APPROACH TO MAXIMIZING CLIENT WEALTH

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1 A PRACTICAL APPROACH TO MAXIMIZING CLIENT WEALTH EXCERPT #1 Canadian Wealth Management Guide Excerpt: [ 426] In-Trust Accounts

2 CANADIAN WEALTH MANAGEMENT GUIDE A REAL LIFE EXAMPLE Determine for yourself whether or not the Canadian Wealth Management Guide is worth the investment. Check out the following pages that have been reproduced in their entirety from the Guide. You ll be impressed by their thoroughness and applicability. Written by Experts The Canadian Wealth Management Guide is the collaborative product of some of Canada s leading tax experts. David Louis JD, CA and Samantha Prasad Weiss BA, LLB, both with the law firm Minden Gross LLP, along with Robert Spenceley BA, MA, LLB, analyst with CCH Canadian, and Joseph Frankovic LLB, LLM, PhD, CFA tax lawyer and member of the adjunct faculty of Osgoode Hall Law School, lead a host of contributors whose expertise make this Guide truly indispensable. David Louis JD, CA Samantha Prasad Weiss BA, LLB Robert Spenceley BA, MA, LLB Joseph Frankovic LLB, LLM, PhD, CFA TRY BEFORE YOU BUY Take advantage of our free trial offer, available on CD-ROM or over the Internet. For more information or to place an order, simply call customer service at Please quote Promo Code TA

3 CANADIAN WEALTH MANAGEMENT GUIDE Although the attribution rules do not specifically apply to capital gains made by children or grandchildren, other tax issues may arise. The most well-publicized of these is the requirement of many brokerage houses and financial institutions that accounts be set up in the name of a parent in-trust (often without naming the particular child). There has been a great deal of confusion about the significance of these accounts, particularly whether they are regarded as trusts by the CRA and the differences between an in-trust account and a full-blown legal trust. The following example shows how the Canadian Wealth Management Guide quickly gets you into the heart of these issues, clarifying the confusion surrounding them and providing an up-to-date summary of the CRA s views. [ 426] In-Trust Accounts [...] There has been a great deal of confusion about the significance of these accounts. They raise several issues: Issue #1: Are these accounts trusts? The first issue is whether these in-trust accounts are actually trusts for tax purposes. Although some practitioners believe that this is the case, recent CRA documents show that, without other supporting documentation, a trust would not likely be established. In order for a trust to exist, the "three certainties" (certainty of intention, property, and objects) must be met. This, of course, is at least in part a question of fact. However, in many cases it is questionable whether there is generally an intention to create a trust. Of course, one of the relevant factors will be the particulars of the in-trust documentation, if any, that is signed by the parent/grandparent. (Some financial institutions do not use the word trust to begin with, raising the question of whether there is a distinction because the word "trust" is used.) The following are some recent Technical Interpretations in these issues: In Technical Interpretation No (September 22, 1997), the CRA showed signs of accepting the proposition that there would typically be no intention to create a trust (although it was indicated that this would depend on the facts of the case). The CRA indicated that where an "in-trust account" is opened by the parent, in the absence of a formal trust document, the certainty of intention to set up a trust arrangement would be a difficult one to prove. As the children involved are most likely minors, often the arrangement is designed to accommodate the fact that minors do not have the legal capacity to enter into legally binding contracts and hence purchase financial instruments in their own name. Thus the arrangement may be one akin to agency as opposed to a trust. (A similar statement was made in Technical Interpretation No , October 27, 1997 and in Document No , April 14, 1999.) The CRA document No (September 6, 1996) deals with the general issue of whether there would be an inter vivos trust where there is no trust indenture. In that document, the CRA reviewed a number of cases in which it had attacked trusts. It was indicated that where there is no trust indenture or deed available to support a claim that an express inter vivos trust created orally exists, the onus of proof clearly rests with both the settlor and trustee in establishing that the three certainties for creating a trust have been established, and that the terms of the verbal agreement communicated by the settlor to the trustee have been adhered to. The fact that significant tax revenue is at stake is not lost on the CRA. In a Technical Interpretation dated April 8th, 1999 (No ), the CRA indicated that it was their understanding that the use of in-trust accounts was widespread in respect of the acquisition of mutual funds and the department generally accepted that the existence of an in-trust account did not, in and by itself, result in the existence of an actual trust. (This view was also confirmed in CRA Document No , dated June 30, 1999.) 3

