Trust income and attribution
The spousal or JP trust will earn portfolio
income and deemed dividends on redemptions of the preferred shares and will allocate
such income to the respective spouse beneficiary. However, income allocated to the beneficiary spouse can attribute back to the
settlor spouse, under either the reversionary
trust rules6 or the spousal attribution rules7;
therefore, careful tracking and reporting of
income on trust and personal tax returns
would be required.
The spousal or JP trust may be drafted to
avoid attribution under reversionary trust
rules. Further, John and Jane could avoid the
spousal attribution rules by electing to have
income taxed in the trusts,8 where it would
be taxed at the highest marginal tax rate.
Such after-tax income would then be allocated
to the respective spouse as a tax-free capital
distribution. Assuming John and Jane will
be taxable at the highest marginal rate due to
other sources of income, there should be no
difference between taxing the trust income
in the trusts or taxing it to the individuals.
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The benefits
First, since the spousal or JP trust—not John
and Jane personally—will own the property
contributed, such property will not be subject to probate on the couple’s deaths; this
means a savings of approximately $280,000
(assuming there’s a 1.4% probate rate on assets
with an FMV of $20 million).5 Second, unlike
the deeds of a will, the deeds of a spousal or
JP trust are not subject to public disclosure.
Third, John and/or Jane can designate anyone
as a beneficiary of their spousal or JP trust, and
such beneficiaries might not be challengeable
under the Wills, Estates and Succession Act
(formerly the Wills Variation Act). This may
be a favourable option if John and Jane wish
to leave property of the spousal or JP trust
disproportionately to their heirs, including
if they have children from previous marriages.
Deemed disposition on death9
The deemed disposition of property on death must be managed carefully. Where preferred
shares are held personally, there is a deemed disposition of the shares on death, resulting in a
capital gain on the deceased’s terminal return. The preferred shares then transfer to the estate
with a high adjusted cost base (ACB) equal to FMV. The preferred shares are typically redeemed
in the estate, resulting in deemed dividends and a significant capital loss. The estate’s executor
then files an election to carry back the capital loss to offset the capital gain in the terminal
return.10
Where the preferred shares are owned by a spousal or JP trust, the same deemed disposition
will take place on death, resulting in a capital gain in the spousal or JP trust. However, when
the shares are later redeemed by a spousal or JP trust, the capital loss may be denied under
affiliate stop-loss rules,11 potentially resulting in double tax in the spousal or JP trust. Careful
planning must be undertaken to mitigate such double tax.
The capital gains deduction
A spousal trust may claim the CGD in the taxation year in which the spouse dies,12 whereas a
JP trust cannot. As an alternative to claiming the CGD through a spousal trust, John and Jane
could elect out of the rollover to the spousal trust and could contribute enough common
shares at FMV to claim their CGD. In either case, the preferred shares in the spousal trust
would have an ACB equal to the CGD claimed. On redemption of the preferred shares, the
resulting capital loss would be denied, as discussed above, and such outcomes would have to
be managed carefully.
As a further alternative, John and Jane could retain sufficient preferred shares personally to
use the CGD on death. The resulting preferred shares would have high ACB and FMV, and—
again—care would need to be taken to manage the high ACB when the preferred shares are
redeemed.
5
The probate savings will decrease as the value of assets decreases in the spousal or JP trust.
Subsection 75(2).
6
Section 74.1, 74.2, or 74.3.
7
Subsection 104(13.1).
8
pousal or JP trusts cannot benefit from the marginal tax rates currently available to
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testamentary trusts. As mentioned in the note to readers, however, the Department of
Finance has proposed that these marginal tax rates should be effectively eliminated.
Pursuant to subsection 164(6).
10
ubsection 40(3.6). Subsection 40(3.61) is a relieving provision that applies to testamentary
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