Canadian federal budget has significant implications for trust and estate practitioners

Tuesday, 18 February 2014
The tune of last year’s budget, closing perceived tax loopholes, continues in the 2014 federal budget, which was delivered by Jim Flaherty, Canada’s minister of finance, on February 11, 2014. The announced changes under Canada’s Income Tax Act will have considerable implications for trust and estate planners.

The most significant changes are the elimination of graduated-rate taxation and other tax benefits for testamentary and certain other trusts, increased flexibility in the tax treatment of charitable donations made on death, and the elimination of so-called “immigration trusts” provided for under Canada's non-resident trust tax rules.

Trusts and estates face changes in tax treatment

The 2014 budget announces a major change in the taxation of testamentary trusts and estates, which will lead to the eventual elimination of the graduated rate of taxation of trusts and estates.

Starting in 2016, estates and testamentary trusts as well as certain “grandfathered” inter vivos trusts will be taxed on all of their income at the top marginal tax rate, except that the graduated tax rates will apply to an estate for its first 36 months.

Immigrant trust exemption terminated

An unexpected measure in the 2014 budget was the axing of the so-called immigrant trust exemption after more than four decades. “It seems […] that Canada is changing its overall outlook towards attracting ‘investor class’ immigrants,” Michael Cadesky TEP writes in this STEP Journal web exclusive. He added that by making Canada a less attractive place for new immigrants, a tax-planning opportunity that formerly was a “cornerstone of Canadian tax planning for immigrants” has been brought to an end.

More flexibility with charitable donations made on death

The 2014 budget improves the tax efficiency of charitable legacies for deaths occurring after 2015 by allowing them to be treated as part of the estate instead of as lifetime gifts.

Further revisions to “kiddie tax”

The 2014 budget proposes retroactively expanding the application of the tax on split income (the so-called “kiddie tax”) to certain partnership and trust arrangements. The intention is to deter efforts by taxpayers subject to high marginal tax rates from shifting income to individuals subject to lower marginal tax rates, such as children under 18.

Stricter withholding tax rules

Budget 2014 proposes to shut down back-to-back loan planning by expanding the anti-avoidance rules in the thin capitalization rules and by adding a withholding tax on interest paid to foreign banks in this situation.

“Unfortunately, in their effort to prevent taxpayers from utilizing creative structures to avoid the thin cap and withholding tax rules, the Department of Finance has made the rules too broad and has caught many innocent arrangements,” McMillan lawyers' tax bulletin comments.

If the proposed amendments are not revised, non-resident shareholders of Canadian corporations should review their security arrangements for the Canadian corporation's credit facilities, McMillan adds.

No more “treaty shopping”

As part of the Canadian government’s plan to combat tax avoidance, international tax planning is under increased scrutiny once again. The 2014 budget proposes rules designed to discourage what the Department of Finance calls “treaty shopping”. Subject to certain limitations, they would apply to deny treaty benefits that would otherwise be available in respect of certain income earned in Canada where one of the main purposes for undertaking any transaction that results in the treaty benefits was for a person to obtain such benefits. Interested parties can submit comments within 60 days of February 11, 2014.

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