DALEYBLACK. Raymond G. Adlington

Transcription

1 ALTER EGO & JOINT PARTNER TRUSTS DALEYBLACK Raymond G. Adlington * The author wishes to acknowledge the invaluable contributions of James MacGowan, c.a., ofdeloitte & Touche, Ed Harris, Q.C., and Richard Cregan, Q.c., of Daley Black, John Roy, F.C.A., and David Biorn, C.A., of Grant Thornton in the review of this paper and the attached materials.

2 ALTER EGO & JOINT PARTNER TRUSTS Client demands to minimize probate tax will increase as a result oftherecent increase in the level oftax applied to the value of assets of an estate. Recently announced proposed amendments! to the Income Tax Ad (the "Act") will assist in meeting these demands to minimize probate tax and also result in other ancillary benefits to assist the estate planner in meeting client goals. As with all other tax minimization techniques, the failure to discuss these techniques with a client could lead to potential future claims against the lawyer. This paper examines the benefits of and the income tax rules behind alter ego and joint partner trusts. I will review the definitions of an alter ego and ajoint partner trust, discuss the advantages in using these new forms of trusts, review the tax treatment to the settlor on the creation of an alter ego or joint partner trust and review the tax treatment to the trust, the beneficiaries, and the settlor on the income eamed by the alter ego or joint partner trust. Finally, I will conclude with a brief discussion of the pitfalls to avoid in the creation or administration of an alter ego or joint partner trust. DEFINITIONS Under the proposed definitions contained in the Act, an alter ego trust is one which satisfies the following four conditions: 3 I At the time of the trust's creation, the taxpayer creating the trust was alive and had attained 65 years of age; The trust was created after 1999; The taxpayer is entitled to receive all of the income of the trust that arose before the taxpayer's death; No person except the taxpayer could, before the taxpayer's death, receive or otherwise obtain the use of any of the income or capital of the trust; and The trust did not file an election for its first taxation year electing that it not be treated as an alter ego trust. 4 I The proposed amendments were released as draft legislation by the Department of Finance on December 17, 1999, and the most recently amended version of the draft legislation was released by the Department of Finance as a Notice of Ways and Means Motion on June 5, R.S.C (5oh Supp.) as amended. Unless otherwise noted, all further statutory references are to the Income Tax Act., See the proposed definition of alter ego trust in ss. 248(1) and draft clause 104(4)(a)(iv)(A). 4 Please note that this final requirement was not part of the originally released draft legislation and was added to the version released on June 5, 2000, to allow trusts the option of electing out of the alter ego trust rules.

3 -2- Under the proposed definitions contained in the Act, a joint partner trust' is one which satisfies the following four conditions: 6 l At the time ofthe trust's creation, the taxpayer creating the trust was alive and had attained 65 years of age; The trust was created after 1999; The taxpayer, the taxpayer's spouse? or the taxpayer's common-law partner,s as the case may be, is, in combination with the spouse, common-law partner or the taxpayer, as the case may be, entitled to receive all of the income of the trust that arose before the later of the taxpayer's death and the death of the taxpayer's spouse or common-law partner, as the case may be; and No person except the taxpayer or the taxpayer's spouse or common-law partner, as the case may be, could, before the later of the deaths referred to above, receive or otherwise obtain the use of any of the income or capital of the trust. Basic precedent Trust Indentures satisfying the respective definitions set out above may be found at the end of this paper. Please take note that many of the provisions contained in the Trust Indentures attached may be amended without affecting the status of the Trust. The sole requirements to meet the definitions are those listed above. WHY RECOMMEND AN ALTER EGO OR JOINT PARTNER TRUST? Alter ego and joint partner trusts can serve to substitute for a will for the purposes of property disposition of an individual over 65" This is accomplished by drafting the trust indenture, In the original version of the draft legislation, this fonn oftrust was referred to as a "joint spousal trust"; however, the reference was changed to "joint partner trust" in the version ofthe draft legislation released on June 5, See the proposed definition of joint partner trust in ss. 248(1) and clauses 104(4)(a)(iv)(8) and 104(4)(a)(iv)(C). 7 Draft clause 104(4)(a)(iv)(8). 8 Draft clause I04(4)(a)(iv)(C). See also the new definitions of " common -law partner" and "common-law partnership" added to ss. 248(1) of the Act by ss. 139(2) ofthe Modernization o/benefits and Obligations Act, S.c. 2000, c These fonns of trust may also be considered a substitute for an enduring general Power of Attorney for those concerned about their future incapacity seeking to avoid the necessity of a guardianship application; however, ifutilized in this fashion, a separate medical consent authorization which is contained in most enduring powers ofattorney should be considered.

