Estate Planning Strategies PDF

Estate Planning Strategies MODULE OVERVIEW In this module, you will learn about the different types of trusts and their specific roles in estate planning. We also explain how to reduce an estate’s income tax burden, both before and after death. Later in the module, we end by providing a checklist o...

Estate Planning Strategies MODULE OVERVIEW In this module, you will learn about the different types of trusts and their specific roles in estate planning. We also explain how to reduce an estate’s income tax burden, both before and after death. Later in the module, we end by providing a checklist of issues you and your clients should consider when preparing an estate plan. LEARNING OBJECTIVES CONTENT AREAS 1 | Describe the different types of trusts, Trusts and explain their application in wealth management. 2 | Describe strategies that minimize or defer Taxation clients’ income tax before and after death to reduce their estate’s tax burden. 3 | Recognize general issues to consider for estate General Issues to Consider for planning. Estate Planning © CANADIAN SECURITIES INSTITUTE (2021) 2 ESTATE PLANNING STRATEGIES KEY TERMS The Key Terms list targets some significant concepts covered in the module. Key terms appear in bold text in each module to help you focus your study efforts on these important topics. 21-year rule irrevocable trust resulting trust charitable remainder trust life insurance trust revocable trust constructive trust personal trust rights or things estate freeze preferred beneficiary social trust express trust private trust spousal trust graduated rate estate qualified disability trust testamentary trust © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 3 INTRODUCTION Trusts are a complex area of the law. The discussion about trusts in this module provides a basic and relatively simplified overview of the mechanism of trusts and its application in wealth management. A trust specialist should be consulted in situations where a client could benefit from setting up a trust. One of the largest tax bills clients (or, more accurately, their estates) invariably face is at death. As such, a lot of effort is expended to reduce the potential burden by planning to minimize taxes before and after death. For example, one major strategy of reducing taxes at death is to provide gifts to heirs before death. Keep in mind that different techniques and strategies have different, often unexpected repercussions, and a tax specialist may need to be consulted to set up everything accurately. Before you begin the module, read the scenario below, which raises some of the questions you might have about estate planning. Think about these questions, but don’t worry if the answers don’t come easily. At the end of the chapter, we will revisit the scenario and provide answers that summarize what you have learned. ESTATE PLANNING WITH JORGE AND NORA Your client Jorge and his new wife Nora are meeting with you as a couple for the first time. They want to discuss Nora’s recent transfer of her investment account. As part of your discovery process, you find out that Nora has never been married, but was previously in a common law relationship with the father of her two children. Nora does not have a will, and Jorge had a will prepared and signed before his divorce from his first wife three years ago. Jorge, a successful small business owner, has brought substantial assets into the marriage, whereas Nora has few assets. Just before he and Nora got married, Jorge downloaded a will template from the Internet, which he personalized, printed, and signed. He believes that this new will supersedes the one he had in place before his divorce. He also believes it provides appropriately for both Nora and his two teenaged children from his previous marriage. Nora’s children are young adults and are not close to Jorge. Nora lives with a debilitating medical condition. What type of trust would be of benefit given Nora’s disability? What can you suggest Jorge and Nora do to reduce potential taxes at death? What can they do to ensure that their children’s needs are met in the event of their death? What can Jorge do to ensure that Nora would be financially secure if he were to die before her? At the same time, how can he protect the rights of his children to his estate? NOTE The content in this module covers both common law and civil code provisions. For study purposes, all content is examinable regardless of the province of your residence. © CANADIAN SECURITIES INSTITUTE (2021) 4 ESTATE PLANNING STRATEGIES TRUSTS 1 | Describe the different types of trusts and explain their application in wealth management. A trust is a relationship that is created when one party (the settlor) transfers assets to another party (the trustee) who holds legal title to the transferred property for the benefit of another party (the beneficiary), who has the beneficial interest. The trust document provides instructions on how the assets are to be managed, and when and how they can be used by the beneficiaries. The beneficiaries may be identified by name or as a class (e.g., “my children”). The settlor, the person who settles the trust, must be of the age of majority and must be legally competent to enter into a contract. Legal restrictions apply to persons with limited capacity to contract, such as a bankrupt or a mentally incompetent person). In setting up an inter vivos trust, it is possible for the same person to be both settlor and trustee, except in Quebec. In such cases, it is important to ensure that negative tax implications, such as attribution of income, are avoided. In certain circumstances, for example, in creating an alter ego trust, the settlor is the same person as the trustee and the beneficiary. However, other than in the case of an alter ego trust, the settlor is typically neither the trustee nor the beneficiary. In Quebec, the settlor or the beneficiary must act jointly with a trustee who is neither the settlor nor a beneficiary. For example, consider a case where a testator leaves the income to her spouse for his lifetime and the residue to her child upon the spouse’s death. In such a case, the spouse and child cannot act alone; a third trustee must be appointed. When a settlor transfers legal title of an asset to a trustee, by will or inter vivos deed, the deemed disposition rule may apply. A capital gain or loss may result for the settlor or the settlor’s estate. However, it is possible to transfer assets to a spousal trust (testamentary or inter vivos) on a rollover basis. Unlike a corporation, a trust is not a legal entity. It is a relationship that exists among a trustee, the property, and the beneficiary or beneficiaries, whenever a trustee accepts holding legal ownership of property for the benefit of beneficiaries. This concept is somewhat different than the one applicable in Quebec, which is discussed below. The procedural and administrative aspects of trusts and the responsibilities and powers of trustees are outlined in provincial Trustee Acts and in the Civil Code in Quebec. Generally, the beneficiary is the person who has any contingent or absolute right to the assets held in the trust. The trustee has control over the assets of a trust, but does not beneficially own the assets held in the trust. Typically, in an inter vivos trust, the trustee is appointed by the settlor, whereas the estate trustee or trustee of a testamentary trust is appointed in a will by the testator. In some circumstances it is necessary for a court to appoint a trustee. At common law, and according to statutory law, trustees are fiduciaries, and are therefore held to a high standard of care. The applicable law places onerous fiduciary obligations on trustees. Additionally, the trust instrument dictates the terms of trust and outlines the duties and obligations of the trustee who is appointed. The terms of the trust, which specify the trustee’s duties, may override those duties at law. DUTIES OF THE TRUSTEE There are four primary duties imposed on trustees by common law, which are also applicable in the province of Quebec. They relate to conflicts of interest, standard of care, delegation of duties, and impartiality. © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 5 CONFLICT OF INTEREST A trustee cannot be seen to be in a conflict of interest between his or her own interest and that of the beneficiaries. In this respect, the following rules apply: A trustee cannot profit from actions taken as a trustee. A trustee cannot acquire trust property or enter into contracts with the trust personally. If a breach of trust occurs, the trustee can be compelled to return the profit and pay financial damages to the beneficiaries. STANDARD OF CARE IN MANAGEMENT OF TRUST FUNDS A trustee is bound by a duty to act honestly and in good