New trust reporting requirements necessitate careful review of trust provisions by the end of the year
Proposed trust reporting rules have been further delayed until the 2023 taxation year. For reasons indicated in this article, it is essential that the terms of all trusts be carefully reviewed and, in certain cases, updated prior to December 31, 2022. We caution our readers to consider the practical implications of the new rules.
Background
In the 2017 federal budget, the Department of Finance announced the government’s intention to consider implementing tax reporting requirements for trusts in order to obtain beneficial ownership information. This would help the government to determine taxpayers’ tax liabilities and to effectively counter aggressive tax avoidance as well as tax evasion, money laundering and other illegal activities. As it currently stands, it has been possible for taxpayers to use trusts to avoid disclosing ownership information.
Presently a trust that does not earn income or make distributions is generally not required to file an annual return of income commonly known as a T3 return. Even if a trust is required to file a T3 return for a year, there is no reporting requirement as to the identity of its beneficiaries.
In the 2018 federal budget, the Department of Finance proposed to institute an obligation for trusts to file a T3 return and to provide additional information. The proposed rules were initially expected to apply to T3 returns required to be filed for the 2021 and subsequent taxation years. Implementation was delayed to the 2022 and subsequent taxation years. Various versions of draft legislation were released by the Department of Finance, with the most recent version introduced on August 9, 2022. The implementation of the new rules has been further delayed so that these rules will now apply to taxation years of trusts that end after December 30, 2023. Since most trusts must file their T3 returns 90 days after the calendar year, 2023 T3 returns will generally have to be filed by March 30, 2024 and they will be subject to the new reporting rules.
Expanded information requirements will allow the tax departments to better police provisions (1) limiting the corporate small business deduction to one such deduction for an “associated” group of corporations; (2) limiting tax deferred transfers out of a trust to residents of Canada and (3) applying the new Underused Housing Tax to trusts that have at least one non-resident beneficiary who is not a citizen or permanent resident of Canada.
Existing trust reporting rules
Under the current rules, a trust is required to file a T3 return where it:
- has income tax payable;
- is resident or deemed resident in Canada and has disposed of a capital property or has a taxable capital gain;
- is a non-resident of Canada and has disposed of taxable Canadian property or has a taxable capital gain (other than certain excluded dispositions);
- received from the trust property any income, gain or profit that is allocated to one or more beneficiaries and the trust has:
- total income from all sources of more than $500;
- income of more than $100 allocated to any single beneficiary;
- made a distribution of capital to one or more beneficiaries;
- allocated any portion of income to a non-resident beneficiary.
Trusts which are simply holding property and that are inactive and have no income tax payable generally do not have to file a T3 return. In any event, the T3 return itself does not identify all of the trust’s beneficiaries.
New trust reporting rules
Under the new reporting rules which will apply to the 2023 and subsequent taxation years of trusts, all express trusts that are resident in Canada will have to file a T3 trust return even if they were not previously obligated to do so. The Canada Revenue Agency considers an express trust to be one created with the settlor’s express intent and usually made in writing; this would exclude trusts established by law or judgment, but would include bare trust arrangements (i.e. arrangements under which the trust can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust’s property).
There are some limited exceptions from the reporting rules which include:
- trusts that have been in existence for less than three months at the end of the relevant trust’s taxation year;
- trusts that hold assets of $50,000 or less throughout the year if the assets are limited to deposits; government debt obligations and certain listed securities;
- trusts which are listed on a designated stock exchange;
- trusts covered by registered plans;
- graduated rate estates;
- qualified disability trusts;
- a trust established for use by members of a professional order, i.e. law societies, provided the trust is not maintained as a separate trust for a particular client or clients;
- registered charity trusts or a trust which is a non-profit organization;
- mutual fund trusts, segregated funds and master trusts;
- employer profit sharing plans;
- employee life and health trusts;
- cemetery care trusts and trusts governed by eligible funeral arrangements, and
- certain government funded trusts.
There is also an exception under the law with respect to information that is subject to solicitor-client privilege. However solicitor-client privilege relates to legal advice and it is not clear how information contained in a trust deed or bare trust agreement will qualify for such a privilege.