4 -3- to meet the above requirements that the settlor, and possibly their spouse or common-law partner, be solely entitled to the income of the trust during the relevant lifetimes and that no one else be entitled to the income or capital during that time. The trust indenture may then go on to provide for the allocation of income and capital of the trust after the relevant lifetimes which would mirror the testamentary intentions of the settlor. PROBATE TAX Currently, the principal reason many clients will consider utilizing these new forms of trust is to minimize probate tax which is payable on their death. Under the Probate Act, a probate tax is payable by the executor or administrator of the estate from the assets ofthe estate to the registrar of the court that makes the grant in accordance with the following schedule: (a) in estates not exceeding $10,000, $70; (b) in estates exceeding $10,000 but not exceeding $25,000, $150; (c) in estates exceeding $25,000 but not exceeding $50,000, $250; (d) in estates exceeding $50,000 but not exceeding $100,000, $700; (e) (f) in estates exceeding $100,000 but not exceeding $150,000, $700 plus an additional $12 for every $1,000 or fraction thereof in excess of $100,000; in estates exceeding $150,000 but not exceeding $200,000, $700 plus an additional $12 for each $1000 or fraction thereof in excess of$150,000; (g) in estates exceeding $200,000, $700 plus an additional $12 for each $1000 or fraction thereof in excess of $200, The current Nova Scotia probate tax ofl.2% of all assets of an estate in excess of$1 00,000 is currently the third highest probate tax in the country, trailing only Ontario at 1.5% over $50,000 and British Columbia at 1.4% over $50,000. Under the current system, the same asset potentially passes through probate twice. Consider a deceased shareholder who drafted his latest will earlier this year and was 70 at the time of his death who owned securities which have a value of$1,000,000, and the balance of the shareholder's assets at the time of his death exceeds $100,000. If those shares are left to the surviving spouse or common-law partner to take advantage of the available capital gains deferral, II then the probate tax 10 Probate Act, R.S.N.S. 1989, c. 359, s. 9B, as added to the ProbateActby s. 63 of the Financial Measures (2000) Act, S.N.S. 2000, c. 4. I would appreciate if someone could explain to me the legislative utility of paras. 9B(f) & (g) above. 11 See ss. 70(6).

5 -4- payable if the executor seeks a grant of probate on those shares is $12,000. If the shares maintain their value and are held by the surviving spouse or common-law partner at the time of their death, an additional $12,000 in probate tax is payable on the same asset. As a contrast, the securities may be transferred by the shareholder to a joint partner trust." The joint partner trust would be established to provide that the shareholder and their spouse or common-law partner are entitled to all of the income of the trust while either is alive and no other person is entitled to the income or the capital of the trust until after the death of the shareholder and their spouse or common-law partner. Upon the transfer of the securities to the trust, legal title to the shares becomes vested in the trustees of the joint partner trust. Accordingly, no probate tax is payable on the death of the shareholder in respect of the shares, as they transferred title to the shares during their lifetime and, therefore, the securities are not an asset of the estate. On the assumption that the trust indenture provides for contingent beneficiaries on the later of the two deaths, no probate fees are payable in respect ofthe securities on the death of the surviving spouse or common-law partner either as the securities remain owned by the joint partner trust. Therefore, in the theoretical case posed above, $24,000 in probate tax has been saved. TESTATORS' FAMILY MAINTENANCE ACT The Testators' Family Maintenance Ad 3 establishes a method by which a dependant l4 may make a claim against the estate of a deceased spouse or parent. The key provision is ss. 3(1) which provides that: Where a testator dies without having made adequate provision in his will for the proper maintenance and support of a dependant, a judge, on application by or on behalf of the dependant, has power, in his discretion and taking into consideration all relevant circumstances of the case, to order that whatever provision the judge deems adequate be made out of the estate of the testator for the proper maintenance and support of the dependant The income tax implications of the transfer are discussed infra. IJ R.S.N.S. 1989, c The term "dependant" is broadly defined in the Testators' Family Maintenance Act in ss. 2(b) as "the widow Of widower Of the child of a testator", without any reference to financial need. " Testators' Family Maintenance Act, supra, note 12, ss. 3(1).

