ALTER EGO TRUSTS AND JOINT PARTNER TRUSTS - TIPS AND TRAPS

ALTER EGO TRUSTS AND JOINT PARTNER TRUSTS – TIPS AND TRAPS
                                M.E. Hoffstein*
                           Lee-Anne M. Armstrong**

Introduction


          The Trust is a popular and versatile tool in the arsenal of the estate planner and is utilized

to achieve a number of estate planning objectives. While tax savings is one objectives, there are

also a number of non-tax reasons for using a trust.

          In particular trusts have been used to:

          1.      set a mechanism in place to manage one’s property in the event of incapacity or
                  disability;
          2.      protect property from the claims of creditors of the transferor or other
                  beneficiaries of the trust;
          3.      provide for beneficiaries under disability without jeopardizing their government
                  and other benefits;
          4.      protect persons who are not able to look after themselves by reason of minority,
                  mental incapacity or other medical illnesses or lack of business experience or
                  because they are spendthrifts;
          5.      provide confidentiality;
          6.      provide for successive interests;
          7.      to create income splitting, opportunities and facilitate other estate planning
                  objectives; and
          8.      to avoid or minimize the application of estate administration tax.

          The sweeping changes to the tax rules relating to trusts which were tabled in the June,

2000 Notice of Ways and Means Motion and re-tabled on March 16, 2001 Notice of Ways and

Means Motion not only clarified and modified existing rules relating to trusts but also introduced

a variety of new trusts for consideration by the estate planner.1


          Our paper today will focus on two of these new types of trusts, namely the alter ego trust

and joint spousal or common-law partner trust (hereinafter referred to as a "joint partner trust")

*
     Partner, Fasken Martineau DuMoulin LLP
**
     Associate, Fasken Martineau DuMoulin LLP.
     The authors wish to acknowledge the invaluable assistance of Paul King, Partner, Fasken Martineau DuMoulin
     LLP with respect to the section on Land Transfer Tax and of Adam Parachin, Associate, Fasken Martineau
     DuMoulin LLP with respect to the research and drafting of the section on Charitable Gifts.
1
     The amendments received Royal Assent on June 14, 2001 pursuant to S.C. 2000 c. 17.
- 2-


and in particular, will focus on some of the issues that have arisen as these vehicles are being

utilized in a variety of estate planning arrangements.


           The paper is divided into five parts:


           Part I of the paper will outline the legislation background and required elements of alter

ego trusts and joint partner trusts. Part II will focus on some of the key income tax rules relating

to the taxation of such trusts and their beneficiaries. Part III will outline estate planning tips and

traps in the use of these trusts. This part will also examine the level of creditor protection

afforded by the use of such trusts. In Part IV, other issues relating to the use of alter ego and

joint partner trusts will be discussed, including administrative considerations and the authority of

an attorney, acting pursuant to a continuing power of attorney, to establish such trusts on behalf

of an incompetent person. Lastly, Part V will identify drafting issues.

I          Legislative Background

(a)        General


           Subsection 248(1) of the Income Tax Act2 introduces by definition, two new trusts,

namely, the alter ego trust and the joint spousal or common-law partner trust (the “joint partner

trust”).

           The alter ego trust is defined as a trust to which paragraph 104(4)(a) could apply if that

paragraph were read without reference to subparagraph 104(4)(a)(iii) and clauses

104(4)(a)(iv)(B) & (C). Thus, for a trust to be an alter ego trust it must satisfy the following

conditions:
       1.         at the time of the trust’s creation, the taxpayer creating the trust was alive and had
                  attained 65 years of age;
           2.     the trust was created after 1999;
           3.     the taxpayer is entitled to receive all of the income of the trust that arises before
                  the taxpayer’s death;


2
    RSC 1985 (5th Supp.) c.1 as amended [hereinafter the Act].
- 3-


         4.        no person except the taxpayer can, before the taxpayer’s death, receive or
                   otherwise obtain the use of any of the income or capital of the trust; and
         5.        the trust did not make an election referred to in subparagraph 104(4)(a)(ii.1). If
                   this election is made after any assets are transferred to the trust, then no rollover
                   will be available on the transfer of the assets into the trust, and the first deemed
                   disposition of the trust will occur 21 years after the establishment of the trust and
                   every 21 years thereafter.

         A joint partner trust is one to which paragraph 104(4)(a) would apply if that paragraph

were read without reference to subparagraph 104(4)(a)(iv) and Clause 104(4)(a)(iv)(A). Thus a

joint partner trust must satisfy the following conditions:
        1.      at the time of the trust’s creation, the taxpayer creating the trust was alive and had
                attained 65 years of age;
        2.      the trust was created after 1999;
        3.      the taxpayer or the taxpayer’s spouse must, in combination with the spouse or the
                taxpayer, as the case may be, be entitled to receive all of the income of the trust
                that arose before the later of the death of the taxpayer and the death of the spouse;
                and
        4.      no other person can, before the later of those deaths, receive or otherwise obtain
                the use of any of the income or capital of the trust.

         The provisions of these trusts will be familiar as being similar to spousal trusts and in fact

expand the scope of the spousal trust to apply to such trusts. It should also be noted that the

expanded definition of spouse is broad enough to include married spouses, common law, and

same-sex partners.


         One prerequisite of the alter ego trust and joint partner trust is that the settlor must be

over the age of 65 years and this requirement limits their usefulness to some extent.3


         It should be noted that the alter ego trust and joint partner trust provisions of the Act do

not preclude the possibility of there being remainder beneficiaries other than the estate of the


3
    It should be noted that paragraph 73(1.02)(b)(a) also contemplate that an individual under 65 years old can also
    establish a trust into which property can be transferred on a rollover basis. In such a case, however, no person
    other than the settlor may have an absolute or contingent right as a beneficiary (as defined under 104(1.1) under
    the trust. Therefore, the settlor of such a trust cannot provide for a gift over of trust property upon his or her
    death. This is different from the rules relating to an alter ego trust which do permit gift over provisions. The
    provisions of subsection 107.4(1) are also of interest. They provide that a transfer of property to a trust where
    the disposition does not result in a change in the beneficial ownership of property, is a qualifying disposition
    such that property can be transferred to such trust on a rollover basis. It is interesting to note that while
    subsection 73(1.02)(b)(ii) requires the trust to provide that the net income must be paid to the settlor, subsection
    107.4(i) has not such requirement.
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settlor. It is therefore possible for an alter ego and joint partner trust to provide for a gift over

following the death of the settlor, in the case of an alter ego trust, and the death of the last to die

of the settlor and the spouse or common law partner of the settlor, in the case of a joint partner

trust.

