This blog has been written by Darren G. Lund, Partner at Fasken LLP
Each year in June, the Canadian branch of the Society of Estates and Trusts Practitioners holds its annual conference. One of the most eagerly anticipated sessions each year is the “CRA Roundtable”. At the Roundtable, representatives from the Canada Revenue Agency respond to questions submitted in advance by STEP on a range of tax issues of concern to the estates and trusts community.
At this year’s CRA Roundtable, one of the questions concerned trusts known as “qualified disability trusts” or “QDT’s”. The response from the CRA is one that will be welcomed by practitioners who do planning for clients or their beneficiaries who have disabilities and who qualify for the disability tax credit (“DTC”).
By way of background, the general rule in Canada is that income in a personal trust is subject to taxation at the highest marginal rate, unless the income is paid or made payable to a beneficiary of the trust in the taxation year. In that case, the trust can generally deduct the income from its taxable income, and the beneficiary to whom the income was paid or made payable in the year will include the income in their personal income tax return, such that it is taxed at the beneficiary’s marginal rates.
The general rule described above was not always so general. Until 2016, the income in “testamentary trusts” – or trusts that are created on and as a consequence of the death of an individual – were in fact taxed at the graduated tax rates available to individuals. When the federal government eliminated the testamentary trust exception to highest marginal rate taxation, they introduced two new types of trusts that would continue to benefit from graduated rate taxation, one of which is the QDT.[1]
As with all things tax-related, the details are important. To qualify as a QDT, the trust must be a testamentary trust that is factually resident in Canada. There must be at least one beneficiary named in the trust instrument who qualifies for the federal DTC (known as the “electing beneficiary”). The QDT and the electing beneficiary must jointly elect each year to designate the QDT as a QDT in respect of that electing beneficiary. Importantly, there can be only one QDT per electing beneficiary.
Given the above requirements, what should planners do if more than one person wants to establish a QDT for the same electing beneficiary? This could occur where parents of an electing beneficiary are separated and are doing independent estate planning, or where individuals other than parents (e.g. grandparents, other relatives, chosen family, friends, etc.) also want to benefit that electing beneficiary. I will call those individuals the “benefactors”. An obvious option, if sufficient coordination is possible, is for each benefactor to make a will that establishes a QDT for the electing beneficiary, but only if a QDT has not already been established (e.g. if one of the other benefactors has already died). If a QDT already exists, then the will would provide that the amount set aside for the electing beneficiary is instead transferred to the existing QDT.
The concern with this approach had typically been that a QDT must be testamentary, and one of the requirements of a testamentary trust is that property cannot be contributed to the trust otherwise than by an individual on or as a consequence of the death of the individual. If benefactor A establishes a QDT for the electing beneficiary in A’s will, and benefactor B dies several years later and the will of benefactor B provides for a contribution to the QDT established by benefactor A, does this taint the QDT as a testamentary trust?
Helpfully, in its preliminary response at the Roundtable, the CRA has suggested that a contribution to an existing QDT from another individual, if the contribution is directed by the will of that other individual on and as a consequence of the death of that other individual, will not in itself taint the original QDT. In other words, the contribution to the QDT is indeed made on and as a consequence of the death of an individual, just not the same individual who originally created the QDT, and that alone is not problematic (i.e. it does not cause the existing QDT to cease to be testamentary). Of course, these scenarios are highly fact-specific, meaning professional advice is always recommended.
In due course, the CRA will provide a written response, but this preliminary response is encouraging, and will provide comfort to families and planners who are planning for beneficiaries with disabilities.
[1] The other trust that continues to benefit from graduated rate taxation is the aptly-named “graduated rate estate” or “GRE”, which is the estate that arises on and as a consequence of the death of an individual (and is treated as a trust for tax purposes). Graduated rate taxation applies only during the first 36 months of the GRE provided all other conditions are met.