6 -5- Claims made in Nova Scotia in reliance on ss. 3(1) appear to be increasing over the past several years. 16 The circumstances under which such claims are being allowed are expanding. For example, in Sandhu v. Sandhu Estate, 17 the spouse, having been estranged for over 30 years, of the testator was awarded $285,000 ofan estate with an approximate value of$3,000,000, the bulk of which was accumulated long after the spouses were estranged. In his decision, Justice Saunders made the following remarks: The claimant need not show actual or urgent need or true dependency in order to succeed. To justify interference with a will a court must find a failure to provide proper maintenance and support and a moral claim to entitlement. In deciding what is proper the Court looks beyond the bare necessities of existence. It should consider the magnitude ofthe estate, the circumstances ofthe claimant, the strength of his or her moral claim to share in the estate and the situation of others having claims upon the testator. It is not the Court's role to rewrite the will of the testator; rather to intercede in those appropriate cases so as to correct amoral wrong. The award the Court may make in substitution for such a testamentary omission is that which a wise and just testator would have considered himself morally bound to make had he been aware of all the relevant circumstances. 18 In Walker v. Walker Estate,19 the testator's son, who saw his father only twice after his parents separated in 1946 when he was I year old, made a claim under the Testators' Family Maintenance Actwhenhis father died in 1992 leaving an estate valued at $1,532,876. Ofthis amount, he was awarded $105,000. In his reasons, Justice Goodfellow noted that a child may make a claim even ifthey are ofthe age of majority, and not otherwise disabled or dependant at law. His reasons also infer that a parents will should make provision for all children to promote some sense of equality among children. Subsection 3(1) of the Testators' Family Maintenance Act provides solely for claims against the estate of the testator. If all, or substantially all, of the assets are transferred to an alter ego or joint partner trust, the estate will be left with little orno assets. As claims under ss. 3(1) may only be satisfied out of assets of the estate, transfers of all or substantially all of a person's assets can effectively 16 See for example, the recent decisions made in Sandhu v. Sandhu Estate (1999), 176 N.S.R. (2d) 67 (T.O.), Walkerv. Walker Estate (1998), 168N.S.R.(2d)231 (TO.), Redmondv. RedmondEstate (1996), 1555N.S.R. (2d) 61 (TO.), and Mollins Estatev. Mollins Estate (1996), 152 N.S.R. (2d) 386 (T.O.) to name but a few, which clearly do not account for the likely many more claims which are filed and settled. 17 Ibid. 18 Ibid, at p Supra, note 16.

7 -6- vitiate claims under the Testators' Family Maintenance Act?O This planning may be of particular benefit for those with estranged spouses or children. POST -MORTEM CHALLENGES If an alter ego or joint partner trust created by the settlor meets the three certainties 21 then the disposition provisions ofthe trust may only be challenged for lack of capacity on the same standard as any conveyance of property may be challenged for lack of capacity. This leaves mental capacity as the sole method for a common law challenge to the transfer of the property. As a contrast, the test for testamentary capacity at the time the will was signed is more strict. 22 Claims of undue influence to set aside a testamentary disposition may not be made to challenge the inter vivos disposition of assets to an alter ego or joint partner trust. Additionally, there are a number of technical provisions of the Wills Ad 3 which may either affect the validity of the entire will or particular provisions or gifts within the will which may not necessarily apply to dispositions made through the mechanism of a gift to an inter vivos alter ego or joint partner trust. 24 PUBLICITY The Registrar of Probate in each County maintains a registry of all documents filed in respect of each estate. For the payment of a nominal fee, any person may examine these records. One such document required to be filed by the executor or administrator is an inventory of all of the assets of the deceased which have come into their possession or knowledge. 25 Therefore, full effective public disclosure of the assets an individual owned at the time of their death is mandated by the Probate Act. The ability to remove certain assets from such public scrutiny through the use of an alter ego or joint partner trusts may be viewed as beneficial by many clients. 20 Any such transfer may be subjectto challenge under the Assignments and Preferences Act, R.S.N.S. 1989, c. 25; however, to be successfully challenged, the transfer of property must be made by an "insolvent person" within the meaning of the Assignments and Preferences Actand the transfer must be with intent to defeat, hinder, delay or prejudice his creditors. This last element is significant as a claim which could possibly be made by a dependant under the Testators' Family Maintenance A ct is a claim against the estate and not the transferor of property while alive. Therefore, the dependant should not be considered a "creditor" within the meaning of the Assignments and Preferences Act. 21 Certainty of object, certainty of subject-matter, and certainty of intentions. materials. 22 For a full discussion of this topic, please refer to Peter Bryson's paper contained later in these conference 2J R.S.N.S. 1989, c "Including, for example, signature and witnessing issues (s. 7-8), subsequent marriage ofthe testator (s. 17), bequests to attesting witnesses (s. 12), and alterations made after execution (s. 20), to name a few. 25 Probate Act, R.S.N.S. 1989, c. 359, s