(b)      Transfer of Property to Trust


         Generally speaking, a transfer to a trust gives rise to a disposition for tax purposes, in

most cases at fair market value.


         The definition of “disposition” in subsection 248(1) provides in subsection (c) that any

transfer of property to a trust (with certain exceptions) is a disposition. Further, paragraph

251(1)(b) provides that a “taxpayer or a personal trust … are deemed not to deal with each other

at arm’s length if the taxpayer or any person not dealing at arm’s length with the taxpayer would

be beneficially interested in the trust.”


         Thus, if a trust were set up for the benefit of the taxpayer or persons related to the

taxpayer, the taxpayer and the trust would not be considered to be at arm’s length and the

provisions of subsection 69(1)(b) would apply.4

         Subsection 73(1) in combination with subsection 73(1.01) and 73(1.02) provides an

exception to the rule where the transfer is to an alter ego trust or joint partner trust so long as

both the transferor and transferee are residents in Canada. If subsection 73(1) applies, a transfer

of property from an individual to an alter ego or joint partner trust will be effected on a rollover

basis. The trust will be deemed to have received the property at an amount equal to the proceeds




4
    Carole Chouinard, “Alter Ego Trusts and Joint Partner Trusts: New Estate Planning Instruments” ( CBAO, 2001
    Institute of Continuing Legal Education, Estates News: and Plans, Schemes, Strategies, Plots and Conspiracies,
    February 1, 2001).
- 5-


of the individual (the adjusted cost base or if the property is depreciable property, a proportion of

the undepreciated capital cost).5


           The opening words of subsection 73(1) contemplate that it is possible for an individual

transferring property to such trusts to elect out of the rollover. Where the settlor of an alter ego

trust or joint partner trust elects out of the rollover, the transfer of property to the trust will be

treated for tax purposes as a disposition at fair market value. It should also be noted that, as

discussed below, an alter ego trust any elect to have the 21 year rule apply to the trust. If an alter

ego trust makes this election, then the rollover under subsection 73(1) will not be available.6

(c)        Taxation of Income and Capital Gains


           As noted above, in order for a trust created by a taxpayer to qualify as an alter ego trust or

a joint partner trust, the taxpayer in the case of an alter ego trust, and the taxpayer in combination

with the taxpayer’s spouse or common-law partner in the case of a joint partner trust must be

entitled to receive all of the income of the trust. For the purposes of this requirement, the income

of a trust, as provided under subsection 108(3) of the Income Tax Act, is the income of the trust

computed for trust accounting purposes minus certain dividends.


           In Technical Interpretation 2001-01137357, Canada Customs and Revenue Agency
(“CCRA”) was asked to consider whether the rollover provisions of subsection 73(1) could apply

to property transferred to a unitrust or percentage trust. Briefly described, these are trusts which

provide that an amount payable to an income beneficiary in any year during the lifetime of the

beneficiary is defined as a percentage of the total value of the trust property at the end of the

year. The appeal of such trusts is that the trustees need not consider the even hand rule in

making investment decisions and can make investment decisions designed to enhance the overall


5
      In Technical Interpretation 2001 – 0099055, dated January 23, 2002 CCRA confirmed that it is possible for two
      spouses to create a joint partner trust by the contribution of property jointly to one trust and to have the rollover
      rules apply. However consideration should be given to the application of the attribution rule in such a case.
6
      See paragraph 73(1.02)(c) of the Act.
7
      March 5, 2002.
- 6-


value of the trust even though such investment strategy may generate less income. The argument

as to why the provisions of subsection 73(1) should apply to such trusts is that if “income”

referred to in paragraph 73(1.01)(c) is the income of the trust as determined under trust law and

trust law provides that the terms of a trust instrument can determine what is trust income, then

the conditions of paragraph 73(1.01)(c)(i) are met. In the Technical Interpretation referred to

above, CCRA rejected this argument on the grounds that a unitrust is not a trust whose terms

clarify particular accounting principles to be used in determining income (such as a trust which

provides the circumstances under which depreciation may be claimed). Rather a unitrust is

similar to a trust with an apportionment clause in that income is not relevant in determining the

amounts to be allocated to income and capital beneficiaries. The trustee cannot change the

nature of what is income and what is capital but merely ensure an equitable distribution of

property to all the beneficiaries.


         The taxation of income and capital gains derived from an alter ego trust can be

summarized as follows:

         1.       income distributed to the individual will be taxed to the individual;8
         2.       if the individual maintains a contingent interest in the capital of an alter ego trust,
                  or otherwise controls the manner of disposition or distribution of the assets of
                  such a trust, capital gains earned and accumulated by the trust will nevertheless be
                  attributable to the individual during his or her lifetime (subsection 75(2));
         3.       capital gains accumulated by an alter ego trust to which s.75(2) of the Act does
                  not apply will be taxable to the trust (subsection 104(6));
         4.       If subsection 75(2) does not apply to the trust, then the income can be taxed in the
                  hands of the settlor or may be taxed in the hands of the trust if the appropriate
                  election is made pursuant to subsection 104(13.1) or 104(13.2); and
         5.       The application of subsection 75(2) to an alter ego trust may not be significant if
                  the trust and the settlor are subject to the same rate of tax. However, where a trust
                  is resident in a jurisdiction where a lower rate of tax is applied, there may be a
                  loss of tax savings.