faith, and to take reasonable and proper care of the trust property. The standard of care that must be met is that of a prudent investor (or “prudent and diligent person”, in Quebec) managing his or her own investments or business. DELEGATION BY TRUSTEE Generally, trustees are not permitted to delegate their power and duties to another person. This law is similar to the law that pertains to directors of companies, which prohibits delegation of director duties. However, in certain circumstances, and depending on the nature of the responsibilities, tasks involving the administration of the trust property may be delegated. The trustee may employ an agent, such as a trust company, or a professional, such as an investment advisor, to carry out certain activities, where appropriate. A trustee is not responsible for any loss caused by the agent’s acts, as long as the trustee did not delegate exercise of discretion. However, because the trustee’s decisions are held to a prudent investor standard, the trustee’s choice of a particular agent must be justified and held to the same standard. Furthermore, the trustee must continue to monitor and supervise the agent’s work. In Quebec, the trustee may not delegate the administration of the trust or the trustee’s discretionary powers, except to co-administrators. For example, a trustee may delegate the investment policy decision to a co-trustee. MAINTAINING AN EVEN HAND Trustees must act impartially in dealing with the trust assets for the benefit of the beneficiaries. In Quebec, this obligation is known as the impartiality rule. It may arise, for example, when investments are made that favour the interests of income beneficiaries to the detriment of capital beneficiaries, or vice versa. EXAMPLE A trust is set up that affects both Rashida and Noura. Rashida is entitled to the income of the trust for her lifetime. Noura will receive the capital upon Rashida’s death. To respect the even hand rule, the trustee will probably decide to consider a balanced portfolio deed. The duty to maintain an even hand does not apply to discretionary distributions of property to the beneficiaries through a discretionary trust. Discretionary trusts generally provide that trustees may use their discretion to benefit any beneficiary, as they see fit. However, they must be impartial in evaluating the needs of each beneficiary and take steps to be informed of each beneficiary’s situation. They must also clearly address the issue of whether to exercise discretionary power, and they must exercise discretion honestly, prudently, and in good faith. The duty to maintain an even hand does not require that the trustee split up trust property equally between beneficiaries of a discretionary trust. © CANADIAN SECURITIES INSTITUTE (2021) 6 ESTATE PLANNING STRATEGIES TYPES OF TRUSTS A trust is constituted when three “certainties” exist: Certainty of intention There is a clear intention to create a trust. Certainty of subject The trust property is delivered to the trustee. Certainty of objects The beneficiaries of the trust (i.e., named individuals, persons, or closed classes) are clearly described and are identifiable. Clients often mistakenly assume that a trust is created simply by the intention to create a trust, much like a contract. However, a trust is generally not created until property is actually settled on the trustee by the settlor. A mere promise by the settlor to transfer property to the trust is not enforceable and does not establish a trust. The Income Tax Act treats a trust as if it were a separate person, and the nature of a trust is that of a relationship. As noted earlier, a trust is not a legal entity; however, for purposes of the Income Tax Act and taxation, it is treated as a separate taxpayer. A separate tax return must be filed each year for the trust. DID YOU KNOW? A trust can be established expressly, by statute, through a will, or by operation of law (as a result of conduct or the occurrence of an event) in common law provinces. TESTAMENTARY AND INTER VIVOS TRUSTS A testamentary trust is created by the testator’s will and arises at the testator’s death. An inter vivos trust, is set up during the settlor’s lifetime. The settlor creates the trust in three ways: By demonstrating an intention to create a trust By transferring legal ownership of certain clearly identified property to the trustee By clearly identifying the beneficiaries for whom the property is being held in trust In common law provinces, inter vivos trusts may be revocable or irrevocable. A revocable trust can be undone by the settlor at any time. However, revoking the trust will bring about negative tax consequences, depending on the nature of the property held in the trust. If the settlor reclaims the assets or changes the beneficiaries, all income and capital gains will be attributed back to the settlor. With an irrevocable trust, the settlor cannot revoke the terms of the trust and has no legal right to take back any of the trust’s assets. If it is not clearly stated in the trust documents that the trust is revocable, it is assumed to be irrevocable under common law. There are several reasons for setting up an inter vivos trust. A recurring concern is to protect assets from being lost through spendthrift behaviour by a beneficiary. Assets may also be protected from creditors’ claims if certain conditions are met. Often, the settlor wishes to gift significant assets to his or her children or other family members, but the gifting is done through a trust, rather than directly, so that the assets can be managed and safeguarded for a lengthy period. Inter vivos trusts have the following drawbacks: The procedures involved in setting them up are complicated. Legal and accounting fees must be paid. Tax must be reported annually. Settlors may be reluctant to give up control, wishing instead to use or benefit from the assets or investment income. © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 7 EXPRESS TRUSTS Express trusts expressly state the terms of trust. Most express trusts are written, outlining the intentions of the settlor or testator. Wills, codicils, discretionary family trusts, and other inter vivos trusts are examples of express trusts. RESULTING AND CONSTRUCTIVE TRUSTS IN COMMON LAW In common law, trusts such as resulting trusts and constructive trusts can be declared to exist by the operation of law. A resulting trust presumes that a person has a share in a property based on that person’s contribution of finance or labour to acquiring or maintaining the property. EXAMPLE Two friends, Alejandro and Elsa, purchase a house. Each contributes $100,000 toward the purchase, but the title to the house is in Alejandro’s name only. Even so, a court could find that Elsa has an interest by means of a resulting trust. Constructive trusts may be formed when one party is unjustly enriched at the expense of another person. The court imposes an obligation on the unjustly enriched party to compensate, or transfer property to, the deprived party. EXAMPLE Sheila looked after her bedridden brother-in-law, Sheldon, for several years before his death. Sheldon had assured Sheila that she would be looked after upon his death. However, Sheldon’s will provided only a small gift of $5,000 for Sheila and left the balance of the $500,000 estate to his son. In this case, Sheila could claim a constructive trust on Sheldon’s property and seek fair compensation. OTHER TYPES OF TRUSTS Three other types of trusts to consider when working with your clients are as follows: Life insurance trust A life insurance trust consists of the proceeds of one or more insurance policies. Charitable remainder A charitable remainder trust is set up with the purpose of benefiting the community trust or the public. This type of trust can also be used to donate funds to a charitable organization. Settlors can receive all the income generated by the trust for their remaining lifetime. When the settlor dies, all remaining capital goes to the charity. Spousal trust A spousal trust is essentially any testamentary or inter vivos trust created by a testator or a settlor for the benefit of a spouse. Such trusts must meet certain conditions. The trust must provide that the spouse is entitled to receive all the income of the trust before the spouse’s death. Furthermore, only the spouse may obtain or use any of the income or capital of the trust before his or her death. THE 21-YEAR RULE Clients often want to establish trusts that will last forever. However, such trusts are generally considered invalid because they are contrary to the common law rule against perpetuities. The 21-year rule is designed to prevent people from tying up assets beyond a certain period (which is ordinarily 120 years). The common law rule has been modified in some provinces. For example, British