8 -7- NURSING HOME COSTS The Social Assistance Ad 6 mandates that the social services committee of each municipal unit provide assistance to all persons in need?? The Municipal Assistance Regulations 28 made pursuant to s. 18 of the Social Assistance Act set out how a social assistance committee is to determine whether a person is a person in need. Specifically, the committee is to consider the person's financial needs and their income, assets and resources available to meet such needs. 29 Assets is specifically defined in the Municipal Assistance Regulations to include the beneficial interest in assets held in trust and available for the maintenance of the applicant. 30 Therefore, as applicants may be required to provide a statement of their assets under oath as part of their application, transfers to alter ego or joint partner trusts should not have an impact on the initial analysis of the application. That said, the transfer of assets to an alter ego or joint partner trust may have an impact in the future in the event the settlor actually receives assistance from the municipality under the Social Assistance Act. The Social Assistance Act provides: Where assistance has been given by a social services committee to or for a person in need, the municipal unit may recover from the person or, in the case of the persons death, from the persons executor or administrator the expenses so incurred in an action brought by the clerk in the name ofthe municipal unit as a debt due the municipal unit, and the clerk may obtain as a creditor letters of administration ofthe estate ofthe person and may file a claim against the persons estate in a court ofprobate. 31 Unlike the Testators' Family Maintenance Act, this provision creates a debt in favour of the municipality, which the municipality may recover from the person or from the estate of the person. Like the Testators' Family Maintenance Act, the claims are necessarily limited to the assets of the recipient of the assistance, or their estate, as the case may be. Therefore, by transferring all 26 R.S.N.S. 1989, c Ibid, 55. 9(1). 28 N.S. Reg 76/81 as amended. 29 Ibid, s Ibid, 55. l(d). Jl Ibid, (1).

9 -8- or substantially all 32 of their assets to an alter ego or joint partner trust, a settlor may defeat such subsequent claims by a municipal unit which has provided them with assistance. The affected municipal unit may bring a claim that the settlement of the trust was void;33 our current understanding is that the policy of the Department of Community Affairs is to review any transfers made by the applicant for assistance during the three years prior to their application being made. TAX IMPLICATIONS TO SETTLOR The creation of an alter ego or joint partner trust necessarily requires the transfer of property to create the trust. Under the former rules, such a transfer constituted a disposition of the property transferred. 34 Since this would result in the realization of capital gains and the concurrent acceleration of the tax payable on such gains, such planning was unattractive. ROLLOVER Under the draft legislation governing alter ego andjoint partner trusts, a tax deferred transfer is now available, such that on the transfer of property to an alter ego or joint partner trust, capital gains are not automatically triggered. 35 There is an ability to elect not to have this "rollover" treatment apply; however, if the election is made then the transfer will be deemed to have occurred at fair market value. 36 In other words, the settlor of an alter ego or joint partner trust does not have the ability to select the proceeds of disposition. If no election is filed, then the proceeds of disposition equal the cost of the property to the settlor. If the election is filed, then the proceeds of disposition equal the fair market value of the assets on which the election is made. The ability to elect out of the rollover may be of value if the settlor ofan alter ego or joint partner trust wishes to maintain ownership, albeit indirect, of a capital property which has a reduced value from when it was acquired. The settlor of an alter ego or j oint partner trust is not affiliated with 32 Care must be taken not to be to overzea]ous in transferring all of a person's assets, as other considerations, such as the ability to file a separate return fortheyearofdeath under ss. 70(2) On certain amounts receivable orlbe immediate consequences of cashing in an RRSP or RR1F to contribute those amounts to an alter ego or joint partner trust should be taken into account. 33 Assignments and Preferences Act, supra note 20, ss. 4(1). 34 See the definition of "disposition" contained in s. 54. JS Draft ss. 73(1). It is also worth note thatthe settlor of an alter ego or joint partner trust can, during their lifetime unwind the trust by, ifthe trustees permit, allocating all ofthe capital ofthe trust to the settlor, which occurs on a rollover basis pursuantto ss. 107(2), and subsequently settling anew alter ego or joint partuertrust making the desired changes. J6 Para. 69(1 )(b).

10 -9- the trust for income tax purposes. 37 Therefore, the superficial loss rules" which deem a loss from the disposition of property, to the extent that the loss is a superficial loss, to be nil do not apply to the disposition of a "loss property" to an alter ego or joint partner trust. This is of value to those able to establish an alter ego orjoint partner trust who wish to realize such losses to offset other gains which may have been realized but who wish to maintain beneficial ownership of the "loss property". The rollover treatment referred to above is subject to an anti-avoidance measure. Specifically, if the settlement of an alter ego or joint partner trust is part of a series of transactions or events in which the settlor received a tax deferred transfer of property from an inter vivos trust one of the main purposes of which was to avoid the deemed disposition of property39 of the transferring trust then the rollover treatment will be denied. 40 ATTRIBUTION OF TRUST INCOME TO SETTLOR Alter ego and joint partner trusts can not be effectively used as an income splitting vehicle. The definitions referred to above for both an alter ego and ajoint partner trust require that the taxpayer, either alone in the case of an alter ego trust or in conjunction with their spouse or comrnonlaw partner, be entitled to the income of the trust prior to their death. This requirement attracts the application of the attribution rule found in ss. 75(2), which provides: Where, by a trust created in any manner whatever since 1934, property is held on condition (a) that it or property substituted therefor may (i) (ii) revert to the person from whom the property or property for which it was substituted was directly or indirectly received (in this subsection referred to as "the person"), or pass to persons to be determined by the person at a time subsequent to the creation of the trust, or (b) that, during the lifetime of the person, the property shall not be disposed of except with the person's consent or in accordance with the person's direction, 37 The definition of "affiliated persons" is contained in ss (I). J8 Sub-para. 40(2)(g)(i) and the definition of "superficial loss" in s See ss. 104(4) respecting deemed disposition dates for capital property of trusts. 40 Draft para. 73( 1.02)( c).