         The rules relating to the taxation of joint partner trusts are similar. With respect to the

application of subsection 75(2), if it applies, the income and capital gains earned by the trust will


8
    Subsection 104(6), Paragraph 12(1)(m), and if applicable Section 74.3 of the Act.
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be taxed in the hands of the person who transfers the property to the trust rather than being

taxable to the spouse or in the trust. If subsection 75(2) does not apply then, as noted above,

there is flexibility in that the trust may elect under subsection 104(13.1) and 104(13.2) to have

some or all of the income taxed in the hands of the trust.

(d)      Application of the 21 year rule


         Subsection 104(4) of the Act provides that a trust is deemed to have disposed of its

property for proceeds equal to its fair market value9 and to have immediately reacquired such

property for fair market value on the day that is 21 years after the latest of:

         (a)      January 1, 1972;

         (b)      the date the trust was created; or

         (c)      the day determined under paragraphs (a)(a.1) or (a.4) of 104(4) where applicable
                  and every 21 years thereafter.

         There are a number of exceptions to the rules including spousal trusts, alter ego trusts and

joint partner trusts. Subsection 104(4) provides that the first deemed disposition date for an alter

ego trust is the date on which the settlor dies and for a joint partner trust is the date of death of

the survivor of the settlor and the spouse or common-law partner, irrespective of whether these

dates occur before or after the 21st anniversary of the trust. However, as noted above, an alter

ego trust (but not a joint partner trust) may elect to instead under clause 104(4)(a)(ii.1) to have

the 21-year rule apply. If this election is made, the first deemed disposition date for the trust will

be the date of the 21st anniversary of the date the trust is established, irrespective of whether the

settlor dies before or after this date.


         Also, as indicated above, if the election to have the 21-year deemed disposition rule apply

is made by the alter ego trust, subsection 73(1) of the Act will not apply – preventing the settlor

from transferring property to the trust on a tax-deferred basis.


9
    As defined in subsection 70(5.3) of the Act.
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         Any gains or losses arising on the deemed disposition of the trust property will be taxable

to the trust. The deemed disposition under paragraph 104(4)(a) is deemed to occur at the end of

the day on which the settlor dies such that the provisions of subsection 75(2) will not apply.10

Given that an alter ego trust or joint partner trust must by definition be created during the

lifetime of the settlor they cannot meet the definition of “testamentary trust”11, and are therefore

considered inter vivos trusts. Thus, the capital gain arising on the deemed disposition resulting

from the death of the settlor may bear more tax than would otherwise have borne in the hands of

the deceased.12

         In passing, it should be noted that an alter ego trust will be deemed to have disposed of

and reacquired property if it is reasonable to conclude that the property was transferred to the

trust by the settlor in anticipation that the taxpayer would cease to be resident in Canada. In such

a case the deemed disposition would occur on the first day after the transfer when the settlor

ceases to be resident in Canada.13 In addition, if trust property is distributed by an alter ego trust

or joint partner to a person other than the life tenant(s) during the life tenant(s)’s lifetime, the

trust will be deemed to have disposed of its property for fair market value.14


         Where subsection 70(5) of the Act applies to deem the individual to have disposed of his

or her capital interest in the alter ego trust immediately before death, paragraph 108(1)(a.1) of

the Act provides that the cost amount of the individual’s capital interest is adjusted to take into

account the deemed disposition of the trust’s property under subsection 104(4). This will ensure

that the deceased individual is not subject to tax on the deemed gain that will be subject to tax in

the alter ego trust.




10
    Technical Interpretation 2001 – 0114045, July 11, 2002; 1999 – 0013165 May 15, 2000.
11
    Subsection 108(1) of the Act.
12
    This is due to the fact that, as described above, unlike testamentary trusts and individuals, inter vivos trusts are
    taxed at the highest marginal rates and therefore do not benefit from the progressive rate structure.
13
    Paragraph 104(4)(a.3). There is an exception to property described in subparagraphs 128.1(4)(b)(i) to (iii) of the
    Act that includes such property and capital property used in a business.
14
   Subsection 107(4) of the Act.
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II.         Tax Issues

(a)        Loss of Testamentary Trust Tax Rates


           A significant tax issue pertaining to the use of alter ego and joint partner trusts is the loss

of the graduated rates of tax enjoyed by testamentary trusts. It will be recalled that inter vivos

trusts are subject to the top marginal rates of tax while testamentary trusts enjoy the graduated

rates of tax. If it is desired to retain access to the graduated rates of tax by using multiple

testamentary trusts for children and other issue, the use of an alter ego trust or joint partner trust

will not achieve this result.


           The term “testamentary trust” is defined in subsection 108(1) of the Income Tax Act as a

trust that arose on or as a consequence of the death of an individual, including a trust referred to

in 248(9.1) other than:

                    A trust created after November 12, 1981 if, before the end of the
                    taxation year, property has been contributed to the trust otherwise
                    than by an individual on or after the individual’s death and as a
                    consequence thereof …


           Clearly, alter ego trusts and joint partner trusts do not qualify as testamentary trusts. The

question, however, is whether a trust can be set up during the lifetime of a person which will

qualify as a testamentary trust under the Act and which can receive the property of the alter ego

trust following the death of the settlor. In the past, CCRA has accepted that an executory trust

which receives the proceeds of a life insurance policy on the death of an individual will be

viewed as a testamentary trust.15




15
      In Technical Interpretation 9238555 issued February 4, 1993, dealing with a life insurance policy, Revenue
      Canada considered whether a trust which was established during the lifetime of an individual to receive the
      proceeds of a life insurance policy on the death of the individual would be a testamentary trust. The issue was
      whether the trust would be legally created at the time of the payment of the life insurance death benefit as a
      consequence of the death of the individual. Revenue Canada was of the view in that Technical Interpretation that
      a trust funded from the proceeds of a life insurance policy available on the death of an individual will be viewed
      as a testamentary trust within the meaning of paragraph 108(1)(i), even though the terms of the trust will have
      been established by the individual during his life separate from his will.
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          However, in the case of a transfer of property from an alter ego trust to a trust created

after the death of the settlor of the alter ego trust, CCRA takes the position that this is not a

testamentary transfer from the settlor. This position has been confirmed in a number of technical

interpretations.16


          In commenting on the difference between the positions with respect to life insurance

