As we continue to absorb the draft legislation (together with explanatory notes and consultation paper) introduced by the Department of Finance to overhaul the system of taxation for private companies, some things have are becoming clear. If essentially enacted as currently drafted, the legislation will likely spell the end of family trusts for tax planning arrangements, particularly in the private company setting.
Traditionally, for tax planning purposes, family trusts are created and structured to permit:
Income splitting or “sprinkling”
Family members as beneficiaries of the family trust to receive income from the business, regardless of their participation in the business (active or passive). The government is proposing a number of measures to limit income splitting to essentially adult family members who have some direct connection to the business thus eliminating the use of a trust for such purposes. Incidentally the proposed rules are somewhat qualitative in nature, which will likely lead to more compliance issues.
Capital gains exemption splitting
Family members as beneficiaries of the family trust claiming of the lifetime capital gains exemption (LCGE) in the event of a 3rd (or arms’ length) sale. The government refers to this as the “multiplication of access to the LCGE without constraint”. The government is proposing measures to limit the application of LCGE based on age and “reasonableness”. Subject to certain exceptions, the proposals ensure property held by a trust will no longer be eligible for the LCGE.
I do note there are transition rules proposed which will permit “income sprinkling” until the end of 2018 and a one-time multiplication of the LCGE for accrued gains in a family trust. We expect the pros to be very busy in the fall in this regard.
Continued use of trusts for family law, succession planning and corporate governance purposes may still be appropriate after 2018 but the creation of trusts for tax planning arrangements will be of limited use indeed. I am hearing the bells already.