All About Estates

The evolution of trust drafting

A trust indenture established today looks nothing like a trust indenture established 10 or 20 years ago. The evolution of trust drafting, and the rigid legalese once used for trusts has given way to language that better anticipates the myriad of potential scenarios typically faced by today’s clients. This evolution in trust language is most noticeable when reviewing the modern beneficiary clauses.

Evolution of trust language

Trusts have always contained basic clauses using minimal language to add or remove beneficiaries based on common scenarios, such as adding a child when they obtained the age of majority or removing a beneficiary when they were subject to a divorce or bankruptcy.  The drafting of trust indentures has slowly become an art form using language that explicitly deals with more complex scenarios while providing sufficient flexibility to accommodate unforeseen events.  Creative drafting can result in clauses providing discretion to the trustees to add or remove beneficiaries, or precise clauses to articulate scenarios that automatically add or remove beneficiaries without the need for trustee discretion.

Association problem with non-discretionary beneficiary clause

The evolution of the language of the non-discretionary removal of a beneficiary clause due to an inadvertent association of private companies will be the focus of this blog.

To start, beneficiaries of a discretionary family trust are deemed, under paragraph (f) of subsection 256(1.2) of the Income Tax Act to own the shares of the capital stock of a corporation that are owned by the trust.  This deeming provision can result in certain beneficiaries inadvertently associating one or more private companies with the private company that is owned by the family trust.  One of the main problems with accidently associating companies through this deeming provision is the sharing of the small business deduction limit within the associated group.

Some of the earlier trusts did not provide a non-discretionary or discretionary method of removing a beneficiary to rectify an association issue.  As drafters became more creative, later trust indentures started using language to specifically address the association issue without eroding the effectiveness of particular corporate structures.

As the legislation in the Income Tax Act continuously evolves, it is important for professionals to constantly review the language that is used in drafting trust indentures. I was recently reviewing a non-discretionary removal of a beneficiary clause dealing with this inadvertent association problem, and I noticed a potential deficiency in the language of the trust clause.

The language that was used in the trust indenture to exclude a beneficiary was as follows:

Any Beneficiary who at any time controls or is deemed to control within the meaning of section 256 of the Income Tax Act of Canada or any successor provision or legislation, a Canadian controlled private corporation that is not a personal service business or specified investment business within the meaning of section 125 of the Income Tax Act or any successor provision or legislation, except Mr. and Mrs. Smith[1]

Sharing vs grind down of the small business deduction (SBD)

The language used in the above clause specifically ignores two types of private companies, a personal service business and a specified investment business as neither will generate active business income that would be subject to the SBD.  Since there is no need to allocate the SBD limit to either of these companies, there is generally no reason to remove the beneficiaries that control either of these  companies.

This is true with regards to the sharing of the SBD limit, but this is not accurate with regards to the grind down of the SBD limit as a result of either:

  • Taxable capital employed in Canada[2], or
  • Adjusted aggregate investment income[3].

Therefore, it is important for professionals to review and revise the language of non-discretionary removal of beneficiary clauses to accommodate situations where beneficiaries control specified investment businesses (SBI) that either have significant taxable capital or investment income, which could result in the grind down of the SBD limit used by the private company owned by the trust.

 

[1] Mr. and Mrs. Smith are fictitious  names used in this blog, and they represent the husband and wife that own and operate the Canadian controlled private corporation for which the trust was set-up for.  Excluding Mr. and Mrs. Smith from the excluded beneficiary clause ensures that they can’t accidently get removed from their own trust.

[2] The taxable capital employed in Canada within an associated group will grind down the small business deduction limit by $1 for every $10 of taxable capital in excess of $10 million. This threshold has been altered by the 2022 Federal budget to now reduce the small business deduction limit by $1 for every $80 of taxable capital in excess of $10 million.

[3] Adjusted aggregate investment income within an associated group will grind down the small business deduction limit by $1 for every $5 of investment income in excess of $50,000.

About John Oakey
National Tax Director for Baker Tilly Canada. John has extensive experience with Canadian corporate and personal income taxes with specialization in the areas of corporate reorganizations, estate planning, succession planning and tax compliance. He also has significant experience dealing with GST/HST issues and U.S. citizen cross-border tax reporting issues.

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