Law Times

Law Times • OcTOber 26, 2015 Page 9 www.lawtimesnews.com Estates bar worried about spousal trusts as federal changes loom BY JUDY VAN RHIJN For Law Times espite intense lobbying from the legal profession, there's as yet no remedy to the anomaly caused by shifting the tax bur- den for spousal trusts. Unless something changes by Jan. 1, 2016, the beneficiaries of a surviving spouse will find themselves bearing the tax liability for the first spouse's estate even if they receive no assets from the spousal trust. An amendment to the Income Tax Act that occurred at the same time as the removal of graduated rates for testamen- tary trusts is posing a difficult problem for those who are trying to provide for their spouse and for the children of a prior relationship. The changes were an attempt to address situations where testa- tors set up trusts in provinces with lower tax rates by making the tax payable by the remaining resident spouse. Lawyers and tax practitioners ex- pressed immediate concern about the im- pact on life interest trusts. In the year the surviving spouse dies, the executor will need to include all of the taxable income, including the amount from the deemed disposition of the spousal trust, even if the deceased's estate will never receive it. Clare Sullivan of Aird & Berlis LLP says that previously, if someone created a trust in a will for a spouse's lifetime, it was deemed to be a disposition when the spouse died. "If there were capital gains, the tax was payable by the spousal trust. Now, it is payable by the estate of the spouse. The new rule provides that it's not the residence of the trust that matters but the residence of the spouse." Jordan Atin of Hull & Hull LLP be- lieves it's a much greater problem than the demise of graduated tax rates. "Yes, they are getting rid of multiple testamen- tary trusts. That was a tax saving that wasn't available to anyone else. That's not a great concern. If there's tax on as- sets after three years, so be it. The major problem for everyone is that the surviv- ing spouse's estate is footing the bill even though it's not getting the assets." The Department of Finance's current position was it would make no comment on the issue due to the federal election. "I believe it is still on the table," says Sulli- van. "But whether any solution can be put in place by Jan. 1 is doubtful. It's already law. They will have to present amend- ments to the legislation before someone has to deal with it." Atin expresses a similar concern. "We've all been worrying and hoping they'd fix it before Jan. 1," says Atin. "The minister says they intend to only go after the first spouse's estate, but that doesn't bind the [Canada Revenue Agency]. If it's easier to go after the surviving spouse's estate to collect the money, why wouldn't they? Our fear is that they'll go after that estate and say, 'Now you go and collect from the spousal trust.' We're not sure if they can do that or if the spousal trust can properly pay that." Atin also worries about the effect on spousal trusts that are already in place. "Spousal trusts are prevalent, not only be- cause of rich people trying to avoid tax but because there are so many people in sec- ond marriages. There is no godfathering. Even if the first spouse has already died and the surviving spouse is living on the income, these rules affect that estate." Sullivan agrees. "There are thousands of spousal trusts already out there where the person has already died. They can't change it to get the tax in the right place. They will need an application to the court for advice and direction with not only the heirs of the first spouse but the heirs of the second spouse as well because they are the ones with the liability. The public guard- ian and trustee will need to appear for anyone that's not competent and the chil- dren's lawyer for anyone under 18." While those trusts may have no re- course apart from the courts, estate plan- ners have future arrangements to make. "There are lots of other changes in the new laws, but this is the worst, especially for those trying to draft wills," says Sul- livan. "The estate bar in Ontario is strug- gling to address this in our drafting. It's a nightmare any way you look at it. You can't draft a simple will anymore, and I am con- cerned that many practitioners that draft wills are not aware of the problem." One law firm is telling its clients to "keep calm and plan," and conferences are can- vassing methods to avoid the problem. "We are trying to come up with ways of planning around it that don't cause prob- lems for everyone," says Atin. "Now, when I'm drafting spousal trusts, I use language that avoids it to the extent we can by say- ing the spousal trust will indemnify the surviving spouse's estate. It works but it causes other problems. If an estate is all from the deceased's own assets, it gets the special tax rate for the first three years. As soon as you add money to that, it taints the estate. We are caught between hurting the surviving spouse in different ways." Sullivan is also aware of the problem. "If you put money in her estate, it is no lon- ger a testamentary trust because there's a contribution by someone else. And how do you figure out the amount? Do you calculate the final tax return if you did in- clude it and if you didn't? The capital gain won't be the only income. If there are capi- tal losses, can you apply them to the gain? There is no good answer. Whatever we do, we're headed for litigation." LT FOCUS Rejoice. Serengeti lets you take charge and take control of your entire legal landscape. You can organize and analyze everything from documents to deadlines, billing to budgets, pricing to profi tability, all with one surprisingly simple, maintenance-free system. 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