What to know about investing within a trust

There have been significant changes to the taxation of testamentary trusts. As of 2016, for instance, any income produced by a trust is taxed at the highest marginal rate, unless it is a Qualified Disability Trust or part of a Graduated Rate Estate.

These changes have limited the traditional tax planning reasons for creating a trust. However, trusts can still address specific family or beneficiary needs, so it’s important for trustees and advisors to understand the applicable investment rules.

Read: Ethical investing in trusts

What are the rules?

Traditionally, the law has recognized three investment principles when considering trust investments:

• All trust investments must be authorized. In other words, what does the trustee deed say? Does it contain restrictions? Does it limit the ability to return capital to beneficiaries?
• All trust investments must be prudent. This tenet has been codified in most provinces. In Ontario, the Trustee Act states that “a trustee may invest trust property in any form in which a prudent investor might invest”. British Columbia’s Trustee Act is almost identical. The Alberta legislation defines a series of criteria a trustee should consider to determine prudency. However, that list should not be seen as exhaustive. Saskatchewan says investments should be “reasonable and prudent.”
• All trustee investments must maintain an even hand and consider the interests of both the income and the capital beneficiaries. Again, a careful reading of the trust deed is advisable when considering this duty. Some deeds specifically direct that an even hand is not necessary and a trustee is therefore is freed from the strict confines of this legal principle.

The marketability of each investment, the needs and circumstances of the beneficiaries, the expected term of the trust, market conditions, the trust’s total value, and the tax effectiveness of the investments are all important considerations in determining whether the trustee has acted prudently.

Read: Balancing the needs of income and capital beneficiaries

What the courts say

The courts have also provided guidance. A 2014 case from the British Columbia Court of Appeal, Miles v Vince, considered prudency. Prior to his death, William Vince settled a family trust and an insurance trust. Vince’s sister was named as trustee of both trusts.

The original assets of the family trust were shares of three companies Vince had incorporated to purchase and develop certain urban properties. The original assets of the insurance trust were the proceeds of just over $2 million of life insurance received after Vince died.

Both trusts were discretionary, granting broad powers to the trustee to invest the trust property and make distributions of income and capital to the beneficiaries.

Vince’s sister began to loan funds from the insurance trust to the family trust to further the development of the building properties. As of December 31, 2012, the family trust owed the insurance trust $2,135,485: principal of $1,750,000 and accrued interest of $385,485. Interest continued to accrue at the rate of $17,795 per month. However, no amount of principal or interest was paid to the insurance trust. Therefore, the beneficiaries of the insurance trust were unable to receive income or encroach upon capital as most of the funds in the insurance trust had been loaned to the family trust.

The question for the court was whether the investment in the building trust was prudent. It appeared to line up with Vince’s wishes, and the interest rate charged on the loans provided a good return (if paid) to the insurance trust. Further, the investment power contained in the insurance trust was broad.

The Court of Appeal was critical of Vince’s sister. The court stated that as a trustee, she had a primary duty to preserve trust assets. In Fales v Canada Permanent Trust Co., the Supreme Court of Canada stated the duty to preserve trust assets applied despite broad discretionary powers in the trust deed. In the Vince case the trustee had failed in her duty to properly preserve the trust property by lending funds to another trust.

The court also found that a trustee has an overriding duty to diversify a trust portfolio. In investing all funds into the family trust, the trustee had failed to comply with this requirement.

Lastly, the court was critical of the trustee’s decision to loan funds to the family trust. The decision was based on a report she had commissioned on the profitability of the family scheme, rather than assessing whether the risk of the loan was appropriate for the insurance trust.

Read: What a trustee should (and shouldn’t) do

Conclusion

A trustee must be thoughtful in executing her duties and should consider the three general investment principles, the provincial statutory regime and relevant court decisions. Broad discretionary language in a trust deed should not be interpreted as carte blanche to invest in any manner whatsoever, nor as protection from liability. Overly risky investments and investments that may be prejudicial to a particular class of beneficiary should be considered cautiously, as the courts are acting as the ultimate protector of a trust’s beneficiaries.

Keith Masterman

Tax & Estate

Keith Masterman, LLB, TEP, is vice-president, Tax, Retirement and Estate Planning at CI Global Asset Management. He can be reached at kmasterm@ci.com.