TRUST AND PROFESSIONAL INCORPORATION Presented by Sammy Lee Barrister, Solicitor & Notary Public of Metcalfe, Blainey & Burns LLP July 2006

And Now, Presenting New Legislation... Business Corporations Act: Ontario Regulation 665/05 “ Health Profession Incorporation 2005 ” Applies to DOCTORS and DENTISTS ONLY!!

Metcalfe, Blainey & Burns LLP Benefit of Incorporating? INCOME- SPLITTING!!!!!!

Metcalfe, Blainey & Burns LLP What is Income-Splitting? Where a high earner in a high tax rate bracket attributes some income to a low earner in a low tax rate bracket Results in tax savings where the attributed income is taxed at the rate of the low earner, instead of at the rate of the high earner Typically occurs between parents and children

Metcalfe, Blainey & Burns LLP Mechanisms of Income Splitting in Doctor/Dentist Corporations “Family Members” within the Health Profession Incorporation Regulation means spouse, parent, minor children or children of majority of the physician/dentist that can hold NON-VOTING shares If family members hold shares, income from the corporation can be distributed to the family members, who are more likely to be taxed at a lower rate Minor children are not allowed to hold shares, so their shares must be held in TRUST by an individual that is not necessarily a shareholder of the corporation

Metcalfe, Blainey & Burns LLP So, after the new legislation, what does it all mean? Only DOCTOR and DENTIST corporations are allowed to have FAMILY MEMBERS to hold NON-VOTING shares in the corporation All other professional corporations are NOT allowed to have family members as shareholders; only practitioners of the SAME profession are allowed too hold shares in a corporation

TRUSTS Terminology Requirements Special Trusts

Metcalfe, Blainey & Burns LLP Basic Structure of a Trust Settlor Beneficiaries Trust Trustee Recipient of Benefits from Trust Manages the assets in the Trust Transferor of assets into Trust

Metcalfe, Blainey & Burns LLP Inter Vivos/Living Trust Example of the establishment of a trust as per trust agreement Stock Portfolio In the name of the creator, Victor So Beneficiaries Individuals who receive income and/or capital So Family Trust Stock portfolio reregistered in the name of the trustee of the So family trust Trustee Reregistration of legal ownership of stock portfolio in the name of the trustee Assets of living person to be placed in trust

Metcalfe, Blainey & Burns LLP What is a Trust? To be valid, a trust must have a settlor, a trustee and ascertained or ascertainable beneficiaries The beneficiaries may be identified by name or being members of a class - ie. “my children”, “my grandchildren” These three parties need not all be different - it is possible for somebody to settle the trust and also be the trustee himself - ie. Parents setting up trusts during their lifetime for dependent children A trust cannot be created until legal title to some asset or property is transferred to the trustee - even if settlor and trustee is one person, he has two roles Trustee has legal title to trust assets, while beneficiaries have beneficial title Different kinds of assets can be placed into trust - ie. Bank accounts, real estate, stocks, bonds, mutual fund units, limited partnership interests and private businesses

Metcalfe, Blainey & Burns LLP Setting up an Inter Vivos Discretionary Family Trust for Minors Discretionary : Trustee has power to decide distribution proportions, frequency of distribution, uses of the income for the benefit of the beneficiary etc. Family : Where the beneficiaries are family members only, to be defined by the creator of the Trust Inter Vivos : Anything created, disposed of, comes into force or happens during the lifetime of the creator of the trust (the settlor), not after the death of creator

Metcalfe, Blainey & Burns LLP Setting up a Trust Requires 3 Certainties to be met: –1. Certainty of Intention to create Trust: –2. Certainty of Object –3. Certainty of Subject Matter

Metcalfe, Blainey & Burns LLP Setting up a Trust 1. Certainty of Intention to Create Trust: - Settlor must clearly indicate that trustee is legally obligated to hold and ultimately distribute assets to the beneficiary - “I wish” does not create a legal obligation for the trustee to do anything

Metcalfe, Blainey & Burns LLP Setting up a Trust 1. Certainty of Intention to Create Trust: –Example: “To my wife and I wish upon her death for any of her undisposed assets to be distributed amongst her children.” Is there a trust for the wife’s children? Intention seems to be to give property to wife, as opposed to give to other people or for wife to hold on behalf of her children Settlor “wishes” for her assets to be distributed to children, but the wife has no legal obligation to do so, as she can used up all her assets during her life and has nothing left upon her death Result? No enforceable trust

Metcalfe, Blainey & Burns LLP Setting up a Trust 2. Certainty of Object: Who Are the Beneficiaries? Must be ascertained or ascertainable If all beneficiaries are known: –Fixed and Discretionary Trusts BOTH possible –Fixed Trust: Equal proportion in distribution

