Read This article is designed for Trustees of particular inter vivos Trusts established to hold shares of a private company for the benefit of their children text version

1741 Brunswick Street Suite 710 Halifax Nova Scotia Canada B3J 3X8 Phone (902) 421-1533 Fax 425-7827 e- mail: [email protected]

UNDERSTANDING TRUSTS DAVID HARRIS B.Comm MBA CMA FICB CD TEP

This article is designed for Trustees of particular inter vivos Trusts established to hold shares of a private company for the benefit of themselves and their children. This article briefly discusses what a Trust is, the responsibilities of the Trustees, use of Trust property and taxation of the Trust income. This article is not intended to substitute legal or tax advice. You should obtain professional advice specific to your own situation.

What is a trust?

A trust is an obligation upon the Trustees to deal with the Trust Fund in and for the best interest of the Beneficiaries. As Trustee, you are the legal owner and have the legal right to deal with the Trust Fund, but, as a Beneficiary, your child is the true owner of the Trust Fund. A Trust comes into existence when the Settlor makes a contribution for the benefit of the Beneficiaries, and signs the Trust Agreement. The Trust Agreement sets out the terms and conditions of the Trust Agreement. You should familiarize yourself with the provisions of the Trust Agreement. If the initial contribution is a coin, it should be retained in a safe place. This coin should be left intact throughout the life of the Trust and not used for the purchase of shares or for any other purpose. There should also be a separate bank account for a Trust, which is used exclusively to hold monies belonging to that Trust. Where shares of a company are issued in the names of the Trustees "in trust" for beneficiaries, the shares must be purchased by the Trust with its own monies. The initial contribution to the Trust should not be used to purchase the shares. As the Trust does not have any funds to purchase the shares, it should borrow the money from a bank of some other arms length party. This loan should be repaid with interest and the assets of the Trust may be pledged as security for repayment of the loan. It is important for income tax reasons that the purchase monies do not come from the Settlor or a trustee. If the purchase monies come from a trustee, it is possible that any dividends paid on those shares could be taxed in the hands of that trustee and not the beneficiary. If the Trust has been established as an Irrevocable Trust, the Settlor cannot revoke the Trust or take back any of the assets of the Trust. Although the shares are issued in the name of the Trustees, they are beneficially owned by the Beneficiaries. This cannot be changed, even if trustees decide they no longer want their children owning shares in a company. However, you may repurchase these shares from the Trust for fair market value.

Definitions

"SETTLOR" - the person, who contributes certain property (i.e. a silver or gold coin) to establish a Trust for the benefit of some other persons. "BENEFICIARIES" - the person or persons, for whose benefit the property is held in trust by the Trustees. In a family trust, beneficiaries normally include parents and children. "TRUSTEES" - the managers of the Trust Fund. Trustees can also be beneficiaries. In a family trust, typically the parents are trustees. ,,TRUST FUND" - the property being held in trust by the Trustees for the Beneficiaries.

Basic Structure

Settlor (provides initial trust property) Trustees (manage trust property)

Trust

Beneficiary

Beneficiary

Beneficiary

Notwithstanding that the shares are issued in your name as Trustee, they are not available to your creditors for satisfaction of your personal debts. For instance, if you become bankrupt, the shares of your company and any other assets of the Trust Fund (including money) would not be subject to the bankruptcy proceedings.

each Beneficiary. You must exercise your discretion in good faith and in the best interest of each Beneficiary and deal with the Beneficiaries in an evenhanded manner. If the Trust Agreement specifically states that you may use the Trust Fund, as you consider desirable, for the support, maintenance, education, or well-being of the Beneficiaries, it may not be necessary for Trust income to be paid directly to the Beneficiary. You may apply Trust monies for anything that would be advantageous for the Beneficiaries. If a Beneficiary is an adult, you should, if reasonably possible, obtain the Beneficiarys consent prior to making payments to third parties on his or her behalf. Although it is not possible to list all the acceptable expenditures of Trust monies, some possible examples are: tuition fees, private schools; educational supplies; music lessons; summer camps; sport clinics; sport club dues; sporting equipment; a computer; class trips; university education (including room and board if away from home; special needs; insurance for the childs benefit; etc. You should also be aware that tax law changes introduced in 1999 imposed an extra tax, sometimes called the "Kiddie Tax" on any amounts paid to minor children. The intent of the Kiddie Tax is to negate any tax benefit from directing income to minor beneficiaries. What expenditures are permitted will depend upon the circumstances. You must ask yourself whether an arms length trustee, acting solely in the interests of the Beneficiaries, would make the expenditure. If you are the parent of a Beneficiary, you may be in the best position to judge what is in the best interest of each Beneficiary. You must exercise your judgment carefully. Any expenditure of Trust monies must be for the sole benefit and advantage of one or more Beneficiaries Trust monies may be invested in real estate, stock, bonds, mutual funds, GICs, business opportunities, etc. provided you do not profit personally, except as a Beneficiary of the trust. In addition, the Trust Agreement may specifically authorize you to purchase insurance for the benefit of the Trust or the Beneficiaries.

