The Taxation of Trusts: Understanding Rates of Tax

Rates of Tax

Under s. 117, ITA, a testamentary trust is subject to tax, at the same graduated rates as an individual, while the rate of tax payable by an inter vivos trust depends on the date the trust was established. Such trusts established after June 17, 1971 are subject to a flat rate of tax equal to the highest marginal tax rate applicable to individuals ITA, s. 122(1) and CRA, Interpretation Bulletin IT-406R2, “Tax Payable by an Inter Vivos Trust”.

According to subsection 122(2), ITA, an inter vivos trust is taxed at the regular graduated rates, when the trust (a) was established before June 18, 1971; (b) was resident in Canada on June 18, 1971 and remained so without interruption thereafter until the end of the year; (c) did not carry on any active business in the year; (d) has not received any property by way of gift since June 18, 1971; (e) has not, after June 18, 1971, incurred (i) any debt or (ii) any other obligation to pay an amount, to, or guaranteed by, any person with whom any beneficiary of the trust was not dealing at arm’s length; and (f) has not received any property after December 17, 1999, where (i) the property was received as a result of a transfer from another trust, (ii) subsection (1) applied to a taxation year of the other trust that began before the property was so received, and (iii) no change in the beneficial ownership of the property resulted from the transfer.

Any deviation from the straight and the narrow of these conditions would permanently taint a pre-June 18, 1971 inter vivos trust. As a consequence, it would be subject to the highest marginal tax rate on every dollar of its taxable income. In order to discourage a taxpayer from creating multiple testamentary trusts, each of which would be entitled to the graduated tax rates, s. 104(2) of the ITA provides that when there are multiple trusts, and in effect all of their properties have been received from one person, and the income accrues, or will eventually accrue to the same beneficiary or group or class of beneficiaries, the Minister can combine all the income from all of the trusts and tax the trusts as if the income had been earned by one trust. There is an exception to this in Mitchell v. M.N.R. (more info on Mitchell v. M.N.R. here), where it was ruled that the Minister could not consolidate four trusts, each of which had as its beneficiary a different child of the one settlor.

Filing

Anybody acting in a fiduciary capacity, like an executor, trustee, or administrator, and having ownership or control of property on behalf of some other person, has to file a Trust Information Return and Income Tax Return (T3 Return). The filing of the T3 Return with the Canada Revenue Agency (CRA) should be done within 90 days from the end of the trust’s taxation year ITA, s. 150(1)(c). The CRA gets from the T3 Return reports of the trust’s income and information about its distributions to beneficiaries. Such beneficiaries of the trust or estate, to whom income is paid or payable or who have made a preferred beneficiary election, should be provided with T3 Supplementary Forms stating the income that they are required to report on their own personal tax returns.

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