11 -10- any income or loss from the property or from property substituted therefor, any taxable capital gain or allowable capital loss from the disposition of the property or of property substituted therefor, shall, during the lifetime of the person while the person is resident in Canada be deemed to be income or a loss, as the case may be, or a taxable capital gain or allowable capital loss, as the case may be, of the person. 4l This provision applies to attribute all income or losses and any taxable capital gains or allowable capitallosses 42 from the property, or substituted property, earned by the transferee alter ego or joint partner trust to the settlor during the settlor's lifetime while the settlor is resident in Canada.43 This attribution rule does not apply to business income; however, it will apply to transfer any interest income, rent, dividends, or any other form of property income to the settlor. The attribution of income and capital gains from the property transferred extends to property acquired by the alter ego or joint partner trust in substitution for the originally acquired property; however, the attribution does not apply to income or capital gains earned on property acquired with income previously attributed. 44 This "second generation" income not subject to attribution can be used in income splitting strategies with the alter ego trust, or, in the case of the joint partner trust, with the trust, the spouse or common-law partner Ss. 75(2) is to be amended for taxation years beginning after 2000 as to replace the word "lifetime" with "existence" to clarify that this attribution rule applies to corporations and to replace the word "therefor" with the phrase "for the property" in paragraph (b) and the postamble respectively. 42 Although all taxable capital gains and allowable capital losses are attributed to the settlor while the settlor is alive, the alter ego or joint partner trust remains a separate person for income tax purposes providing potential planning opportunities to avoid the application of the identical property cost base averaging rules found in s J Please note that para. I 04(4)(a.3) provides that where it is reasonable to conclude that property was transferred to an alter ego or jointpartnertrust in anticipation thatthe settlor would subsequently cease to reside in Canada and the settlor subsequently ceases to reside in Canada the alter ego or joint partner trust so established is deemed to have disposed of all of its property for fair market value proceeds of disposition on the first day after the settlement on which the settlor ceases to reside in Canada... See JT-369R, Attribution of Trust Income to Settlor, para. 6 (March 12, 1990). 45 More on the limited income splitting strategies available utilizing alter ego or joint partner trusts is discussed in the section on provincial residency implications.

12 -11- TAXATION OF AN ALTER EGO OR JOINT PARTNER TRUST GENERAL RULES Both alter ego trusts and joint partner trusts are inter vivos trusts. Both are considered individuals for tax purposes;46 therefore, both are required to file income tax returns. 47 Both calculate their income as would an individual. 48 Similarly, an alter ego or joint partner trust may, in computing its tax payable, claim certain tax credits, including the charitable tax credit, the dividend tax credit and the foreign tax credit; however, it may not claim those which are inherent to individuals, such as the basic personal amount, the marriage tax credit, the tuition tax credit, etc.. As inter vivos trusts, both alter ego and joint partner trusts calculate tax payable on taxable income at the highest marginal rate,, 9 Trusts, including alter ego and joint partner trusts, do have some special rules which are applicable in calculating their income for tax purposes. In a tax year, the trust may deduct any of its income which was paid or made payable to a beneficiary of the trust. 50 Concurrent with this deduction, the beneficiary must include the same amount paid or made payable by a trust as taxable income. 51 The trust may designate that the character of the income be passed on to the beneficiary so that the beneficiary has the benefit of advantageous tax treatment enjoyed by certain forms of income. 52 If income is not paid or made payable in the year, then the trust bears the tax obligation, and the net amount is added to the capital of the trust. Although the attribution rule contained in ss. 75(2) discussed above serves to attribute all trust income on the property contributed, or property acquired in substitution for this property, the trust income rules still have an impact on alter ego and joint partner trusts. Specifically, these 46 Ss. 104(2). 41 T3 returns of income for a trust must be filed within 90 days from the year end ofthe trust, which is December 31 for all inter vivos trusts including both alter ego and joint partner trusts. "Income attributed to the settlor as noted above is not income of the alter ego trust or joint spousal trust as it is deemed by ss. 75(2) to be income of the settlor. 49 S so Para. I 04(6)(b). Pursuantto draft sub-para. I 04(6)(b )(iii), an alter ego or joint partner trust is limited in the deduction it may take in the year ofthe death of the beneficiary creating the deemed disposition pursuant to para. I 04( 4)(a) in respect of income of the trust which accrued up to the time of the death to that amount which was paid or payable to the deceased beneficiary prior to their death. 51 Ss. 104(13). This income inclusion only applies to certain types of Canadian resident trusts, which includes alter ego and joint partner trusts. 52 For example, dividends (ss. 104(19) & (20», taxable capital gains ( (21», foreign source income (ss. 104(22», and foreign tax paid (ss. 104(22.1».

