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RBC Wealth Management Services Living / family trusts A living trust can be an effective wealth planning tool in appropriate circumstances, facilitating strategies such as income splitting, business succession planning and charitable giving

This article provides a general overview of living trusts established in common-law provinces in Canada. The following topics will be addressed:

●● What is a trust?

●● Creating a living trust

●● Parties to a trust Please contact us ●● Potential uses of a trust for more information about the topics ●● Taxation of trust income discussed in this ●● Assets held in a trust article. ●● Winding up a trust

This article outlines several strategies, not all of which will apply to your particular financial circumstances. The information in this article is not intended to provide legal or tax advice. To ensure that your own circumstances have been properly considered and that action is taken based on the latest information available, you should obtain professional advice from a qualified legal advisor before acting on any of the information in this article.

What is a trust? A trust is a legal arrangement or An inter-vivos trust, also known as a relationship. An individual (known living trust, is a trust created during a as the “settlor”) creates the trust person’s lifetime. by entrusting some or all of their property to people of their choice (the A trust is not a separate legal entity like trustee(s)). The trustee holds legal title a corporation, although it is treated as to the trust property and is obliged to a separate taxpayer for tax purposes. hold the property for the benefit of one 2 | RBC Wealth Management

or more individuals or organizations trustee, and how and when income (the beneficiary), usually specified by and capital are to be distributed to the the settlor. The trustee owes a fiduciary beneficiary and to which beneficiary. duty to the beneficiary. This means the trustee is required to act in the best The instructions provided to the interests of the “beneficial” owners of trustee can be very specific or more the trust property. general depending on the settlor’s underlying objectives. The terms of a trust are The terms of a trust are usually set out usually set out in writing in writing in a trust document. The Discretionary vs. non-discretionary in a trust document. trustee is obliged to administer the trusts trust in accordance with both the A trust can be structured as terms of the trust document and the discretionary or non-discretionary. governing laws of the jurisdiction in A discretionary trust is a trust which the trust is resident. where the beneficiary and/or their entitlements to the trust fund are Creating a living trust not fixed, but are determined by A living trust is created when the settlor the criteria set out by the settlor in transfers the title of specific assets to a the trust agreement. Discretionary trustee for the benefit of their intended trusts can be discretionary in two beneficiary. The trust actually comes respects. First, the trustee usually into existence with the transfer of at has the power to determine which least one asset to the trustee. beneficiary (from within the class) will receive payments of income or For a trust to be valid, three capital from the trust. Second, the certainties must be met: trustee can select the amount of trust property that the beneficiary receives. 1) Certainty of Intention – there Although most discretionary trusts should be a clear intention to create allow both types of discretion, either a trust by the settlor; can be allowed on its own.

2) Certainty of Property – there It is possible for a trust to have a fixed should be a clear intention to create number of beneficiaries and for the a trust by the settlor; trustee to have discretion as to how much each beneficiary receives. 3) Certainty of Beneficiary – he Alternatively, it is possible to have beneficiary of the trust must be a class of beneficiaries from whom clearly identifiable by name or class. they could select members. Most A trust can be created informally, as well-drafted trust agreements give the demonstrated by the actions of the trustee the power to add or exclude parties to the trust, or formally by beneficiaries from the class; this signing a legal document referred gives the trustee greater flexibility to to as a trust agreement. It is always deal with changes in circumstances, preferable that the establishment especially changes in the tax laws of of the trust be documented. The the applicable jurisdiction. trust agreement indicates the settlor, A non-discretionary trust allows the trustee(s), beneficiary(ies), the assets trustee little or no latitude, and the being transferred to the trustee, the trustee must simply follow the directions powers and restrictions placed on the outlined in the trust agreement. 3 | RBC Wealth Management