Columbia’s Perpetuity Act has a “wait-and-see” rule that will only invalidate a trust if vesting has not occurred within 80 years. (Vesting is the right © CANADIAN SECURITIES INSTITUTE (2021) 8 ESTATE PLANNING STRATEGIES of the beneficiary to absolute ownership of property.) The wait-and-see rule does not apply in Quebec, but the province has other provisions that limit the duration of a trust. Not all provinces have a perpetuity act in place. Under the Income Tax Act, a trust is taxed every 21 years, as if it had disposed of and re-acquired all capital property at fair market value. (In other words, a deemed disposition occurs.) REASONS FOR CREATING INTER VIVOS TRUSTS Inter vivos trusts are created for several non-tax-related reasons, including asset management and protection and to avoid deemed disposition and probate fees. ASSET MANAGEMENT The flexibility that results from trusts becomes most apparent in the context of an estate freeze, when the shareholder uses a discretionary trust rather than issuing shares directly to family members. When a trust is used, benefits arising from the shares are not fixed and can be adjusted from time to time as circumstances change. Examples might include health problems, drug dependencies, mental breakdowns, marital breakdowns, or tax changes. When direct ownership by family members is employed, relative shareholdings are fixed, and the reallocation of shares and resulting benefits, becomes far more problematic. ASSET PROTECTION Holding assets in an irrevocable discretionary trust can protect the assets both from the beneficiaries’ creditors and from the beneficiaries themselves. A settlement of property in a trust by a settlor who is insolvent or close to insolvency may be subject to attack under fraudulent conveyance legislation. A trust must not be made to delay, hinder, or defraud creditors of their just and lawful remedies. A disposition of property under circumstances of collusion, guile, malice, or fraud is void and has no effect against the wronged party. AVOIDING DEEMED DISPOSITION AT DEATH AND PROBATE FEES Assets placed by a person in an inter vivos trust before death will not be subject to the deemed disposition rule at the time of that person’s death. The assets do not form part of the deceased’s estate and are not subject to probate; instead, they are held by the trustee for the beneficiary. Thus, the deceased avoids a significant tax bill at death. However, tax may be payable when the trust is settled (i.e., when assets are transferred to the trust). PROVISIONS IN TRUST AGREEMENTS In creating a trust agreement, the settlor must be identified along with the trustee or trustees. The deed must also identify the trust property given to, and accepted by, the trustee. It must also clearly identify the income beneficiaries and the capital beneficiaries. Other provisions in trust agreements are discussed below. DETERMINATION OF THE BENEFICIARIES The beneficiaries must be identified carefully. They are often defined as a closed class, such as the children or grandchildren of the settlor or testator. PURPOSE OF THE TRUST The purpose for which a trust is established (called appropriation in the Civil Code of Quebec) should be clearly described. The purpose can vary. In a purely discretionary trust, the trustee has absolute and unfettered discretion to distribute the trust income and capital to any beneficiary, such as their spouse, children, or grandchildren. In a non-discretionary trust, the distribution of income and capital occurs according to the fixed terms prescribed by the settlor or testator. © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 9 EXAMPLE The settlor of a trust set up for a charity might direct that only the income from a certain asset should go to that particular charity. Furthermore, the settlor might direct that income should be used only for cancer research. INDEMNIFICATION OF THE TRUSTEE In theory, the fiduciary duties associated with being a trustee are so onerous that it would be difficult to recruit trustees. For this reason, trust deeds typically contain provisions to lower the high standards that trustees must otherwise meet. The effect is that trustees are liable only in the event of wilful default of their duties. In addition, trustees are often indemnified for any actions they take within the scope of the duties specified in the trust deed. However, limits on the trustee’s liability in the trust indenture alone may not limit the trustee’s liability to a third party. Accordingly, trustees should make sure that this limitation on liability is included in the documents relating to any transaction they undertake as a trustee. TRUSTEE’S INVESTMENT POWERS Unless a trust deed states otherwise, the trustee’s investment powers are those allowed under the applicable provincial statute. Because statutory powers are usually restrictive, the trust deed may enlarge investment powers beyond what is allowed under the provincial statute. In Quebec, unless otherwise provided for in the trust instrument, trustees have full authority. Their power to invest is not limited to a restricted investments list. However, they are still bound by the duty to act with prudence and diligence and in the best interest of the beneficiaries. AVOIDING THE 21-YEAR RULE Many personal trusts contain a provision under which all trust property is distributed to the beneficiaries on a tax- deferred basis before the 21-year deemed disposition rule applies. This distribution of capital can be made only to the capital beneficiaries of a trust, not to the income beneficiaries. In many cases, but not always, the income beneficiary and the capital beneficiary are the same person. For example, a trust that holds an investment portfolio may distribute the income generated by the capital, the funds of which are invested, to certain named beneficiaries during their lifetime. Upon the death of the last of the income beneficiaries, other named individuals, the capital beneficiaries, will receive the capital, the trust funds, as capital distributions. Until the death of the income beneficiaries, the capital beneficiaries are not entitled to receive any distributions. Canadian resident capital beneficiaries of a Canadian resident trust can receive the capital distribution on a tax deferral basis, as long as the distribution occurs prior to the expiry of 21 years from the trust’s date of creation. In such a case, the recipient capital beneficiary assumes the trust capital property at its ACB. EXAMPLE A stock was acquired by a trust at an ACB of $100. The trust’s assets are now being distributed to the capital beneficiary of the trust. A rollover occurs on a tax-deferred basis at the ACB of $100. When the capital beneficiary sells the stock (or dies) the capital gain will be taxed in his hands (or in the hands of his estate). This provision may serve to wind up the trust on a tax-deferred basis. However, such a clause does not prevent trustees of a discretionary trust from distributing the property, as they choose, before the end of the 21-year time limit. © CANADIAN SECURITIES INSTITUTE (2021) 10 ESTATE PLANNING STRATEGIES DID YOU KNOW? The 21-year deemed disposition rule does not apply to a spousal trust; the deemed disposition is deferred until the death of the surviving spouse. After that spouse dies, the 21-year rule is applied in accordance with the Income Tax Act. FAILURE OF THE TRUST—LACK OF BENEFICIARIES If a trust fails because there are no beneficiaries, the trust property ordinarily reverts to the settlor by operation of law (or the settlor’s estate if the settlor is deceased). A trust should provide for an alternative method of distribution that prevents trust property from reverting to the settlor. This provision ensures that the trust has no reversionary element that would subject the settlor to attribution during his or her lifetime. POWER OF APPOINTMENT Trustees often exercise powers of appointment (i.e., powers to determine, distribute, or hold property for a particular beneficiary). In Quebec, power of appointment may be exercised by the trustee or a third person designated by the settlor only if a class of persons is clearly determined in the trust deed. LETTER OF WISHES A non-binding declaration of the settlor’s wishes is often annexed to the will. This provision is a way of suggesting how the trustee should administer the trust and exercise discretionary powers in the case of a discretionary trust. LEGAL ASPECTS OF TRUSTS IN QUEBEC Several legal aspects related to trusts differ in Quebec from those that apply elsewhere in Canada. Under the Civil Code of Quebec, a trust results from an act whereby the settlor transfers property from his or her patrimony to that of another person for a particular purpose. The trust takes effect as soon as the trustee agrees to hold and