Monday, 28 January 2019

What Do The New Tax On Split Income (“TOSI”) Rules Mean For Trusts?

By: MaryAnne Loney


A recent tax change that has gotten a lot of attention is the tax on split income, or “TOSI”. Through design or inadvertently, many trusts will be affected by these rules. Many family trusts were set up at least partially to split income to family members. Even when income splitting is not an express purpose of the trust, where a trust owns property that earns money from the work or investment of a person (“source individual”) who is related to a beneficiary, there is a risk TOSI may apply.

Things Trustees and their advisors should know about TOSI


1.      TOSI doesn’t just apply to dividends
While dividends have gotten the most press, TOSI may apply to any income from a “related business”.

A related business is any business, whether operated personally or through a partnership, corporation or trust, where a source individual at any time during the year was “actively engaged on a regular basis in the activities” or in which he or she had a qualifying interest (for a corporation this is 10% or more).  TOSI may apply to any dividends, shareholder benefits, capital gains, or interest derived from a related business.

This means trustees need to look carefully at any source of income and ensure it is not caught under the TOSI rules. I recommend starting with the assumption that TOSI applies to any income, unless you can find a reason why it should be excluded.
2.      Beneficiaries of trusts cannot own “excluded shares” through a trust
One of the main exclusions to the TOSI rules is if the recipient owns “excluded shares”. Shares are excluded shares when an individual owns at least 10% of the shares of a corporation which meet specific criteria. Income earned on excluded shares, or gains earned on disposing of excluded shares, are not caught by TOSI.

Unfortunately, even if a trust owns shares that would otherwise be excluded shares, income allocated through the trust to a beneficiary on those shares owned by the trust will not qualify as shares “owned by the specified individual”, (and therefore not “excluded shares”) since the beneficiary and not the trust would be the specified individual.

This is a significant disadvantage of owning what otherwise might qualify as excluded shares through a family trust. In some cases, it may make sense to distribute shares owned by a trust to a beneficiary so they do qualify as excluded shares for that particular beneficiary.
3.      Some exclusions from TOSI will still apply to allocations from trusts
There are, however, exclusions that will still apply to payments through a trust.

While capital gains from a related business are now generally caught by TOSI, capital gains that qualify for the capital gains exemption are specifically excluded, including for allocations from trusts.

A second exemption is that if the income derives from a business which is an “excluded business” for the beneficiary, then it will not be caught by TOSI.

A business will be an “excluded business” if the beneficiary was actively engaged on a regular, continuous and substantial basis in the activities of the business in either the taxation year or any prior five taxation years.

While “actively engaged” is not defined, if the beneficiary works at least an average of 20 hours per week in the business (while the business operates), the beneficiary will be deemed to be actively engaged.

Recent CRA publications and responses to questions at conferences have also suggested that passive investment income earned on the investment of income from a related business, is not itself necessarily income from that related business.

This suggests that, with the right structure, investment income earned on income itself caught by TOSI could be an excluded amount.

Conclusion 

The new TOSI rules will make things more complicated for trustees and their advisors when it comes to allocating income to beneficiaries. Existing trusts should be re-examined to determine whether they should be restructured or their operations changed. Potential settlors, trustees and their advisors will need to more carefully consider whether setting up a new trust is the best option.

However, trusts will continue to be used for non-tax reasons where it is advisable to separate legal and beneficial ownership and, depending on individual circumstances, trust will continue to make sense in certain tax plans.

Monday, 30 July 2018

The Value of Digital Assets and Why It Should Not Be Ignored in Estate Planning

Author: Marika Cherkawsky, Student-at-Law

Your house, children, jewelry and art, these are all the typical items a person will think about when planning their Estate.  However, what is often forgot about is a person’s digital assets. In a report on digital assets, Kimberly Whaley, defines digital assets as digital photos, word and excel documents, blogs, iTunes collection, tweets, or even Airmiles points. A report by Deloitte estimates that by 2020, the average Canadian will have accumulated over $10,000 in digital assets. Yet, BMO Wealth Institute finds over 57% of Canadians have failed to plan for their digital assets in their estate plans. With an increasing trend towards the digital way of life, it is key that one keeps their digital assets in mind when planning their Estate. This post attempts to demonstrate why digital assets are so important, and what steps can and should be taken to protect ones digital assets after death.
 
