OVERVIEW OF TRUSTS
A trust is a relationship under which a person, called the settlor, transfers property to another person, called the trustee, who holds that property for the benefit of another person called the beneficiary.
The law does not recognize a trust as a legal entity. A trust is a relationship between persons relative to property held under that trust relationship. A trust cannot be named as a defendant in a legal suit nor can a trust sue in its own name as a plaintiff. A trust cannot own property in the name of the trust and a trust cannot enter into a contract as a party. Instead, in each of these instances, it is the trustees who have to personally stand in the place of the trust. It is the trustees who are named as plaintiffs on behalf of the trust and it is the trustee who acts as the defendant if the trust issue.
Notwithstanding the legal treatment of a trust, for income tax purposes the Income Tax Act of Canada deems a trust to be an individual. This classification of deeming a trust to be an individual brings with it connections to many parts of the Income Tax Act that have an impact on how things are taxed.
Parties to a Trust
There are generally three parties to a trust. Settlor, the trustee and the beneficiary. It is not unusual to have more that one settlor, trustee and beneficiary. A single person can simultaneously fill one, two or three of these roles. If one person were to fill all these roles, there should be at least one more beneficiary, otherwise there is a risk that the trust may not be considered a trust.
The settlor is the person who contributes or settles property on the trust. This generally involves the voluntary contribution of property into the trust. If the contribution is cash there is generally not tax consequences to the settlor on advancing those funds. If the contribution is other than cash, there may be tax consequences to the settlor at the time of the contribution. The settlor of the trust must be the owner of the property that is to be settled into the trust.
The trustee is the person who holds the property and is under an obligation to administer it under the terms of the trust for the benefit of the beneficiaries. A trustee is held to high standards for integrity to discharge his duties. A trustee can be held liable to the beneficiaries for losses occasioned by negligence.
The beneficiary is the person who is entitled to the use, enjoyment and advantage derived from the property. If the trust property is in the form of investments, the beneficiary might be in the form of access to income. A beneficiary can be an individual or a corporation.
Beneficiaries are divided into two types.
Income beneficiaries are ones who are entitled to receive distributions from the trust. Capital beneficiaries are ones who are entitled to receive capital distributions or the transfer of assets from the legal ownership of the trustee.
Beneficiaries can be only income beneficiaries, or capital beneficiaries and some may be both income and capital beneficiaries.
Types of Trusts
For the purposes of this article, I will be discussing personal trusts, and specifically testamentary trusts and inter vivos trusts. Personal trusts are treated as individuals for income tax purposes and can be categorized into:
This trust is defined as a trust that arose on and as a consequence of the death of an individual. This trust is most commonly established as a result of the deceased persons will. It can also be made under a law of a province that provides for the relief or support of dependents.
The trust created by the will of a deceased person is very common and the will provides functional guidance for the trustee(s) as to how the assets of the deceased will be distributed.
Inter Vivos Trusts
An inter vivos trust is defined to include any trust other than a testamentary trust. This trust is a personal trust created during the lifetime of the settlor.
To qualify as a personal inter vivos trust, no one can become a beneficiary by paying something to the trust for an interest in the trust. The only beneficiary interest that is available is to the person who settles the trust with an initial contribution of property, the beneficiaries (who contribute nothing to the trust) named in the trust deed and possibly the trustee.
The follow-up to this article is intended to discuss personal inter vivos trusts (a discretionary family trust) and their effective use for families planning on some form of succession to their children. It will cover the reasons for establishing a trust, the taxation of the trust and the transfer of the accumulated trust assets to the beneficiaries at some future date.