administer the trust patrimony for the beneficiaries. The trust patrimony consists only of the property transferred in trust. It is distinct from other property belonging to the settlor, trustee, or beneficiary, and none of them has any real right to the property held in trust. The settlor’s creditors cannot take legal action against the property held in trust unless the trust was specifically created to defraud them. A trust is established by contract, whether for payment or for free (e.g., by will or gift); in certain cases, it is established by operation of law. A trust must be created in a written document. TYPES OF TRUSTS IN QUEBEC In addition to express trusts, inter vivos trusts, and testamentary trusts, three other types of trusts exist under Quebec’s Civil Code: Social trust A social trust is a trust constituted for cultural, educational, philanthropic, religious, or scientific purposes. A social trust is set up for the general benefit of the community, not to generate a profit. Personal trust A personal trust is a trust constituted for free to secure a benefit for a particular person (i.e., a trust established by a will or a gift). For example, a trust set up for the benefit of a spouse is considered to be a personal trust. © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 11 Private trust A private trust is a trust created for specific purposes, such as maintaining or preserving property for a specific use (e.g., maintenance of a grave or memorial). It can also be a trust constituted by onerous title, as one created for the purpose of making of profit (e.g., mutual funds or RRSPs). DID YOU KNOW? Resulting and constructive trusts do not exist in Quebec. TAXES AND TRUSTS When income earned in a trust is distributed to the beneficiaries, it is taxed in their hands and retains its character for tax purposes. For example, in a trust as for an individual, Canadian dividends are eligible for the dividend tax credit, and only 50% of capital gains are taxable, whereas interest income is fully taxable. The general rule for the taxation of personal trusts is that the income of the trust is not taxed in the trust’s hands to the extent that it is paid or payable to a beneficiary in the year. A personal trust is effectively treated as if its property were owned by an individual. That person is deemed to be subject to tax and to be a completely separate tax-paying entity. If the trust is deemed to be a resident of Canada but earns income from foreign sources, its worldwide income is subject to Canadian tax. It is important to note that a personal trust is not eligible for personal tax credits. A trust generally calculates its income in much the same way an individual would. The distinction between testamentary and inter vivos trusts has little bearing on the way the trust’s income is determined. In either case, that income includes income from business, property, and other income. It also includes any taxable capital gains, minus allowable capital losses. As previously mentioned, trusts are deemed to dispose of all trust property every 21 years, including capital properties, land inventories, and resource properties. The residence of a trust determines the income tax jurisdiction in which the trust will be taxed. Residence is established based on the trustees’ place of residence, the location of the assets, and the location from which the assets are administered. DEDUCTING VERSUS DESIGNATING TRUST INCOME Trusts differ from living persons in that a trust may deduct amounts that are paid or are payable to its beneficiaries in a particular year. This deduction is claimed when computing the income of the trust for the year in which the payment is made or the liability to pay is incurred. The deduction is included in the beneficiaries’ income and taxed in their hands. However, any income not paid or payable to beneficiaries is taxed in the trust. A trust may retain income earned in one taxation year and pay it out to a beneficiary in the following taxation year. In such cases, the beneficiary does not pay additional tax if the funds have already been taxed. In other words, the income is taxed either in the hands of the trust or in those of the beneficiary, but not both. Thus, double taxation is avoided. The election to tax income in the trust (referred to as designating the income as being taxed) can be made under three conditions: The trust is a resident in Canada throughout the year. It is not exempt from tax. It is not a specified trust. © CANADIAN SECURITIES INSTITUTE (2021) 12 ESTATE PLANNING STRATEGIES These rules apply to income paid or payable to beneficiaries. The designation is usually made when there are non- capital losses that can be deducted against capital gains. It is also important to note that, when there are multiple beneficiaries, the designation applies to all beneficiaries. Once the designation is made on the trust’s tax return, this amount cannot be deducted off the trust’s tax return. ADDITIONAL PROVISIONS APPLICABLE TO PERSONAL TRUSTS Since 2015, a personal trust must file its income tax return within 90 days of December 31. (In contrast, individuals must file their income tax returns no later than April 30 of the year following the taxation year.) Trusts (both testamentary and inter vivos) must have a taxation year ending December 31 and must make quarterly instalments. TAXING OF MULTIPLE TRUSTS Some people may wish to create more than one trust, such as one trust for each child. In such cases, incomes of the trusts may be added together and taxed as if they were the income of a single trust. This outcome arises when both of two conditions apply: Substantially all of the property of the various trusts is received from one person. The income accrues, or will ultimately accrue, to the same beneficiaries or group of beneficiaries. Drafting of the trust deed must be precise, so that the separate trusts are clearly established to split income between several trusts. TRUSTS FOR MINOR CHILDREN Typically, the terms of a trust for a minor child stipulate that the trust capital, and perhaps all or some of the income, will be retained within the trust until the beneficiary reaches a certain age. In this case, even though the trust income is not actually paid out in a particular year, it is deemed to be payable to the minor. In other words, the amount is deducted from the trust’s income and added to the minor’s income. In such cases, to be in accord with the Income Tax Act, the following conditions must be met: The income must not become payable in the year. The beneficiary must be under 21 years of age at the end of the year. The beneficiary’s right to the income must be vested by the end of the year without the exercise or the non- exercise of a discretionary power. The beneficiary’s right must not be subject to any future conditions (other than a condition that the age of survival cannot exceed 40 years). CAPITAL GAIN DISTRIBUTIONS The terms of a trust should specify whether a taxable capital gain realized by the trust is to be included in the income of one or more beneficiaries for tax purposes. If a trustee is bound to pay only income to a beneficiary, the amount paid to the beneficiary does not include a capital gain. Capital gains are not income under trust law unless contrary directions are specified in the trust deed. However, all or part of the payment may involve a distribution of capital to a capital beneficiary (e.g., at the termination of the trust). In that case, all or part of the taxable capital gain realized by the trust can be included as part of the distribution. Thus, the beneficiary can offset any allowable capital losses realized in the year or carried over from another taxation year against the capital gain. © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 13 FOREIGN INCOME A trust resident in Canada that has income from foreign sources may allocate all or part of this income to its beneficiaries. The amount allocated in this way is deemed to be the beneficiaries’ income from foreign sources; therefore, the beneficiaries can claim a foreign tax credit. The applicable portion of the foreign tax will be deemed to have been paid by the beneficiary. If the trust income comes from more than one foreign country, these allocations must be made on a country-by-country basis. QUALIFIED DISABILITY TRUST A qualified disability trust (QDT) is a type of trust designed to benefit disabled individuals by permitting the lower tax rates to apply to the trust. A QDT remains subject to graduated tax rates as long as the named beneficiary with a disability is eligible for the tax credit. In order to qualify, a QDT must meet the following conditions: It must be a testamentary trust. It must be resident in Canada. It must make a joint election in its T3 tax return with one or more of its