What is a Digital Asset and Why Should I Care
Whaley distinguishes between digital assets and digital accounts. As defined above, digital assets include any digital file a person owns. Similar to the physical and financial assets typically provided for in a Will, digital assets hold both sentimental and monetary value.   
Think about all of those photos stored on your computer or hard drive. Previously the boxes of physical photos could easily be found in the basement. But with digital photos, there needs to be clear instructions on how to find and access them if you wish to pass them on. What about your Facebook page? After death do you want your page shut down, or left up as a digital memorial site for your loved ones to visit?
On the monetary end of things, one simply has to think of Bitcoin, the first decentralized digital currency. Currently, the total value of Bitcoin supply in circulation is over $100 billion Without taking Bitcoin into consideration in estate planning, one could be simply throwing away real value. The same goes for loyalty programs such as Airmiles or cash back credit card accounts. 
Unlike digital assets, which are the digital files themselves, digital accounts are how one accesses those files. According to Whaley, digital accounts can be separated into three categories:

  1. accounts that contain virtual currency that could be transferred to your heirs and include a PayPal account, loyalty program accounts such as credit card accounts with cash back, and Bitcoin;
  2. accounts containing virtual property such as Kobo and iTunes accounts. For these accounts people only own a licence to use the digital files and therefore do not actually “own” them; and
  3. accounts containing information likely of personal or commercial interest such as personal email accounts, your Facebook page, Twitter, or LinkedIn.

When planning for your digital assets it is important to always take note of your digital accounts since without access to the digital accounts your digital assets may be subject to its provider’s terms of service. A further obstacle is most account providers will err on the side of caution when it comes to granting access to non-account holders out of fear of breaching Canadian privacy laws. What does this mean? Well, for example, without explicit instruction in a will, grieving family members may be facing a legal battle against big businesses, simply for access to a deceased’s Facebook, email or blog. Recently, in the United States, there have been a number of cases where grieving families embroiled in legal battles with Facebook over access to a deceased family member’s Facebook account.[1] 

What Should You Do

Currently, the law says little to nothing with respect to digital asset management after death. This means it is up to you to take steps to protect your digital assets and accounts. The following steps may assist in this process:

  • Identify all of your digital assets and accounts. This includes documenting the location of all mobile devices, computers and flash drives;
  • Instruct exactly what you want done with each digital asset and account. You may want to leave this responsibility with your chosen executor, or appoint a separate trustee who will be responsible for managing your digital assets;
  • Provide access to your chosen appointed person. This can be done by leaving a password-protected list of digital assets and digital accounts. An online password manager such as LastPass  or 1Password  may assist in this step; and
  • Update your digital assets and digital accounts as often as possible.

One final point is that it is important not to list any passwords to digital assets and accounts within the actual Will. The reason for this is that if, and when your estate goes through probate, the court process by which a Will is proven valid or invalid, the contents of the Will may become public record. Thus, putting your digital assets and accounts at risk. 





[1] Stassen v Facebook is a case from Wisconsin whereby the Stassen;s 21 year-old son committed suicide.  The Stassen’s wanted to access their son’s Facebook and Gmail accounts.  Facebook refused to release any information, citing concerns over breaching their client’s ownership rights.  Facebook refused to disclose their son’s personal account information even after a court order declared the parents the heirs to their son’s estate.

Wednesday, 4 July 2018

Changes in the Wind for Cohabitating Couples

Author: Karen Platten, Q.C.

For many individuals in Alberta, living in a relationship of interdependence (a common law relationship) without the benefit of marriage is a choice. The choice involves the notion that they do not want the legal obligations of marriage, such as division of property, to apply to their relationship.

However, there are changes to legislation being contemplated which would impact those individuals who are in a common law relationship. The Alberta Law Reform Institute ("ALRI") in its report entitled "Property Division for Cohabitants", is reviewing the law in the area of property rights for cohabitating couples and will be forwarding their findings to the provincial government for its own review of the topic.

The ALRI report is based on consultations with individuals who are currently cohabitating as well as with lawyers who practice in the area and other interested individuals. It appears, from the ALRI report, that many cohabitating couples already believe that they fall within the same rules regarding division of property on separation that married couples are subject to. Additionally, the majority of responses to various ALRI surveys, indicate that the public is in favour of having the same or somewhat the same rules that apply to married couples also apply to common law couples.

While common law couples currently have rights to division of property based on rules relating to the doctrine of unjust enrichment, these rules are cumbersome and generally result in unsatisfactory outcomes for both parties. The reform of the law in this area would make it clear for couples from the outset of their relationship as to what their responsibilities and obligations are to their partners.

