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.
Trusts are a powerful tool used in tax and financial planning. The main advantage of a trust is that it allows the taxpayers to separate the control and management of assets in the trust from its ownership. Trusts have many uses in both family and estate planning and as a tool to administer an estate on the death of an individual.
In order to increase the transparency of how trusts are used — and on the persons who have created, control, and benefit from trusts — the federal government announced new CRA trust reporting rules in its 2018 budget to improve the collection of this information. By introducing these new reporting rules, Canada Revenue Agency ("CRA") is better able to track and potentially tax trusts. The new trust reporting requirements are a considerable change from the current rules and carry significant penalties for non-compliance. Trustees of affected trusts need to understand the new reporting obligations, assess whether the required information is readily available, plan to obtain the necessary obligations, assess whether the required information is readily available, and arrange to obtain the necessary details to ensure compliance, and of course to comply.
The legislation to support this measure is included in Bill C-32 which received Royal Assent on December 15, 2022. Bill C-32 changes the effective date of these reporting rules to taxation years ending after December 30, 2023. The CRA will advise taxpayers once their system has been updated to receive this information and the applicable forms have been published. As the beneficial reporting requirements are effective for years ending after December 30, 2023, taxpayers should file their 2022 T3 as usual.
Existing CRA Trust Reporting Rules
Generally, a trust must file an annual income tax (T3) return if the trust has tax payable or it distributes all or part of its income or capital to its one or more beneficiaries. Personal information on trustees, beneficiaries, settlors, or other persons are not currently required to be reported to the CRA. There is no current reporting requirement for Canadian trusts that have no income, or for bare trusts — an arrangement where a trust can reasonably be considered to act as agent for its beneficiaries with respect to all dealings in all of the trust's property.
The New Trust Reporting Rules
For trust taxation years ending after December 30, 2023, all non-resident trusts that currently must file a T3 return and express trusts that are resident in Canada, with certain exceptions, will be required to file a T3 return and to report additional information as part of that return each year. The draft legislation also specifically includes bare trusts within the scope of these new trust repoting rules.
The New Trust Reporting Requirements
With limited exceptions, the new rules generally require the filing of a T3 return by express trusts that are resident in Canada even if it does not have any income to report.
An express trust is generally a trust created with the settlor's express intent, such as through a trust deed or a will, as opposed to a resulting or constructive trust, or certain trusts deemed to arise under the provisions of a statue. This new filing requirement will include trusts such as those created to hold private company shares as part of an estate freeze, and trusts created to hold vacation or other personal property.
Enhanced Reporting Obligations
Each year, affected trusts must report additional information on all trustees, beneficiaries, settlors, and each person who has the ability to exert control or override trustee decisions over the appointment of income or capital of the trust (e.g., a protector), which includes their:
- Date of birth (in case of an individual)
- Jurisdiction of residence
- Taxpayer identification number, such as Social Insurance Number, Trust Account Number, Business Number or Taxpayer Identification Number used in a foreign jurisdiction.
For purposes of this reporting, a settlor refers to a person who has made a loan or transfer of property, to or for the benefit of the trust at anytime. A loan or transfer made for the benefit of the trust would include, for example, the transfer of property to establish the trust (the traditional meaning of settlor), a low-interest loan, or a transfer at less than fair market value to an entity in which the trust has an interest. Commercial loans and transfers for value by an arm's length persons would not create a settlor relationship.
This enhanced reporting obligation aims to help the government more effectively counter aggressive tax avoidance, tax evasion, money laundering, and other criminal activities perpetrated through the misuse of trusts. However, of course, it covers all mundane trusts, even those that have no nefarious purpose. With this in mind, trustees should know that reporting this new information may prove onerous for certain trusts and should plan ahead to be compliant.
Even if the trust has no income to report, the trust will have to report the additional beneficial ownership information by filling the new schedule along with the T3 return.
In the case of family trusts, this means that they will need to be transparent with respect to all possible beneficiaries including contingent beneficiaries of the trust as well as making annual trust filings in years where there is no distribution of income or capital.
Since most trusts must file their T3 returns 90 days after the calendar year, 2023 T3 returns will generally have to be filed by March 30, 2024, and they will be subject to the new reporting rules.
Which trusts will not have to provide additional information?
