Today’s blog was written by Darren Lund, associate from Fasken Martineau DuMoulin LLP.

Cooler weather, shorter days, leaves changing colours and, at long last, the Blue Jays playing in the playoffs, are sure signs that Autumn is here and Winter is just around the corner. For estates practitioners in 2015, these are also signs that January 1, 2016 — the effective date for changes to the taxation of testamentary trusts first introduced in Budget 2014 — is also just around the corner.

In the Budget 2014 document, The Road To Balance: Creating Jobs and Opportunities, released on February 11, 2014[1], the government confirmed its intention, first announced in Budget 2013, to eliminate certain advantages enjoyed by testamentary trusts, including taxation at the graduated tax rates applicable to individuals, subject to two exceptions; namely, the first 36 months of an estate (defined as the “graduated rate estate” in subsequent implementing legislation) and “trusts having as their beneficiaries individuals who are eligible for the federal Disability Tax Credit.”[2]  The second exception was expressly stated to be for the benefit of disabled persons in response to submissions from stakeholders:

…during the consultation the Government heard from a number of stakeholders that the existing graduated rate taxation of testamentary trusts for the benefit of disabled individuals was an important tool in preserving access by these individuals to income-tested benefits, in particular provincial social assistance benefits. In response to these submissions, graduated rates will continue to be provided in respect of such trusts having as their beneficiaries individuals who are eligible for the federal Disability Tax Credit. More detail regarding the parameters of this exception will be released in the coming months.[3]

When the parameters were released on August 29, 2014, we learned that the rules for this exception, now defined in subsection 122(3) of the Income Tax Act as a “qualified disability trust” (“QDT”), in fact complicate planning for beneficiaries who are receiving benefits under provincial means-tested programs such as the Ontario Disability Support Program (“ODSP”).

To qualify as a QDT, the trust be a testamentary trust that is factually resident in Canada, it must jointly elect with one or more beneficiaries who qualify for the Disability Tax Credit (each such beneficiary known as an “electing beneficiary”) to be a QDT, and an electing beneficiary may not make such an election with any other trust in the same year. In short, there can only be one QDT for a particular electing beneficiary at a particular time.[4]  It is this last point I will focus on in this blog.

When planning is implemented for a disabled beneficiary, it is often difficult to assess with certainty what the disabled person’s future needs will be, and therefore whether the family’s resources will be sufficient to meet those needs, or if the continued receipt of benefits such as ODSP will be necessary to meet those needs. In addition, it is not uncommon for more than one family member to implement planning intended to preserve access to such benefits, given these inherent uncertainties (e.g. grandparents who have greater financial resources than the disabled person’s parents, divorced parents who wish to individually plan for their disabled child, or a sibling who wants to benefit a disabled niece or nephew). Under the current rules, multiple family members can set up Henson-style trusts in their wills to preserve access to benefits and each such trust would benefit from graduated tax rates. Under the new rules, multiple Henson-style trusts can still be set up for one disabled beneficiary, but only one of them can be a QDT that benefits from graduated tax rates. While the implications of this change have yet to be fully worked through by the profession, the need for coordination among multiple parties is likely to add unnecessary complexity, and therefore cost, to the planning process, often for clients with limited means.

We have been down this road before. Section 60.011 of the Income Tax Act was introduced to permit the deferral of income tax that would otherwise be payable on the death of an RRSP annuitant where the refund of premiums is used to acquire a specific type of annuity, the annuitant of which is a “lifetime benefit trust” (as opposed to the disabled person). Once again, the problem is in the details. The definition of “lifetime benefit trust” in subsection 60.011(1) provides that no person other than the taxpayer (i.e. the disabled person) may receive or otherwise obtain the use of the income or capital of the trust during the taxpayer’s lifetime. This is a problem in jurisdictions such as Ontario where the accumulation of income inside a trust is limited to a statutorily-defined period (i.e. 21 years). After the expiration of the accumulation period, all of the trust’s annual net income must be paid or made payable to the beneficiaries. However, ODSP rules restrict the amount of voluntary payments (including trust distributions) that can be made to an ODSP recipient in a 12-month period. Accordingly, if the trust’s annual net income exceeds the ODSP limits and the disabled person is the only income beneficiary, his or her benefits are in jeopardy. For that reason, a Henson-style trust will normally include additional income beneficiaries, but that is expressly forbidden in the case of a lifetime benefit trust.

In the above cases, the details of the legislative initiatives have either added unnecessary complexity and cost to the planning process or limited the usefulness of an otherwise promising initiative. The devil is in the details, as they say. Let’s hope that the next initiative intended to benefit disabled persons has less devil in those details.

Thanks for Reading

Darren Lund

 

 

[1]       The Budget 2014 document can be accessed online (in html or pdf format) at https://www.budget.gc.ca/2014/docs/plan/toc-tdm-eng.html.

[2]       Budget 2014, at p. 329.

[3]       Budget 2014, at p. 329.

[4]       Practitioners should note the new “recovery tax” regime set out in proposed paragraph 122(1)(c) of the Income Tax Act. A discussion of the recovery tax is beyond the scope of this blog.