Tax planning with non-resident trusts

The offshore trust. Once the estate-planning vehicle of choice for wealthy Canadian families, these structures are now largely off-limits. The popularity was understandable: setting up a trust in a low-tax jurisdiction, such as Barbados, significantly reduced a family’s tax bill. But that meant less CRA revenue, so the Department of Finance has spent the last 15 years making it difficult for Non-Resident Trusts (NRTs) to be tax shelters.

“From a Canadian tax perspective, the landscape is pretty bleak for non-resident trusts,” says Michael Cadesky, managing partner at Cadesky Tax in Toronto.

Certain people can still benefit. In some cases, it’ll be someone who doesn’t set one up herself: think of someone who comes to Canada for school, gets a high-paying job here and permanently relocates, but is a beneficiary of a trust her parents established back home. But beware: such arrangements are lined with potential traps.

Resident vs. deemed resident vs. non-resident trusts

Trusts subject to Canadian tax pay the top marginal rate. The federal component is 29%; the provincial rate varies by province. In Ontario, combined federal and provincial tax is 49.53%; in Alberta, it’s 40.25%. If a Canadian resident contributes assets to a trust that’s resident outside Canada, that trust is deemed resident Canadian for tax purposes.

Take an NRT located in the Bahamas that adds a Canadian resident contributor. The NRT’s then deemed resident, and becomes subject to Canadian tax. But, there’s no provincial tax because the trust isn’t resident in any province; so to compensate, Cadesky says, CRA requires the trust to add 48% of what it owes in federal tax. So, a trust that owes $100,000 in federal tax would owe an additional $48,000.

If you’re in a high-tax province like Ontario and can jurisdiction-shop, consider finding more tax-favourable homes for your trust, such as Barbados or Alberta. (The Barbados trust would be an NRT, deemed resident for tax purposes; the Alberta one, a fully resident trust.)

How to choose? The first step is to calculate anticipated tax: for Alberta, it’s federal plus provincial rates; for Barbados, it’s Canada’s federal rate plus 48% of that amount, and any Barbados taxes (e.g., on Barbados-source income).

In both cases, add trust administration fees. It’s more time-consuming and expensive to set up a non-resident trust than a resident one.

Martin Rochwerg, a senior partner in the Tax Group at Miller Thomson in Toronto, notes the big Canadian banks have affiliates operating as independent trustees in popular low-tax jurisdictions offshore.

CRA strictly enforces trust residency rules. A 2012 Supreme Court ruling established that a trust’s residency is determined by where its “mind and management” are located. “This is normally where the trustees reside,” explains Cadesky. “So, it is possible to set up a trust that is resident in [a country or] province other than where the family resides, provided there are independent trustees.”

CRA has little patience for those who get cute with the rules. Says Cadesky: “If someone is looking to set up a trust in Alberta, they [should] go to considerable lengths to ensure all the trustees were resident in Alberta, that the trust had a bank account in Alberta, that its address and place of management were there, and that trustees manage the trust without interference from the family that contributed the assets or [from] the beneficiaries.”

The same goes for an NRT, he adds. “CRA has a lengthy checklist of questions, [and] they’re quite probing. If you don’t have good answers, you’re liable to end up with the trust being [deemed] resident of the province where the family resides.”

A lucky case

Cadesky notes NRTs can exist if both the people who set up and contribute to the trust — parents, for example — and the trustees reside in a foreign country.

One typical case: a Hong Kong-based couple has three children, one of whom comes to Canada for an advanced degree. She then marries a Canadian and has a successful career here. Since the “mind and management” of the trust is offshore, and none of the contributors are Canadian residents, the trust is considered non-resident for tax purposes.

“She’s in an attractive position,” says Robert Reymond, a partner at Stikeman Elliott in London, U.K. She can receive tax-free distributions of trust capital, but she would need to report it to CRA on Form T1142 Information Return in Respect of Distributions from and Indebtedness to a Non-Resident Trust.

If she receives income distributions from the trust, they are taxed as income (and she would also file Form T1142). So, Reymond says, trustees should distribute capital whenever possible.

NRT horror stories

Opportunities to save tax through NRTs have dwindled, but these vehicles still feature in many horror stories. Take the case of a Canadian-resident couple with two children in university. The parents permanently relocate to the U.K., leaving the kids behind, who have no plans to move to the U.K. themselves. The parents’ advisor recommends U.K.-based trusts for estate planning. “But if they establish a trust [in the U.K.] within five years of emigrating from Canada, and the trust benefits their Canadian-resident children, the trust will be deemed resident and taxable in Canada on worldwide income,” Reymond explains. “It’s a real trap. You’ve left Canada, you filed your last return as a Canadian resident and you’re now living in the UK. […] Because you’ve established the trust within five years of leaving Canada, it stays within the Canadian tax net” because the beneficiaries are Canadian residents. Reymond notes this five-year rule could also wreak havoc for Canadian immigrants.

Say a French family has long-established, France-based trusts with the children as beneficiaries. One child moves to Canada for university and then stays here permanently. The parents later move to Canada.

If the parents contribute to their French trusts within five years prior to the date they move to Canada, “the trust is resident retroactively to the year in which they made that contribution,” says Reymond.

So, if they move to Canada in 2015 and their earliest contribution within the prior five-year period was in 2011, the trust is deemed Canadian resident, starting in 2011. That means it’s subject to the same tax consequences that would apply to a fully resident Canadian trust.

Cadesky has another horror story. Say there’s a family in Spain that’s had several trusts for many years. The entire family moves to Canada at the same time.

They know the immigration trust exemption is no longer available, but “what they don’t realize is their trusts become taxable from January 1 of the year they become resident,” says Cadesky. So, if they move to Canada on November 1, they still have to pay CRA tax for trust income earned from January 1 to October 31.

Families coming to Canada should consider reorganizing trust assets prior to January 1 of the year they move. This can mean paying dividends from holding companies, for instance, triggering tax at their home jurisdiction’s rate.

Cadesky says many newcomers don’t seek out Canadian advice until their immigration applications are approved and they’re preparing to move. “Then, it’s too late” — so they should do so at least a year prior to moving.

Tax rule overhaul

Canada’s trust rules underwent a sea change in 2007, explains Michael Cadesky, managing partner at Cadesky Tax. Pre-2007, three conditions had to be met for a trust to be resident:

• Canadian resident contributes assets to the trust;
• trust has Canadian beneficiaries; and
• beneficiaries and contributor are related.

He notes “people spent a lot of time [trying] to not meet one of these [conditions].” So, the government scrapped requirements two and three. Now, there needs to be only one Canadian-resident contributor for the trust to be taxed. There’s also a 60-month rule that applies to former Canadian residents: if you set up a trust in your new country of residence within 60 months of leaving Canada, and the trust has Canadian-resident beneficiaries, CRA will deem the trust Canadian resident and tax it as such.