13 -12- rules will apply to the "second generation" income of the trust, being income earned on the income generated from the contributed property. Also, these rules will apply to both alter ego and joint partner trusts after the settlor has died. To qualify for the rollover treatment found in draft ss. 73( 1) on the transfer of property to an alter ego or joint partner trust, one of the requirements is that the trust be resident in Canada without reference to any provisions which would deem the trust resident in Canada. The residency of a trust is generally determined in accordance with the residency of the trustee who manages the trust or controls the trust assets. 53 Ifmore than one trustee shares this role, then the trust is resident where a majority ofthe trustees is resident. These rules apply to determine both Canadian residency as well as provincial residency. DEEMED DISPOSITIONS Alter ego and joint partner trusts may not be used to defer the tax which would be payable on the death of the taxpayer, or, the later death of the taxpayer and their spouse or common-law partner if a spousal rollover is utilized on death, as a result of the deemed disposition of capital property which occurs on death. 54 In the case of an alter ego trust, the trust will be deemed to have disposed of all of its capital property for fair market value proceeds of disposition on the death of the settlor. 55 In the case ofajoint partner trust, the trust will be deemed to have disposed of all of its capital property for fair market value proceeds of disposition on the later death of the settlor and their spouse or commonlaw partner as the case may be. 56 In the case of both alter ego trusts and joint partner trusts, further deemed dispositions occur on each 21 st anniversary of the initial deemed disposition date. 57 In addition to the deemed disposition arising as a result of death referred to above, deemed dispositions by an alter ego or joint partner trust arise in two other specific situations as antiavoidance measures. Specifically, an alter ego or joint partner trust is deemed to have disposed of all of its capital property on the day on which a capital distribution is made where it is reasonable to conclude that the distribution was financed by a liability of the trust and one of the purposes of 53 See IT-447, Residence ofa Trust or Estate, para. 2 (May 30, 1980). The Canada Customs and Revenue Agency has laid down a number of administrative guidelines as to specific cases where they do not consider this general guideline to apply in IT-447. They also administratively allow that where the trustee is a trust company, the trust will be resident in the location of the branch and not necessarily where the corporation is resident. 54 S. 70(5). "Draft clause 104(4)(a)(iv)(A). "Draft clauses 104(4)(a)(iv)(B) & (C). 57 Draft para. 104(4)(c).

14 -13- incurring the liability was to avoid taxes otherwise payable as a consequence of the death of any individual." An alter ego or joint partner trust is also deemed to have disposed of all of its capital property'9 on the day the settlor ceases to reside in Canada ifit is reasonable to conclude that the property was so transferred in anticipation that the taxpayer would subsequently cease to reside in Canada. 60 Therefore, the transfer of assets to an alter ego or joint partner trust is an effective means for deferring the "departure tax" if, at the time the transfer of property to the trust is made, the settlor is not anticipating emigration. 6I The settlor, and their spouse or common-law partner if applicable, are also not deemed to have disposed oftheir interest in an alter ego or joint partner trust on their emigration from Canada. 62 PROVINCE OF RESIDENCY IMPLICATIONS The deemed disposition arising on the death of the settlor, or the later death of the settlor and their spouse or common-law partner, referred to above creates a tax liability to the trust. 63 Given the move by the provinces to taxation on income systems and the widely varying provincial tax rates, this could lead to some tax planning opportunities for those able to establish alter ego or joint spousal trusts. The Nova Scotia Income Tax Acl 4 imposes a tax on the taxable income of an inter vivos trust "Draft para. 104(4)(a.2). "With the exception of taxable Canadian property, as defined in ss. 248(1), inventory ofa business carried on in Canada, and the right to receive specified forms of payment enumerated in sub-para (4)(b)(iii). 60 Draft para. 104(4)(a.3). This prevents avoidance of the "departure tax" which arises pursuant to the application of para (4)(b); however, please take note of the discussion of the province of residency implications, infra, as the transfer of assets to an alter ego or joint partner trust could still result in provincial tax savings on emigration subject to the potential application of the general anti-avoidance rule. 61 If a beneficiary of an alter ego or joint partner trust is a non-resident of Canada then the implications of Part XII.2 tax and the withholding tax applicable to distributions made to the non-resident should be considered. For a detailed review ofthe withholding tax obligations ofthe trust, please see IT -465R, Non-residentBeneficiaries of Trusts, September 19, See draft sub-para I (4)(b)(iii) and draft para. U) ofthe draft definition of "excluded right or interest" in draft ss (10), which provides that an excluded right or interest includes an interest of an individual in a personal trust resident in Canada ifthe interest was never acquired for consideration and the interest in the trust did not arise as a result of a qualifying disposition within the meaning of draft ss ( I). 6J The capital gain arising as a result ofthis deemed disposition will not be attributed to the settlor under ss. 75(2) as ss. 75(2) applies only during the settlor's lifetime and the deemed disposition under sub-para. 104(4)(a)(iv) occurs allhe end ofthe day on which the settlor dies (assuming the settlor outlives their spouse or common-law partner in the case of a joint partner trust), which must necessarily be after the settlor has actually died. 64 R.S.N.S. 1989, c. 217, as repealed after s. I and replaced by s. 61 ofthe Financial Measures (2000) Act, S.N.S. 2000, c. 4.