Couples who do not want to be bound by the new legislation, do have an option. They can contract out of the legislation with a properly crafted agreement which deals with division of property on separation. Similar in nature to a prenuptial agreement, the agreement would determine how property would be divided on separation. Many couples prefer to retain ownership of assets which they brought into the relationship and protect the growth on those assets from division as well.

For anyone interested in reading further on the proposed reforms, we refer you to the ALRI Report for Discussion, September 30, 2017.

In the meantime, if you are in a common law relationship and would like to protect your assets from division with your partner, you should consult with a lawyer who is familiar with cohabitation agreements so that you can remove the possibility of the changes in legislation applying to your relationship.

Monday, 14 May 2018

New Trust Reporting Requirements – Big Implications?

Authors: MaryAnne Loney and Mike Harris
 
All trustees need to be aware that trust reporting requirements are changing. 
Currently, a trust only needs to file an income tax return in certain circumstances, including if it earns income, disposes of capital property, or makes distributions to beneficiaries during the year. There is no current requirement to identify all of the trust’s beneficiaries.
However, the 2018 Federal Budget announced that starting in 2021, except for specifically exempted trusts, trusts resident in Canada and non-resident trusts required to file in Canada will need to:
1.      file income tax returns annually;
2.      report all the settlors, trustees and beneficiaries; and
3.      identify persons who exert control over trustee decisions related to income and capital (“protectors”).

Excluded trusts include constructive or resulting trusts (which usually no one knows exist until proclaimed by a judge), lawyer trust funds, trusts that qualify as non-profits or charities, trusts governed by registered plans (which already require significant reporting), and graduated rate estates. Most importantly, many common forms of trusts (such as family trusts and spousal trusts) will not be exempted from this reporting requirement.
There will also be penalties for late filing of up to $2,500, plus a penalty of 5% of the maximum fair market value of the property if the failure to file was made knowingly or due to gross negligence. Given the CRA’s willingness to find gross negligence on the part of taxpayers, this is quite alarming.
The purpose of these changes is to help identify aggressive tax planning, tax evasion and money laundering – concerns that have been in the media both nationally and internationally. 
However, trustees that have not been responsible for filing tax returns in the past will now have to ensure returns are properly filed, which adds an additional administrative burden. 
Further, the new requirement for trusts to report settlors, beneficiaries, trustees and protectors will provide the CRA with substantially more information they can use for audit purposes.

Potentially Big Implications?
While there are a few years before these changes come into effect, it is important trustees know the changes are coming and consider the implications this additional disclosure may have. 
Currently, there are many rules dealing with beneficiaries and trusts that are rarely audited because the CRA doesn’t know what trusts are out there and who all their beneficiaries are. 
For example, in a discretionary trust, pursuant to subparagraph 256(1.2)(f)(ii) of the Income Tax Act, all beneficiaries are considered to own all the shares of corporations owned by the trust in determining whether corporations are associated. The effect of this provision was recently upheld by the Tax Court in Moules Industriels et al v The Queen (2018 CCI 85).
When corporations are associated, they are required to share a single $500,000 business limit for purposes of claiming the small business deduction. Association rules are complex, but the effect is that corporations owned by beneficiaries of a discretionary trust, depending on the various share ownerships, may be associated with any corporations owned by the trust. Further, since two corporations that are associated with a third corporation are in turn associated, corporations owned by two beneficiaries of a trust, with no connection beyond both being owned by someone who is a beneficiary of the trust, may end up being associated. Cousins with completely unrelated corporations may suddenly find themselves sharing a single small business deduction.
While this issue has existed for several years, it has not been a significant concern because the CRA usually did not know who the beneficiaries of a trust were – especially not the beneficiaries of discretionary trusts who owned profitable corporations of their own, as they were less likely to receive distributions and therefore come to the CRA’s attention.
All this will change once the first trust returns are filed for 2021. The CRA will suddenly have records of every beneficiary of every trust (except for trusts where the trustees fail to file and are subject to penalties). The CRA will be able to combine this information with their records of all private corporations shareholders. It’s far too easy to imagine them putting together an algorithm to identify where associated corporations have not been properly identified in corporate tax returns – not just for 2021 but for previous years as well.
And this is only one potential new audit avenue open to the CRA. Trusts and their beneficiaries are often considered to be related for many purposes and as soon as any of the parties are non-resident there are a whole slew of other potential issues.