electing trust beneficiaries to be a QDT for the year. It must have income for the taxation year (not including income from a preferred beneficiary election) which does not exceed the dependant tax credit. In addition, each electing beneficiary must be named as a beneficiary by the particular individual (i.e., the testator) in a will. The beneficiary must also be eligible for the disability tax credit for the beneficiary’s tax year in which the trust’s year ends. An electing beneficiary cannot jointly elect with any other trust to be a QDT for the other trust’s taxation year that ends in the beneficiary’s taxation year. THE PREFERRED BENEFICIARY ELECTION In certain cases, a trust document will not permit a distribution of income or capital until the beneficiaries reach a certain age. In other cases, the distribution of income or capital may be at the trustee’s discretion. In the second situation, the trustee may decide that it would be inappropriate to distribute income or capital in a particular year. In either case, the trust’s effective income would probably be considerably higher than it would have been if the income and capital gain had been allocated to the beneficiaries. This is because trusts that do not pay a portion of their income to the beneficiaries during the year may not claim the beneficiaries’ income deduction in the trust’s tax return. Since 2016, any taxes on the accumulating income (including realized capital gain) are payable by the trust at the trust’s maximum tax rate. A preferred beneficiary can be one of two types: A Canadian resident who is a beneficiary of a trust at the end of the trust’s taxation year and who qualifies for the disability tax credit under the Income Tax Act. A Canadian who is an adult, dependent on others by reason of a mental or physical infirmity, and who is also either: The settlor of the trust The current or former spouse or common law partner of the settlor of the trust A child, grandchild, or great-grandchild of the settlor of the trust, or the spouse or common law partner of any such person. The preferred beneficiary election is available to testamentary trusts. However, for tax reasons, it was used mostly by inter vivos trusts in the past. Any accumulating income in an inter vivos trust would otherwise be taxed at the maximum personal income tax rate, rather than at graduated tax rates. Since 2016, graduated tax rates have been eliminated in testamentary trusts, so this election is now used more frequently. © CANADIAN SECURITIES INSTITUTE (2021) 14 ESTATE PLANNING STRATEGIES TAXATION 2 | Describe strategies that minimize or defer clients’ income tax before and after death to reduce their estate’s tax burden. In this section we explain how clients can minimize or defer income tax before death to reduce their estate’s tax burden. DISPOSITION OF CAPITAL PROPERTY BEFORE DEATH A disposition of capital property includes both depreciable and non-depreciable property. It generally occurs at fair market value, with a resulting capital gain or loss and possible recapture of capital cost allowance or terminal loss. Exceptions to this general rule include the following types of transfers: Transfer of capital property to a spouse or to a spousal trust Transfer of qualified fishing property to a child Transfer of qualified farm property to a child Transfer of personally owned property from an individual to a corporation (subject to several conditions) If a client transfers assets with an accrued loss (i.e., assets that have dropped in value) to an affiliated person, the capital loss could be denied under certain stop-loss tax rules. The transfer might also lead to double taxation. (A spouse is considered to be an affiliated person, but children are not. Certain corporations or partnerships can also be affiliated.) However, a client may transfer property at fair market value to offset non-capital (business or property) losses or capital losses. In other words, the client can deliberately create capital gains or recapture the capital cost allowance for this purpose. TRANSFER OF CAPITAL PROPERTY TO A SPOUSE OR SPOUSAL TRUST DURING THE SETTLOR’S LIFETIME One way your clients can remove property from their estate for the purposes of reducing probate fees at death is to transfer the asset to another person or to a trust. The transferred assets, therefore, are not part of the probate procedure. Clients can transfer their capital property, tax-free and at the adjusted cost base (ACB), to the following recipients: The taxpayer’s spouse (including a common law spouse, or a de facto spouse in Quebec) A spousal trust A former spouse in settlement of a divorce Both the transferor and the spouse or spousal trust must be resident in Canada at the time of the transfer. This rule, which creates the deferral of tax, is known as a spousal rollover. EXAMPLE Jerome, a small business owner, wishes to shield certain personal assets (including an investment portfolio and real estate property) from business creditors. He transfers them to his wife without immediate tax consequences. In other words, the transfer does not result in an immediate capital gain or loss to Jerome. © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 15 ATTRIBUTION RULES If assets are put into a spousal trust, all the income and capital of the spousal trust must be exclusively for the use of the spouse during the spouse’s lifetime. The transferor’s proceeds of disposition in a spousal rollover are known as the tax basis, or ACB, of the assets. For example, the proceeds of disposition for depreciable property are deemed to be the undepreciated capital cost of the depreciable property. A spousal rollover occurs on a tax-free basis. However, if the spouse disposes of the property during his lifetime, any capital gain or loss is attributed back to the transferor, unless the transferor is no longer married to the recipient spouse. In addition, any income earned from the transferred property after the transfer is attributed back to the transferor. Therefore, it is not possible to split income or capital gains between spouses simply by transferring property. However, the payment of tax on a capital gain is deferred until the recipient spouse disposes of the property. Furthermore, there is no income attribution after the spouses have separated and, if both spouses jointly elect, there is no attribution of capital gains to the transferor spouse. ELECTION TO AVOID ROLLOVER The transferor may elect to have the proceeds of disposition and the cost of acquisition to the transferee be equal to the fair market value of the property. This option is important if a person transfers property to a spouse and subsequently divorces or separates from the spouse. If no election is made, the recipient spouse will, upon disposing of the property, pay tax on the capital gains based on the transferor’s ACB as mentioned above. In effect, the recipient pays tax not only on his or her own capital gain, but also on that of the former spouse. SHARES OF A SMALL BUSINESS CORPORATION Small business corporations are exempt from the income attribution rules, which apply to loans and transfers made to corporations, the shares of which are held by a spouse or minor children (subject to certain limitations). Also, capital gains on the disposition of shares of a qualified small business corporation may qualify for the lifetime capital gains exemption. TRANSFERRING CAPITAL PROPERTY TO A CORPORATION A client can transfer certain property to a corporation and elect to defer the full accrued gain or realize a portion of the gain. To do so, the client can use estate freeze techniques under Section 85 and 86 of the Income Tax Act. ESTATE FREEZE The main reason to freeze an estate is to limit the shareholder’s tax liability for potential asset growth. To do so, shareholders must freeze the value of their specified growth assets, so that future growth occurs normally in the hands of their children or spouse. Growth assets generally consist of capital property likely to increase in value, such as stocks, bonds, real estate, business interests, and shares of a private corporation. In an estate freeze, the accrued value in the assets, before the freeze starts, belongs to the owner of the shares – the shareholder or transferor. Subsequent growth in the value usually accrues to the owner’s children or spouse. When the transferor dies, the increase in value up to the freeze date is taxed in the hands of the estate. (Or, it is taxed in the owner’s hands if the owner disposes of the assets before death.) Any subsequent growth in value will be ultimately taxed in the hands of the children or spouse. An estate freeze may be structured so that the owner of growth assets transfers them directly to his or her children or spouse. © CANADIAN SECURITIES INSTITUTE (2021) 16 ESTATE PLANNING