This blog has been written by Pritika Deepak, Associate at Fasken LLP.

Trusts play a significant role in wealth management and tax and estate planning. This blog post is not intended to supplant the important role played by the various and excellent texts written and published on the taxation of trusts.  Rather, this blog post skims the surface of some important points to consider when dealing with trust taxation.

Trusts Taxed as Individuals

In Canada, income tax obligations are generally determined by residency status. This blog focuses exclusively on Canadian resident trusts and does not delve into the more complex rules surrounding the determination of a trust’s residency or its associated implications.

Trusts in Canada are treated as if they are individuals for tax purposes. However, they are not legal persons in the same way that individuals or corporations are. Instead, it is the trustee who acts on behalf of the trust, ensuring that tax obligations are met, including filing tax returns and paying any taxes owed.

Understanding how trusts are taxed requires a good grasp of trust law and certain provisions of the Income Tax Act (Canada). Often, a helpful starting point is identifying the key differences between the taxation of individuals and trusts. Let’s break down some of the basic rules.

Estates Treated as Trusts

When a person passes away, their estate is treated as a trust for tax purposes until the estate’s assets are fully distributed to the beneficiaries. Estates that qualify as “graduated rate estates” benefit from special tax rules, which will be touched on shortly.

Comparing Trusts and Individuals: Key Differences in Taxation

While trusts are taxed as individuals, there are notable differences. For example, trusts cannot claim personal tax credits such as the basic personal amount, age credit, or pension credit. Additionally, unlike individuals, trusts are subject to unique rules, including the “21-year deemed disposition rule,” which is discussed further below.

• Tax Rates: Most trusts are taxed at a flat rate, which is the highest marginal tax rate for individuals. However, “graduated rate estates” and “qualified disability trusts” (special types of trusts) are exceptions to this rule, as they are taxed at “graduated rates” or “marginal rates”, similar to individuals.
• Taxation Year: Trusts, like individuals, generally follow a calendar year for taxation purposes. An exception exists for graduated rate estates, where the executor can choose a fiscal year-end that does not exceed 12 months from the date of the deceased’s death.
• Filing Deadlines: While individuals must file their tax returns by April 30 (or June 15 for self-employed persons), trusts must file by the 90th day following the end of their taxation year. For most trusts, this means March 31 (or March 30 in a leap year).
• Capital Gains and Exemptions: Trusts cannot claim the capital gains exemption that individuals may be entitled to. However, in certain circumstances, a trust can allocate capital gains to beneficiaries, who may then claim the exemption.
• Deemed Dispositions: Most trusts are generally subject to the “21-year deemed disposition rule,” which means that every 21 years, a trust is considered to have disposed of its property at fair market value. This can trigger capital gains tax. Individuals, on the other hand, are generally only subject to a deemed disposition upon death or emigration.
• Principal Residence Exemption: Both individuals and some personal trusts may claim the principal residence exemption if they meet the applicable criteria.

Conclusion

The taxation of trusts in Canada is a complex area governed by detailed provisions in the Income Tax Act (Canada), which distinguish trusts from individuals. Trustees should be aware of these distinctions to ensure compliance and proper administration. Stay tuned for Part II, which will explore the flow-through nature of trust income to beneficiaries.

Disclaimer: This blog post is intended for informational purposes only and should not be considered legal or tax advice. For advice tailored to your specific situation, please consult a qualified professional.