Metcalfe, Blainey & Burns LLP Setting up a Trust 2. Certainty of Object: Who Are the Beneficiaries? – If there are potential unknown beneficiaries: Trustee has duty to look for a range, but no duty to look to every single potential claimant –A range of “all beneficiaries that are poor” is insufficient but a range of “all my former staff” is sufficient Trustee has greater flexibility - can distribute assets even if there are potential beneficiaries that will come forward in the future Only Discretionary Trust is possible Trustee can decide the proportion that each beneficiary will receive Any individual that comes forward fitting the description of the objects in the will may claim

Metcalfe, Blainey & Burns LLP Setting up a Trust 3. Certainty of Subject Matter –Property to be distributed must be: Ascertained: specific property - ie. 123 Blackacre, $50,000 Ascertainable: through a formula, such as part of a larger fund - ie. 5% of my shareholding in company ABC, all accumulated dividends of 5% if my shareholding – For inter vivos wills, subject matter must be ascertained or ascertainable at the time the trust is created

Metcalfe, Blainey & Burns LLP Modes of Transfer 1st Mode: From Settlor to Trustee 2nd Mode: From Third Party to Trustee 3rd Mode: Declaration of Self as Trustee

Metcalfe, Blainey & Burns LLP Time of Division Specifies when the trust will collapse –ie. when the settlor dies, in x years Rule Against Perpetuity : where interests in property must be passed onto a relevant (alive at the time of the will) “life in being” no later than 21 years after the death of the last relevant person at the time the trust is created Prevents settlor from passing on title to property indefinitely –ie. To my son, then to his widow, then to my son’s children then living –The settlor’s grandchildren is presumably not yet conceived when the will was made, so the grandchildren are not “lives in being” at the time the will is made, so that the grandchildren will not counted as a life-in- being for the purposes of this trust –But a child conceived or born at the creation of the trust will be treated as a life-in-being

Metcalfe, Blainey & Burns LLP Time of Division Under the Accumulations Act - – Rule Against Accumulation: where trustee cannot withhold distribution of income from disposition of real or personal property under an inter vivos trust for longer than, at the most: 21 years after the death of the settlor or the lifetime of a beneficiary of minority that was already conceived or born at the death of the settlor Under the Income Tax Act - – Deemed Disposition Rule: For tax purposes, even if distribution is withheld for more than 21 years to avoid tax levies, at the 21 year mark, the asset is still treated as it has been disposed of and capital gains will be taxed at that time on a fair market value basis

Metcalfe, Blainey & Burns LLP Use of Trust Assets Before Distribution In the context of Doctor and Dentist Professional Corporations, the benefit of creating a trust for minor children shareholders is to: – 1) Allow minor children to hold shares – 2) Income splitting - to attribute all dividend income distributed to minor children’s shareholding to the minor children, to be taxed at a lower tax rate – 3) control the uses of any respective dividends

Metcalfe, Blainey & Burns LLP Use of Trust Assets Before Distribution Ideally, the dividend income from the Professional Corporations are attributed to the minor children because it will be taxed at a lower rate However, the federal government put in place Anti-Avoidance rules to disallow such attribution to lower tax rate individuals

Metcalfe, Blainey & Burns LLP Use of Trust Assets Before Distribution The so-called “Kiddie Tax” : –All taxable dividend income on private, non-listed shares of Canadian and foreign companies received through a trust by those 18 years of age and under as of December 31st of the year will be attributed back to the doctor/dentist and –This dividend income will be taxed at the highest marginal tax bracket of 29% plus surtaxes and provincial taxes –This tax will only be reduced by dividend tax credit and foreign tax credit, but not the personal tax credit or any child tax exemptions

Metcalfe, Blainey & Burns LLP Use of Trust Assets Before Distribution The purpose of Doctor/Dentist Professional Corporations defeated? NO!!! All is not lost… Ways to get around anti-avoidance rules –1) “Prescribed rate” investment loans to children –2) Split attribution of income and capital gains

Metcalfe, Blainey & Burns LLP “Prescribed Rate” Investment Loans If the shares held by minor children were purchased with the children’s property, then attribution rules will not apply Parent physicians/dentist or other family members can “loan” money to the children to purchase the shares Charge the prescribed rate used by the Canada Revenue Agency based on 90-day treasury bill rates to the minor children Must keep property record of interest payments and must make all interest payments before the end of the year to avoid attribution rules Net income earned will not be subject to attribution rules

