Which tax slips1 are issued and who reports income for tax purposes depends on the legal relationship underlying the account and whether the attribution rules of the Income Tax Act (ITA) will apply.2
An ITF can be a trust, a gift, or neither
A trust requires three certainties: the certainty of the intention to establish the trust; certainty of purpose, who are the beneficiaries of the trust; and the certainty of the matter, which is property in trust. In common law jurisdictions, certainties do not necessarily have to be stated in writing, but a written trust deed is proof of the existence and conditions of a trust.
An ITF, often referred to as an informal trust, does not have the proper documentation to prove the intention to create the trust in the first place. Nonetheless, it can be considered a trust depending on the facts of each case. The Canada Revenue Agency (CRA) will take into account the intent at the time the property was transferred to the ITF and how the account was handled to determine if a trust relationship exists and who is liable for tax payable on any income or gain drawn from the account. .
If the CRA determines that one of the three certainties required for a trust is not present, contributions to an ITF account may be considered a gift to the beneficiary.
When an ITF account represents a gift or is created to hold an inheritance or an insurance settlement for a minor, the account holder acts as agent for the minor’s property.
In the absence of clear evidence of an irrevocable transfer of ownership, there is no trust or donation.
Let’s take a hypothetical example. Barbara opens a bank account in her name, in trust for her minor granddaughter Stacey. The account opening documents clearly identify Barbara as a contributor and trustee, and Stacey as a beneficiary. The funds legally belong to Barbara as a trustee until Stacey reaches the age of majority in her province (18 in Ontario and 19 in British Columbia, for example). The account would be considered a trust.
If Barbara had opened the account in Stacey’s name, there would be an immediate donation of legal and beneficial ownership to Stacey.
If the account had been opened in Barbara’s name with no clear intention whatsoever for Stacey, the account would not be a trust or a gift.
To help clarify the status of the account, especially when it is questioned by the CRA or when requests are made by beneficiaries, it is helpful to document the contributor’s intention to irrevocably transfer property to the named beneficiary. and keep records of the source of funds.
Taxation of ITF accounts
Transfers of beneficial ownership without a spouse (whether indirectly through a trust or directly by a gift) are provisions taxable to the transferor in the year of the transfer. The transfer of cash or unrecognized assets will reduce exposure to capital gains tax.
Trusts are taxed as separate individuals under the Tax Act. The CRA makes no distinction between formal and informal trusts for tax purposes, including the requirement for the trustee to file a T3 trust income and information return each year.
Trust income and taxable capital gains that are not paid or payable to a beneficiary or allocated to the transferor are taxed in the trust at the top marginal rates.
Since Stacey is related to Barbara, any income other than capital gains will be attributed to Barbara until Stacey is 18, whether the transfer is for an immediate gift or a trust. If, instead, Barbara created a discretionary trust for Stacey, then subject to the same attribution rules for minors and also subsection 104 (18) of the ITA, for a particular year in which no amount in the trust is made. ‘was paid to Stacey, the trust’s income and capital gains would be taxed in the trust.
Income not subject to attribution and capital gains paid or payable to a beneficiary are taxed in the hands of the beneficiary at the beneficiary’s graduated tax rates. Losses generally cannot be attributed to a beneficiary.
If, after reviewing the facts, the CRA determines that the ITF is not a trust, all income and capital gains can be attributed to the contributor since the account was opened, resulting in tax arrears and penalties.
In Blum vs. the queen, a grandfather successfully appealed a CRA reassessment in which the CRA allocated capital gains to him that were previously taxed in the hands of his grandchildren. Even though there was no formal trust agreement, he won his appeal as it was determined that all three certainties were present. The trust property (shares of his own companies) has been identified and clearly delivered in his name as trustee for the benefit of his grandchildren as named beneficiaries.
Rules for attribution and transfers to related minors
Subsection 74.1 (2) of the ITA provides that first generation income other than capital gains, from property transferred free of charge to a related minor either indirectly through a trust or directly by gift, reverts to the transferor. for tax purposes. Second generation income and taxable capital gains are taxed in the hands of the minor.
Subsection 75 (2) of the ITA may apply where a trust allows the contributor to retain control of the trust property after the creation of the trust, including, for example, if Barbara has appointed herself as sole trustee of the account she opened for Stacey. Where 75 (2) applies, all trust income, capital gains or losses accrue to Barbara for tax purposes. Barbara could mitigate exposure to 75 (2) by appointing someone other than her as trustee or by appointing more than one trustee.
The attribution ceases if the contributor dies or becomes a non-resident of Canada, and the attribution does not apply to inheritances or most arm’s-length transfers.
Whether it is a gift or a trust, contributions to an ITF cannot be redirected or returned to the contributor without tax consequences, including the risk that a beneficiary may claim the capital and income of the fund. account since its inception.
Alternatives to an ITF include an RESP, paying certain expenses for the child, or setting up a formal trust and using a prescribed rate loan strategy to avoid attribution rules then. that the beneficiaries are minors. Whether an ITF account is the best alternative depends on the resources and goals of the family.
Rebecca Hett, CPA, CGA, TEP, is Vice President, Tax, Retirement and Estate Planning at CI Global Asset Management.
1 A T3 Trust Income Allocation and Allocation Statement identifies beneficiaries and reports the income and capital gains that the trust designates to them. A T5 Return of Investment Income is issued in respect of investment income and capital gains earned in a named client, nominee or agency account.
2 For the purposes of this article, all parties are presumed to be residents of Canada in provinces other than Quebec.