On August 9, 2022, Finance Canada released draft income tax technical amendments, legislation, and explanatory notes to implement outstanding Budget 2022 and other measures. Many of these measures were discussed in our Federal Budget Commentary 2022. Included in the draft income tax legislation are expanded compliance measures for trusts which aim to increase the transparency of trusts in Canada. This was initially announced by Finance in November 2020. We have summarized some of the key highlights of the new trust legislation. The proposed rules are effective December 31, 2022.
Expanding Filing Requirements
Under the new rules, trusts will have to file an income tax return even if they do not have any income or distributions to beneficiaries. There are limited exceptions to this rule. For example, Graduated Rate Estates or a lawyer’s general trust account are excluded (an exhaustive list of exclusions is provided in the Finance Explanatory Notes on page 158). Generally, a trust that holds assets with a total fair market value of more than $50,000 at any time during the year, would be required to file under the new rules. As a result, many trusts created in conjunction with an estate freeze to hold private company shares or a trust created to hold a cottage or other property will likely be required to file.
The proposed legislation also specifically includes “bare trusts” which are common in real estate arrangements. Bare trusts are often nominee corporations that hold legal title to a particular property in trust for the beneficial owners. These bare trust arrangements will be required to file under the new rules since the fair market value of the real estate held in trust will exceed the $50,000 fair market value threshold.
In addition to the expanded filing requirements, the draft legislation includes regulations that outline additional information required to be reported by trusts when filing their returns. The additional information to be disclosed includes the name, address, date of birth, jurisdiction of residence and SIN/taxpayer identification number for each person who:
- is a trustee, beneficiary or settlor of the trust
- is a person who can exert control or can override trustee decisions regarding the appointment of income or capital of the trust (i.e. a protector).
Obtaining this information can be challenging especially if the beneficiaries are broadly defined in the trust instrument. The explanatory notes provide that the requirement to provide the information in respect of the beneficiaries is met if “reasonable efforts” are made by the trustee to obtain the information. For beneficiaries whose identity is not known or ascertainable with “reasonable effort” by the trustee, the trustee must provide sufficiently detailed information to determine with certainty whether any person is a beneficiary of the trust.
In addition to the existing late filing penalties applicable to trusts, failure to comply with the new reporting and disclosure requirements can result in additional penalties if a trust fails to file a return or knowingly under circumstances amounting to gross negligence either makes a false statement or omission in the return. The penalty is the greater of:
- $2,500 and
- 5% of the highest total fair market value of all the property held by the trust in the year.
The penalty can be significant especially if real estate assets are held in trust. Assuming a trustee knowingly fails to comply and holds title to a $5 million commercial property, the penalty will be $250,000 in a single year.
Trustees should begin gathering the necessary information for the disclosure requirements as it may be difficult to gather complete information. This process should be started as soon as possible and well in advance of the filing deadline. Furthermore, trustees should take this as an opportunity to perform some housekeeping and clean up the books and records of the trust. Ensuring resolutions and minutes are up to date is highly recommended. This will be imperative in the event of a CRA review or audit. Trustees should also consider winding up dormant or inactive trusts that no longer serve a purpose given the additional compliance requirements and costs of maintaining the trust annually.
The information in this article is of a general nature and is in summary form. Contact one of our tax professionals to discuss these matters in the context of your situation before acting upon such information.