Metcalfe, Blainey & Burns LLP “Prescribed Rate” Investment Loans Example –Suppose a 6% return on the minor child’s shares Physician/dentist parent “loans” money to minor child to buy shares in professional corporation The prescribed rate from 90-day treasury bill is 2% The child “pays” interest of 2% before December 31st You declare 2% interest income The child declares 4% dividend income but will be taxed at his own tax rate and not at the highest marginal rate of 29% under the “kiddie tax”

Metcalfe, Blainey & Burns LLP Split Attribution of Income and Capital Gains “Kiddie Tax” and attribution rules apply to children under 18 receiving income through trust For children over 18, their income is taxed at their own tax rate, which is much lower than the parent’s tax rate As such, if a family has children of majority, it should attribute some dividend income to the children of majority to pay for his or her expenses - ie. Education tuition It is the same as if the parent is paying the tuition - but the income is taxed at a lower rate, resulting in more after-tax dollars

Metcalfe, Blainey & Burns LLP Split Attribution of Income and Capital Gains With capital gains, it is taxed at half the rate of income, Since attribution rules apply only to income and not capital, any capital gains accrued from the investment held in trust of minor children will be taxed at the normal capital gains rate Any assets generating capital gains should be attributed to minor children - ie. Disposition gains from sale of a piece of land should be attributed to a minor child

Metcalfe, Blainey & Burns LLP Special Types of Trusts Alter Ego and Joint Spousal Trusts

Metcalfe, Blainey & Burns LLP Alter Ego Trusts and Joint Spousal Trusts In 2001, the Income Tax Act was amended to permit taxpayers aged 65 years or older to transfer property during the settlor’s lifetime into a trust on a tax-deferred basis of accrued capital gains If the conditions are met, taxes on accrued capital gains of any property transferred to such trusts are deferred until the earlier of the death of the beneficiary or the disposition of the property For an alter ego trust, the income from the trust must be for the settlor’s own benefit during his/her lifetime For a joint spousal trust, the income from the trust must be for the settlor and the spouse/partner’s own benefit during their lifetimes Trust deeds can name after-death beneficiaries

Metcalfe, Blainey & Burns LLP Alter Ego Trusts and Joint Spousal Trusts Requirements: –1) The settlor of an alter ego trust, and the settlor spouse (not necessarily both spouses) of a joint spousal trust must be 65 years of age or over, and the trust must be created after 1999 –2) In alter ego trust, settlor must be the only beneficiary during his lifetime, and entitlement to all income and capital must be prior to the death of the settlor (ie. Cannot only be entitled after he dies) In a joint spousal trust, the settlor or his spouse/partner must be the only beneficiaries during their lifetimes, and entitlement to all income and capital must be prior to the surviving spouse’s death –3) The individual and/or the spouses/partners must be resident(s) of Canada

Metcalfe, Blainey & Burns LLP Benefits of Alter Ego and Joint Spousal Trusts 1) Assets transferred to these special trusts do not form part of estate, so these assets avoid Probate Process and Probate Tax: –Probate: A public process for court approval testamentary will; lists every asset in the estate for public to see. –Estates going through probate are levied a 1.5% probate tax assessed on the total assets’ value 2) Can name after-death beneficiaries, successor trustee and specify other directions in case of mental incapacity –No need to have will and assets under special trusts can be distributed directly to named beneficiaries in trust deeds without going through probate and inherent delays

Metcalfe, Blainey & Burns LLP Benefits of Alter Ego and Joint Spousal Trusts 3) Normally, transferring assets to trust is treated as deemed dispositions, and capital gains tax is levied –Transferring assets to these special trusts does not trigger capital gains tax but is deferred until death of the settlor (in alter ego trust), or death of the surviving spouse (in joint spousal trust) – Under Joint spousal trust, this can mean decades of deferral of taxes 4) 21-year deemed disposition rule does not apply to these special trusts during the lifetime of the settlor or surviving spouse –Even if trust goes on for more than 21 years, any capital gains are still deferred until the death of the settlor (alter ego trust) or surviving spouse (joint spousal trust)

Metcalfe, Blainey & Burns LLP Too Good to be True? Perhaps… As are the cases with assets held under normal trusts or assets held personally by individual, income generated from assets under these special trusts attract the attribution rule That is, income earned from these assets is taxed in the hands of the settlor of the special trust every income taxation year, at the top marginal rate So, no deferral of income tax! Only capital gains tax deferred!

Thank You Sammy Lee Metcalfe, Blainey & Burns LLP 18 Crown Steel Drive, Suite 202 Markham, Ontario L3R 9X8 Tel: (905) Ext.327 Fax: (905)