Conclusion
With this change on top of other recent changes, such as the taxation of corporations, this is now a very good time for trustees to review the tax implications of their trust’s current structure. Especially family trusts owning shares of a private corporation may no longer make sense.
Even if there continues to be valid reasons to have the trust in place, it is more important than ever everyone is properly reporting to the CRA. The chances of getting caught for failing to do so are going up substantially.

Wednesday, 4 April 2018

Judicial Discretion, Consent and Closure: Priority and Control Over the Dead


The Alberta Court of Appeal in Campbell v. Campbell, 2018 ABCA 46, agreed with the chambers judge, dispensing with the consent of the appellant-father of the deceased to have his son’s remains tested to determine the cause of death under “suspicious circumstances”.  Although the father opposed the mother’s application in order to maintain the integrity of their deceased son’s remains, the chambers judge empathized with the mother, who believed testing was necessary to bring dignity to their son’s death and closure to their family.

On appeal, the father argued that Section 36 of the General Regulation to the Funeral Services Act, Alta Reg 226/1998, gave him priority and control over the disposition of the deceased’s remains.  Section 36 specifically states that, “subject to an order of the Court,” the right to control the disposition of human remains vests in the prescribed order of priority, which includes a parent of the deceased.  Where parents of the deceased cannot agree to whom controls the disposition of the remains, the General Regulation stipulates, “the order of priority begins with the eldest person in that rank.”  This would mean the father of the deceased in this case.  

Despite the father conceding that the General Regulation gave the Court discretion to depart from the prescribed priority, he argued that the Court must have persuasive reasons for doing so.  Specifically, the father argued that there was no factual basis to support the chamber judge’s decision.  He stated that no evidence was presented that supported the position that testing should be done on the deceased’s remains or that testing would accomplish anything.  Although the Court of Appeal agreed that no expert evidence was presented to identify a potential connection to the death of the deceased, such as having a history of concussions, this did not provide sufficient reason for the Court to prevent further testing as other possibilities such as mental illness and substance abuse had already been ruled out.  

Considering the facts before him, the chambers judge concluded that the benefits of conducting testing on the preserved remains of the deceased outweighed the lost opportunity of determining the deceased’s cause of death.  The Court of Appeal agreed, finding that the chambers judge acted reasonably in exercising his discretion, ultimately dispensing with the father’s consent, and providing closure for the family.  At the end of the day, the facts of this case, Court of Appeal and the drafters of the General Regulation to the Funeral Services Act gave the chambers judge control over the dead.

Thursday, 15 February 2018

Who Gets the Farm?

Author: Joel Franz

Justice Nielsen released his decision in Kachur Estate, 2017 ABQB 786, on December 19, 2017. While disputes regarding estate succession in the farming context are common throughout Alberta, reported decisions are less plentiful, given that most matters settle prior to a hearing. This decision provides some guidance regarding the passing of farm land and equipment in not uncommon circumstances. 

In this case, the testator farmed some property with his brother. The testator’s will provided that a life estate be provided to the brother to allow him to continue farming, along with “all of my farm equipment”. Upon the death of the brother, the land and equipment was to go to the testator’s two nephews in equal shares. Other issues were also dealt with in the decision, but for the purposes of this blog post, we will be dealing with what the court decided relating to “farm equipment” and the extent of the brother’s gift. The brother argued at trial, that he owned the farm equipment jointly with his brother, and that upon the testator’s passing, all of the property passed to him. The brother’s argument was rejected based on conflicting evidence, and section 11 of the Alberta Evidence Act, which requires that parties to estate litigation “shall not obtain a verdict…on that party’s own evidence in respect of any matter occurring before the death of the deceased person, unless the evidence is corroborated by other material evidence”. In this case, only the brother’s evidence suggested that the farm equipment was to be passed to him jointly and pass outside the estate.

Justice Nielsen also had to determine what included “farm equipment” for the purposes of the will. Justice Nielsen’s first port of call was the Oxford Dictionary which defined farm equipment as “the necessary items for farming”. No list of farm equipment was provided and evidence was provided at trial that if the equipment was used on the farm, it was likely farm equipment. This would include vehicles and other items that may not necessarily be considered farm equipment per se, however if they were used for the primary purpose of farming they would be included in the definition.   