4 In Technical Interpretation No A (July 31, 2003), the CRA noted that it continues to receive a steady flow of enquiries about the legal status of in-trust accounts. Its position remains unchanged: the question must be determined through the application of trust law to the facts of each given case. The document, in fact, provides a handy summary of the case law on point. The CRA concludes the document as follows: The CRA's role is to administer the Income Tax Act and to make sure its provisions are properly applied to the legal relationships established by taxpayers. Whether a trust exists at law is a factual and legal issue. An indication in an investment account form will not create a trust unless the three certainties are met and can be proven. In light of the variety of circumstances and types of forms that may exist, the CRA is in no better position than the courts in making that determination and cannot make a general statement with respect to the nature of In Trust accounts. Issue #2: What happens if there is a trust? It is here that there may be the most confusion. As we will see shortly, non-trust status is not necessarily fatal to capital gains splitting. In fact, if the in-trust account does constitute a trust, a number of issues are raised: Presumably, trust returns are required. Fortunately if these are "nil returns", the CRA will often be lenient when it comes to late-filing penalties. (This may depend on the amount of income flowing through the trust.) Are the capital gains taxable to the child or to the trust? More specifically, pursuant to the in-trust account arrangement, is this type of income paid or payable to the child? This is required in order to tax the capital gain in the hands of the child; otherwise, the capital gains would be taxable to the trust. Does it matter if these amounts are actually paid in the year to another account for the children? If this account is also an in-trust account, do we have yet another trust (so that a high rate of tax would still apply) and so on? One provision that might be relevant is subsection 104(18), which abrogates the paid or payable requirement if the property is held in-trust for an individual under 21, the right to the property vested (otherwise than by the exercise of the discretionary power) and the right is not subject to any future condition (other than a condition that the individual survived to an age not exceeding 40 years. In an in-trust account situation which is basically undocumented, it may be difficult to establish that subsection 104(18) applies because it obviously implies specific terms. Do the reversionary trust rules in subsection 75(2) apply, so as to tax the capital gains in the hands of the funding parent/grandparent, after all? Loosely speaking, the reversionary trust rules will apply to a trust if the trust property may revert to the person from whom the property was received, is passed to persons determined by the person, or if the person maintains a veto over the disposition of the property. One fairly simple antidote to the reversionary trust rules that has been suggested is to ensure that the person named in the trust account differs from the funding parent/grandparent. (See 2142 for further discussion of the reversionary trust rules.) If in-trust accounts are not trusts, what is the effect on capital gains splitting? As stated previously, it is often assumed that if trust status is unsuccessful, capital gains splitting will fail. However, to obtain capital gains splitting advantages with children, a trust is not necessarily required what is necessary is a transfer of beneficial ownership of the investment to a child. Besides a trust, this can be documented as a gift and/or a declaration that the arrangement is a bare trustee. These documents, which are considerably simpler than a full-blown trust, should be considered, especially where a substantial investment is involved. At time of writing, it is not at all clear that, as a matter of actual assessing practice, the CRA is actively inclined to disrupt capital-gains splitting using in-trust accounts. Even so, it is possible that, without supporting evidence, the CRA could take the position that there was no transfer ownership of the investment. An individual's tax position in this regard may depend on what financial institution documentation (if any) is signed when he or she sets up the in-trust account : some documentation might be helpful, some not. This risk would, of course, be accentuated if the individual acted in a manner that is inconsistent with such a transfer (for example he or she simply took the money back or gave it to another child). GAAR gives the CRA broad powers to nullify the benefits of tax-motivated transactions. When GAAR was introduced, it was stated that where an income splitting manoeuvre involves the transfer of assets to a family member, and it is apparent that the family member was never really supposed to benefit from the transfer, GAAR might apply e.g., when a gift is made to an adult child who sells the property and simply gives the proceeds back to his or 4

5 her parents. The CRA later published an Information Circular on GAAR but did not repeat this warning in the Circular. (See section 245.) Issue #3: Protective aspects The main reason a funding individual may want a trust is for non-tax reasons, because of the protection over the investment asset. This is especially the case if a large investment is involved. An outright transfer probably means the individual is giving the asset away, no strings attached. For example, it has been observed that without a trust, the child may be entitled to the in-trust account, the account would be subject to marital and creditor claims against the child, and so on. These are legitimate concerns, which, of course, are endemic to a transfer of ownership. A properly drafted trust, on the other hand, can protect the asset and provide flexibility. For example, a so-called discretionary trust can allow the individual to shift income and capital between beneficiaries, and so on. However, this also means the trustees will have to file annual trust returns, and possibly prepare promissory notes (to evidence the fact that the capital gains are payable to the child every year, i.e., if they are not actually paid out to the beneficiary during the year), and so on. However, a full-blown trust is generally advisable if relatively large investment is involved. Just some of the reasons for making this Guide your planning partner. Feature: Focus on investors. Benefit: The information is aimed to give advice on generating and maximizing one s wealth, for individuals, private corporations, and public corporations. Feature: Written in a non-technical manner. Benefit: Information in the service can be transmitted directly to clients or incorporated into correspondence. Feature: Practical rather than theoretical. Benefit: Readers can see how the law applies to them currently in any given situation. Apart from the foregoing, a number of practical considerations arise in respect of in-trust accounts : It is recommended that an in-trust account be established for each child rather than establishing one in-trust account for a number of children. The in-trust account should be established with the child's social insurance number, rather than the parent's. Otherwise, a computer cross-check of the account could attribute the income to the parent. It is desirable that the child be named e.g., David Louis, in trust for Alyssa Louis. In some cases, the financial institution will decline to do this but persistence will often result in a change of policy. The commentary on this topic is current as of January 2nd,

6 CANADIAN WEALTH MANAGEMENT GUIDE See inside for excerpt: [ 426] In-Trust The Canadian Wealth Management Guide is available in CD-ROM and online formats. Other tax planning guides available from CCH Canadian Limited: Tax Planning for Small Business Guide Canadian Estate Planning Guide 96M3-3-07

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