Law Times

Law Times • OctOber 20, 2014 Page 11 www.lawtimesnews.com Lawyers gear up for tax changes to testamentary trusts By JuDy vAn RhIJn For Law Times s lobbying continues to prevent the remov- al of graduated tax rates for testamentary trusts, some lawyers believe the efforts are futile. The government was invit- ing stakeholders to comment on its draft legislative propos- als by Sept. 28, but there are those who believe it has already made its decisions. "There's no point in further lobbying," says John Peart, a partner at Nelligan O'Brien Payne LLP in Ottawa. "I think it's done. The gov- ernment did the consultation. The new provisions for special treatment for the disabled and a 36-month grace period showed a little bit of budging. Now the government has moved on." When the federal govern- ment's 2014 economic action plan repeated last year's proposal to eliminate graduated tax rates for testamentary trusts, those in the legal and accounting com- munities who had joined forces to oppose the change weren't happy. On Aug. 29, 2014, the Department of Finance released draft legislative proposals that would implement the measures for consultation. While they include an exception for testa- mentary trusts whose beneficia- ries include individuals eligible for the disability tax credit and allow a 36-month window for estate administrators to fund the trust, they otherwise mirror the original proposal. Some members of the Cana- dian Bar Association, however, haven't accepted that the issue is over. They sent out letters to op- position parties in July attaching submissions previously made to Finance Canada during the 2013 consultation period. "We are still interested in the topic," says Richard Niedermayer, a partner at Stewart McKelvey in Halifax and past chairman of the CBA's national wills, estates, and trusts section. "We continue to believe that what the federal government has done is to use a large weapon to solve a small problem. They've taken a broad brush to eliminate a legitimate and important tool that they were not really con- cerned about from a policy per- spective." Niedermayer remains hope- ful some change will happen. "We'll continue to push the agenda. It is unlikely to change in the short term, but they may review it over the next few years." In the meantime, lawyers are adjusting their advice on the basis of the imminent change, weighing whether there are still benefits to using the testamen- tary trust mechanism. Nieder- mayer believes there is still a place for the structure. "There are estate planning reasons, in- dependent of tax planning rea- sons, for disabled, spendthrift or vulnerable beneficiaries." He also cites second marriage situations, provisions for minor beneficiaries or young adults, and creditor and matrimonial planning as additional reasons. "Making that decision was easy before because we knew the trusts would get graduated rates. Now we need to make the choice more clearly. If it is tax neutral or even tax inefficient, will you still do it? We've been weighing that choice since the budget came in." Peart foresees the use of tes- tamentary trusts declining con- siderably. "By far and away, they are used most by people who have obtained advice from in- vestment advisers. I don't think they will use them anymore. Any income left in the trust at the end of the calendar year will be taxed at the highest marginal rate for an individual. In On- tario, that is approximately 46 per cent." This arrangement will still allow some tax opportunities. Niedermayer believes testamen- tary trusts may still be useful for income splitting within a family where there are multiple beneficiaries. "You can push income to various beneficiaries to make use of their individual tax brackets. There is also the opportunity to top up a benefi- ciary to a higher tax rate rather than keep all the income in the trust and have 100 per cent taxed at the higher rate. You can use the beneficiary's full set of tax rates before reaching the highest rate." Peart believes that any ben- efits remaining will be on an individual basis. "So much de- pends on the tax rate of the ben- eficiary and non-tax situation of the beneficiary. For instance, the primary purpose may be credi- tor proofing or a Henson trust or other special circumstances where the trustee would want to manipulate how much mon- ey goes into the beneficiary's hands." The government has allowed one concession that will benefit those with disabilities by allow- ing those beneficiaries who are eligible for the federal disability tax credit to continue to enjoy graduated rates. "The doctor can fill out a specified form to get certain additional medical credits," says Peart. "If the beneficiary has a dis- ability certificate, a testamen- tary trust will still get beneficial tax treatment." The difficulty is that the certificate is only available to people with a severe and pro- longed impairment of physical or mental functions. Even those who qualify for the Ontario dis- ability support program don't always meet the criteria for the certificate. "There are a great number of people in Canada who will not meet the criteria for a disability certificate who are still vulnerable individuals, including seniors and people whose competence is ques- tionable and should really have a trust established for their own protection," says Niedermayer. "Often, these people are in receipt of social assistance. It affects their social benefits if the money is paid out." Niedermayer does recog- nize that the federal govern- ment needs an ascertainable and clear standard to deter- mine who should receive beneficial tax treatment. "The disability tax certificate is a clear benchmark. I can see it's difficult when you're dealing with less than that. Hopefully, we can come up with something so that mid- dle segment of the Canadian population is protected." Lawyers are also looking at whether there are alternative structures that could protect the vulnerable. "In the future, there might be some mechanism but right now anything I can think of would be so complex that it would certainly not be used by the mainstream population," says Peart. "Many people will be caught between the cracks." Niedermayer predicts an increase in the use of inter vivos trusts. "Previously there was a big distinction between the two. Now there is no distinction," he says. There remains a three-year grace period after the date of death before the highest tax rates kick in. Executors can hold off on funding the trust for the three years while they decide what to do. "People who set these up as a tax de- vice often name the benefi- ciary as the trustee as well," says Peart. "Obviously, during the first three years after the testator dies, they will ask whether it makes any sense to keep it. It's not that some- body's trapped. Testamen- tary trusts usually have a mechanism to wind up the trust. They could do that be- fore the highest rate clicks in or there may by reasons why it is a good thing to continue." Given that the scheme won't grandfather existing trusts, lawyers will be busy reviewing proposed and past arrangements in the run- up to implementation at the start of 2016. Peart is already expanding trust arrangements to include beneficiaries and their children. 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