Considerations for trustees as trusts approach the 21st year

TUESDAY, FEBRUARY 7, 2023

Family trusts are required to pay tax on unrealized capital gains that exist 21 years after the trust was created.  Trustees may implement one of a few options to avoid this nasty result.  Also, it’s sometimes a good idea to consider the issue a few years early if you think that the value of the assets is lower now than they might be in the 21st year.

The most common avoidance strategy is for the trustees to distribute the property to the Canadian beneficiaries prior to 21 years.  Capital property can be distributed from a trust to its beneficiaries on a tax-free basis.  The result is that the trust avoids the capital gain and the beneficiary receives the property at the trusts original cost base.

Trustees are sometimes concerned that allocating the assets to beneficiaries may result in an unexpected transfer of control to the beneficiaries and possible exposure to family law issues should the beneficiary run into marital issues.  These are important and valid concerns and can be at least partly mitigated through good planning.  Options to consider include:

(a)    Transferring shares in a private company that are non-voting so that the voting shares can continue to be controlled by the trustees;

(b)  Freezing the value so that future growth can be passed to a new trust (thereby limiting the value of the shares owned by the beneficiary);

(c)   Entering into a shareholders’ agreement; and

(d)  Insisting on marital contracts before allocating shares to a family member

Trustees might also want to consider unwinding trusts earlier if they believe that markets are at a low point and wish to have as much of the growth as possible held within a new trust.  This might occur in a scenario where the trustees cannot fully mitigate the family law issues and prefer that as little as possible is in the hands of the beneficiaries. 

One complication when considering this planning: the tax-free transfer can only occur if the shares are passed to a Canadian resident.  Tax planners had developed a strategy involving the use of a Canadian corporation owned by the nonresident beneficiary; however, that strategy no longer works. 

 If your trust was created in 2005 or earlier and holds significant assets with unrealized gains it’s time to start planning. 

Please reach out if you have any questions.