Bare trusts: Is your client prepared for increased tax filings?

Bare trusts are an effective tool commonly used for estate planning and real estate purposes. However, new tax rules increase the tax filing obligations and include trust and underused housing filing requirements, with hefty penalties for not complying.

What is a bare trust and how is it commonly used?

Ownership of a property is broken up into two components: legal and beneficial ownership. In a bare trust arrangement, the trustee holds legal title and has no obligation other than to deal with the property as instructed by the beneficiary. Beneficial ownership of the property remains with the beneficiary. From an income tax perspective, all income and gains realized on the trust property are taxed in the beneficiary’s hands.

Bare trust arrangements are commonly used for, but not limited to, the following:

• maintaining anonymity of the property owner when ownership information is public (via land registration records);
• simplifying ownership of real estate when there are multiple owners of a single property; and
• facilitating efficient property transfers to minimize land transfer tax or probate fees, as legal title of the property never changes from the trustee.

Client example Leslie, a widow, owns her Toronto home solely under her own name. Leslie’s neighbour recently sold their home for $3 million and Leslie estimates that her home would be worth the same. As Toronto real estate prices continue to soar, Leslie begins to worry about the Ontario estate administration tax (EAT) that will be due on her death. She is hoping to keep the home within the family and is concerned about how the EAT of $44,250 will be funded. She meets with an estate lawyer who says a bare trust arrangement could help eliminate the EAT. She will need to establish a corporation (“BareCo”) to which she will transfer legal title of her home. There shouldn’t be any immediate tax implications, as Leslie continues to be the beneficial owner. What are Leslie’s filing obligations?

A typical bare trust arrangement may be set up with a nominee corporation and, historically, this simple arrangement required little maintenance other than maintaining the corporate minutes and the filing of an annual nil T2 corporate income tax return. The T2 is due six months after the corporation’s year-end, and a failure to file a return will result in late filing penalties equal to 5% of the unpaid tax due and 1% of the unpaid tax for each complete month that the return is late, up to a maximum of 12 months.

Starting with the 2023 tax year, the trust reporting rules have expanded to capture bare trust arrangements. In Leslie’s case, even though BareCo is a corporation, as a bare trust it will be obligated to file a T3 trust income tax and benefit return. In addition, enhanced information reporting will require BareCo to annually disclose the name, address, date of birth, tax jurisdiction and tax information number of the bare trust’s settlor, trustee and beneficiaries (including contingent beneficiaries).

The T3 is due 90 days after the trust’s taxation year-end. Bare trusts that have existed for less than three months or hold less than $50,000 in assets (limited to deposits, government debt obligations and listed securities) throughout the year may be exempt from the filing requirements.

A failure to file the T3 will result in penalties of $25 a day (minimum of $100, maximum of $2,500). An additional penalty could be applied if the trust failed to file a return knowingly or due to gross negligence: the greater of $2,500 or 5% of the maximum value of the trust.

Bare trust arrangements that are used to hold legal title of residential real estate property will also be subject to the underused housing tax (UHT) rules, which took effect on Jan. 1, 2022. The UHT regime imposes a 1% annual tax on the value of a residential property in Canada, owned by non-residents or non-citizens of Canada, that is considered vacant or underused.

The annual tax filings are due April 30 of the following calendar year. The CRA has provided administrative relief for this first year’s filing such that no late-filed penalties will apply if the return is filed and tax is paid by Oct. 31, 2023. Tax filings may still be required even if there are no taxes due.

Individuals who are either Canadian citizens or residents are “excluded owners” and exempt from the taxes and the tax filing. In our example, Leslie is a Canadian resident, so how could these new rules impact her? The filing obligation resides with the legal title owner and, as such, the onus is on BareCo to file the UHT return. As a corporation, BareCo is not considered to be an excluded owner.

In general, a tax exemption should be available where the beneficial owner of the residential property is a Canadian citizen or resident. However, even if an exemption applies and no taxes are owing, so long as the owner is not an “excluded owner,” a UHT return must be filed.

Failure to file the required UHT return will result in a penalty equal to the greater of:

(1) $5,000 when the legal title owner is an individual, or $10,000 for all others; or

(2) the total of:

• (a) 5% of the UHT tax payable in respect of the residential property for the calendar year, and
• (b) 3% of the UHT tax payable times the number of months after the due date that the balance is paid.

If a return is not filed by Dec. 31 of the following calendar year, the penalty is determined as if the exemptions were not available and part 2 of the calculation would be determined as if the property were subject to the tax.

Takeaway

Bare trust arrangements are still an effective tool, but the new rules could create a significant administrative burden to this once simple arrangement. In Leslie’s case, while no taxes may be due, BareCo is still expected to file three different returns annually: T2, T3 and UHT.

Those who are implementing or already have such arrangements in place should take extra care in ensuring all annual filings are completed, given the significant late-filing penalties that can be imposed. Some may also consider whether it is appropriate to wind up the structure if the ongoing maintenance costs outweigh the expected benefits and tax savings.

Catherine Hung is vice-president, Tax, Retirement and Estate Planning with CI Global Asset Management.