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Family Trust: Everything You Need to Know

16 January 2019 by National Bank
Family trust

Whether you want to pay less taxes, plan the transfer of your wealth or protect your child’s assets or interests, creating a family trust is worth considering. This is especially true for entrepreneurs. Find out if a family trust is beneficial for you.

What is a family trust?

Like a company, a family trust is a legal entity. It can hold assets, invest and enter into contracts with third parties. Therefore, the assets no longer belong to the person who transferred them.

When setting up a family trust, three actors each play a key role. They are:

Settler

The settler creates the family trust by transferring a portion of their assets into the trust company for the benefit of the beneficiaries. “Normally, the settler does not have any family ties to the beneficiaries,” explains François Archambault, Financial Planner & Senior Advisor at National Bank Private Banking 1859’s expertise centre. “This is to avoid the application of certain tax attribution rules.”

Trustee(s)

These are administrators of the trust or, if it was a company, the directors. They manage the trust’s assets and decide, in particular, on the allocation of income or capital to the beneficiaries. To do this, they have to take into account the provisions of the trust agreement that outlines their roles and responsibilities. If a trustee is also a beneficiary, a second independent trustee without beneficial rights must also be named.

Beneficiary/Beneficiaries

These are the people who receive income and capital from the trust. Because they benefit from the trust’s profits, it’s a little like they are shareholders of a company. In a family trust, it’s often members of the family who play this role.

How is a family trust different from a management firm?

The operation of a family trust is similar to that of a management firm but is not, however, identical.

Often, a management firm is used in the business of an operating company. “Having too much money in a business can lose the deduction for capital gain,” says Archambault. “Therefore, to avoid this, surpluses are sent to a management firm.”

Also, administrators of a management firm have an annual mandate and must be re-elected each year. Trustees, however, remain in office as long as they have the capacity and do not resign.

Finally, the shares of a management firm that are held by a shareholder could be seized after a lawsuit or bankruptcy. “This problem does not occur when a family trust holds the shares,” adds Archambault. “Unless the trust was created right before bankruptcy or  creditors’ rights fraud.”

Advantages of a family trust

1.       Reduce the tax payable on death

A family trust allows you to pay less in taxes upon the death of the shareholder. This is relevant in cases where an entrepreneur has accumulated enough assets for retirement and does not need the future capital gain of their company. “By using the estate freeze strategy, the trust becomes the owner of the company’s participating shares. Therefore, the capital gain of the shares is in the trust,” explains Archambault. “Upon the shareholder’s death, the capital gain of the shares since the estate freeze is not taxable.”

2.       Plan the transfer of wealth

In addition to minimizing the amount of tax payable, a trust helps better prepare the transfer of wealth within the family after the death of the entrepreneur. “The trust can be used to do an estate freeze for an eventual transfer of a business,” notes Archambault. “Often the entrepreneur can ask themselves who would be the best person to take over in the family. They can also redistribute shares later.”

3.       Protect assets

A family trust holds assets on behalf of its beneficiaries all while being protected from claims for payments that creditors may exercise over them. “A trust is an independent and distinct patrimony,” says Archambault. “Assets therefore cannot be seized after a lawsuit or bankruptcy.” Warning! The trust must, however, be created when everything is going well. If there are already problems during its creation, a judge could authorize the seizure anyway.

4.       Multiply deductions for capital gains

Upon selling shares of a company, there is normal a tax to be paid on the capital gain. However, if shares qualify for capital gains deduction, this could be distributed to many beneficiaries. “The tax payable is therefore minimized because it is shared between beneficiaries. On the other hand, to use this strategy, the trust must hold shares from an operating company,” explains Archambault.

5.       Protect a child

The rules are set once the trust is created. Among these, some may specify the way in which money will be given to the children. “A family trust allows you to make a donation without putting it directly in their hands,” says Archambault. “It could, for example, help secure the future of a severely disabled child or even eventually benefit grandchildren.”

From a more technical point of view, a family trust has long been popular for splitting the income of adult children. However, this possibility was considerably limited with the recent reform by the Minister of Finance, Bill Morneau.

What are the disadvantages?

 

The main disadvantage of a family trust is the deemed disposition rule on the 21st anniversary of the family trust. It’s a little like if, every 21 years, the family trust sold its assets at their fair market value. Therefore, there is tax to pay on capital gains. With a little planning, it’s possible to avoid the application of this rule (for example, assets can be given to the beneficiaries).

On the other hand, the income tax rate for the family trust corresponds to the highest marginal rate. The trust must be seen as a full taxpayer. It is therefore taxed on the income it generates. That’s why creating a family trust entails significant administrative involvement. “You have to file a tax return every year and issue tax slips,” says Archambault. “Trustee must also prepare written minutes of proceedings when making decisions and producing financial statements.”

What are the steps to create a family trust?

 

To create a family trust, you must follow a few steps:

1.       Draw up the trust agreement, ideally by a notary or tax lawyer. Among other things, it allows the naming of the trustee and beneficiaries and the inclusion of various clauses.

2.       Make a donation. Normally, to create the trust, there is always an irrevocable donation. Often it is a gold or silver bar. Then, the trust gains its legal existence.

3.       Register the donation with the Registre des droits personnels et réels mobiliers (RDPRM).

4.       Open a bank account under the name of the family trust.

5.       Follow the closing agenda. “A tax professional provides a list of steps to transfer assets, such as shares, into the trust,” says Archambault.

6.       Produce annual tax returns and financial statements. Minutes of proceedings must also be written after each decision is made.

Obviously, the different steps of creating a family trust entail costs. Most notably, you should plan for the fees of the various professionals involved in the file. The total costs can vary greatly.

A family trust has several advantages. Work with professionals to make a good analysis of your situation. You will then be able to determine if this solution works for you or if a management firm would be preferable.

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