There may be instances where a beneficiary has an immediate need to access funds held in trust yet, the terms of the trust prevent the trustees from proceeding with an income or capital distribution to such beneficiary. In such a situation, if the deed of trust grants the right to the trustees to make a loan, it may be appropriate for the trustees to consider lending an amount to the beneficiary instead of making a capital distribution to the beneficiary.

Documenting the Loan

Should the trustees opt to make a loan to a beneficiary, it is key that the loan be properly documented.  Further, the loan can be with interest or interest-free and the loan document should stipulate the specific terms of repayment.

It is worth noting that the Canada Revenue Agency (the CRA) will not assess a taxable benefit to the beneficiary if the loan is interest-free.

Why Should Trustees Consider Making a Loan?

Why make a loan? One of the reasons for trustees to consider making a loan to a beneficiary may be that the trustees wish to preserve the capital of the trust (or a specific asset held by the trust) for the benefit of the other beneficiaries. Proceeding with a loan allows the trustees to assist the beneficiary in need while preserving the capital of the trust.

If the loan is with interest, it may qualify as a “commercial obligation” as defined under the Income Tax Act (the “Act“), thus, if the trustees simply forgive the loan, it could result in a taxable benefit to the beneficiary. On the other hand, if the powers granted to the trustees allow, the trustees could eventually proceed with the in-specie distribution of the loan as a capital distribution to the beneficiary/borrower.  Such a distribution would extinguish the loan under the doctrine of “merger.”

At the STEP Roundtable in 2022, the CRA commented that such in-specie capital distribution should not give rise to a “forgiven amount” for the purpose of section 80 of the Act (the “debt forgiveness rules”).  That being said, trustees should act cautiously and seek professional tax and legal advice prior to proceeding with such a distribution to confirm they are complying with the tax and trust rules and in accordance with their fiduciary duties.

Trustees’ Discretion – Is not Absolute

Most deeds of trust provide “absolute discretion” to the trustees in their administration of the trust.  However, such discretion is not absolute per se. The trustees must ensure they make proper decisions and exercise their discretion in good faith. The jurisprudence has established that any decisions made in bad faith and to the detriment of other beneficiaries can be challenged by the beneficiaries even if the deed of trust provides absolute discretion to the trustees.

A trustee making a loan to a beneficiary may be permissible according to the powers conferred in the deed of trust, but such discretionary decision should not be deliberately to the detriment and prejudice of the other beneficiaries.

Therefore, prior to lending to a beneficiary of the trust, the trustees should properly consider whether such a decision is in accordance with their powers and for the benefit of the beneficiary without prejudice to the other beneficiaries.

Conclusion

This article highlights an option that may be available to trustees who wish to assist a beneficiary but may be prevented from making a distribution at the time. Having the trust make a loan to such beneficiary can provide immediate assistance to the beneficiary while preserving the capital of the trust.