What is a Trust?
A trust is a legal relationship between someone called the “settlor” who establishes the trust together with another person called the “trustee” to receive and hold certain property “in trust” for the benefit of others called the “beneficiaries”. A Trust is typically documented by a written agreement called a trust deed or trust Agreement. A trust is categorized as a trust created by the settlor when he or she is alive (an inter vivos trust) or it is created as a result of the settlor’s death (a testatmentary trust) under a document which comes into effect on death, such as a Will, or a beneficiary designation for a RRSP, TFSA, or life insurance policy. Due to tax considerations, RRSP/TFSA beneficiary designations should only be used for trusts in appropriate circumstances.
The Trust Deed
The trust deed describes the three parties to the trust (settlor, trustee and beneficiary), and sets out the purposes and objects of the trust. Although the beneficiaries are entitled to receive benefits from the trust, they do not sign the trust deed and unless they are also a trustee. A trust deed is an agreement between the settlor and the trustee. Unless they are also a beneficiary, the beneficiary of a trust has little or no input into how the trust deed is drafted, the property put into the trust, and how they are to benefit from the trust.
The trust deed is prepared by the lawyer acting for the settlor or trustee, and customized to meet the specific requirements of the people directing the creation of the trust such as the settlor or the initial trustee. The creation of the trust may also have occurred under the advice of their tax accountant if income tax considerations are motivating the creation of the trust, which often occurs.
Generally speaking, the person who is planning to put most if not virtually all of the property into the trust determines who the parties to the trust are and other matter relevant to the trust including: who the initial trustee is; who the successor trustee will be or how a successor trustee should be appointed; who the initial beneficiaries of the trust are; who the successor beneficiaries are; whether a beneficiary can be added or removed; how the beneficiaries are going to benefit; the authority of the trustee over the investment management and distribution of the trust property; how the trust deed can be amended or changed and what parts of the trust should not be changed; how the trust comes to an end; and what happens to the property remaining in the trust when the trust does come to an end.
Once the trust is established, unless there is authority in the trust deed for amendments to the terms of the trust, a trust can be very difficult to amend, which would require the consent of the people involved in the trust, and the amendment should be reviewed and ratified by a court order from the Supreme Court of B.C. under the Trust and Settlement Variation Act, http://www.bclaws.ca/civix/document/id/complete/statreg/96463_01. Other jurisdictions usually have similar legislation which would apply if a trust is located or resident there.
Also, once a trust is established the trustee has legal duties to keep accurate books and records relating to the financial activities of the trust, maintain financial statements for the trust, prepare and file annual tax returns for the trust (or the trustee can hire an accountant to do so), and have the accounts of a trust reviewed and approved by the court, unless of course all the beneficiaries unanimously approve the trust accounts or waive the requirement to have the trust accounts approved by the court (see s. 99 of the Trustee Act of B.C.).
The settlor settles or completes the creation of the trust by transferring an initial asset to the trustee to be dealt with according to the trust deed. Traditionally, this asset is a gold or silver coin but it can really be anything of confirmed value, such as money, or even a special heirloom of known or appraised value. Thereafter, further assets can be transferred or settled into the trust by the settlor, usually with the consent of the trustee.
In certain circumstances like an alter-ego trust, or a joint partner trust, the settlor and trustee and the beneficiaries of the trust can all be the same people. In other situations, like a family trust or a testamentary trust (established by a Will, RRSP, TFSA or Life Insurance beneficiary designation), the settlor is usually a different person from the trustee and the settlor typically cannot be a Beneficiary of a family trust.
So, if the nature of the trust contemplates it, the settlor may continue to be involved in the operation and management of the trust, and a Settlor may even wear more than one hat like trustee or Beneficiary.
The trustee agrees to accept title to the trust assets and to deal with them according to the terms and conditions of the trust deed. The trustee receives and holds legal ownership of the trust property but the trustee never has beneficial ownership of the trust property. The beneficial ownership of the trust property belongs to the beneficiary.
The trustee has a fiduciary duty to the beneficiaries to comply with the objects of the trust and terms of the trust deed for the benefit of the beneficiaries. A fiduciary duty is among the highest legal duties which one person can have to another under the law. It includes an extremely high standard of conduct for the trustee, such as the duty to act in good faith towards the trust property and the beneficiaries, the duty to avoid conflicts of interest with the trust property and the beneficiaries, and the duty to refrain from any conduct that would breach such duties. The law treats trustees who breach their duties seriously. Trustees are personally liable for any loss or damage suffered by the trust due to a breach of a trustee’s fiduciary duties, and the Court can trace or follow and recover trust money that may have been received by a third party as a result of a breach of a trustee’s duties. In British Columbia, the Trustee Act http://www.bclaws.ca/civix/document/id/complete/statreg/96464_01 codifies certain duties and obligations of a trustee, supplementing the terms of the trust deed itself.
The trustee is entitled to be paid for their services to the trust, in accordance with the compensation arrangement is provide for in the trust deed or if such compensation is not specifically provided for or even restricted or prohibited in the trust deed itself, trustee compensation is set out in sections 88 and 89 of the Trustee Act.
A Trust deed must set out who the beneficiary or beneficiaries of the trust are. They may be named specifically or be described as a class of persons (e.g. sons, daughters, grandchildren or other defined eligible beneficiaries). There is flexibility in determining who the beneficiaries are; however, care must be taken to ensure that no one is appointed a beneficiary who ought not to have such status. For example, the settlor is usually prohibited from being a beneficiary of a family trust, and beneficiaries are usually prohibited from receiving a benefit from a family trust if they are under 19 years of age.