proceeds CCRA notes as follows:17

                   You referred to CCRA document 9238555, in which we opined
                   that a trust which is created upon or after the death of an individual
                   is not disqualified as a testamentary trust solely by reason of
                   receiving the proceeds from a life insurance policy as a
                   consequence of the death of that individual. That opinion was
                   based on the understanding that no amount would be settled on the
                   insurance trust prior to the receipt of funds from the insurance
                   policy as a result of the individual’s death, that the individual who
                   died was the owner of the policy and had designated the trust as
                   the beneficiary of the insurance policy and that the insurance
                   designation was a testamentary instrument. Although the terms of
                   such a trust may be set out before the individual’s death, separate
                   from the individual’s will, our comments were based on the
                   understanding that the trust would not be created until such time as
                   the insurance proceeds were settled upon the trust. It remains our
                   view that a trust which was settled prior to the individual’s death
                   remains an inter vivos trust following the death of that individual,
                   even though it may receive the bulk of its capital as a beneficiary
                   under an insurance policy.


          CCRA goes on to note that inter trust transfers between testamentary trusts do not

disqualify the trust from being a testamentary trust:

                   A trust is not disqualified from being a testamentary trust where as
                   a consequence of an individual’s death, property is contributed to
                   the trust, on or after the individual’s death, providing the trust
                   otherwise qualifies. The definition of a testamentary trust does not
                   require that the transfer occur at a particular time and a
                   contribution to a testamentary trust may occur at a later date; for
                   example, following the death of the individual’s spouse. In this

16
     Technical Interpretation 2000 – 0059755, March 23, 2001; 2000 – 0075375, March 23, 2001; Technical
     Interpretation 2000 – 0005135, March 23, 2001; and 2001 - 0079285, November 2, 2001.
17
     Technical Interpretation 2000 - 0059755, March 23, 2001; and 2000 – 0075375 March 23, 2001.
- 11-


                  case, the transfer to the second testamentary trust is from a
                  testamentary trust, for the benefit of the spouse, through the
                  direction given in the decedent’s will. Similarly, it is possible for a
                  contribution to be made to an existing testamentary trust on the
                  death of an individual. For example, a parent may direct that on
                  death, a portion of his or her estate would be contributed to a
                  testamentary trust established by a grandparent. The transfer of
                  property to an existing trust would be a contribution on or after the
                  individual’s death and as a consequence thereof.


         The position of CCRA is therefore clear: property transferred to an inter vivos trust does

not belong to the settlor of the trust. On the settlor’s death, therefore, the property of the trust

cannot be considered to be a "contribution by the settlor as a consequence of the settlor’s death to

a trust that is created subsequent to the settlor’s death”, i.e., a contribution by the settlor to a

testamentary trust. The impact of this loss of testamentary tax rates must be carefully weighed

against the tax savings that can result from the establishment of alter ego and joint partner trusts,

such as, for example, probate tax savings, in determining the best estate planning strategy for a

particular client.

(b)      Principal Residence Exemption18


         A principal residence can generally be transferred into an alter ego trust or joint partner

trust without losing the eligibility for principal residence exemption.


         The definition “principal residence” in section 54 of the Act19 permits a personal trust to

designate a property as a principal residence if:

         (a)      The trust’s housing unit is ordinarily inhabited in the calendar year ending in the
                  trust year by a specified beneficiary20 of the trust for the year or by the spouse or
                  former spouse of such beneficiary or by a child of such beneficiary;



18
   See IT-120R2 for a discussion of the application of the principal residence exemption for personal trusts.
19
   See paragraph 54(c.1)(ii) of the Act for the definition of "principal residence".
20
   Subsection 248(25) of the Act defines a "specified beneficiary" as an individual who, for the calendar year ending
in the trust year, is beneficially in the trust and who ordinarily inhabited the housing unit or has a spouse, former
spouse, or child who ordinarily inhabited the housing unit in the year for the purpose of the calculations in
subsection 40(2)(b) and 40(2)(c).
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          (b)      There are no corporations (except registered charities) or partnerships beneficially
                   interested in the trust at any time in the year; and

          (c)      No other property is designated as a principal residence by a specified
                   beneficiary, a specified beneficiary’s spouse (other than one from whom the
                   taxpayer was legally separated throughout the year), a specified beneficiary’s
                   unmarried child who is less than 18 at the calendar year ending in the trust year,
                   or, if the specified beneficiary is unmarried and less than 18 at the calendar year-
                   end, by the beneficiary’s mother, father, or unmarried brother or sister who is less
                   than 18 at calendar year-end.

          Since alter ego trusts and joint partner trusts qualify as personal trusts, the principal

residence exemption can be claimed in respect of an actual or deemed disposition of a principal

residence.


          Subsection 40(4) applies when a principal residence has been transferred between

spouses and subsections 70(6) or 73(1) applied to the transfer. If property is transferred to an

alter ego or joint partner trust and the trust subsequently disposes of the property, subsection

40(4) can apply with respect to the principal residence exemption claimed by the trust and the

trust is deemed to have owned the property throughout the period the settlor owned it and the

property is deemed to be the principal residence of the trust for each taxation year for which it

was the principal residence of the settlor.21


          Prior to 1982 a family could have more than one principal residence allowing an

individual and his or her spouse to make principal residence designations with respect to two

different properties. As of 1981, a taxpayer can have only one principal residence and no other

property may be so designated by another member of the taxpayer’s family unit. As a result,

where one of the properties is transferred to an alter ego trust, the trust and the settlor can have

different principal residences for years prior to 1982. If the settlor acquires the property from his

or her spouse in circumstances to where subsection 70(6) or 73(1) applied, and then transfers it

to an alter ego trust, the property will be the principal residence of the trust for each year it is


21
     In Technical Interpretation 2000 - 012416 dated June 19, 2000 and 2002 - 0126685 dated June 18, 2002, CCRA
     considers a fact situation which contemplates inter spousal transfers and the subsequent transfer of the property
     by one of the spouse to an alter ego trust.
- 13-


deemed to be the principal residence of the settlor under subsection 40(4)(b), even if the settlor

designated another property as a principal residence for years prior to 1982.22


           Subsection 40(4) ensures that an alter ego trust is not precluded from claiming the

principal residence exemption notwithstanding the rollover treatment of subsection 73(1).