Parties to a trust ●● Administer the trust in the best Settlor interest of the beneficiaries A settlor is the person who actually These duties may be expanded or creates the trust by transferring narrowed by the terms of the trust property to a trustee to be held and agreement, but, in most instances, administered for the benefit of the cannot be eliminated completely. beneficiary. The settlor generally arranges to have the terms of the trust Beneficiary drawn up according to their wishes. A beneficiary is a person entitled to the use and enjoyment of the Contributor trust property. A beneficiary can A contributor is a person who transfers be an income beneficiary, a capital A trustee’s property to a trust for the benefit of beneficiary, or both. It is important to responsibilities are the beneficiary. Often, the settlor is note that what may be considered to governed by the a contributor to the trust; however, a be income for tax purposes may not terms of the trust third party can also be a contributor. be considered to be income for trust agreement and This article assumes that the settlor is law purposes. The trust agreement also the contributor to the trust. trust law in their should specify what is considered to be income and capital. If the trust jurisdiction. Trustee document is silent on this issue, the A trustee’s responsibilities are governed trustee will need to seek legal advice. by the terms of the trust agreement and trust law in their jurisdiction. Typical Overlapping roles obligations include the duty to: While the roles of the settlor, contributor, trustee and beneficiary ●● Carry out the express terms of the are all different, the people acting trust arrangement in these capacities can overlap. In other words, the settlor of a trust can ●● Defend the trust also be a trustee and/or a beneficiary

●● Prudently invest trust assets of the trust. Some combinations of overlapping roles can have tax or legal ●● Remain impartial among the implications. beneficiaries For example, the attribution rules ●● Account for their actions and keep (discussed later on) may apply where the beneficiaries informed about the settlor is the sole trustee of the the trust trust or a capital beneficiary of the trust. ●● Remain loyal In such a case, the income and capital ●● Not delegate their duties unless gains earned in the trust may be specifically allowed by the trust taxable to the settlor as opposed to agreement or governing legislation the trust or another beneficiary. Also, while a trustee can be a beneficiary ●● Not profit from the trust of a trust, they may want to take extra care to ensure they are fulfilling their ●● Not be in a conflict of interest fiduciary duties and acting in the best position interest of all beneficiaries of the trust. 4 | RBC Wealth Management

Potential uses of a trust can allow the settlor to retain some control of the capital through the Some of the potential uses of a living terms of the trust. In order to evaluate trust are outlined below. There may the merit of this strategy, consider be additional circumstances, not whether the tax savings outweigh addressed in this article, that warrant the costs incurred to create and the use of a trust. administer the trust. To implement an estate freeze To provide support for disabled A business owner who anticipates a children or elderly parents significant increase in value over the Support for a disabled child or elderly coming years may want to consider parent, who cannot manage their implementing an estate freeze to lock own financial affairs can be provided in the current value of the business by a trust. This trust may also help and transfer the anticipated growth protect a disabled beneficiary’s A living trust can provide to other taxpayers. An estate freeze entitlement to provincial or territorial a mechanism for typically involves exchanging the disability related benefits. For more splitting income between owner’s common shares for cash, and/ information on a living trust for a higher income and lower or promissory note and preferred disabled beneficiary, ask your RBC shares. As the preferred shares will income family members advisor for the “Henson Trust” article. to minimize a family’s not grow in value, this effectively freezes the value of the old common overall tax burden. To donate to charity shares to their present market value without triggering tax. The company If a person wishes to give a portion then issues new common shares, of their estate to charity, but requires commonly to a trust, for the benefit the assets to support their current of the beneficiary(ies) who are usually lifestyle, a trust can be created to children or other family members. achieve this objective as well as Any growth of the business will accrue provide them with a tax break today. to the common shares held in the A charitable remainder trust, as it is trust. For more information about the commonly referred to, is created by estate freeze strategy ask your RBC donating a residual interest in a trust advisor for the “Estate Freeze” article. to charity. The settlor of the trust may qualify for a non-refundable tax credit To provide support for adult children upon the trust’s creation. The trust is structured to provide the settlor A trust may be used to provide with income for their lifetime and to for adult children that require have the capital pass on to charity at ongoing financial support in a tax death. This strategy is well suited for effective manner. If capital is gifted older individuals in a high tax bracket. to a properly structured trust, the Ask your RBC advisor for a copy of income earned on that capital may the guidebook entitled “Charitable be taxable in the adult child’s hands Giving”, which discusses the use of (if paid or made payable to the child) charitable remainder trusts and other while the trustee maintains control ways to include charitable giving as of the capital. Assuming the child is part of your wealth planning. receiving little or no other income, the trust income may be received To reduce probate fees tax-free. In addition, the use of a trust may be more advantageous than Assets that are transferred to a properly gifting capital directly to a child as it structured living trust will no longer be 5 | RBC Wealth Management

