficiaries of the capital of the trust. This is especially useful when parents create a trust with their children as beneficiaries but have not yet decided how the shares will be distributed when the trust is liquidated.
However, when a trust is created, those involved often forget that its holding of shares can affect whether corporations are associated.
Control by the trust or trustees?
Corporations are associated if they are controlled by the same person or group of persons. When a trust holds the shares of a corporation, who controls the corporation — the trust or its trustees? Subsection 104(1) of the Income Tax Act (the Act) states that a reference to a trust shall be read to include a reference to a trustee. Thus, when a trust controls a corporation, this also implies control by one or more of the trustees.
When there is only one trustee, that trustee clearly controls the corporation. However, if there is more than one trustee, it will be necessary to analyse the trust deed to determine who controls the corporation. For example, when under the trust deed, a trustee has a veto right and can impose his will on the other trustees, that trustee has control of the shares. When decisions must be taken unanimously, the trustees as a group exercise control. When decisions require a majority, the control of the corporation may be attributed to any group of trustees who constitute a majority.
In the context of associated corporations, then, the choice of a trustee or trustees can be crucial. Consider a simple example. Andrea, the sole shareholder of Corporation A, dies. In accordance with her will, a trust is created to hold the shares of Corporation A until her youngest child reaches age 35. As trustee, she appoints her good friend Martin, a knowledgeable businessman who owns 75 per cent of the voting and participating shares of Corporation X. If Martin agrees to act as trustee, Corporation A and Corporation X will become associated, since they are controlled by the same person.
In this matter of control by the trustee and associated corporations, there are two exceptions. First, subsection 256(4) states that two corporations controlled by the same trustee or group of trustees will not be considered to be associated if the Minister is satisfied that the trusts holding the shares of these corporations:
- were not created by the same individual or by individuals not dealing at arm’s length; and,
- were created on the death of the individual who created
the trust.
The second exception is set out in subsection 256(5) of the Act and applies only to corporate trustees. Thus, a corporation acting as trustee will not be associated with the corporations controlled by the trust that it administers. This exception does not apply if the settlor of the trust, at any time in the year, controlled the trustee corporation or was a member of a related group that controlled it.
Deemed ownership
Paragraph 256(1.2)(f) of the Act sets out rules on deemed ownership of shares held by a trust, and they must also be taken into consideration in determining whether corporations are associated. These rules do not change the actual ownership of shares by the trust or its control by the trustee, but their effect is that several persons may be considered to hold the same shares simultaneously. This sometimes complicates matters when determining whether the corporations are associated. Some corporations may be associated as a result of the control exerted by the trustee, while other corporations may be associated because of the rules on deemed ownership.
Generally speaking, the rules on deemed ownership of shares held by a trust are as follows:
- each income and capital beneficiary whose share of the income or capital is discretionary is deemed to own all the shares held by the trust; and,
- each income or capital beneficiary whose share is not discretionary is deemed to hold a portion of the shares proportional to the fair market value of his beneficial interest in the trust in relation to the fair market value of all interests of beneficiaries in the trust.
In the case of discretionary trusts, several persons are deemed to hold the same shares simultaneously. Furthermore, each person is deemed to hold all the shares. This presumption can mean that corporations become associated, whereas this would not have been the case if the trust were not discretionary.
For example, the Green family trust is a discretionary trust whose beneficiaries are Mr. and Mrs. Green and their four children. The trust holds all the shares of Corporation 1. Marie, one of the children, holds all the shares of another corporation, Corporation 2. Since the Green trust is discretionary, Marie is deemed to hold all the shares of Corporation 1 and, as a result, Corporation 1 and Corporation 2 are associated. If the Green trust, instead of being discretionary, had provided Marie with a fixed share representing less than 25 per cent of the income and capital of the trust, she would have been deemed to hold less than 25 per cent of the shares of Corporation 1, and the corporations would not have been associated.
Note that a special rule may apply in the case of some testamentary trusts. When this rule applies, only the income beneficiaries are deemed to hold the shares of the corporation.
When the trust is covered by the attribution rule in subsection 75(2) of the Act, there is an additional presumption of ownership. The person from whom the trust acquired assets in the circumstances set out in subsection 75(2) is also deemed to own all the shares held by the trust.
In addition to rules on deemed ownership of the shares of a trust as set out in paragraph 256(1.2)(f), it is also necessary to keep in mind subsection 256(1.3), which provides that parents are deemed to own the shares held by their minor child unless, having regard to the circumstances, the child manages the business and affairs of the corporation and does so without a significant degree of influence by the parents. The combined effect of these rules on presumption may be illustrated by the following example. James is divorced and has three children, one of whom is a minor. He creates a discretionary trust with his children and himself as beneficiaries. The trust holds all the issued shares of Corporation B. Adela, James' ex-wife and the mother of his three children, is the sole shareholder of Corporation Z, which she founded after her divorce. Since the trust is discretionary, each of the beneficiaries of the trust is deemed to own all the shares of Corporation B that are held by the trust. Thus, the minor child is deemed to own all the shares of Corporation B. Since the child is a minor, James and Adela are each deemed to own the shares of Corporation B. Since Adela owns all the shares of both Corporation B and Corporation Z, the corporations are associated.
As the previous examples show, creating a trust can have a major impact on whether corporations are associated. To avoid unpleasant surprises, special attention must be paid to the rules on associated corporations when choosing the trustee(s) and when determining the interests —i.e., discretionary or fixed — of the beneficiaries.
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Francine St-Onge, BBA, BCL, LLB, FCGA, practises tax and corporate law in Sutton, Quebec. She is co-author of the CGA-Canada course Taxation 2.
"Tax Strategy" is co-ordinated by J. ThomasMcCallum, CBV, FCGA, a business valuation and income tax consultant based in Whitby, Ontario, and author of several CGA-Canada professional development courses. E-mai ljtmc@jthomasmccallum.com.
The information appearing in "Tax Strategy" is provided for the interest of the readers. Neither CGA Magazinenor the column authors and co-ordinator assumes any responsibility or liability to any persons relying on the information in the article to perform tax planning and/or compliance of any kind.