Nevertheless, if there is a large accrued gain at the time the property is transferred to the alter

ego trust, consideration should be given to electing out of the subsection 73(1) rollover,

triggering the gain and claiming the principal residence exemption. The alter ego trust or joint

partner trust would acquire the principal residence at its fair market value at the time of the

transfer.

(c)        Capital Gains Exemption


           Subsections 110.6(2) and (2.1) of the Act provide a $500,000 capital gains exemption on

the disposition of qualified farm property and qualified small business corporations shares.23

Thus, where an individual owns such property at the time of death, he or she can use the

exemption to shelter up to $500,000 of capital gains from tax.                Where such property is

transferred to an alter ego or joint partner trust, the issue arises as to whether this exemption is

available on the deemed disposition which occurs at the trust level on the death of the life tenant

or life tenants (in the case of a joint partner trust).


           Subsection 110.6(12) provides that certain spouse trusts can access the unused capital

gains exemption of the beneficiary spouse for the taxation year in which the beneficiary spouse

dies. Since alter ego trusts and joint partner trusts are not included in the provision, in order for

the capital gains exemption to be available it would be necessary for the trust to designate to the

extent possible the deemed capital gains as taxable capital gains of the beneficiaries under

subsections 104(21) and (21.2).               Subsection 104(21) provides that in order to access this

designation, however, the taxable capital gains must be included as income of the beneficiary by

22
      Supra note 4.
23
      As defined in subsection 110.6(1) of the Act.
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virtue of subsection 104(13), 104(14) or section 105 of the Act. The deemed capital gain arising

on the death of the settlor cannot be so allocated and is therefore taxable in the hands of the trust.

The $500,000 capital gains exemption is therefore not available to shelter the deemed capital

gains arising on the deemed disposition of qualified farm property or qualified small business

corporation shares on the death of the settlor, in the case of an alter ego trust, and on the death of

the last to die of the settlor and his or her spouse or common law partner, in the case of a joint

partner trust.


        Based on the above, consideration should be given to having the settlor transfer the

qualified farm property or qualified small business shares at fair market value by electing out of

the rollover provisions of subsection 73(1) of the Act. Such an election would trigger a capital

gain in the hands of the settlor, who can then utilize the exemption under 110.6(2) or (2.1) of the

Act. A partial rollover to the alter ego or joint partner trust may also be considered where only a

portion of the capital gain can be so sheltered.

(d)     Charitable Gifts

        Charitable gifting is a critical estate planning consideration for many individuals. It is

therefore relevant to consider some of the unique charitable gifting issues that are raised by the

establishment of alter ego trusts and joint partner trusts. These issues may be illustrated by

comparing the disparate tax consequences of an individual making a gift to charity in his or her

will versus the establishment of an alter ego or joint partner trust which provides for a transfer of

property from the trust to a charity upon the death of the settlor, in the case of an alter ego trust,

and upon the death of the last to die of the settlor and his or her common law spouse or partner,

in the case of a joint partner trust.


(i)     Gifts Made by Will

        There are three key tax advantages for an individual to provide for a gift to charity in his

or her will.
- 15-


          First, subsection 118.1(5) of the Act provides that a gift to charity made by will is deemed

to have been made by the donor immediately prior to his or her death. This is advantageous

because it ensures that the charitable tax credit arising from the gift may be used in the terminal

return of the donor to offset tax liability arising from the deemed disposition upon his or her

death under subsection 70(5) of the Act.24


          Second, there is an enhanced donation limit for gifts made in the year of death. The usual

donation limit is seventy-five per cent of the donor’s income for the year,25 but this is increased

to one hundred per cent for gifts made in the year of death.26


          Third, to the extent that the charitable tax credit arising from the gift by will is not

exhausted in the donor’s terminal return, there is a one-year carry-back of the credit to the year

proceeding the year of death.27 As with the year of death, the donation limit for the year

preceding death is one hundred per cent of the donor’s income.28


As explained below, these tax advantages may in some ways be preferable to those available in

circumstances where charitable gifting is undertaken through an alter ego or joint partner trust.




24
     CCRA has recently revised its position regarding the application of subsection 118.1(5). Formerly, CCRA took
     the position that subsection 118.1(5) was applicable only where the will directed the executors to make a gift to a
     specific charity or a charity to be selected by the executors out of a list of charities specified in the will. If no
     specific charity was mentioned or no list provided, a charitable tax credit was nevertheless available to the estate
     under subsection 118.1(3). However, this was less advantageous because the estate is a separate taxpayer to the
     deceased and as a result the tax credit available to the estate under subsection 118.1(3) could not be claimed in
     the deceased’s terminal return to offset tax liability arising from the deemed disposition on death under ss. 70(5).
     In technical interpretation 2001-0090205, dated April 11, 2002, CCRA relaxed its position on this issue so that it
     is no longer necessary for the will to name a specific charity or to provide a list of charities in order to qualify for
     the credit under subsection 118.1(5) of the Act.
25
     The 75 per cent limit is bumped up to reflect 25 per cent of taxable capital gains and 25 per cent of recapture
     arising from gifts to charity in the year. See the definition of “total gifts” in subsection 118.1(1) of the Act.
26
     See the definition of “total gifts” in subsection 118.1(1) of the Act.
27
     Subsection 118.1(4) of the Act.
28
     See the definition of “total gifts” in subsection 118.1(1) of the Act.
- 16-


(ii)    Charitable Gifts and Alter Ego/Joint Partner Trusts

        As indicated above, the terms of an alter ego trust are required by the Act to provide that

no person other than the settlor is entitled to receive any property of the trust during the settlor’s

lifetime. Similarly, the terms of a joint partner trust must provide that no person other than the

settlor or his or her spouse or common law partner may receive any of the property of the trust

during the settlor’s and his or her spouse’s or common law partner’s lifetime. Thus, while a

beneficiary of one of these trusts may gift to charity any income or capital paid to him or her out

of the trust, a gift to charity directly from the trust may not be made prior to the death of the

settlor, and in the case of a joint partner trust, the settlor’s spouse or common law partner.


