FOCUS ON WILLS, TRUSTS & ESTATES — Changes come as taxing authorities across the world move toward transparency
As new trust reporting and disclosure rules come into force for 2021, the New Year will see wills, trusts and estates lawyers grappling with how the changes impact their practice — and some lawyers predict this could be just the beginning.
“We think this might open up more inquiries into what is going on behind the scenes with these trust funds,” says Jordan Atin, counsel at Hull & Hull LLP.
“It may well be just the thin edge of the wedge in terms of what they’re going to do with this new reporting requirement.”
New income tax rules have been introduced that require trusts — with limited exceptions — to provide additional information, says Margaret O’Sullivan of O'Sullivan Estate Lawyers LLP. Certain trusts that may have had no reporting and disclosure obligations previously because they had no income will now also be required to file a trust income tax and information return.
“This is a very timely issue we are all thinking about as 2020 rolls in. We only have one year to get this figured out,” O’Sullivan says, noting that Canada is one small piece in a much bigger global puzzle, where taxing authorities around the world are moving toward more transparency, including with regards to trusts.
Suzana Popovic-Montag, managing partner at Hull & Hull, says the changes are in line with Ontario’s introduction a few years ago of new reporting obligations on the details of assets of estates to the finance minister through the introduction of the Estate Information Return.
"There has been a historical lack of transparency in the administration of trusts and estates, and governments are now taking an interest in the use of these tools in the transfer of assets for taxation purposes,” she says, adding that one can “expect concern surrounding privacy issues” any time there are new or enhanced disclosure obligations.
While lawyers may not be the ones gathering the information required — which includes the name, address, date of birth and tax identification number of the settlor, trustees and beneficiaries, as well as anybody who has the ability to exert influence over trustee decisions, such as a protector — the changes will have them “thinking how it impacts our planning,” O’Sullivan says.
“I think we’re all going to need to focus more when we’re planning new trusts that this disclosure will be required. I think it will impact who we include in a class of beneficiaries, to some extent, and we’re going to have to focus on that issue more whereas before the idea was a trust was entirely private.”
O’Sullivan adds that if it’s a very broad group of beneficiaries, collecting the information could be “quite onerous or in fact could be quite sensitive to a particular client who established the trust.”
“The beneficiary might not find out the terms of the trust, but it would raise the question of ‘why are you asking me what my tax information number is?’” she says.
There may be an impact in terms of what clients do under a trust going forward, O’Sullivan says, adding that the idea of a private trust “may slip from our vernacular in 2021, as the public sphere grows wider, the private sphere shrinks and change becomes more than ever the new constant.”
Clients might opt to keep the trust more generic and use a will instead to make a number of legacies to named individuals or lay out specific bequests of property. Other approaches to passing assets or setting out intentions — such as letters of wishes — might become more desirable options.
“We’ll need to look at all those tools,” O’Sullivan says.
She also predicts that 2020 will see a lot of activity as trustees prepare for the new rules, “including winding up trusts where appropriate, such as those that are redundant and no longer serve a purpose.”
“Our firm will be communicating with the trustees of trusts we have assisted to establish to alert them with respect to the new rules so they can proactively deal with them,” O’Sullivan says.
Atin predicts the changes will have “a dramatic impact” on the use of trusts as they were a great way of keeping financial matters private, and that was a major reason for using them.
Family trusts, for example, are often created to be “a very flexible conduit” where the trustee can “sprinkle” the money around to children or grandchildren any way they want, he says. They weren’t doing anything illegal before — they were delivering income to beneficiaries. Now, a person would have to tell the government everything — who oversees the money, who has control of it, who the beneficiaries are.
“If I had a family company and I held it in my own name, I’d have to declare the income and CRA would know I own it; but, historically, the trust would own it and the CRA wouldn’t know who ultimately are the real owners,” Atin says. “That’s what governments are trying to get after, not just whose name appears — for example, the John Doe Family Trust. Now, they’re digging deeper — who really owns this?”
He says lawyers used to tell clients about the trust’s privacy, but, “now, we say you’ll have to file tax returns and there are certain exemptions for very small trusts — but you’ve got to assume you’ll have to tell the CRA everything,” says Atin.
“This inquiry, this disclosure, is going to open up a lot more areas for CRA to investigate whether all the taxes that should be paid are being paid.”
And, failure to report comes with stiff penalties, O’Sullivan says. If a taxpayer knowingly fails to disclose or if there is gross negligence, the penalty is $2,500 or five per cent of the highest fair market value of the trust's assets, whichever is greater.
“For a trust that holds a cottage worth $3 million, that could be a whopping $150,000,” she says.
While the change in reporting and tax filing obligations “may be a sign of other changes to come,” Popovic-Montag says, it will not in itself expose trusts to a new form of taxation.
“Trusts holding assets generating income, which is often the case, already file tax returns on an annual basis,” she notes, adding that, in her view, the new reporting requirements “are unlikely to change how clients choose to deal with their assets.” She says trusts function with several benefits unrelated to privacy.
“What may be the more notable change is the new disclosure obligation,” says Popovic-Montag. “For clients currently acting as trustees, these changes will result in additional work in preparing tax filings and obtaining and submitting the necessary disclosure. Some clients may be reluctant to do so, especially in circumstances where they may prefer these personal matters to remain private.”
Along with O’Sullivan, she also predicts the changes may encourage trustees to take early steps to wind up trusts where “their continued existence will be more work than the benefits of the trust structure may offer.”
However, Popovic-Montag says trustees have already been found to have an obligation to disclose the existence of a trust and its terms to beneficiaries in the 2018 Supreme Court of Canada decision Valard Construction Ltd. v. Bird Construction Co. While the changes might see some individuals reluctant to disclose this information to the government, “it does not otherwise alter who is legally entitled to this information,” she says.
“Generally, we already encourage full disclosure in terms of ensuring that beneficiaries are aware of their interest in a trust, whether distributions are ongoing or have yet to take place and whether that beneficiary’s interest is vested or contingent,” says Popovic-Montag. “Trustees may have greater reason to err on the side of full disclosure as a result of the new rules.”
In terms of estate planning, Popovic-Montag says, wills remain “the most common tool used by clients” regardless of the fact that these documents often become part of the public record upon the filing of an application for a certificate of appointment of estate trustee with a will. For these reasons, she says, the new reporting obligations for trusts “may not have a significant impact on how Canadians use these vehicles to manage and transfer wealth.”
As the new reporting obligations take effect, she says, the firm intends to “incorporate a reminder in our standard reporting letter to clients who are acting in the capacity of trustee that tax advice needs to be obtained, regardless of whether trust assets are generating income.”
“It’s one more thing that needs to be done in a compressed time period,” O’Sullivan agrees. “It’ll be quite important for this information gathering to happen earlier rather than later so people are ready when the first tax returns need to be filed in 2021.”