A Canadian tax lawyer's guide to the In-Trust-For (ITF) Account

Introduction: In-Trust-For Accounts

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm.

An In-Trust-For (ITF) account, also commonly referred to as an In-Trust Account, is an unregistered investment account commonly set up for minors in Canada. In-Trust-For (ITF) accounts have become a popular option for Canadians to invest for their children's or grandchildren's futures. Unlike a Registered Education Savings Plan (RESP), there is no contribution limit for an ITF account. An In-Trust-For account requires a contributor/settlor, a trustee, and a beneficiary who is under the age of majority. Both the contributor/settlor and the trustee must have reached the age of majority in his or her province.

An ITF account essentially sets up a trust holding assets for the beneficiary while the trustee manages the assets provided by the contributor/settlor. However, unlike a formal trust, the only written documents often required for setting up an ITF account is investment contracts or account documents of the financial institution where the account is hosted. Once the assets are transferred into an ITF account, the transfer is technically irrevocable, and the contributor/settlor may be subject to additional tax obligations if he or she claws back the assets.

An ITF account is primarily set up for income splitting and Canadian tax planning purposes. It is therefore necessary for the trustee of an ITF account to keep in mind the tax consequences following different types of investments. There is always a risk that all income generated in an ITF account may be attributed to the contributor/settlor. In particular, under subsection 75(2) of the Income Tax Act, if the contributor/settlor is also the trustee, or if the assets in the ITF account can only be disposed of by direction of the contributor/settlor, then all of the income are likely included in the income of the contributor/settlor.

But typically, before the beneficiary reaches the age of majority, interest and dividend income generated in an In-Trust-For account is taxable in the hands of the contributor, while all capital gains or third-part income are taxable in the hands of the minor beneficiary. Once the beneficiary reaches the age of majority in his or her province, or the contributor/settlor passes away, then all income is taxable in the hands of the beneficiary. The contributor/settlor will also not be taxed on any income generated in the ITF account if the funds in the account are solely derived from inheritance or Canada Child Tax Benefits payments.

Tax Implications of ITFs

For contributors/settlors, similar to contributions made to a TFSA account, contributions made to an ITF account are not tax-deductible. As a result, there is no immediate tax benefit for contributors/settlors to make contribution to an In-Trust-For account. However, typically, only first-generation interest and dividend income generated in the ITF account are included in the contributors' income. First generation income refers to income directly derived from the original assets contributed to the ITF account. Capital gains and other income are generally taxable in the hands of the minor beneficiary. Since the minor beneficiary is unlikely to have annual income higher than the contributor/settlor, there is a benefit to split the income generated in the ITF account. In addition, when a contributor/settlor passes away or if the funds in the ITF account are solely derived from inheritance or Canada Child Benefit payments, all income are immediately taxable in the hands of the beneficiary.

In the event that the Canada Revenue Agency (CRA) decides that an ITF account does not qualify as a trust, the CRA may attribute all income to the contributor/settlor from the date on which the account was set up. Consequently, the contributor/settlor may be subject to unexpected tax obligations and penalties.

The trustee of an In-Trust account should file annual T3 trust returns to report income no later than March 31 every year. Failure to file T3 trust returns accurately and on time may result in penalties and interests assessed against the trustee personally. It is necessary for a trustee to be aware of any new legislation and tax policies impacting a trustee's obligations. For example, effective for trust taxation year ending after December 30, 2023, trustees are generally required to file T3 returns for resident trusts in Canada even if the trusts do not have any income to report. You can read more about the enhanced reporting obligations here: Federal Government Introduce New Trust Reporting Rules To Take Effect In 2023 Taxation Year.

Other Issues Concerning ITF Accounts

A trustee of an ITF account should appoint an alternate trustee in his or her will. If no alternate trustee is appointed in the will, in the event of the trustee's death, the ITF account will be managed by the trustee's estate until the beneficiary reaches the age of majority. A trustee of an In-Trust-For account should also be careful with the responsibility to manage the ITF account. A beneficiary has the right to pursue legal actions if he or she believes that the trustee fails to act in the beneficiary's best interests or breaches the trustee's duties.