15 -14- at the rate of 16.67%.65 In computing the taxable income of the trust, the taxable capital gain is equal to % of the capital gain. A surtax ofl 0% is applicable to tax payable by the trust in excess of$1 0, This yields an maximum effective marginal Nova Scotian provincial tax rate on capital gains of approximately 12.22%. In its most recent budget, tabled May 2, 2000, the Province of Ontario announced the latest in their ongoing tax cuts. Ontario, like Nova Scotia, has shifted to a tax on taxable income system. The top marginal tax rate proposed by the Province of Ontario for 200 I, which presumably would apply to an inter vivos trust, is %. However, unlike Nova Scotia, Ontario has proposed to reduce its capital gains inclusion rate to 62% for 2001 and to 50% by Therefore, assuming that there are no other changes in Ontario, the maximum effective marginal Ontario provincial tax rate on capital gains will be approximately 8.70% in In its most recent budget, tabled February 23, 2000, the Province of Alberta also announced the latest in their ongoing tax cuts. Like Nova Scotia and Ontario, Alberta is also shifting to a system of tax on taxable income system, starting in 200 I. Alberta is proposing a flat tax on all of its resident individuals, which will presumably include trusts, of 11 %. This is subject to personal and spousal basic exemption thresholds which will not apply to trusts. Assuming that Alberta adopts the federal rate of capital gains inclusion of% of the capital gain, the maximum effective marginal Alberta provincial tax rate on capital gains will be approximately 7.33%. Therefore, a real tax savings may be available by a taxpayer in Nova Scotia establishing an alter ego or joint partner trust resident in Ontario or Alberta to hold assets which have appreciated in value. If the Nova Scotia resident dies and they are subject to the deemed disposition rule in ss. 70(5) on assets which have an accrued capital gain of$i,ooo,ooo, then the estate will be liable for a Nova Scotian provincial tax liability of$122,200 on the terminal return as a result of the gain. If that same resident died after 2003 having previously established an alter ego trust in Ontario, the trust would have an Ontarian provincial tax liability of$87,000. If that same resident died having previously established an alter ego trust in Alberta, the trust would have an Albertan provincial tax liability of $73,300. It is worth note that Nova Scotia has adopted the general anti-avoidance rule contained in s. 245 of the Act 67 and may attempt to challenge the transfer of assets to an alter ego or joint partner trust resident in another province. We are unaware of any cases considering the general anti-avoidance rule in the context of provincial tax shifting to date. 65 Ibid, SS. 7(b) and s Ibid, s Nova Scotia Income Tax Act, s. 100.

16 -\5- POTENTIAL PITFALLS OF ALTER EGO OR JOINT PARTNER TRUSTS TESTAMENTARY TRUST PLANNING As noted above, both alter ego and joint partner trusts are inter vivos trusts and are taxed at the highest marginal rates. 6 ' As noted earlier, alter ego and joint partner trusts may serve as a substitute method for testamentary disposition. If those same assets are left to surviving heirs through a trust created by a will, then the income earned by the testamentary trust 69 on those assets is taxed on the graduated marginal rate system rather than at the top marginal rate. 70 This allows an heir to effectively "income split" with a testamentary trust, minimizing overall tax payable. If the wishes ofthe settlor of an alter ego or joint partner trust include such income splitting for their heirs then it is advisable to leave some assets in the name of the settlor to be transferred to the heirs creating named testamentary trusts. The contingent beneficiaries of the alter ego or joint partner trust could then be the same named testamentary trusts created by the will. Upon the death of the settlor, the trustees of the alter ego or joint partner trust could then wind up the trust and transfer the capital of the trust to the named testamentary trusts.71 In a technical interpretation, the Canada Customs and Revenue Agency allowed that it would consider that such a transfer from an inter vivos trust to a named testamentary trust would not disqualify the recipient trust as a testamentary trust Supra, note Defmed in ss. I 08( I). A testamentary trust will become an inter vivos trust if property has been contributed to the trust otherwise than by an individual on or after the individual's death and as a consequence thereof pursuant to para. (b) ofthe definition of a testamentary trust and the definition of an inter vivos trust also found in ss. 108(1). 70 Ss. 117(2). 71 This would occur on a rollover basis pursuant to ss. 107(2); however, the deemed disposition which occurs on death would serve to "bump" the cost base to the fair market value of the assets at the time of death, so only gains accrued subsequentto thattime are at issue. The trustto trust transfer would also attract the application of ss. I 04(5.8) which provides that the transferee trust would be forced to adopt the earlier deemed disposition date of itself and the transferor trust; again, this is largely irrelevant as the difference between the deemed disposition dates will be negligible as both are essentially measured from the date of the relevant death. 72 Canada Customs and Revenue Agency Technical Interpretation , Defmition of "testamentary trust", September II, Note that para. (b) ofthe definition oftestamentary trust clearly leaves open the possibility that someone other than the deceased individual could contribute to the trust without affecting its status, para. (b) refers to a contribution made by an "individual", which a trust is deemed to be for the purposes ofthe Act by ss. 104(2). Therefore, the legislative authority for such contributions by an inter vivos trustto a testamentary trust exists. Nonetheless, the ability to engage in this form of planning remains uncertain as the Canada Customs and Revenue Agency is not bound by its technical interpretations and no court decisions have been rendered to our knowledge on this point.

