Alter-ego and joint-spousal trusts are inter-vivos trusts commonly used in estate plans to hold legal title of assets for the benefit of the individual and/or their spouse, prior to death, accomplishing some of the following benefits: avoiding probate, providing privacy, expediency of inheritance distribution, and minimization of legal challenge on estate assets.
Tax deferred transfer
The transfer of assets to these trusts are accomplished on a tax-deferred basis by relying on subsections 73(1), 73(1.01) and 73 (1.02) of the Income Tax Act. These subsections combine to provide the following conditions necessary for a tax-deferred transfer of assets from the settlor to the trust:
- The trust is created after 1999;
- The settlor has attained 65 years of age at the time the trust was created;
- Both the transferor and transferee are resident in Canada at the time of asset transfer; and
- Limitation on income and capital of the trust:
- Alter-ego trust – The settlor is entitled to receive all of the income of the trust arising before his or her death and no other person may receive or otherwise obtain the use of any of the income or capital of the trust before that individual’s death;
- Joint-spousal trust – the settlor in combination with their spouse are entitled to receive all of the income of the trust arising before the death of the second spouse and no other person may receive or otherwise obtain the use of any of the income or capital of the trust before the death of the second spouse.
Ensuring the conditions are met when setting up either of these trusts seems easy enough, but be careful with the actual use of certain assets held by the trust. Let’s take a cottage for example. Grandma Joan sets up an alter-ego trust and transfers her cottage to it. At the time the trust was set-up, Grandma Joan intended on using the cottage for her personal use and enjoyment. One year after the set-up of the trust, Grandma Joan had a stroke and had to move into a full-time nursing home. Grandma Joan had always told her children that if anything happened to her, they were to continue using the cottage. Her children and grandchildren had lots of great memories at Grandma Joan’s cottage, so they agreed to honor her wishes and continue to use the cottage. This may seem like an innocent act of kindness by Grandma Joan, but does this kind gesture cause unintended tax consequences to her estate plan?
Canada Revenue Agency (CRA) at the 2020 Canadian Tax Foundation roundtable expressed concern related to this type of situation:
However, when considering the use of the personal use property by another individual, one must remember that for an alter ego trust, in order to meet the conditions outlined in paragraph 73(1.01)(c), the alter ego trust must be a trust under which no person except the settlor may receive or otherwise obtain the use of any of the income or capital of the trust before the settlor’s death. Similarly, in the case of a joint spousal or common-law partner trust, the terms of the trust must provide that no person other than the settlor and their spouse may obtain the use of any of the income or capital of the trust before the later death of the settlor and their spouse.
With CRA’s cautionary response, Grandma Joan’s kind gesture might taint the alter-ego trust, in which case the transfer of the cottage to the trust would not have occurred on a tax-deferred basis. Putting personal use property like a cottage in an alter-ego or joint-spousal trust might be a good idea but be careful with possible usage by individuals other than the settlor or the settlor’s spouse during their lifetime.
 For the purposes of this blog, any reference to “spouse” includes a common-law partner
 73(1.01)(c) contains two subclauses. Subclause (ii) relates to alter-ego trusts and subclause (iii) relates to joint-spousal trusts. 73(1.01)(c)(ii) alter-ego trust – such that the individual is entitled to receive all the income of the trust arising before his or her death and under which no person except that individual may receive or otherwise obtain the use of any of the income or capital of the trust before that individual’s death. 73(1.01)(c)(iii) joint-spousal trust – such that the individual and his or her spouse or common-law partner is entitled to receive all the income of the trust arising before their deaths and under which no one other than the individual or the individual’s spouse or common-law partner is permitted to receive or otherwise obtain the use of any of the income or capital of the trust before the death of both the individual and the individual’s spouse or common-law partner.