Reporting requirements
Specified information must now be reported by the trustees of a trust in respect of anyone who qualified at any time in the year as a settlor (or other contributor to the trust), trustee, beneficiary or anyone who has the ability (through the terms of the trust or a related agreement) to exert influence over trustee decisions regarding the appointment of income or capital of the trust, for example trust protectors.
Contingent beneficiaries are considered to be beneficiaries.
The required information includes the name, address, date of birth (in the case of an individual), jurisdiction of residence and taxpayer identification number such as a social insurance number, trust account number, business number or foreign tax identification number.
In respect of beneficiaries who are unknown or unascertainable (for example, grandchildren who are not yet born), the person making the return may provide sufficiently detailed information to determine with certainty whether any particular person is a beneficiary of the trust. Beneficiaries which are ascertainable such as a category of corporations which are controlled by one or more beneficiaries must be specifically listed and the above-mentioned information provided.
Penalties
The penalty for not supplying the relevant information is $25 per day with a minimum penalty of $100 and a maximum penalty of $2,500.
Where a trustee has knowingly or in circumstances amounting to gross negligence not reported or made a false statement in relation to the trust reporting requirements, such person will be liable to a penalty equal to the greater of $2,500 or five percent of the highest fair market value of the trust property at any time of the year.
The existing penalties for not filing a T3 return will continue to apply.
Quebec trusts
Quebec will harmonize its rules with the federal requirements.
Why must trust provisions be reviewed
Associated groups of corporations
It will be much easier to identify “associated” corporations for the purpose of limiting the availability of small business deductions. This deduction allows a corporation to benefit from a low corporate tax rate on the first $500,000 of active business income. All associated corporations must share one small business deduction.
Where a discretionary trust has minor children listed as beneficiaries, even though they are designated beneficiaries not entitled to any income or capital of the trust until they are 18 years old, any shares owned by the trust are deemed to be owned by both parents of the children (each parent being deemed to own 100 percent of the shares at the same time) even if the parents have no connection to the trust. This “deeming” provision could also serve to associate companies for income tax purposes.
21 year deemed disposition rule
The tax departments will be able to identify trusts with non-resident beneficiaries.
A trust will generally be deemed to dispose of its capital property at fair market value on the 21st anniversary of the trust, which could give rise to a significant tax liability. Trustees have the discretion to distribute trust capital to Canadian residents before such date in a manner which will not have an immediate tax consequence. However distributions of trust capital to non-resident beneficiaries whether before or after the 21st anniversary of the trust are generally deemed to be disposed of by the trust at fair market value, resulting in immediate tax consequences.
Underused Housing Tax Act (“UHTA”)
Effective for 2022, the UHTA implements an annual one percent tax on the value of vacant or underused residential property directly or indirectly owned by individuals who are neither citizens nor permanent residents of Canada [for more information on the UHTA read our article]. Trusts with at least one beneficiary who is neither a citizen nor permanent resident of Canada can be subject to this tax.
A person that is a registered owner (other than an excluded owner) of one or more residential properties on December 31 of a calendar year is required to file a return for each residential property for the calendar year. The UHTA return must be filed by April 30 following the calendar year.
Trustees of trusts (other than personal representatives, who are citizens or permanent residents of Canada, in respect of deceased individuals) are not excluded owners, and therefore must file the UHTA return. Certain exemptions may apply such that no tax is payable by the owner for that calendar year.
A person who fails to file a return on time is liable to a penalty equal to the greater of the following amounts:
CA$5,000, if the owner is an individual, or CA$10,000, if the owner is not an individual; and
The total of five percent of the applicable tax for the property for the calendar year and three percent of the applicable tax for each complete calendar month the return is late.
Trusts that own residential properties (whether or not they have beneficiaries who are neither citizens nor permanent residents of Canada) must file the UHTA return. Trustees beware!
As the law is new, it is somewhat difficult to foresee all the practical consequences of the reporting rules. However this article does outline some of the increased audit risks which will surely arise. Each particular trust situation should be carefully reviewed.
For more information or assistance with this matter, please do not hesitate to contact any member of our Tax and Estates practice.
