Alter ego and joint partner trusts were born in 2000, when the Income Tax Act, Canada was changed to allow people 65 years or older to transfer assets into special trusts without incurring capital gains tax on the assets until they die or the assets are disposed.
Although alter ego and joint partner trusts are fairly new, trusts have been around for hundreds of years. A trust is created when one person, called the settlor, transfers assets to one or more persons, called trustees, for the use and enjoyment of others, called the beneficiaries. In this way, one can separate who has title and management of an asset, from those who benefit from it.
Trusts are useful estate planning tools. For example, you can set up a trust during your lifetime as a will substitute for some of your assets (although you should still have a will for those assets you hold outside of the trusts). The assets you transfer into the trust will be governed by the trust deed, and can be distributed to the beneficiaries after your death under the terms of the trust. In British Columbia, your executor will not have to list the assets in the trust when applying for probate of your will, and he or she will not have to pay probate fees on those assets.
You may be able to use a trust to protect assets from claims against your estate or claims by independent adult children under the Wills Variation Act, R.S.B.C. 1996, c. 490. The Wills Variation Act allows spouses and children to make a claim to the court to vary a will if they feel adequate provision has not been made for them. (See my posts of September 4, and September 27, 2005.) This legislation has been interpreted to allow independent adult children to successfully vary their parent's wills in many circumstances, even when the children are estranged from their parents. However, the Wills Variation Act does not give the court the power to vary a trust established outside of a will. To succeed in claiming a share of assets that were transferred into a trust, an adult child would have to establish a legal basis for challenging the trust or the transfer of assets into it. This makes it much more difficult for an adult child to attack his or her parent's estate plan.
While there can be advantages to setting up a trust outside of your will, Canadian income tax law can create impediments. For example, generally when you transfer an asset into a trust, you are deemed to dispose of it at fair market value. If the value of the asset has gone up since you first acquired it, you may have to pay tax on the increase in its value. Furthermore, the trust is deemed to dispose of the asset every 21 years, which can also trigger tax.
The provisions in the Income Tax Act, including Sections 73 (1.01) and (1.02) , and 104 (4)(a) , for alter ego trusts remove some of the tax impediments to transferring an asset into a trust in certain circumstances. There is no tax triggered when assets are transferred into an alter ego trust or joint partner trust. The 21 year deemed disposition rule does not apply until after the settlor's death, in the case of an alter ego trust, or until after the death of both the settlor and the settlor's spouse in the case of a joint partner trust. The trust is deemed to dispose of the assets on the death of the settlor, in the case of an alter ego trust, and on the death of the last to die of the settlor and the settlor's spouse in the case of a joint partner trust.
There are several requirements that must be met for a trust to qualify as an alter ego trust. If you want to set one up you must meet the following conditions:
1. You as the Settlor must be a taxpayer, age 65 or older when the trust is created.
2. The trust must be a resident in Canada.
3. The trust must hold capital property.
4. You as the Settlor must be the only person entitled to, and pay tax on, the income from the trust during your lifetime.
5. No one except you may be entitled to receive or use the trust's assets during your lifetime.
The Income Tax Act also recognizes joint partner trusts. These are similar to alter ego trusts, but in the case of a joint partner trust, only the Settlor and the Settlor's spouse may be entitled to income and capital from the trust during their lives.
Alter ego and joint partner trusts can be quite useful in certain circumstances. However, as with other estate planning techniques, they don't make sense for everyone. Although they can save probate fees, in some cases, they can give rise to higher income tax on the death of the settlor or the settlor's spouse than would be the case if the assets had not been transferred into the trust.
This article was co-written by R. Percy Tinker Q.C. and Stanley Rule.