        The specific tax consequences of a transfer of property from an alter ego or joint partner

trust to a charity upon the death of the settlor (or his or her spouse or common law partner) are

dependent upon the terms of the trust. A critical variable is whether or not the terms of the trust

provide for a power of encroachment during the settlor’s (or his or her spouse’s or common law

partner’s) lifetime.


(iii)   No Power of Encroachment

        The Act does not require that the settlor or, in the case of a joint partner trust, the settlor’s

spouse or common law partner, be entitled to capital from the trust during his or her lifetime.

Instead, the Act provides that no person other than the settlor or, in the case of a joint partner

trust, the settlor’s spouse or common law partner, be able to receive or otherwise obtain the use

of any of the capital of the trust during his, her or their lifetime(s). It is therefore not necessary

that an alter ego or joint partner trust contain a power of encroachment.
- 17-


          If an alter ego or joint partner trust provides for a charitable remainderman and does not

contain a power of encroachment in favour of the settlor or the settlor’s spouse or common law

partner, it is possible that the trust may qualify as a charitable remainder trust.


          A charitable remainder trust is a form of deferred giving by which a charity is gifted an

equitable interest in the capital of the trust. Since the interest given to the charity is a remainder

interest, the charity does not actually receive any property from the trust until the expiration of

all prior life interests. The settlor of a charitable remainder trust, however, is entitled to a

charitable tax credit under subsection 118.1(3) at the time that property is transferred to the trust.

The amount of the tax credit will be equal to the value of the remainder interest given to the

charity.29


          There are four key criteria that must be satisfied in order for there to be a charitable

remainder trust. First, as indicated above, the terms of the trust must not provide for a power of

encroachment.         The inclusion of such a power makes it impossible to determine what, if

anything, the charity will ultimately receive from the trust and therefore precludes the issuing of

a charitable gift receipt at the time that the trust is established.


          Second, the terms of the trust must provide a charity with a remainder interest in the trust.

This interest must vest in the charity at the time the property is transferred to the trust.30


          Third, the trust must be irrevocable.




29
     Valuing the remainder interest requires an actuarial analysis of the following key factors: the fair market value of
     the property transferred to the trust at the time of transfer, current interest rates, anticipated future economic
     conditions, the age of the life tenant(s) and mortality tables. A power of encroachment is disallowed because the
     inclusion of such a power makes it impossible to determine the value of the remainder interest.
30
     The remainder interest will be considered to have vested in the donee charity if (1) the donee charity is in
     existence and ascertained, (2) the size of the beneficiaries’ interests are ascertained and (3) any conditions
     attaching to the gift are satisfied.
- 18-


          Fourth, the transfer of property to the trust by the settlor must be voluntary and the settlor

must have no expectation of benefit from the donee charity.31


          The unique feature of a charitable remainder trust is that even though the settlor retains

an income interest in the property transferred to the trust he or she does not have to wait until his

or her death, as is the case with a gift by will, to receive a charitable tax credit under subsection

118.1(3). It may nevertheless be preferable in certain respects for an individual to make a gift by

will to charity than to establish a charitable remainder trust.


(iv)      Timing of Tax Credit

          As indicated above, a gift by will results in the availability of a charitable tax credit at the

time of death of the donor whereas a charitable remainder trust results in the availability of a

charitable tax credit at the time that the trust is established. For many donors, the charitable tax

credit will result in the greatest tax savings if it is available at the time of death, at which time a

significant tax liability will result from the deemed disposition on death under subsection 70(5)

of the Act (except to the extent that the donor has taken advantage of the rollover provisions of

the Act).


          The availability of a charitable tax credit to the settlor at the time of establishing a

charitable remainder trust may be less beneficial, since the charitable remainder trust, if it is

structured as an alter ego or joint partner trust, will be established on a rollover basis.32 In

addition, since the charitable tax credit is received by the settlor at the time of establishment of

the trust, the trust itself will not be entitled to receive a charitable tax credit at the time that it



31
     This correlates with the general requirement articulated in Interpretation Bulletin IT-110R3 that a charitable gift
     entail a voluntary transfer of property without valuable consideration.
32
     The donor could nonetheless carry the credit forward for up to five years to apply against his or her tax liability
     in these years.
- 19-


actually transfers property to the charity. This is significant because this transfer will occur at a

time when the trust will face a significant tax liability due to the deemed realization of capital

gains under subsection 104(4) upon the death of the settlor, in the case of an alter ego trust, and

the death of the last to die of the settlor and the spouse or common law partner of the settlor, in

the case of a joint partner trust.


(v)        Amount of Tax Credit

           As indicated above, the ceiling for a gift by will is one hundred per cent of the donor’s

income in the year of death and the year preceding death. Given the significant income inclusion

that may arise from the deemed disposition on death under subsection 70(5) of the Act, the

charitable tax credit available on death can be of significant value.


           The ceiling for a gift structured as a charitable remainder trust, however, is lower,

namely, seventy-five per cent of the donor’s income for the year.33 The potential value of the

charitable tax credit arising from the establishment of a charitable remainder trust may therefore

be significantly lower than in the case of a gift by will.


(vi)       Flexibility

           A gift by will provides greater flexibility than does a charitable remainder trust. A will is

revocable and may be amended at any time. In addition, as indicated above, it is not necessary

for the donor to name a specific charity in his or her will in order to have been considered to

have made a gift by will under subsection 118.1(5).34 The will can instead leave the selection of




33
      As indicated in footnote 25, the 75 per cent ceiling is bumped up to reflect 25 per cent of taxable capital gains
      and 25 per cent of recapture arising from gifts to charity in the year. If the charitable remainder trust is
      established as an alter ego or joint partner trust, however, these additional amounts (assuming no other charitable
      gifts have been made in the year) will not be available since the trust will be established on a rollover basis.
34
      See footnote 24.
- 20-


the charity to the discretion of the executors.35 A gift may qualify as a gift by will even if the

charity is not in existence at the time of the donor’s death where the terms of the will direct the

executors to establish the charity upon his or her death.36


          In contrast, a charitable remainder trust is required to be irrevocable and must name as

the residuary beneficiary a specific charity in existence at the time that the trust is established.

The donor is therefore unable to change the gift if he or she subsequently decides to support a

different charity.


(vii)     Inclusion of a Power of Encroachment

          As a practical matter, many clients will be reluctant to transfer a significant portion of

their assets to an alter ego or joint partner trust where the trust provisions do not include a power

of encroachment. There are a few possibilities for such individuals to consider.


          First, an alter ego or joint partner trust could be structured as a charitable remainder trust,

i.e., no power of encroachment, with the settlor transferring only a portion of his or her assets to

the trust. The settlor could in the future transfer additional portions of his or her property to the

trust as he or she becomes more comfortable doing so. Unfortunately, however, it is the current

practice of CCRA to disallow a charitable tax credit for such additional contributions to a

charitable remainder trust.37


35
     The will must, however, not leave the decision of whether to make a gift to charity to the executors in order to
     qualify for a gift by will under subsection 118.1(5). In addition, the will must specify the dollar amount of the
     gift or the percentage of the residue of the estate to be gifted to charity. Technical interpretation 2001-0090205,
     dated April 11, 2002.
36
     Technical interpretation 2000-0005187, dated March 6, 2001. The charity must in fact constitute a qualified
     donee at the time that money is transferred to it by the executors.
37
     In technical interpretation 2001-0101845, dated January 14, 2002, CCRA takes the position that the property
     gifted to charity upon the establishment of a charitable remainder trust is an equitable interest in the trust rather
     than the capital of the trust. Accordingly, it is the position of CCRA that when additional capital is transferred to
     the trust there is no new gift made to charity for which a charitable tax credit is available. It is submitted that
     CCRA’s reasoning in this regard draws something of an artificial distinction between the equitable interest gifted
     to charity upon the establishment of a charitable remainder trust and the capital of the charitable remainder trust.
     The equitable interest gifted to charity is an equitable interest in the capital of the trust. To the extent that
- 21-


           Second, an alter ego or joint partner trust could be structured to provide for a charitable

remainderman subject to a power of encroachment during the lifetime of the settlor, and in the

case of a joint partner trust, his or her spouse or common law partner. This precludes the

availability of a charitable tax credit to the settlor at the time that the trust is established. The

power of encroachment, however, provides assurance to the settlor that he or she, and in the case

of a joint partner trust, his or her spouse or common law partner, may access the capital of the

trust if this should prove necessary prior to death.


           If the trust is structured in this manner, the remainder interest to charity will not become

relevant for tax purposes until property is actually transferred from the trust to the charitable

remainderman.38 There are three possible tax results at this time.


(viii)     Charitable Tax Credit Under Subsection 118.1(3)

           The transfer of property from the trust to the charitable remainderman may be treated as a

charitable gift made by the trust. If this occurs, the trust will be entitled to a charitable tax credit

under subsection 118.1(3). The trust may use this charitable tax credit to offset the tax liability

of the trust arising as a result of the deemed realization of capital gains by the trust under

subsection 104(4) upon the death of the settlor, in the case of an alter ego trust, and upon the

death of the last to die of the settlor and his or her spouse or common law partner, in the case of a

joint partner trust. This will only be the case, however, if the “gift” is made by the trust to the

charitable remainderman in the taxation year in which such death occurs. The reason for this is

that, as indicated above, unlike the charitable tax credit available under subsection 118.1(5) in




     additional contributions of capital enhance the value of this interest an additional gift has arguably been made to
     the charity for which a gift receipt should be available.
38
     This will not occur until, in the case of an alter ego trust, the death of the settlor, and in the case of a joint partner
     trust, the death of the last to die of the settlor and his or her spouse or common law partner.
- 22-


respect of a gift by will, the charitable tax credit available under subsection 118.1(3) cannot be

carried back (it can only be carried forward for a period of five years).


(ix)   Deduction Under Paragraph 104(6)(b)

       The transfer of property from the trust to the charitable remainderman may be treated as a

distribution in satisfaction of the charity’s income interest in the trust. If this occurs, the trust

will be entitled under paragraph 104(6)(b) to deduct the amount distributed to the charity from its

income for the year of transfer. However, for purposes of determining the amount that the trust

will be able to deduct under paragraph 104(6)(b), the income of the trust will be calculated

without regard to income arising from the deemed realization of capital gains in the trust under

subsection 104(4). This characterization of the transfer from the trust to the charity, even if such

transfer occurs in the taxation year in which the deemed realization occurs, will not therefore

provide relief against the tax liability arising from this deemed realization.


(x)    Rollout Under Subsection 107(2)

       The transfer of property from the trust to the charitable remainderman may be treated as a

distribution in satisfaction of the charity’s capital interest in the trust. If this occurs, subsection

107(2) will allow the property to be transferred from the trust to the charity on a rollover basis.

Subsection 107(2) will therefore operate to trump subsection 69(1), which, but for subsection

107(2), would deem the trust to have received from the charity proceeds of disposition equal to

the fair market value of the property transferred to the charity. Since a deemed realization of

capital gains will in any event occur under subsection 104(4) prior to the transfer of property to

the charity, the rollover under subsection 107(2) will be of minimal to no benefit to the trust.


       Which of these three possibilities is most likely to occur?
- 23-


          Generally, where a gift is made out of a testamentary trust’s income to a charity, the trust

is administratively permitted to choose whether to treat the charity for that year as an income

beneficiary or to claim a charitable tax credit for the gift. CCRA has stated, however, that this

administrative practice is restricted to testamentary trusts and therefore does not apply to alter

ego or joint partner trusts.39


          CCRA has stated that it is ultimately a question of fact as to whether a transfer to a

charity is appropriately characterized as a charitable gift or a distribution in satisfaction of the

charity’s beneficial interest in the trust. In particular, in technical interpretation 9918215,40

CCRA stated that:


          With respect to inter-vivos trust arrangements, your letter raised questions as to
          the application of subsections 118.1(3) and 107(2) on the distribution of capital
          property of the trust to the discretionary capital beneficiaries. Again, we assume
          that the terms of the trust provide the trustees with the discretion to make
          charitable gifts. Based on this assumption, and as indicated above, with respect to
          the application of subsections 118.1(3) and 104(6), on the distribution of income
          from a trust to a charity at the discretion of the trustees of the trust, this is a
          question of fact which depends upon the specific wording of the trust agreement
          and the intentions of the trustees in making the distribution to the charity.
          [Emphasis added.]


There is therefore no “bright line” test to determine whether a transfer from an alter ego or a joint

partner trust to a charity will result in a charitable tax credit under subsection 118.1(3) being

available to the trust. However, it appears as though the availability of such a credit requires that

the transfer be capable of being characterized as voluntary. This is consistent with the definition

of a charitable gift provided in Interpretation Bulletin IT-110R3 as a “voluntary transfer of

property without valuable consideration.”


39
     Technical interpretation 2000-0056625, dated April 4, 2001.
40
     Although technical interpretation 9918215, dated December 1, 1999, did not deal with alter ego trusts or joint
     partner trusts, CCRA stated in technical interpretation 2000-0056625 that the principles articulated in that
- 24-


       What is required in order for a transfer from a trust to a charity to be characterized as

voluntary? It is arguable that where the terms of the trust provide for a power of encroachment

in favour of the life tenant with a remainder interest to charity the eventual transfer of property to

the charity is necessarily voluntary.            This rationale was adopted by CCRA in technical

interpretation 9811782 in the context of a spousal trust.41                    The terms of the trust under

consideration in this technical interpretation provided for a power to encroach on capital in

favour of the life tenant with the remainder of the trust property to charity upon the death of the

life tenant. CCRA determined that the trust would be entitled to a charitable tax credit at the

time that it transferred property to the charity reasoning as follows:


       The distribution by the trust to the charity constitutes a “voluntary transfer” as the
       power to encroach on capital gives the trustees discretion not to distribute any of
       the trust assets to any charity.


       However, it is not entirely clear that a transfer from an alter ego or joint partner trust will

necessarily be treated as a charitable gift simply because the inclusion of a power of

encroachment arguably renders the transfer to the charity discretionary.                              In technical

interpretation 2000-0056625, CCRA commented that:


       Where the trust agreement empowers the trustees to make a gift and the trustees
       exercise this power, it would be appropriate for subsection 118.1(3) to apply. On
       the other hand, where the charity is an income beneficiary and a distribution is
       made out of the trust’s income, subsection 104(6) would be the relevant provision.


       The difficulty with having articulated the issue in these terms is that it seems to pose as

mutually exclusive the possibility of the charity being a mere donee of a charitable gift from the

trust and the possibility of the charity being a beneficiary of the trust. These are not, however,


  technical interpretation apply to alter ego trusts (which, by logical extension, means they should also apply to
  joint partner trusts).
- 25-


mutually exclusive possibilities. As a matter of trust law, no transfer may be made from a trust

to a charity unless the charity is a beneficiary of the trust. Moreover, the mere fact that a transfer

to charity is as a result of the exercise of discretion by the trustees does not lead inexorably to the

conclusion that the charity is a mere donee of a charitable gift from the trust as opposed to a

beneficiary of the trust. The definition of beneficiary contained in the Act, for example, is broad

enough to encompass persons who are discretionary income or capital beneficiaries of a trust.42


          There is therefore some uncertainty with respect to what the specific tax result will be

where property is transferred to charity from an alter ego trust following the death of the settlor

or from a joint partner trust following the death of the last to die of the settlor and his or her

spouse or common law partner. Even assuming, however, that a charitable tax credit would be

available to the trust in respect of such a transfer it may still be preferable for the donor to

undertake charitable gifting in his or her will rather than through an alter ego or joint partner

trust.


(xi)      Timing of Tax Credit

          As indicated above, the charitable tax credit arising from a gift by will is necessarily

available to offset the donor’s tax liability arising from the deemed disposition on death under

subsection 70(5). As also indicated above, however, the charitable tax credit available to the

trust (assuming that one will be available) will only offset the tax liability resulting from the

deemed realization of capital gains in the trust under subsection 104(4) if the transfer to the

charity is made in the same taxation year as the death of the settlor, in the case of an alter ego




41
     The Department of Finance commented in the Revised Explanatory Notes issued in June 2000 that the income
     tax regime for alter ego and joint partner trusts would parallel that of spousal trusts.
42
     See the definition of “beneficiary” contained in subsection 108(1) and the definition of “beneficially interested”
     contained in subsection 248(25) of the Act.
- 26-


trust, or the death of the last to die of the settlor and his or her spouse or common law partner, in

the case of an alter ego trust.


(xii)      Amount of Tax Credit

           As indicated above, the ceiling for a gift by will under subsection 118.1(5) is higher than

is the case for a gift made by a trust under subsection 118.1(3). The charitable tax credit arising

from a gift made to charity under the terms of a will is therefore potentially more valuable than is

the case with respect to a charitable gift made by a trust.


(xiii)     Flexibility

           As indicated above, it is not necessary for a will to name a specific charity in order for a

gift under the will to qualify for the charitable tax credit under subsection 118.1(5). Unless the

intent is to create a charitable remainder trust as defined above, there is similarly no requirement

for the terms of an alter ego trust or joint partner trust to name a specific charity as the

remainderman. Both of these gifting arrangements are therefore equally flexible in this regard.

However, since a will may at any time prior to death be revoked or amended with ease, a gift

made by will may nevertheless be said to offer greater flexibility.


(e)        Canada - U.S. Tax Convention Issue43

           The use of an alter ego trust may not be an attractive estate planning tool for a Canadian

resident who is a U.S. citizen. It would appear that the transfer of property to such a trust would

be non-recognitionable for U.S. tax purposes, since the trust should qualify as a grantor trust.

However, there may be an element of double tax if, for example, the grantor (settlor in Canadian




43
      The authors are grateful to Howard M. Carr for pointing out this issue.
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