Finally, the court noted that as part of the brother’s life interest, he would be required to pay the cost of insurance for the land, buildings, farm equipment, as well as taxes, utilities, and cost of reasonable maintenance and repair of the land and farm equipment until the brother passed away. The court acknowledged that there was case-law authority suggesting no obligation on a life tenant to insure property. However, after considering all of the evidence, the court held that it would have been in the reasonable contemplation of testator that the land, property and equipment be insured, particularly when all of these items were to be passed to the next generation after the brother had passed away. 

The court did note that the brother was not obliged to pay for major repairs to the land, home or other buildings including farm equipment and that the nephew beneficiaries were responsible for expenses of a capital nature. Only ongoing routine maintenance was to be paid for by the brother. 

This case serves as another useful reminder that in joint farming operations, it is always best to have agreements put in writing as to properly clarify each party’s position and to prevent costly litigation. 

Friday, 26 January 2018

The Importance of Signing


Alberta’s Wills and Succession Act, SA 2010, c W-12.2 (“WSA”) gives courts the power to order that a will is valid, even where it does not comply with formal requirements required by the Act. But how far can a court go?

The Alberta Court of Queen’s Bench found, on December 6, 2017, that power will not allow a court to add a signature to an unsigned will where the testator had not had the opportunity to review the will and had not been given the chance to sign it.

Facts

In the decision of Edmunds Estate, 2017 ABQB 754, a paralegal prepared a will according to the instructions of the testator, Ms. Edmunds. However, Ms. Edmunds never had the opportunity to review the final version of the unsigned will; she was hospitalized and then passed away unexpectedly before she had a chance to execute it. The beneficiary of the unsigned will asked the Court to validate it despite the absence of Ms. Edmunds’ signature.

Law

Section 39 of the WSA allows the Court to add or subtract from a will to make it accord with a testator’s evidenced intentions. However, in order to do so, the Court must be satisfied, “on clear and convincing evidence”, that the will does not reflect the testator’s intentions because of an accidental slip or omission or if the person preparing the will failed to give effect to the testator’s instructions.

When it comes to adding a signature, the Court is only permitted to add the testator’s signature if the Court is satisfied on clear and convincing evidence that the testator:
(a)  intended to sign the document but omitted to do so by pure mistake or inadvertence, and 
(b)  intended to give effect to the writing in the document as the testator’s will.

Analysis

In order for a court to rectify the will, there must first be an accidental omission, or a situation where the person who prepared the will misunderstood, or failed to give effect to, the testator’s instructions.

The death of a testator, as in Edmunds Estate, is not an accidental omission. The Court in that case found, ['Ms. Edmunds'] death cannot be responsibly characterized as an ‘accident’ that resulted in the omission of her signature on the unsigned will.” The Court did find, however, that if she attended a meeting to execute the will but failed to do so, there may have been a basis for a different conclusion.

The Court also found that an unsigned will does not represent a failure on the part of  the person preparing the will to give effect to a testator’s instructions. The instructions, the Court found, were never given by Ms. Edmunds as the execution meeting never occurred and therefore this section did not apply.

The Court also determined that a signature can only be added if there was clear and convincing evidence it was omitted by “pure mistake or inadvertence.” The Court relied on other cases which showed that a testator dying does not satisfy the element of omission by “pure mistake or inadvertence.” The Court found a pure mistake implies that the testator thinks she is doing one thing but, in fact, does something else (ex: executing a power of attorney and mistaking it for a will). Inadvertence arises from accidental oversight. Neither were present in this case.

In Edmunds Estate, there was no clear and convincing evidence of intention to sign the document and to give effect to the writing in the document as the testator’s will. Though, if Ms. Edmunds had attended upon execution and attempted to sign the will, the Court indicated it may have arrived at a different conclusion.

Conclusion

It is difficult to imagine a scenario in which a Court will ever validate an unsigned will where the testator had not had the opportunity to review and execute it. It is, therefore, critically important for an individual to follow through with completion of the will to ensure that his or her intentions will be carried out.

Where a testator dies before reviewing and signing his or her will, it will be challenging to show clear and convincing evidence that he or she intended to sign the unsigned will. The Court recognized that wills are frequently revised, sometimes dramatically, at the very meeting convened to deal with execution. Arguing that a document never reviewed by the testator perfectly reflected his or her wishes is likely going to be unsuccessful.

Further, the death of a testator does not constitute evidence that the failure to sign arose through pure mistake or inadvertence. Death, even accidental death, does not meet the definition of “pure mistake” or “accidental oversight.”