The new trust reporting rules propose that the following types of trusts (that are either resident in Canada , or non-resident but required to file a T3 return) are not required to provide additional information:
- Mutual fund trusts, segregated funds, and master funds.
- Trusts governed by registered plans (i.e., deferred profit sharing plans, registered pension plans, registered disability savings plans, registered education savings plans, registered pension plans, registered retirement income funds, registered savings plans, registered supplementary unemployment benefit plans and tax free savings accounts).
- Lawyers' general trust accounts.
- Graduated rate estates and qualified disability trusts.
- Trusts that qualify as non-profit organizations or registered charities.
- Trusts that have been in existence for less that three months
- Trusts that hold less than $50,000 in assets throughout the taxation year (provided that their holdings are confined to deposits, government debt obligations and listed securities).
Penalties for not complying with the new trust reporting rules:
Under new trust reporting rules, a penalty will apply if a trust that must file a T3 return fails to do so or fails to provide the additional information about the beneficial ownership.
The penalty will be equal to $25 for each day of delinquency, with a minimum penalty of $100 and a maximum penalty of $2,500.00. If a failure to file the return was made knowingly, or due to gross negligence, an additional penalty will apply. The additional penalty will be equal to 5% of the maximum value of property held during the relevant year by the trust, with a minimum penalty of $2,500.00.
In addition, the existing penalties in respect of the T3 return will continue to apply. The penalty for the failure to file T3 return is $25 per day with a minimum of $100 and can increase up to $2,500.00.
Why must the trust provisions be reviewed?
Expanded information requirements will allow the tax departments to better police provisions. For example:
- Limiting the corporate small business deduction to one such deduction for an "associated" group of companies.
- Limiting tax deferred transfers out of trust to residents of Canada.
- Applying the new Underused Housing Tax to trusts that have at least one non-resident beneficiary who is not a citizen or permanent resident of Canada.
Associated groups of Corporations
It will be much easier for CRA to identify "associated" corporations for the purpose of limiting the availability of small business deductions. This deduction allows a corporation to benefit from a low corporate tax rate on the first $500,000 of active business income. All associated corporations must share one small business deduction.
Where a discretionary trust has minor children listed as beneficiaries, even though they are designated beneficiaries not entitled to any income or capital of the trust until they are 18 years old, any shares owned by the trust are deemed to be owned by both parents of the children (each parent being deemed to own 100 percent of the shares at the same time) even if the parents have no connection to the trust. This "deeming" provision could also serve to associate companies for income tax purposes.
21 year deemed disposition rule
The tax departments will be able to identify trusts with non-resident beneficiaries.
A trust will generally be deemed to dispose of its capital property at fair market value on the 21st anniversary of the trust, which could give rise to a significant tax liability. Trustees have the discretion to distribute trust capital to Canadian residents before such date in a manner which will not have an immediate tax consequence. However, distributions of trust capital to non-resident beneficiaries whether before or after the 21st anniversary of the trust are generally deemed to be disposed of by the trust at fair market value, resulting in immediate tax consequences.
Underused Housing Tax Act
Effective for 2022, the UHTA implements an annual one percent tax on the value of vacant or underused residential property directly or indirectly owned by individuals who are neither citizens nor permanent residents of Canada. Trust with at least one beneficiary who is neither a citizen nor permanent resident of Canada can be subject to this tax.
A person that is registered owner (other than an excluded owner) of one or more residential properties on December 31 of a calendar year is required to file a return for each residential property for the calendar year. The Underused Housing Tax return must be filed by April 30 following the calendar year.
Trustees of trusts (other than personal representatives, who are citizens or permanent residents of Canada, in respect of deceased individuals) are not excluded owners, and therefore must file the UHTA return. Certain exemptions may apply such that no tax payable by the owner for that calendar year.
A person who fails to file a return on time is liable to a penalty equal to the greater of the following amounts:
- $5,000, if the owner is an individual, or $10,000, if the owner is not an individual; and
- The total of 5% of the applicable tax for the property for the calendar year and three percent of the applicable tax for each complete calendar month the return is late.
Trusts that own residential properties (whether or not they have beneficiaries who are neither citizens nor permanent residents of Canada) must file the UHTA return.
