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Use and Taxation of Discretionary Family Trusts

16/06/2010


Unlike a corporation, a trust is not a legal entity, but is a legal relationship. The trust relationship is created by intention.  A person, called a settlor, transfers property to the trustees expressing the intention that it be held for one or more beneficiaries. The intention to create a trust is usually evidenced by a document signed by the settlor and the trustees which outlines the obligations and powers of the trustees, as well as the interests of the beneficiaries.

When determining who the settlor should be, consideration must be placed on choosing a person, preferably a relative, who has an interest in the well being of the beneficiaries of the trust. Once the settlor has given the property to the trustee, the settlor will have no ongoing involvement with, or liability to, the trust. The settlor will not be a trustee, nor will the settlor ever be a beneficiary.

The trustees have discretion to allocate income or capital to the beneficiaries. This discretion allows the beneficiaries to be treated differently. Once income or capital has been allocated to the beneficiary, it will be necessary to ensure that the funds are eventually paid, or the assets are transferred, to the beneficiary. The trust is deemed to sell all of its’ property every 21 years, for tax purposes. One way to ensure that you do not have to pay tax on the capital gain at the 21st anniversary of the trust is to roll the assets out of the trust to the beneficiaries before the 21 year deadline.

A discretionary family trust can be included as a shareholder of your private company, and this allows dividends to be paid to the trust. The trustees can allocate the dividends to the beneficiaries to fund their education or other needs. It is suggested that dividends not be received before the beneficiary is 18, otherwise the “kiddie tax” will be applicable.

Once the dividend has been allocated to the beneficiaries, it will be included on their tax return and taxed at the beneficiary’s rate of tax. If the beneficiary has no other income, they can receive annual dividends of approximately $30,000 without being subject to personal tax. Therefore, the discretionary family trust is a great tool to use in your corporate group to help fund the educational needs of your family.

While the ability to pay dividends through a family trust is a great benefit, it also has other advantages, such as the ability to limit your tax exposure on death, and can even be valuable in protecting the business from a matrimonial dispute.

In a nutshell, the family trust can enable you to pay dividends to the beneficiaries today, without having to make the decision of who will eventually receive the shares for 21 years. This flexibility is unrivalled by other structures.

The benefits and issues with a family trust should be considered very carefully. In order to determine if a family trust would be valuable addition to your corporate structure, please contact myself or your local MNP advisor, and we would be happy to assist you with the planning for your business structure.

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