STRATEGIES THE USE OF HOLDING COMPANIES AND INTER VIVOS TRUSTS The traditional method of freezing an estate is to use a holding company (often referred to as a “holdco”). A holding company is generally a company that has control over another company through ownership of a sufficient proportion of that company’s shares. It is also possible to use an inter vivos trust or family trust in conjunction with a holding company when conducting an estate freeze. Clients making an estate freeze may have the following requirements: Maintain control over the assets, even though any growth passes to the next generation. Secure a source of income after the estate freeze. Get assurance that no immediate tax liability arises on the estate freeze. A typical estate freeze is accomplished through a holding company. A person who owns all the common shares of a thriving company can transfer them into a newly incorporated holding company. The person can then take back, as consideration, the holding company’s preferred shares of the same value as the common shares that were exchanged for the preferred shares (under Section 85 of the Income Tax Act). The transfer is effected at cost, and no taxable capital gain arises. Figure 1 shows the estate freeze process. Figure 1 | Holding Company Freeze Before the Freeze After the Freeze Parents Parents Children B 100% Preferred Common Ownership Shared Shares Common A Holding Shares Rollover Company Operating Operating Company Company In Figure 1, the following rules apply: The cost base of the common shares flows through to the preferred shares, along with any gain in the common shares. (A) The preferred shares are voting, non-participating, non-cumulative, redeemable shares, with a fixed dividend rate. (B) The preferred shares are redeemable at the fair market value of the common shares transferred into the holding company. The holding company’s newly issued, nil-value common shares (the new growth shares) are issued to the children in such a way that the preferred shares have more votes than the common shares. Because the preferred shares have a fixed redemption amount, any future growth in the common shares belongs to the children. In this kind of estate freeze, shareholder or transferor maintains voting control in the holding company through the voting preferred shares. The shareholder also receives preferred share dividend income, but the future growth of the assets accrues to the children. The fixed preferred dividend can be set to meet the shareholder’s income needs. © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 17 Alternatively, a person can achieve a partial estate freeze by transferring only a portion of the growth assets to the next generation. If a client requests an estate freeze, you should seek expert assistance from a lawyer and an accountant. RISKS OF ESTATE FREEZING Freezing an estate carries the following risks: Once an estate freeze is in place, any growth in the new common shares accrues to the children. Non-growth assets taken back by the shareholder or transferor, such as promissory notes or preferred shares, may not provide adequate income. Regarding the second point, inflation or other changes after the estate has been frozen, for example, may reduce the value of the assets. After the freeze, clients may change their mind and feel that those benefiting from the freeze no longer deserve to do so. However, once established, an estate freeze is difficult to reverse, and doing so may involve considerable cost. SALE OR GIFT TO ACHIEVE AN ESTATE FREEZE In some cases, a simple sale or gift can result in an estate freeze. For example, it may be simpler and less expensive for parents to sell or give securities to their children rather than incorporating a holding company or setting up an inter vivos trust. Future growth in the value of the shares will not accrue to the parents. However, control of the securities is lost after the sale or gift is made. TAXES AT DEATH The following taxes arise on the death of an individual in Canada: Tax on income from the deemed disposition of capital property on death, as reflected in the deceased’s final personal income tax return Income tax on deemed proceeds of RRSPs and RRIFs Foreign estate taxes and succession duties (if any of the deceased’s property is outside Canada or if the deceased was a citizen or resident of a foreign country) Neither the federal government nor the provinces levy a gift or estate tax. Instead, they collect final taxes through the deceased’s last income tax return. Income tax paid when the deceased’s final tax return is filed includes tax on capital gains from the deemed disposition of capital property at death. The amount of tax payable depends on the extent to which the estate can use the qualifying small business corporation exemption for capital gains. It also depends on whether the capital cost allowance needs to be recaptured. (The capital cost allowance claimed on depreciable property in earlier years may have to be brought into income at death and taxed). Previous years’ capital gains reserves can be transferred to a spouse or spousal trust through a rollover, but they do not qualify for the capital gains exemption. MINIMIZING OR DEFERRING TAXES ON DEATH When drawing up a will, clients should consider certain techniques to minimize or defer tax at death. The procedure may require the executor or liquidator to file up to four separate income tax returns for the deceased, as follows: The deceased’s final personal tax return A second tax return for rights or things belonging to the deceased A third tax return if the deceased was a partner or owner in a business enterprise A fourth tax return if the deceased had an interest in the income of a testamentary trust (defined later in this module) © CANADIAN SECURITIES INSTITUTE (2021) 18 ESTATE PLANNING STRATEGIES RIGHTS OR THINGS According to Canada Revenue Agency’s tax guide T4011, “rights or things are amounts that were not paid at the time of death and had the person not died, would have been included in his or her income when received”. They could also be considered items that are earned but not received at the date of death. The following items are examples of rights and things: Accrued (i.e., owed to deceased), but unpaid, salaries and wages Accrued (i.e., owed to deceased), but unpaid vacation pay Uncashed matured bond or debenture interest coupons Bond interest earned to a payment date before death, but not paid and not reported in previous years Unpaid dividends declared before the date of death Supplies on hand, inventory, and accounts receivable if the deceased was a farmer or fisherman and used the cash method Work in progress, if the deceased was a sole proprietor and a professional (e.g., a medical doctor, veterinarian, chiropractor, accountant, dentist, or lawyer, or, in Quebec, an advocate or notary) who had elected to exclude work in progress when calculating his or her total income Old Age Security benefits that were due and payable before the date of death The following items are not rights or things: Amounts that accumulate periodically, such as interest from a bank account Bond interest accumulated between the last interest payment date before the person died and the date of death Income from an RRSP Eligible capital property Canadian or foreign resource properties DID YOU KNOW? Eligible capital property can be broadly described as intangible property, such as goodwill. The cost of such property neither qualifies for capital cost allowance nor is deductible in the year of its acquisition as a current expense. TAXATION OF RIGHTS OR THINGS Two elective provisions are available to an executor: File a separate return on the rights or things, as though the deceased were another person entitled to personal tax credits. Advantages of this provision are the double use of certain personal tax credits and the application of a relatively lower marginal tax rate. Personal tax credits include the basic personal amount, spouse amount, eligible dependant amount, and age amount. Include the right or thing in the beneficiary’s income for that year rather instead of the right or thing being taxed in the deceased’s estate. This provision is useful for beneficiaries in a low tax bracket. The executor should calculate income tax on the rights or things under each provision and select the one that results in lower tax. © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 19 THE DISPOSITION OF CAPITAL PROPERTY AT DEATH Two rules apply when disposing capital property at death: Unrealized capital gains on capital property (including depreciable property) are taxed in the deceased’s final income tax return. Exempting provisions may be used, which are discussed below. A taxpayer is deemed to have disposed of all capital property, including depreciable