In today’s world of international families it is not uncommon for a Canadian family to have one or more members that are non-residents of Canada. When that same family has set up a Canadian discretionary family trust that is intended to benefit its members with, say distributions from a family business, a number of complexities arise for the administration of that family trust. Often the trustees of such a family trust operate on the principle that absent extenuating circumstances, distributions of capital will be made equally among the beneficiaries. In the context of a class of beneficiaries that includes non-residents of Canada, a variety of challenges arise in the administration of the trust. Those challenges include:
- how do you address differences in currencies when quantifying the value of a capital distribution,
- what if the jurisdiction where the beneficiary resides imposes additional disclosure obligations on a beneficiary of a foreign trust and those disclosure obligations require the trustees to incur additional professional expenses to provide the beneficiary with the needed information, or
- what if the jurisdiction where the beneficiary resides has a taxation system that imposes an estate or inheritance tax based on the beneficiary having a potential interest in the family trust or a certain level of control over decisions related to the trust.
Another of the complexities is in the context of making capital distributions.
Under Canada’s Income Tax Act a Canadian discretionary family trust is a taxpayer separate from the beneficiaries. Under the tax rules the trust can distribute capital property to a Canadian resident beneficiary on a tax-deferred, “rollover” basis. For example, let’s say the trust property includes shares of ABC Co. with a cost base of $10 and a fair market value of $100, the trust can distribute the shares of ABC Co. to a Canadian resident beneficiary without incurring a tax liability itself. Specifically, the trust is considered to have disposed of the shares at their cost base and thereby not incur a tax liability on the distribution. The Canadian resident beneficiary would inherit the cost base and when s/he later disposes of the shares, s/he will realize the tax liability on the accrued capital gain. This scheme is not, however, applicable when a Canadian discretionary family trust distributes property to a beneficiary that is a non-resident of Canada. In this context, the trust will have disposed of the shares at their fair market value and will have a tax liability on the realization of the accrued capital gain. The upshot is that taxes will be owing by the Canadian discretionary family trust. This could have an indirect impact on the Canadian resident beneficiaries, as the trust will need to expend funds to pay the tax liability.
Over the past number of years one common strategy to address the above issue was to ensure the class of beneficiaries of the Canadian discretionary family trust included Canadian resident corporations, the shareholders of which are one or more of the individual beneficiaries, including the non-resident individual beneficiaries. The trust would then make a distribution of capital property to a Canadian resident corporation, the shareholder of which might include a non-resident family member beneficiary. This would allow the trust to avoid realizing a taxable disposition.
At the annual Canada Revenue Agency (“CRA”) roundtable at the Canadian Tax Foundation Annual Conference, the CRA was asked a few questions related to trusts. One in particular posed a fact scenario that proposed a Canadian discretionary family trust making a distribution of capital property to a Canadian company (“Canco”) owned by non-resident beneficiaries. Canco was also a beneficiary of the trust. At the CRA roundtable, CRA confirmed that it would consider applying the general anti-avoidance rule under the Income Tax Act to this scenario. CRA stated that its basic policy is to tax accrued gains on a regular basis. On the proposed facts, the beneficiaries would effectively be permitted to indefinitely defer realizing gains. The proposed facts would also be inconsistent to how resident beneficiaries are taxed. CRA also noted it would no longer grant rulings on this type of transaction. As a result, planning how to structure distributions of capital property from a Canadian discretionary family trust to a non-resident beneficiary will be even more complex.