Asset Protection Trust – What is it?

In the context of asset protection planning tips, many entrepreneurs, shareholders and business people (“entrepreneurs”) have established asset protection trusts. These trusts may hold, among other things, the principal residence since it generally constitutes a materially and personally important asset (“residential trust”).

In order to ensure maximum protection for potential creditors of any kind, the residential trust is a discretionary trust for several beneficiaries, namely, spouse, common-law partner, children, and other persons, if applicable (“discretionary residential trust”). Naturally, the purpose of the discretionary residential trust is to prevent the principal residence from returning to the transferor if he or she is in financial difficulty.

In the event that the principal residence was acquired by the discretionary residential trust upon a transfer by a contractor, there was generally no tax rollover pursuant to section 73 of the Tax Act. income (“LIR”). However, this would not normally result in a tax for the transferor if the residence qualifies for the principal residence exemption. Also, before the new measures were filed, it was possible for this type of trust to apply for the principal residence exemption when it was sold.

The new measures

The new measures introduced on October 3, 2005, bring significant changes to the fact that certain trusts hold a principal residence in respect of the principal residence exemption.

For taxation years beginning after December 31, 2016, only the following trusts will be eligible for the principal residence exemption (“qualifying trust”): a self-benefit trust (no age limit), a trust for the sole benefit of the author in his lifetime, a spousal trust, a joint spousal trust, a testamentary trust for a disabled person and a trust for a minor child whose perpetrator and his spouse died before the beginning of the year.

As a result, discretionary residential trusts that were put in place before 2017 and are not qualifying trusts will lose their right to the principal residence exemption for taxation years that begin after December 31, 2016.

However, in order to take into account the gain accrued before 2017, transitional rules were introduced in the AVM. For this purpose, when a non-qualifying trust has a principal residence, new subsection 40 (6.1) ITA will apply. This new subsection provides for a notional fair market value (“FMV”) provision as at December 31, 2016, on the actual disposition of the principal residence, which isolates the gain that accrued between the vesting date and December 31, 2016. This gain accrued prior to 2017 will be subject to the same principal residence exemption rules that existed prior to the filing of the AVM. Therefore, to ensure that you have the required information when you actually dispose of the home in 10, 15 or 20 years,

Also, in the event that the proceeds of disposition at the time of the sale of the residents are less than its FMV as of December 31, 2016, subsection 40 (6.1) ITA provides a deduction equivalent to the decrease in value between the 31 December 2016 and the actual disposition date. 

Discharge for transferor or spouse

As a general rule, where a person transfers a principal residence to a trust, subsection 75 (2) ITA applies because the transferor has a right of return. As a result, since the trust is contaminated, an exit rollover is only possible if the property goes back to its owner, spouse or common-law partner (“transferee”).

Upon the transfer of the principal residence by the trust, if subsection 107 (2) ITA applies (rollover on exit), the transferee will be deemed by subsection 40 (7) to have been the owner of the principal residence since the trust acquired it.

To the extent that the different conditions are fulfilled for the principal residence exemption, a full exemption may potentially be requested by the assignee. 

Therefore, if the trust is not a qualifying trust at the time of the sale of the principal residence, it will still be possible to transfer the principal residence prior to the sale. 

Outbound roll for other beneficiaries

Prior to the announcement of the new measures, it was not possible in a contaminated trust context to transfer rolled-out property to another beneficiary other than the transferor, spouse or common-law partner. This was not necessarily a problem since, when the residence was sold, the trust was entitled to apply for the principal residence exemption to the extent that the different conditions were met.

The new measures provide that if a distribution is made after 2016 by a trust that is not an eligible trust in its first taxation year that begins after 2016 and that trust has a principal residence at the end of 2016, it will be possible to transfer to another beneficiary other than the transferor, spouse or common-law partner.

Also, the beneficiary of the property will be able to benefit from the application of subsection 40 (7) of the ITA in order to potentially benefit from the full principal residence exemption.

Qualifying trust created after October 2

For an eligible trust that acquires a principal residence after October 2, 2016, the AVM states that the terms of the trust indenture must provide that the beneficiary has a right to use the dwelling as a residence throughout the period of the year in which the trust owns the property.

It will be questionable regarding an eligible trust created before October 3, 2016, which does not own a principal residence before that date and whose terms of its act do not provide for the right of use as it is mentioned previously. Would it be better to write a new trust deed or go to the courts to amend it, of course in order to allow the trust to benefit from the principal residence exemption?

Transfer taxes

In the context where a trust that holds a principal residence does not qualify as a qualifying trust for the purposes of the principal residence exemption starting in 2017 and it has been decided to transfer the principal residence to one of the principal residences. beneficiaries to reduce the tax bill when selling the residence, the potential application of the transfer duties must be taken into consideration.

In subsection 20e (1) of the Real Property Transfer Tax Act (“IMDA”), an exemption is provided for the transfer of an immovable owned by a trust to one of its beneficiaries. To qualify for the exemption, the trust must have acquired the property of a beneficiary (“transferor”) for which the trust was established or of a related person. For the purposes of paragraph 20 (e.1) of the LDMI, a person related to a transferor includes the father, mother, son, daughter or spouse of one of those persons. Also, this includes the spouse, father, mother, son or daughter of that spouse.

In the event that the trust has acquired the residence of a third party (a purchase outright), it will not be possible to benefit from an exemption from the transfer duties when transferring to one of the beneficiaries of the trust.

Disclosure of the provision

According to the long-standing policy of the Canada Revenue Agency (“CRA”), a taxpayer who has a principal residence is not required to complete and file Form T2091 (IND) with his or her tax return when the following conditions are fulfilled:

(1) the residence has been the taxpayer’s principal residence for each year since the date of acquisition;

(2) the taxpayer or his or her spouse or common-law partner did not file Form T664 or T664 (seniors) with respect to the property that was the taxpayer’s principal residence (election of February 22, 1994).

Starting in the 2016 taxation year, any taxpayer (including partnerships) who owns the real or real property will have to declare this provision on pain of having their extended reassessment period. Indeed, new paragraph 152 (4) (b.3) ITA will allow for reassessment beyond the normal contribution period if the taxpayer fails to report the disposition on his or her income tax return. For an individual, information regarding the disposition of a principal residence must be included in Schedule 3, whether there is again or not. However, the reassessment can only be made in relation to the non-disclosure of the disposition of a building or real property.

Therefore, even if a taxpayer is entitled to the full principal residence exemption, he or she will have to inform the CRA that he or she has a residence. For Quebec, that does not change anything, because Form TP-274 was to be produced in all cases. 

Exemption for non-residents

The proposed new measures provide that the “one plus number” factor applies only if the taxpayer resides in Canada during the year in which he acquires the principal residence.

In order to maximize asset protection, certain trusts that have been put in place for the holding of a principal residence will no longer be eligible for the principal residence exemption for the value that accrues after December 31st. In this context, an analysis will have to be conducted to determine whether the trust will be retained or liquidated. In this respect, it will be necessary to take into consideration the transfer duties potentially applicable during the transfer, the expected duration of the residency, the increase of value in the future, the protection sought, etc.

Leave a comment

Your email address will not be published.