property, immediately before death. The person is also deemed to have received proceeds equal to the fair market value of the property. Any resulting taxable capital gain (50% of the capital gain) is considered income of the deceased. THE TRANSFER OF PROPERTY TO A SURVIVING SPOUSE As discussed earlier, tax rules provide for a rollover of capital property from a deceased to a surviving spouse or to a testamentary spousal trust. Non-depreciable property is transferred at its ACB. Depreciable property is transferred at its undepreciated capital cost. The deceased must have been resident in Canada immediately before death. The capital property must be passed to either a resident spouse who resided in Canada at the time of death or a testamentary spousal trust. (The residency of the trust is determined by the residency of the trustees as this is where the central management and control of trust assets takes place.) The testamentary trust must provide that the spouse is the only beneficiary entitled to the income after death, and that no person other than the spouse may receive any capital from the trust before the spouse’s death. In other words, the capital property must vest in the spouse or spousal trust without restrictions within 36 months after the death of the taxpayer. A statement that remarriage or cohabitation of the survivor spouse will bring about a capital distribution to someone other than the spouse taints the spousal trust. In such a case, the tax deferral would be denied upon death. The Income Tax Act permits an executor to make an election for any property subject to a spousal rollover. By doing so, the executor intentionally triggers a deemed disposition at fair market value. In this way, capital gains can be created to absorb unused capital losses or bring an accrued capital gain into the income of the deceased (where the tax rate warrants it). NON-DEDUCTIBLE RESERVES ON THE DECEASED’S FINAL TAX RETURN Taxpayers are allowed to deduct certain reserves when computing taxable income, so that income is deferred to a future year. (Normally, income is deferred until the year in which the proceeds are actually received.) In the year of death, however, a final tax return is filed on the deceased’s behalf; therefore, reserves cannot be deducted to defer income. The following reserves are not deductible: Amounts receivable from property sold in the course of a business Unearned commissions Amounts receivable on the disposition of capital property Amounts receivable on the disposition of a resource property A tax-free rollover is allowed if an election is filed and the reserves pass to the deceased’s spouse or spousal trust. The spouse or spousal trust can claim these reserves, although they had originally belonged to the deceased. The amount of the reserve claimed is then included in the income of the spouse or spousal trust in the first taxation year ending after the death of the taxpayer. The spouse or spousal trust may, in turn, claim a reserve to the extent the deceased person could have claimed it, had he or she survived. Therefore, it is possible to shift some income to a spouse in a lower tax bracket. That spouse can pay the tax as payments are received over a number of years. © CANADIAN SECURITIES INSTITUTE (2021) 20 ESTATE PLANNING STRATEGIES An executor can file a separate tax return when a proprietor or a partner dies after the business’s fiscal year end, but before the calendar year end. This applies from the close of the fiscal period to the date of death. The deceased’s personal exemptions may be claimed on this separate tax return, despite having been previously claimed on the deceased’s final tax return. EXAMPLE Lynn’s consulting practice has a year-end of January 31. If Lynn died on April 30, 20x7, her executor could choose between the following filing options: One final return reporting 15 months of income from February 1, 20x6 to April 30, 20x7 Two tax returns: A final return reporting 12 months of income for the period ending January 31, 20x7 An optional return reporting the business income for three months from February 1, 20x7 to April 30, 20x7 ALLOWANCES FOR CAPITAL LOSSES A taxpayer’s allowable capital losses in the year of death may exceed the taxable capital gains in the same year. In such cases, the excess can be applied against other income in the year of death and in the immediately preceding tax year. Subject to certain limitations, the executor may treat losses from the estate’s disposition of capital property as if they had been incurred by the deceased, rather than the estate. The executor must file an amended personal tax return for the deceased to take advantage of this election. GRADUATED RATE ESTATES Recent amendments were introduced affecting taxation at death, introducing the rules affecting graduated rate estates (GRE). Subject to a few conditions, a GRE is an estate that arose on, and as a consequence of, the death of a person. Such an estate remains qualified as a GRE for no more than 36 months after the date of death. (This period is considered by Canada Revenue Agency to be a reasonable requested time to settle an estate.) Among other advantages, a GRE benefits from being subject to graduated tax rates. Income realized during the 36 months after the death and not paid to the beneficiaries is taxable at the graduated rates. HIGHEST MARGINAL RATE TAXATION Testamentary trusts have been taxed as individuals, benefiting from graduated tax rates, until December 31, 2015. Beginning in 2016, testamentary trusts are taxed at a flat top rate. However, graduated rates will continue to apply when the trust is for the benefit of a disabled person eligible for the disability tax credit. Both testamentary and inter vivos trusts are now subject to the highest marginal rate of tax on all their income. CHARITABLE DONATION AT DEATH As an advisor, you should discuss the issue of charitable donations at death with your clients. As of January 1, 2016, taxation rules permit greater flexibility in using the donation tax credit for donations made by will and for gifts by direct designation. The rules now allow a donation to be allocated between the deceased and his or her estate when the donation is made by a GRE. In such cases, the deceased may use the donation credit in the year of death or in the year immediately preceding death. Alternatively, the GRE may use the donation in the year of the donation, carry it back to any of its prior taxation years, or carry it forward for up to five years. It is also important to consider that there is no tax on capital gains for gifts of publicly traded securities, as long as the gift is made by a GRE. © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 21 A GRE is in existence as long as at least a part of the estate remains undistributed. Therefore, that undistributed part of the estate is still legally in the hands of the executor, to be managed for the benefit of the residuary beneficiaries. Only that part of the estate that is the GRE is subject to the lower tax rates (and only for 36 months from date of death). Any assets already distributed no longer comprise part of the estate, and are not part of the GRE. POST-MORTEM PLANNING FOR PRIVATE CORPORATIONS AT DEATH When a testator dies owning shares of a private corporation, a capital gain may be realized under the deemed disposition at death rule. If there is no rollover to a spouse or to a spousal trust, the person who acquires the shares is deemed to have acquired them at a cost equal to their fair market value immediately before the deceased’s death. With respect to a private corporation, this deemed disposition does not alter the ACB of the underlying assets owned by the corporation. When the assets are extracted from the company, corporate taxes are triggered and paid on any accrued value or recapture from the disposition of the assets. A taxable dividend results from the distribution of the assets or substituted property to the shareholders. As a result, double taxation occurs. The fair market value of the corporation is taxed first as a capital gain in the terminal return of the deceased. It is then taxed a second time in the estate as a dividend on distribution from the company. Post-mortem planning becomes essential at this point. In such cases, three techniques may be used in planning for the estate’s first taxation year: loss carry-back, pipeline, and bump. The implementation of these three approaches requires in-depth planning with a tax specialist, which is beyond the scope of this course. However, a brief overview of the three approaches is provided below. LOSS CARRY-BACK TECHNIQUE The loss carry-back technique involves the creation of a capital loss in the estate’s first taxation year, which is carried back to offset capital gains at death. This planning typically involves the