If a beneficiary passes away before he or she is able to create a valid will, the assets in his or her In-Trust-For account will be distributed under the laws of intestacy in the beneficiary's province. As a result, if the contributor/settlor is not related to the beneficiary, then the contributor/settlor is very unlikely to be able to retain the assets in the ITF account.

Alternatives To an In-Trust-For (ITF) Account

People who would like to invest in their children's or grandchildren's future should explore alternatives to an ITF Account. The most common option is to set up a formal trust agreement for the beneficiaries, to clearly set out the intention to transfer the assets to the beneficiary and conditions of a trust. In addition to becoming a subscriber to the beneficiary's Registered Education Savings Plan (RESP), Parents and grandparents can also start contributing to the beneficiary's Tax-Free Savings Account (TFSA) once the beneficiary reaches the age of majority.

Pro Tax Tips

If you are considering opening up an ITF Account or if you are a beneficiary to an ITF Account, you should understand the tax implications for the contributor/settlor, trustee, and beneficiary.

For contributors/settlors, similar to contributions made to a TFSA account, contributions made to an ITF account are not tax-deductible. Typically, only interest and dividend income are included in the contributors' income. In the event that the CRA decides that an ITF account does not qualify as a trust, the CRA may attribute all income to the contributor/settlor from the date on which the account was set up. Consequently, the contributor/settlor may be subject to unexpected tax obligations and penalties.

The trustee of an ITF is required to file annual T3 trust returns to report income no later than March 31 every year. Failure to file T3 trust returns accurately and on time may result in penalties and interest assessed against the trustee personally. Trustees should also pay attention to any new trust reporting rules taking effect in Canada.

Capital gains and second-generation income in an ITF account are generally taxable in the hands of a beneficiary. Once the beneficiary reaches the age of majority, all income is included in the beneficiary's income.

FAQ

What type of investments can be made in an ITF account?

As an unregistered investment account, an ITF account is technically not subject to any additional restrictions on the type of investments that can be made in the account. However, an ITF account is primarily set up for income splitting and tax planning purposes, it is important to keep in mind the tax consequences following different types of investments.

There is always a risk that all income generated in an ITF account may be attributed to the contributor/settlor. But typically, before the beneficiary reaches the age of majority, interest and dividend income generated in an In-Trust-For account is taxable in the hands of the contributor, while all capital gains or third-part income are taxable in the hands of the minor beneficiary. Once the beneficiary reaches the age of majority in his or her province, or the contributor/settlor passes away, then all income is taxable in the hands of the beneficiary.

How can I protect myself from the CRA if I am a contributor/settlor to an ITF?

As a contributor/settlor to an In-Trust account, you should be aware of the risk that the CRA may audit the account and find that there is no trust relationship established. To minimize the risk, a contributor/settlor should prepare and maintain a written document clearly setting out the intentions. Recall that there are three certainties required of a valid trust: intention, object, and subject. There must be clear intention to transfer the trust property to the beneficiary permanently. The trust must also have a named trustee and an identified beneficiary.

In addition, a contributor/settlor should be proactive in keeping track of the ITF account activities. With certain exceptions, income from interests and dividends should be taxed in the hands of a contributor/settlor. Failure to report the income will likely result in penalties and interests.

It is also beneficial for a contributor/settlor to obtain legal opinion on the potential tax treatment for income generated in the In-Trust account.

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm and is a Certified Specialist in Taxation Law who has completed the CICA in-depth tax planning course. He appears regularly in print, radio and TV and blogs extensively.  

With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, cryptocurrency traders, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax audit representation and tax litigation. Visit www.Taxpage.com and email David at david@taxpage.com.

Read the original article in full on Mondaq. Author photo courtesy Rotfleisch & Samulovitch P.C.