Depending on the nature of the trust, a Trust deed may include a provision for adding and removing beneficiaries, setting out who has the power to appoint or remove a beneficiary, and the basis upon which it is to be exercised (i.e. fully discretionary or upon a certain event occurring, or both etc.). This can allow future tax planning for the trust and to protect the trust from claims being made by a spouse or other third party who are not named as a beneficiary of the trust.
The beneficiaries may be entitled to receive fixed or specifically defined benefits from the trust, such as a spousal trust intended to take advantage of spousal rollovers under the Income Tax Act, which require the spouse to receive all of the income earned by the trust.In most other cases, a beneficiary’s entitlement to the trust is discretionary where the timing and amounts of distributions to the beneficiaries and even the beneficiaries who receive benefits are all determined in the discretion of the trustee. A discretionary trust will typically codify such discretion to be wide or unfettered to ensure a beneficiary cannot take any proceedings against a trustee to enforce receipt of benefits from the trust.
Many families use Trusts to distribute income among the beneficiaries. Very often family members need to fund extracurricular activities or schooling, and the money that is used to pay for those activities comes from the after tax dollars of the family member with the highest marginal tax rate. The use of a properly established family Trust will allow the income to be distributed to and taxed in the hands of the family member who is using the income. This can result in substantial income tax reduction to the family as an entire entity because that family member usually has a lower marginal tax rate.
A trust is located or resident where it is controlled, which is typically in the jurisdiction where the trustee or majority of the trustees who control the trust reside. A trust can be established or become resident in any province or territory in Canada or in a jurisdiction outside Canada. The residence of a trust is or can be directed by the settlor through the selection of trustee or trustees, or by the appointment of new trustees controlling the trust resident elsewhere. The residence of a trust is usually tax driven as there may be income tax concessions or benefits for doing so. Some people have created off shore trusts to avoid income tax in Canada but doing so or trying to do so is not “legal” in Canada. Under Canada’s Income Tax Act, a trustee resident in Canada must report and file tax returns for a trust located anywhere in the world and report distributions from the trust to beneficiaries. Similarly, a beneficiary resident in Canada must self report the receipt of income or any other distribution from a trust located anywhere in the world. Failing to do any of this will be an offence under the Income Tax Act and expose the parties involved to the assessment of fines, penalties, and interest, as well as criminal prosecution.
A trust cannot be created specifically to avoid or protect people involved in the trust from creditors because that would arguably made transferring property to a trust for that reason a fraudulent transfer which can be set aside. A trust set up for a legitimate purpose, such as estate planning, wealth succession planning, or tax planning, can provide a level of protection for the assets in the trust from the creditors of the beneficiaries or of the settlor.
A beneficiary’s creditor or spouse will not be able to make a claim against a fully discretionary trust as a source of payment for the beneficiary’s obligation to them. Similarly the capital of a discretionary trust will not usually be considered to be the property of or an asset belonging to a beneficiary or a trustee who becomes insolvent or goes bankrupt for any reason. This is because the trust property is legally owned in the name of the trustee on behalf of the trust, and beneficially owned by the beneficiaries. While any income or capital distributions made to an insolvent beneficiary can be accessed by such beneficiary’s creditors after it is received, providing and insolvent beneficiary with the right to use property still belonging to the trust does not render it available for seizure and sale by the beneficiary’s creditors.
Disability Benefit Preservation
A discretionary trust is a very useful with respect to a disabled beneficiary in B.C. Under current welfare or disability benefit legislation and regulation, property held in a discretionary trust for the benefit of a recipient of social welfare or disability benefits is not considered to be the asset or property of a beneficiary rendering such person ineligible for the receipt of future benefits. Further the terms of a discretionary trust usually enable the trustee to structure the distribution of benefits from the trust in a way that allows the trust to improve the lifestyle of a beneficiary while maintaining his or her ability to collect government benefits.
The control which a trustee may have over the nature, timing and value of distributions to beneficiaries is disabled also useful in relation to family members resident in countries which have strict laws on inheritance, and can enable payments to be made to people who might have to be excluded from a Will made in the settlor’s homeland. In addition a Trust can be used to ensure that assets to be used for the benefit of family members do not form part of a matrimonial property division with that family member’s spouse upon the breakdown of the relationship between the beneficiary and his or her spouse.
It is important for a trustee to ensure that all Income Tax Act filings and remittances are made in relation to trust distributions are filed and made, especially in relation to persons resident outside Canada for tax purposes. All distributions to a non-resident are subject to a 15% non-resident withholding which must be remitted to Canada Revenue Agency. The non-resident beneficiary may then be able to file a return in Canada in an effort to get some of that money released to them. Naturally getting the advice of a tax advisor familiar with non-resident tax issues is important.
Anonymity and Flexibility
The trust deed created during the lifetime of a Settlor is a secret document. It is not recorded anywhere and is not available for viewing by the beneficiaries or members of the public. Trusts created in a person’s Last Will and Testament however may become public knowledge if a probate order is required to administer a deceased person’s estate. Trusts created through the beneficiary designation for an RRSP, TFSA, or Life Insurance Policy can usually remain private unless there is some litigation involving them.
Probate is not always required with respect to the administration of a person’s wealth and trusts can be a useful way to avoid the probate process and costs associated with it. Probate Fees.
It is important to get qualified accounting and legal advice before creating a Trust to avoid adverse income tax consequences or legal difficulties by setting the trust up incorrectly.
The information set out in this article reflect generally on this area of law and is not meant to constitute legal advice. The impact of the law on any given situation depends upon each individual’s circumstances and the opinions contained in this article should not be relied on for assessing anyone’s legal position. Advice should be obtained directly from our lawyers regarding your personal situation.