the settlor’s property so those assets Assets transferred to the trust would not be included in their estate When the settlor transfers non-cash when determining probate fees. assets to the trust, a tax liability may result. In general, the assets are To maintain privacy treated as if they have been sold at A living trust can be used as a discrete fair market value. Any unrealized means of transferring assets outside of capital gains or losses are deemed to the Will. While a Will becomes a public be realized by the settlor and should document when filed with the courts be declared on the settlor’s tax return. for probate, the trust remains private. There are instances where these rules Only the settlor, the trustee(s) and the may not apply, such as in the case beneficiary(ies) will know about the of an alter ego or joint partner trust. transferred assets. For more information, ask your RBC Since a trust is treated advisor for our article on “Alter Ego To income split as a separate taxpayer, and Joint Partner Trusts”. it must file an annual A living trust can provide a mechanism tax return as if it were for splitting income between higher Income and capital gains earned an individual. income and lower income family and retained in the trust members to minimize a family’s Since a trust is treated as a separate overall tax burden. taxpayer, it must file an annual tax return as if it were an individual. If A parent or grandparent can establish the trust is properly structured, all a family trust for the benefit of low- income and capital gains earned on income family members and fund the the trust’s capital are declared on its trust by way of a gift or loan. Subject tax return with a deduction claimed to the attribution rules discussed later for any income or capital gains that on, income and capital gains earned have been paid or made payable to in a properly structured trust that are the beneficiary during the year. The allocated to a beneficiary can be taxed income and capital gains earned and in the beneficiary’s hands at their retained in the trust are taxed at the marginal tax rate. If the beneficiary top individual marginal tax rate for the has no other source of income, they trust’s province of residence. The trust may pay little or no tax. This could is not entitled to claim personal tax provide a significant tax savings credits. There is no tax advantage to for the parent or grandparent, and retaining income in the trust. potentially the whole family. Income and capital gains paid or Taxation of trust income made payable to a beneficiary A living trust is considered to be a Subject to the attribution rules separate taxpayer, distinct from the discussed below, if the trust is settlor and the trust’s beneficiary. The properly structured, income or trust may be required to pay income capital gains paid or made payable tax on income and capital gains to a Canadian resident beneficiary earned in the trust. A living trust is are included in the beneficiary’s subject to tax at the highest marginal tax return and subject to tax at the rate in its province of residence on beneficiary’s marginal tax rate. every dollar of income earned. 6 | RBC Wealth Management