winding up or redemption of the corporation by the estate. It may also involve redemption of all or some portion of the estate’s shares in the deceased’s terminal return. Loss carry-back requires that the loss be sustained in the estate’s first taxation year, and is subject to numerous stop-loss rules. PIPELINE TECHNIQUE The pipeline technique is attractive for private corporations that were formerly carrying on business, and have significant retained earnings that have not given rise to capital dividends or to refundable tax. This technique essentially involves depleting the surplus to the extent allowed by the Income Tax Act as a means of avoiding double taxation upon death. According to tax specialists, the benefit of the pipeline transaction is that it reduces the tax on the removal of corporate surplus to the capital gains rate applicable on the death of the shareholder. EXAMPLE A company shareholder dies, leaving his shares of a private corporation named A Co with a fair market value of $1,000 and an ACB of zero. The shareholder is deemed to have disposed of the shares for $1,000 and the estate is deemed to have acquired the shares at an ACB of $1,000. The estate then incorporates a holding company named B Co and sells the shares of A Co to B Co, taking back as consideration a $1,000 promissory note (payable to the estate). A Co and B Co are then merged by winding up or amalgamating. Alternatively, the shares of A Co owned by B Co may be redeemed and the assets of A Co paid to B Co as the proceeds of the redemption. The assets of A Co then become available to repay the promissory note to the estate. There is no tax payable by the estate on the repayment of the promissory note, and the estate may then distribute the acquired assets to the beneficiaries as tax-free capital distributions. Again, planning and execution of the pipeline technique should be done with the assistance of a tax specialist. It is important to verify CRA’s position on this topic on a regular basis. © CANADIAN SECURITIES INSTITUTE (2021) 22 ESTATE PLANNING STRATEGIES BUMP TECHNIQUE The bump technique is similar to the pipeline strategy. The initial steps are the same, up to the issuance of the promissory note. Upon winding up or amalgamation, the newly combined company can bump up the ACB of capital property to the fair market value of the property held at the time the acquirer last acquired control of the company from an arm’s length person. Generally, this would be the date of death. This strategy is useful when the holding company will be retained and there are significant inherent gains in the underlying capital property of the corporation, such as a large investment portfolio. In this case, the promissory note can be repaid over time. GENERAL ISSUES TO CONSIDER FOR ESTATE PLANNING 3 | Recognize general issues to consider for estate planning. Estate planning exists for clients who want to pass on their assets to their heirs in a relatively trouble-free and tax efficient manner. When those clients die, their will should reflect their desires, and they should have taken steps to minimize taxes where possible. To ensure that their remaining assets are distributed effectively, you and your clients should consider the following questions: Does the client need to write a new will or modify an existing one? Has the client selected one or more executors or liquidators, trustees, or guardians and their substitutes? Has the client chosen an independent trustee to act with the settlor or beneficiary, in Quebec? Has the client evaluated the effect of any existing marital agreements or family law considerations, such as partition of family patrimony, in Quebec? Has the client evaluated opportunities to make an estate freeze or other strategies to minimize taxes when transferring assets? (This item is a consideration in business succession planning, for example, where it may include a partial or full estate freeze or a buy-sell agreement.) Does the client need to revise beneficiary designations for RRSPs, tax-free savings accounts, pension plans, or insurance contracts? Does the client need to revise insurance coverage and name appropriate beneficiaries? Have you reviewed the suitability of joint ownership of assets (in common law provinces)? Has the client made certain that funeral instructions are left with the executor or close family members? Does the client need a pre-paid funeral plan? Have you identified any associated special needs? (Consider special protection for physical or mental incapacity, minors, dependants, and the potential for bankruptcy or family breakdown.) Has the client determined the amounts to leave to beneficiaries and charities? Have you explained the trust types designed for special needs, such as a QDT, a family trust, or a discretionary trust? Have you assessed the suitability of inter vivos trusts for transferring wealth in the present? Have you explained the tax benefits of planned giving (i.e., giving gifts to charitable organizations now or upon death)? Has the client appointed a power of attorney (enduring or not) or a protection mandate, in Quebec? Has the client prepared a living will to convey instructions to relatives and medical personnel at the time of a critical illness? © CANADIAN SECURITIES INSTITUTE (2021)  ESTATE PLANNING STRATEGIES 23 ESTATE PLANNING WITH JORGE AND NORA At the beginning of this chapter, we presented a scenario in which newly married Nora and Jorge were looking for estate planning advice. Now that you have read the chapter, along with the relevant chapters in KPMG’s Tax Planning guide, we’ll revisit the questions we asked and provide some answers. Nora lives with a debilitating medical condition. What type of trust would be of benefit in her situation? A qualified disability trust (set up as a testamentary trust) would help in her situation because it is designed to benefit disabled individuals by permitting lower tax rates to apply (i.e., graduated tax rates instead of the top marginal tax rate). To be eligible, Nora would have to qualify for the federal disability tax credit. What can you suggest they do to reduce potential taxes at death? You should suggest they take the following steps: « Look for ways to avoid capital gains taxes upon death. (For example, they can transfer or gift assets prior to death, or they can establish qualifying trusts into which they can transfer assets at their ACB. Both strategies can help to reduce estate taxes and probate fees.) « Take advantage of the lifetime capital gains exemption regarding Jorge’s small business. Implement an estate freeze on some of Jorge’s assets to reduce taxes (and probate fees) upon his death. What can Jorge and Nora do to ensure that their children’s needs are met in the event of the parents’ death? What can Jorge do to ensure that Nora would be financially secure if he were to die before her? At the same time, how can he protect the rights of his children to his estate? Jorge could set up a testamentary trust to establish Nora’s life interest (or an usufruct in Quebec) in his estate’s assets, with those assets passing to his children after Nora’s death. He could also establish an inter vivos trust to ensure that his children are provided for and that they use the assets and income they receive from the trust responsibly. Jorge would appoint a trustee, whose role is properly defined, so as to fulfill his wishes. © CANADIAN SECURITIES INSTITUTE (2021) 24 ESTATE PLANNING STRATEGIES SUMMARY In this module, we discussed the following key aspects of estate planning: A trust is an effective vehicle for transferring assets to heirs. A trust may be testamentary (arising as a consequence of death) or inter vivos (arising from a transfer of property by a person who is living). There are different types of trust for different needs. The four primary duties imposed on trustees relate to conflicts of interest, standard of care, delegation of duties, and impartiality. Taxes arising on the death of an individual in Canada include tax on income from the deemed disposition of capital property, income tax on deemed proceeds of RRSPs and RRIFs, and foreign estate taxes and succession duties. To minimize or defer taxes on death, the executor or liquidator may file separate income tax returns for the deceased, taking advantage of tax provisions for different types of income. In an estate freeze, the accrued value in the assets, before the freeze starts, belongs to the shareholder. Subsequent growth in the value usually accrues to the owner’s children or spouse. When the owner dies, the increase in value up to the freeze date is taxed in the hands of the estate. The traditional method of freezing an estate is to use a holding company or a combination of holding company and an inter vivos or family trust. © CANADIAN SECURITIES INSTITUTE (2021)