Estate Plans Involving Trusts Require Review

Subsections 104(13.4) and 160(1.4) (enacted on December 16, 2014 and applicable to the 2016 and subsequent taxation years) complicate and delay the administration and distribution of estate and trust assets. The subsections have the potential to derail current estate plans that use spouse trusts, alter ego trusts, and joint partner trusts.

Subsection 104(13.4) deems trust income arising from the death of an individual—for example, the spouse in a spouse trust, or a similar income beneficiary of an alter ego trust or a joint partner trust—to become payable in the year to that individual. Where this subsection deems an amount to be payable to an individual, and thus taxed in the hands of the individual’s estate, the individual and the trust are jointly and severally liable for the taxes payable up to that amount under subsection 160(1.4).

To understand how these provisions create a problem and how the problem can be solved, consider a situation involving a second marriage. Assume that Husband and Wife have both been married before and both have children from the previous marriages. Husband wants to provide for Wife after his death, but he wants his children to ultimately receive the bulk of his estate. Husband’s will sets up a spouse trust under the rollover provisions in subsection 70(6), naming Wife as income beneficiary and Husband’s children as capital beneficiaries. Wife’s will is different: under it, she simply leaves all of her estate to her children. Assume that Husband dies first and that Wife dies a few years later.

Under the current tax provisions, on the death of Wife, there will be a deemed disposition at fair market value of all the capital property in the spouse trust. Any resulting tax liability will be paid using the assets in the spouse trust; the remainder will be available for distribution to Husband’s children.

Starting in the 2016 taxation year, on the death of Wife, there will still be a deemed disposition at fair market value of all of the capital property in the spouse trust, but any resulting tax liability will be paid by Wife’s estate (subsection 104(13.4)), not by the spouse trust. Consequently, all the assets in the spouse trust will be available for distribution to Husband’s children.

The problem is that a full distribution of the trust’s assets cannot happen until the spouse trust trustee is sure that Wife’s estate has paid the tax liability arising from the operation of subsection 104(13.4); if such a payment did not occur, there could be a need to hold back the funds required to pay a liability under subsection 160(1.4). However, the trustee for the spouse trust cannot pay the tax owing because that would be a breach of his or her duties as a trustee (to preserve the assets for the benefit of the trust’s beneficiaries). Paying the tax effectively takes money from the beneficiaries (Husband’s children) and uses it to benefit someone else (Wife’s children).

The estate executor could consider obtaining a clearance certificate from the CRA certifying that the estate has satisfied all of its tax liabilities, but providing the certificate to the spouse trust trustee could constitute a breach of confidentiality. Further, the spouse trust trustee would not be able to make a successful Privacy Act request to determine whether a clearance certificate had been issued without the authorization of the estate executor.

This problem can be solved simply by amending the two wills, provided that Husband and Wife are still alive and mentally competent. After Husband’s death, however, a court order will be required. Since a court will have to weigh the interests of different parties against one another, the outcome is uncertain.

Colleen D. Ma
Dunphy LLP, Calgary
cma@dunphyllp.ca

Canadian Tax Focus
Volume 5, Number 1, February 2015
©2015, Canadian Tax Foundation

Comments

  • Anonymous 2/10/2015 9:52:39 AM

    could not the surviving spouse, as a condition of inheriting under the spousal trust, be required to authorize the trustee of the spousal trust to receive confirmation upon her/his death that her/his estate has received a clearance certificate

  • Colleen Ma 2/12/2015 11:56:58 AM

    From my understanding, you are asking whether a potential solution could be making the surviving spouse's inheritance under the spousal trust conditional on that person authorizing the trustees of the spouse trust as a representative and signing a Privacy Request form.

    Good idea, but there are a few issues that arise with this plan.

    First, the surviving spouse's estate is a different taxpayer than the surviving spouse so it would have to be the surviving spouse's estate trustees that would authorize the exchange of information. The surviving spouse's will would have to direct the trustees to execute the appropriate authorizations but the spouse can revoke or amend his or her will at any time.

    Further, it would be difficult to prepare the necessary documents before the surviving spouse inherits under the spousal trust. A trustee named in the will may not necessarily be the trustee that administers the surviving spouse's estate. They could, for example, have renounced their appointment or have passed away after the surviving spouse lost capacity and is unable to change his or her will.

    Also, it is possible that the condition would be a condition subsequent, which would taint the spousal trust because the entitlement to receive all of the income of the trust would not vest indefeasibly.

    Colleen D. Ma
    Dunphy LLP, Calgary
    cma@dunphyllp.ca