Income or capital gains “paid” to the or low interest, attribution may also beneficiary are physically paid to the apply to income allocated to an adult beneficiary or used to pay for expenses child beneficiary. that directly benefit only the beneficiary such as private school tuition, lessons, In spite of the attribution rules, there camp, and childcare expenses. are still opportunities to use a living trust for income splitting. Unlike Income or capital gains “made payable” dividend and interest income, capital With proper planning, are not paid out to the beneficiary, but gains distributed from a properly are retained in the trust. These funds structured trust to a related minor ideally at least one are legally owed to the beneficiary and child are taxable in the child’s year in advance of the supported by a promissory note to hands. In this case, growth-oriented 21-year anniversary, substantiate that the beneficiary can investments such as stocks could be steps may be taken to enforce payment of these amounts. considered. Income distributed from defer the tax on the the living trust to adult children or deemed disposition. Income or capital gains allocated to other adult family members (except the beneficiary from the trust retain a spouse) may be taxable in the their character. This means that beneficiaries’ hands. interest, dividends and capital gains earned in the trust will be taxed as if The attribution rules can also be the beneficiary earned these types of avoided if the funds are loaned to income personally. a properly structured trust at the Canada Revenue Agency’s prescribed The attribution rules rate. The trust must pay interest on Trusts are frequently used as a means the loaned funds annually to the of income splitting. This strategy lender. The lender must declare involves transferring income from a the interest received as income on family member in a higher tax bracket their tax return. The benefit of this to a member in a lower tax bracket. prescribed rate loan strategy is that The ability to income split with there is no attribution on any income family members can be significantly or capital gains allocated by the trust restricted due to the “attribution rules” to the beneficiary(ies). Although the in the Income Tax Act (ITA). lender must pay tax on the interest income received at their marginal tax The attribution rules require income rate, the tax savings on the income or capital gains earned on property allocated to the beneficiary(ies) transferred by gift or low-interest should ideally compensate for this. or no-interest loan to the trust be attributed back (i.e. taxed) to the In addition to these attribution rules transferor in certain situations. noted previously, the ITA contains a These rules may apply when a gift set of “super attribution rules” that or low-interest or no-interest loan is apply specifically to trusts. These made to the trust and income (and rules may apply where the person capital gains in the case of a spouse) who transfers property to the trust earned on that property is allocated (e.g. settlor) retains control over that to a spouse or related minor child property or where that property can beneficiary. If the transferor lends revert back to the settlor. capital to the trust with no interest 7 | RBC Wealth Management

Examples of situations where these taken to defer the tax on the deemed rules might apply include where the disposition. Speak to a qualified tax trust is a revocable trust or where and/or legal advisor regarding the the settlor is the sole trustee or the planning that may be available. controlling trustee of the trust. If the super attribution rules apply, all Tax treatment of distributions income and capital gains earned from a trust on the transferred property will be If the trust is properly structured, The trust agreement taxed in the settlor’s hands at their income payable to a beneficiary of should be reviewed marginal tax rate. a trust is generally included in the to determine what the beneficiary’s income. Distributions of trustee can or cannot do The attribution rules should be capital are generally received tax free with regards to investing. discussed with a qualified tax advisor by the beneficiary. The trustee may prior to setting up a living trust. be able to choose to make the capital distribution in cash or in kind. In Deemed disposition of trust assets general, in kind capital distributions In order to prevent the indefinite can generally be made on a tax- deferral of capital gains accumulated deferred basis. in a trust, the tax laws require that unrealized gains on the trust’s assets This rule is subject to certain (other than depreciable property) exceptions. For example, capital be declared every 21 years. This is distributions to a non-resident referred to as the 21-year deemed beneficiary must be done at fair disposition rule. At this point in time, market value, triggering a taxable the trust must report all accumulated disposition in the trust. Also, if the gains on its tax return as if it actually super attribution rules apply to a sold the assets. If the trust holds real trust, capital must be distributed to a estate or business assets, this may beneficiary at fair market value. involve valuators to establish a proper value. Assets held in a trust Almost any type of asset can be Any gains realized as a result of this transferred to a trust. Investments deemed disposition are taxed in the such as stocks and bonds are the most trust at the highest marginal tax rate commonly held assets in a living trust. in the trust’s province of residence. The settlor of the trust may choose These gains cannot be allocated to the to place restrictions on the types of beneficiary to be taxed in their hands. assets that are held in a trust. The power to invest trust assets is usually Even though a trust must pretend to set out in the trust agreement. The dispose of everything and pay the tax, trust agreement should be reviewed it does not mean the trust must be to determine what the trustee can or wound up. Once the tax is paid, the cannot do with regards to investing. trust continues to operate as it did before. With proper planning, ideally Where the trust agreement is at least one year in advance of the silent with respect to the trustee’s 21-year anniversary, steps may be investment powers, the trustee must 8 | RBC Wealth Management