Responsibilities of the Trustees

As Trustee, you are responsible to deal with the Trust Fund in trust for the Beneficiaries until the distribution date set out in the Trust Agreement, at which time the Trust Fund must be transferred to the Beneficiaries for their absolute benefit. In your discretion, you may distribute the Trust Fund, or any portion thereof, for the benefit of the Beneficiaries at any time prior to the distribution date. As Trustee, you are in a position of great trust and confidence. This is referred to as a fiduciary relationship and requires that you not permit your personal interest to conflict with your responsibility to the Trust, that you not profit from the Trust, that you keep a proper accounting of Trust Activities, and that you act strictly in the best interest of the Beneficiaries. As such, you must, at all times exercise your powers in the utmost of good faith for the sole benefit of the Beneficiaries. You must also conduct your personal affairs separate from those of the Trust. You are expected to deal with the Trust Fund as a reasonable prudent person would deal with his or her own property. If you are a Co-Trustee, you must consult with the other Trustee and act jointly in dealing with the Trust Fund. You may not, as long as you are a Trustee, delegate or transfer any of your powers or duties to another person. Provincial law and the terms of the Trust Agreement impose certain powers and restrictions upon Trustees. Be sure to review the terms and conditions of the Trust Agreement. If the trust owns shares of a company, and income earned on these shares becomes part of Trust Fund. Any dividends paid on these shares will be payable to you, as Trustee, and you must deposit these monies in the bank account established for the Trust. It is important that these dividends not be deposited into your own bank account or, in any way, intermingled with your own assets. Remember to keep, at all times, a proper accounting of the Trust Fund, its income and expenditures. As Trustee, you have a duty to inform the Beneficiaries of their interest in the Trust and to provide a reasonable amount of detail regarding the Trust Fund, without being requested to do so by the Beneficiaries. If, however, the Beneficiaries are your minor children, you may wait until they reach the age of majority before informing them of their interest in the Trust.

Taxation of the Trust Income

The rules for taxation of Trusts are complicated and you should consult your professional tax advisors in this regard. The following information is of a general nature and, again, we remind you that the rules may vary according to the individual circumstances of the Trust and Beneficiaries. All inter vivos Trusts (those created during the Settlors life) must have a December 31 year-end for purposes of income taxation. The Income Tax Act deems a Trust to be an individual and, as such, the income taxation rules applicable to individuals

Use of the Trust Fund

In accordance with the terms of the Trust Agreement, you may have the discretion to determine when the Trust capital and income will be paid to, or applied on behalf of, the Beneficiaries. In the case of a family trust, you may also have the discretion to determine how much will be paid to, or applied on behalf of,

generally apply to the Trust in calculating its net income and taxable income. There are, however, some exceptions to the general rule. First, there are no personal non-refundable tax credits available to a Trust and a Trust is not afforded a capital gains exemption (subject to exceptions beyond the scope of this article). As such, any capital gains should be allocated to the Beneficiaries so that they may use any capital gains exemptions available to them. Second, all income taxed in the Trust is taxed at the highest marginal rate in the province. To take advantage of lower tax rates, it is generally advantageous to arrange to have the income of a trust taxed in the hands of the beneficiaries. Any Trust income that is "paid or payable" to a Beneficiary will be deductible to the Trust and taxed in the hands of the Beneficiary. In this regard, it is important that the Trustees clearly document what income has actually been paid to Beneficiaries. If it is intended that income be payable to a Beneficiary but is not paid out, this should be documented by the Trustees making an enforceable declaration that the income is payable to the Beneficiary. If the income is not paid out only because the Beneficiary is a minor, the income may nevertheless be deductible to the Trust and taxed in the Beneficiarys hands. You should be aware that if you loan money or other assets to a Trust for the benefit of your child, income earned on the loaned property might be attributed to you for income tax purposes. As such, you should not make any contributions or loans to the Trust. The Settlor of a trust should be someone who is not (and could never become) a beneficiary. If the Settlor is or could become a beneficiary, the trust becomes a "reversionary trust". This may have adverse tax consequences. Most trusts require that there be at least two trustees. In the event you become the sole Trustee, you should not distribute any Trust assets until a Co-Trustee is appointed. BE SURE TO CONSULT YOUR TAX ADVISORS WITH RESPECT TO THE TAXATION OF THE TRUST AND ITS INCOME AND THE FILING OF TAX RETURNS. We would like to thank Daren Baxter and Kate Harris of Baxter Harris Neonakis Barristers and Solicitors for their contribution to this article.

Harris Beattie MacLennan & Co. Limited is Atlantic Canadas leading consulting firm providing tax planning assistance to professionals and business owners.

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This article is designed for Trustees of particular inter vivos Trusts established to hold shares of a private company for the benefit of their children

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