In Canada, the use of trusts as a way to protect your assets and manage your wealth is a long-standing tradition. When structured correctly, a trust can protect your assets and allow you to manage how your assets are used by your beneficiaries. Structuring a trust wrong, however, can lead to some less-than-ideal situations. Here’s what you need to know to protect yourself and successfully incorporate trusts into your asset protection strategy in Canada. 

What is a Trust?

A trust is a representation of a relationship between three parties: the Settlor of the Trust (the party that owned the asset initially), the Trustee of the Trust (the party that will be holding onto the property), and the Beneficiary (the party will eventually receive the asset). 

Three Certainties must be established for a trust to be created in a valid manner. They are:

1. Certainty of Intent: There must be a clear intention, either expressed verbally or in writing, by the Settlor to give up an asset permanently in order to create the Trust.

2. Certainty of Subject Matter: There must be a clear description of the asset being held in the Trust.

3. Certainty of Object: There must be a clear description of who the beneficiary is.

If these certainties are not established properly, legal issues may arise. 

How Can Trusts be Effectively Used?

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Trusts Can Protect Your Business Assets

Trusts can offer greater flexibility and control over your business, making them integral to a well-planned asset protection strategy. This is especially helpful in cases where you may not want to give family members direct shares in your company. For example, you may not want to give your family members the power to vote on certain fundamental issues within the company, which even non-voting shareholders have the right to via the Canada Business Corporations Act. By setting up a trust, the beneficiaries will still benefit from the shares placed into the trust, without being able to influence fundamental decisions regarding the family business. 

Trusts Can Be Used Alongside an Estate Freeze

An estate freeze strategy can also be implemented alongside a family trust to shelter your assets from taxes. When an estate freeze strategy is implemented, the owner of an asset locks the value of their asset at its current fair market value; any further growth in the value of their assets will not accrue to them, but to the family trust that was set up as a part of the estate freeze. This reduces the amount of tax that they will owe on their business assets upon their death. 

Trusts Can Be Used to Split Your Income (to an Extent)

Another use of a trust is to use a trust to split your income. To do this, multiple family members are named the beneficiaries of the trust. The trust then “earns” income, which is taxed at a lower rate, assuming the beneficiaries qualify to be taxed at lower tax brackets. 

While the purpose of income splitting seems fairly simple on the surface, there are numerous tax traps and limitations to watch out for when setting up a trust. The Canadian Income Tax Act contains several provisions to ostensibly prevent trusts from being abused. For example, in section 120.4, income split with a minor will be taxed at the highest marginal tax rate, unless they are enrolled as a full-time student at a post-secondary institution, or disabled. This is to prevent parents from using their children as a tax avoidance measure. Otherwise, the beneficiaries must be actively engaged with the business to avoid being taxed at the highest marginal rates. 

However, not all federal tax laws are detrimental to trusts. With proactive planning, you can use a trust to multiply the lifetime capital gains exemption on the disposition of shares in a qualified small business corporation. In this case, each beneficiary of the trust has the potential to claim the lifetime capital gains exemption on the sale of the shares, shielding any capital gains from taxes.

Trusts Can Provide Protection in Cases of Divorce

Although it may be unpleasant to think about, trusts can be used as a part of your asset protection strategy in case of a divorce. Since what you place into a trust is not legally yours, the asset in the trust is protected in the event that a divorcing spouse attempts to claim said asset. However, numerous legal implications can complicate this approach, so it’s best to plan as early as possible with the help of an advisor. 

What Type of Trust Should I Set Up?

There are two main types of trusts: an inter-vivos trust and a testamentary trust. 

An inter-vivos trust is set up during your lifetime. They are used to hold the assets of a trustor and can help with avoiding probate fees at the time of your death. With an inter-vivos trust, the trustor is able to use the assets and benefits from the trust during their lifetime. In addition, the trustor can be named the trustee of an inter-vivos trust, allowing the trustor to manage the assets allocated to the trust. This allows you to retain control over the assets placed in a trust. 

A testamentary trust, on the other hand, is created upon the death of an individual through their Will or Trust Declaration. Testamentary trusts also allow a trustee to professionally manage the assets in the trust, as directed by the settlor. Once the trust expires, control over the assets is handed over to the beneficiary. This makes testamentary trusts a crucial part of estate planning. 

Get a Professional to Help You With Your Asset Protection Strategy

When trusts are structured properly, you and your family will be able to implement an effective asset protection strategy; navigating the laws around trusts, however, requires a deep understanding of how trusts work within different financial frameworks. At Global Solutions West, we leverage well-planned wealth preservation strategies to protect your hard-earned assets and deliver solutions to even the most complex wealth preservation challenges. Contact us today to find out how we can help. 

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