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Trust Changes Hurt Middle Class More Than Rich

MEDA-2013-02-11-Trust Changes Hurt Middle Class More Than Rich(Header)

Melissa Shin

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You tried to sway the government, but it didn’t work.

Budget 2014 has proposed eliminating graduated tax rates on testamentary trusts, despite protests from advisors and estate planners.

“I’m getting tired of the government paying lip service to these consultation processes,” grumbles Kim Moody, director, Canadian Tax Advisory at Moodys Gartner Tax Law in Calgary.

The only substantial change from the consultation, which occurred over six months in 2013, is that graduated tax rates will remain for beneficiaries eligible for the Disability Tax Credit.

Now, “All wills need to be reviewed to see if the ultimate tax result is going to be acceptable,” says Moody. He points out many clients use such trusts primarily for non-tax reasons, such as to prevent irresponsible children from inheriting large amounts all at once.

“This new provision is penalizing people who take a long-term strategy with the next generation, because they would be paying more tax [via the trust] than if the income had been received by the child,” says John Nicola, CEO of Nicola  Wealth Management in Vancouver. “That part is not well thought out,” since it could influence trustees to give out capital sooner than planned.

To illustrate, if a trust generates a $100,000 yearly income, with graduated tax rates in B.C., it’ll pay roughly $24,000 in tax. If not, the trust will pay $44,000 in tax. To escape this hit, the trustee must allocate the money to a beneficiary in a lower bracket.

But that’s not possible if a trust’s terms restrict distributions by way of timing (e.g., no distributions until a child turns 25) or usage (e.g., the money can only go toward education) – and many currently do, says Nicola.

As a result, “We will suggest trusts give flexibility for distributing taxable income,” he says.

John Campbell, tax group leader at Hilborn LLP in Toronto, says the budget’s changes can disproportionately hurt the middle class. That’s because wealthy folks already earn beyond the highest tax bracket.

Say a husband and wife live off their investment income, putting them both below the highest tax bracket. Under the new rules, if the husband dies, triggering a testamentary trust, “although the wealth of the family unit hasn’t changed, the taxes paid on income generated will increase” since the trust income is now taxed at the highest tax rate. “That impact could be in the range of $15,000 a year.”

As proposed in 2013, graduated rates will apply for the first three years of the trust. The rules change in 2015.


There’s one positive for estate planners. Clients who bequeath donations will now have some flexibility regarding when they’re used to offset income.

“When large donations are made, sometimes the tax credit isn’t fully utilized,” says Campbell. Plus, it used to be that either the deceased or the estate could use the donation tax credit. Now, it’s available for both, and a trustee can choose when to allocate it (up to the last two taxation years of the deceased).

Trustees should “make the donation in a tax period that is going to give the full utilization of the donation credit,” says Campbell. “If some was not going to be used, you could hold on for another year [when] you can shelter more.”

The rules change in 2016.


CRA noticed some businesses were using trusts and partnerships to split business and rental income with minors. This budget expands the income-splitting definition to include these activities, so they’re now subject to the Kiddie Tax.

But Nicola notes the government includes rental income in the split income definition. He says the current wording implies that REITs, which distribute rental income, might be subject to the kiddie tax if purchased by a trust with minor beneficiaries. “Why is that more of an abuse than buying shares in [a bank]?”

He says the only legitimate way to income split with a minor using trusts is for someone to lend money to a trust, and collect the interest on the loan at the prescribed rate (1%). “Whatever the trust earns is then allocated to beneficiary on his personal tax return, regardless of his age.”

The rules change immediately.


Spousal income splitting and TFSA increases were absent from this budget, but since these would be popular policy changes, Nicola says you can expect them in next year’s pre-election budget. “It will get them votes.”

And while the government’s not raised taxes, “in actual fact they are, by eliminating loopholes or tweaking the system at the margins,” says Nicola. “If you take a look at last year’s budget, they gave away $100 million in benefits, but earned $3 billion in new revenue.”

The government’s made it clear, adds Campbell, that “perceived tax abuses will be dealt with in the fine print of the budget.”

Nicola anticipates further pressure on the wealthy, since income inequality is rising around the world. “It’s hard to imagine us being in an environment when tax rates won’t rise,” he says.

Plus, the federal budget only represents half the revenue governments spend. “The biggest liability is at the provincial level, and deficits there are a disaster.”