rely on the statutory investment Evaluating the merits of a trust powers that govern the trust. Ask There are many reasons for your RBC advisor for a copy of the establishing a living trust. Regardless article entitled “Trustee Investment It is essential that of the reasons, it is essential that Powers” for more information on the the trust be properly the trust be properly structured to investment powers of a trustee. structured to achieve one’s goals. Because of the complexity that comes along with achieve one’s goals. Winding up a trust trust law and taxation, it is important The power of the trustee to wind up to consult a professional legal advisor the trust depends on the terms of the to determine if a living trust would trust. Trust agreements may provide be advantageous in the particular that the trust be wound up prior to its circumstance. 21st anniversary in order to avoid the deemed disposition.

If the trust agreement does not deal with the wind up, the trustee may need to seek court approval if they wish to wind up the trust.

Please contact us for more information about the topics discussed in this article.

This document has been prepared for use by the RBC Wealth Management member companies, RBC Dominion Securities Inc. (RBC DS)*, RBC Phillips, Hager & North Investment Counsel Inc. (RBC PH&N IC), RBC Global Asset Management Inc. (RBC GAM), Royal Trust Corporation of Canada and The Royal Trust Company (collectively, the “Companies”) and their affiliates, RBC Direct Investing Inc. (RBC DI) *, RBC Wealth Management Financial Services Inc. (RBC WMFS) and Royal Mutual Funds Inc. (RMFI). *Member-Canadian Investor Protection Fund. Each of the Companies, their affiliates and the Royal Bank of Canada are separate corporate entities which are affiliated. “RBC advisor” refers to Private Bankers who are employees of Royal Bank of Canada and mutual fund representatives of RMFI, Investment Counsellors who are employees of RBC PH&N IC, Senior Trust Advisors and Trust Officers who are employees of The Royal Trust Company or Royal Trust Corporation of Canada, or Investment Advisors who are employees of RBC DS. In Quebec, financial planning services are provided by RMFI or RBC WMFS and each is licensed as a financial services firm in that province. In the rest of Canada, financial planning services are available through RMFI, Royal Trust Corporation of Canada, The Royal Trust Company, or RBC DS. Estate & Trust Services are provided by Royal Trust Corporation of Canada and The Royal Trust Company. If specific products or services are not offered by one of the Companies or RMFI, clients may request a referral to another RBC partner. Insurance products are offered through RBC Wealth Management Financial Services Inc., a subsidiary of RBC Dominion Securities Inc. When providing life insurance products in all provinces except Quebec, Investment Advisors are acting as Insurance Representatives of RBC Wealth Management Financial Services Inc. In Quebec, Investment Advisors are acting as Financial Security Advisors of RBC Wealth Management Financial Services Inc. RBC Wealth Management Financial Services Inc. is licensed as a financial services firm in the province of Quebec. The strategies, advice and technical content in this publication are provided for the general guidance and benefit of our clients, based on information believed to be accurate and complete, but we cannot guarantee its accuracy or completeness. This publication is not intended as nor does it constitute tax or legal advice. Readers should consult a qualified legal, tax or other professional advisor when planning to implement a strategy. This will ensure that their individual circumstances have been considered properly and that action is taken on the latest available information. Interest rates, market conditions, tax rules, and other investment factors are subject to change. This information is not investment advice and should only be used in conjunction with a discussion with your RBC advisor. None of the Companies, RMFI, RBC WMFS, RBC DI, Royal Bank of Canada or any of its affiliates or any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. ® Registered trademarks of Royal Bank of Canada. Used under license. © 2016 Royal Bank of Canada. All rights reserved. NAV0177 (05/16)