All About Estates


I previously blogged about the new qualified disability trust (“QDT”), which became law on January 1, 2016. In my previous blog, I left a discussion of the “recovery tax” for another day. Looking outside as I write this, it appears the proverbial rainy day has arrived!

By way of review, to qualify as a QDT, a trust must be a testamentary trust that is factually resident in Canada, it must jointly elect with one or more beneficiaries named in the trust who qualify for the Disability Tax Credit (the “electing beneficiary”) to be a QDT, and an electing beneficiary may not elect with any other trust in the same year. During the period the trust qualifies as a QDT its income will be taxed at the graduated tax rates applicable to individuals, which is an exception to the new rules, also effective on January 1, 2016, that eliminated graduated rate taxation for testamentary trust other than a QDT or a graduated rate estate.

A trust will cease to qualify as a QDT in any year there is no electing beneficiary at the end of the taxation year (including the year the electing beneficiary dies), if the trust ceases to be factually resident in Canada, or if the trust distributes capital to a beneficiary other than an electing beneficiary. If any of those conditions are met and the trust ceases to be a QDT, all of the trust’s taxable income in that year is subject to tax at the highest marginal rate and the recovery tax provisions in paragraph 122(1)(c) of the Income Tax Act are triggered. The recovery tax is applied to each preceding year of the trust, but not including a prior year in which the recovery tax was applied or the years preceding the prior application of the recovery tax.

The quantum of the recovery tax is represented by formula “A minus B”. For a particular year, “B” represents the actual tax paid by the trust in the year and “A” represents the amount of tax that would have been paid in the year if the income retained in the trust was taxed at the highest marginal rate. However, variable “A” is subject to two adjustments. First, if any of the income retained in the trust in the particular year is distributed to an electing beneficiary as capital in a subsequent year, but prior to the year the trust ceases to be a QDT, it is deducted from the taxable income for the particular year. Second, the federal and provincial income tax paid in the particular year in respect of the subsequently-distributed retained taxable income is also deducted from the taxable income for the particular year. In short, the purpose of the recovery tax formula is to put the trust in the same position it would have been in if all of the retained taxable income for the particular year, less any amounts subsequently distributed to an electing beneficiary and the related tax liability, was taxed at the top marginal rate.

No recovery tax will be payable to the extent that, prior to the year a trust ceases to be a QDT, all of the retained income has been distributed to an electing beneficiary as capital. Of course, this will not always be possible. For example, if the QDT is also a Henson-style trust intended to preserve eligibility for provincial disability benefits, the amount that can be distributed to the electing beneficiary in a particular year is limited. It is prudent, therefore, for trustees and advisors alike to plan for the day when someone will be charged with the unenviable task of calculating the recovery tax. It is hoped that the Canada Revenue Agency will provide some guidance on the standards that will be applied in determining whether a particular capital distribution was made from previously accumulated income. In the interim, prudent trustees should take steps to ensure they are in a position to demonstrate a connection. A trustee resolution with appropriate recitals should always be used to document distributions of capital out of previously accumulated income. In addition, the trustee might consider segregating accumulated income into a separate “accumulating income” account, which would enable the trustee to easily demonstrate, beyond doubt, that a particular capital distribution was made out of previously accumulated income. Until we have more guidance, these steps and good record-keeping are important tools to protect trustees, beneficiaries, and advisors alike from the recovery tax blues…


About Darren Lund
Darren Lund is a member of the Trust, Wills, Estates and Charities at Fasken, Toronto office. Darren has expertise in a broad range of estate planning matters, including multiple wills, inter vivos trusts, disability planning, estate freezing, and planning for beneficiaries and assets outside Canada. Darren advises trustees and beneficiaries on all aspects of estate administration, both contentious and non-contentious, and his experience includes passing of fiduciary accounts, trust variations, post-mortem tax planning, and administering the Canadian estates of non-residents. He also speaks and writes on a variety of related topics such as estate planning for spouses and couples, inheriting overseas property and estate planning for persons with disabilities. He previously practised estates law at a large national law firm. Email: