The federal government’s proposed expansion of trust reporting rules to cover “bare trusts” will add costly compliance obligations to ordinary financial arrangements, tax and estate experts say.
With a bare trust, a trustee’s only duty is to transfer property to a beneficiary on demand. Bare trusts are commonly used to facilitate efficient property transfers, to mitigate or avoid provincial land transfer tax or probate fees, or to ensure privacy. In general, bare trusts aren’t used for income tax planning.
Under draft trust reporting legislation released in February, the trustee of a bare trust would need to file a T3 trust tax return and report the name, address, date of birth, jurisdiction of tax residence and tax information number of the bare trust’s settlor, trustee and beneficiaries annually.
Penalties exist for failing to file trust returns, but the proposed enhanced reporting rules introduce a new penalty for deliberately not filing or for gross negligence: $2,500 or 5% of the value of the property, whichever is greater. The draft legislation is out for consultation until April 5.
The government first proposed stricter rules on trust reporting in Budget 2018 to be effective this year, but the measure never passed into law.
The draft legislation released last month will be effective for trusts with taxation years that end on and after Dec. 31, 2022. It also extends the reporting rules to any “arrangement where a trust can reasonably be considered to act as agent for its beneficiaries with respect to all dealings in all of the trust’s property. These arrangements are generally known as ‘bare trusts.’”
Investment Executive asked the Department of Finance why the stricter trust reporting rules were being expanded to bare trusts. “Better information on who owns which legal entities and arrangements in Canada — known as beneficial ownership information — will help authorities to effectively counter aggressive tax avoidance, tax evasion, money laundering and other criminal activities perpetrated through the misuse of corporate vehicles,” a Finance official said in an emailed response.
The Canada Revenue Agency (CRA) already has information on any income or gains earned on property held in a bare trust, and beneficiaries would still have to report these amounts on their personal tax returns. The new reporting rules do not appear to change the tax treatment of bare trusts.
However, the expanded reporting rules would provide the government with detailed information about the existence of a bare trust. This would help the government achieve greater transparency regarding beneficial ownership of trusts, said John Oakey, national director of tax services with Baker Tilly Canada in Dartmouth, N.S.
MaryAnne Loney, a partner with McLennan Ross LLP in Edmonton, suggested the new reporting rules may cast too wide a net, however.
For example, clients often use a bare trust to deal with the delay between the sale of a property and obtaining land transfer registration from the province. In the interim, property is held in a bare trust, with documentation acknowledging that beneficial ownership of the property has changed.
“Clearly, this [kind of transaction] is not what the government is going after,” Loney said.
While the draft legislation contains potential carve-outs for bare trusts that exist for three months or fewer, the backlog for land transfer registration in Alberta is currently longer than that, Loney said.
Bare trusts are often used to avoid unnecessarily triggering land transfer tax or other fees where a property is transferred within a corporate group, said Katherine Ratcliffe, a partner with Lindsey MacCarthy LLP in Calgary. If the corporate group is controlled by the same person or people, “there’s generally no concern about leaving the legal title where it is.”
Bare trusts are also used to mitigate or plan around the relatively high estate administration tax (a.k.a. probate tax) in Ontario, said Brittany Sud, an associate with Miller Thomson LLP in Toronto.
For example, a client may use a bare trust in combination with a dual-will structure to allow for a home or cottage to pass through a secondary will, which would govern assets not subject to probate. A corporation would serve as the bare trustee holding legal title to the property, but the client would retain beneficial ownership and control. At the client’s death, the property could be transferred to a beneficiary via the secondary will. Title on the property would not have to be re-registered, as the corporation retains legal title.
Sud said if the draft legislation is enacted, clients might have to reconsider the benefit of such structures in light of the new compliance requirements.
Bare trusts are sometimes used to keep ownership of property confidential, a “relatively common” practice among public figures, said Rebecca Hett, vice-president, tax, retirement and estate planning with CI Global Asset Management in Calgary.
Finally, clients may have bare trust arrangements — and, under the proposed legislation, compliance requirements — without being aware of them. For example, a parent co-signing a mortgage with an adult child might constitute a bare trust, with the parent being a legal owner of the property and the child the beneficial owner. Under the draft legislation, the trustee would have to file the T3 annually for the property in trust. Failure to do so could result in penalties.
A bank account opened by a parent for the benefit of a minor child might also be considered a bare trust. However, the new reporting rules make an exception for bare trusts with a value of less than $50,000. This exception is only available if the trust holds no property other than cash, shares on a designated exchange and/or certain other assets.
It may be difficult for the CRA to enforce compliance of the draft legislation if taxpayers themselves don’t know they have a bare trust arrangement.
“I could see a situation where [the CRA] is doing an audit for other reasons, and potentially comes across the existence of a bare trust that hasn’t been reported,” Ratcliffe said, adding that it’s unclear whether the CRA would apply failure-to-file penalties if the taxpayer was genuinely unaware of the bare trust.
Loney said she hopes that compliance requirements will be amended to focus more exclusively on trusts the government finds concerning.
“I never like rule changes that put large portions of the population offside who are not doing anything wrong,” she said.
In the meantime, estate experts agreed that clients should review their trust structures more broadly to either wind up a trust that is no longer serving a purpose or to collect information related to the trust well ahead of the effective date.
“Just be ready for a world in which more compliance and reporting appears to be the trend,” Hett said.