Written on December 13, 2012 – 8:55 am | by Paul Fensom
As discussed in previous Blogs, testamentary and intervivos trusts are employed in a variety of estate planning situations. With last weeks’ announcement that the Canada Revenue Agency (“CRA”) prescribed interest rate for the first quarter of 2013 will remain at the 1% level yet again, I thought I would remind readers how intervivos trusts can be used for income splitting purposes.
The idea is fairly simple and works as follows. A Trust Agreement is created with the usual features including, Settlor(s), Trustee(s) and beneficiaries. The next step is for the high income earner to lend assets, preferably cash to the Trust, at the CRA prescribed rate of 1%. The Trustees of the Trust then arrange to invest the assets to generate investment income. At the end of the year, the Trust pays the interest on the loan at the prescribed rate of 1% and then the Trustees of the Trust arrange to have the balance of the investment income allocated to the beneficiaries, who are in low tax brackets.
The savings can be significant. Let’s take one example whereby a cash loan of $1 million is provided to a Family Trust that has three children as the listed beneficiaries. If the Trust is able to invest the $1 million and earn 4% or, $40,000 then, after the interest on the loan ($10,000), the net investment income of $30,000 can be split among the three children beneficiaries. If the three children have no other sources of income then their basic personal tax exemption would likely eliminate any tax liability on their share of the income. In other words the ‘family’ in this example has saved the tax otherwise payable on $30,000 of investment income.
Before considering such a plan there are a number of potential pitfalls to consider. For example, lending appreciated property to a Trust will be considered a disposition for income tax purposes and would trigger a capital gains tax liability. Another matter to consider is the type of investments in the Trust. If the Trust invests in private company shares or partnerships then the ‘kiddie’ tax could be applied. In conclusion, as my co-blogger Derek de Gannes has in the past pointed out, you should always consult with a professional to consider tax planning of this nature.