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.