CRA modernizing T3 trust return processes
In anticipation of the increase in volume of T3 returns that will be filled because of the new rules, the CRA is modernizing its systems and processes used for T3 returns. Planned changes will be rolled out over the next few years, beginning with online application for trust account numbers and subsequent registration of trust account numbers in CRA's My Account or My Business Account. T3 electronic filling for most inter-vivos and family trusts was available for 2021 T3s. Mandatory e-filing of T3 returns is proposed to start as of January 1, 2024, meaning that the majority of 2023 trusts will need to be e-filed if the proposed legislation is passed.
When the CRA has the capability to receive and process T3 returns electronically, it will be better equipped to analyze and assess T3 information, including the new beneficial ownership details required to be required. Taxpayers should get used to the increased transparency with respect to trusts, which will likely come with heightened scrutiny from the CRA.
Other considerations: Foreign Account Tax Compliance Act and Common Reporting Standard
While these trust disclosure requirements may be new to some, similar disclosures had already been implemented under FATCA and CRS [Parts XVIII and XIX of the Canadian Income Tax Account ("ITA"), respectively]. Foreign Account Tax Compliance Act (FATCA) is an American federal law which requires non-U.S. financial institutions to enter into an agreement with the U.S. Internal Revenue Service (IRS) to report the IRS accounts held by U.S. residents and U.S. citizens (including U.S. citizens that are residents or citizens of Canada.
While FTACA is an American law, Common Reporting Standard (CRS) is the global standard for the exchange of Financial Account information whose members include over 100 countries including Canada. Because many Canadian financial institutions have adopted combined FATCA and CRS certifications to collect information on their account holders to satisfy both FATCA and CRS, it is likely that a trust involving non-Canadian persons has already been asked to complete a certification related to a bank account, brokerage account or other investment relationship, and that some of the information has been provided to the CRA (i.e. under FATCA and CRS, the financial institutions provide controlling person information to the CRA only when the controlling persons identified by the trust are US persons or other non-Canadian persons).
As a result, trustees should ensure that their disclosures under the new trust reporting rules are consistent with those under FATCA or CRS. In anticipation of these new rules, trustees should review their submissions to various authorities for discrepancies.
Pro Tax Tip: New Trust Reporting Rules
The new reporting obligations can be onerous for certain trusts. As the rules will apply for trust taxation years ending after December 30, 2023, trustees should invest the time to understand the new requirements and plan ahead so compliance obligations can be met. This may include reviewing trust documents in detail to ensure all relevant parties are identified. It is advisable to engage in early communications with the affected parties, such as beneficiaries and settlors, so that obligations are clear, and the required information can be gathered in a timely manner. Being proactive is advisable especially in situations where beneficiaries may be unknown or potentially uncooperative.
Where it makes sense, trust administrators should also consider unwinding trusts that are no longer needed to minimize ongoing compliance obligations. Any trusts wound up in 2022 will not be subjected to the new reporting obligations. However, affected trusts wound up in 2023 will not be exempt from fillings, unless they are graduated rate estate, as the year-end of inter-vivo trusts and testamentary trusts that are not graduated rate estates is December 31, even if the trust has distributed all its assets by December 31.
As the law is new, it is somewhat difficult to foresee all the practical consequences of the reporting rules. However, this article provides the outline of some of the increased tax audit risks which will surely arise.
Where can taxpayers get more information about new trust reporting obligations?
CRA provides the latest information on the proposed changes on Canada.ca. Taxpayers should check online regularly for updated forms policies, guidelines, questions and answers, and guidance. The taxpayer may also refer to the additional information on trusts.
In the meantime, please consult the Department of Finance Canada's Budget 2018 documents for details.
Do the new trust reporting obligations affect Quebec Trusts as well?
Yes, because the Province of Quebec will harmonize its rules with the federal requirements.
What is a bare (nominee) trust and how is reporting for these Trusts affected by the new trust reporting obligations?
A bare trust or a nominal trust is an arrangement where one person can reasonably be considered to act as agent for another person (the principal). Such an arrangement usually involves the trustee holding legal title to the trust property and dealing with the trust property in accordance with the principal's instructions. Under the current rules, a bare trust is disregarded and is not required to file a T3 Tax Return. The New Draft Rules provide that a bare trust will be required to file a T3 Tax Return and disclose details about the beneficial ownership of its principal unless it otherwise qualifies as an Excepted Trust.
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 firstname.lastname@example.org.
Read the original article on Taxpage. Title image: iStock. Author photo courtesy Rotfleisch & Samulovitch P.C.