17 -16- An inter vivos trust has a year end of December 31. A testamentary trust is pennitted to select an off-calendar year, allowing for the potential deferral of tax payable. 73 If this deferral is important to the settlor then a conversion ofthe inter vivos alter ego or joint partner trust to a testamentary trust as described above may be carried out. PRIVATE INVESTMENT COMPANY PLANNING Many individuals hold shares in private investment holding companies. Frequently, the shares which are held have a relatively low cost base compared to the fair market value of the shares owing to appreciation in the securities held by the investment holding company. On death, the individual, assuming no rollover is available, reflects the taxable capital gain on their tenninal return. Once the securities are sold, the investment holding company also incurs a tax liability for the capital gain realized by the company. If no planning is undertaken then the same growth is ultimately taxed twice, once in computing the taxable capital gain arising on the death of the individual shareholder and once on the sale of the underlying securities by the investment holding company. One strategy to avoid the double taxation problem is to take advantage of the cost base "bump" provisions available on the winding-up of wholly-owned subsidiaries after the death of the controlling shareholder. The method avoids double taxation by allowing a successor corporation to increase the cost base ofthe underlying securities to the fair market value of those securities on the date of death. To achieve the "bump", all of the shareholders of the private investment company, including the estate ofthe deceased controller, must transfer their shares of the investment holding company to a newly incorporated company in exchange for shares having the same characteristics as the shares transferred.?4 The investment holding company would then be wound-up into the newly incorporated company. This would allow the newly incorporated company to designate that the cost of its non-depreciable capital property received on the wind-up be up to the fair market value of each such property as at the date of the death.?5 This method for avoiding the double taxation problem is not available if the controlling shareholder makes an inter vivos transfer of the shares to an alter ego or joint partner trust.?6 7J Ss. 104(23). 74 To defer the recognition of any inherent capital gains, elections must be filed pursuant to ss. 85(1), in form TZ057, within the time period specified by ss. 85(6), electing thatthe transfer occur, for each transferor of shares, at the cost amount of the shares to the transferor. 15 The designation is allowed by para. 88(1)(d). Please note that the designation may be made only up to the fair market value of the property acquired on the date control of the corporation was last acquired, which is deemed by para. 88(1)(d.3) to be the date of the death of the controlling shareholder. 76 The "bump" method is unavailable as no equivalent to para. 88(1)(d.3) has been proposed to deem an alter ego or joint partner trust to have acquired the shares ofthe investment holding company from a person who dealt at arm's length immediately after the death of the settlor.

18 -17- Another common strategy to avoid this double taxation is to wind-up the investment holding company within the first taxation year of the estate. 77 The winding-up of the investment holding company will result in the company incurring the tax liability on the appreciated value of the underlying securities,78 which the recipient shareholders are deemed to acquire at the fair market value on the date of the winding-up.'9 The estate becomes liable for tax on the resulting dividend received from the investment holding company. so If the executors so elect then the capital loss arising on the disposition of the shares of the investment holding companysi is deemed to be a capital loss of the deceased in their terminal year. S2 The effective result of this strategy is to "transform" the capital gain arising on death into a dividend, the tax liability for which is borne by the estate rather than the deceased taxpayer. The same potential for double taxation exists if shares of an investment holding company which have appreciated in value are transferred to an alter ego or joint partner trust. The solution is also the same; however, the provisions which are relied upon in implementing the solution differ. The loss carry back available under ss. 164(6) is only available to the executors of an estate, not to an alter ego or j oint partner trust. Nonetheless, an alter ego or joint partner trust is considered an individual for income tax purposes. Unlike an individual, an alter ego or joint partner trust does not cease to exist due to the death which creates the deemed disposition of the investment holding company shares. The alter ego or joint partner trust could cause the winding-up of the investment holding company. The same rules discussed above apply relating to the disposition of the underlying securities by the corporation, the receipt ofthose securities by the trust at a cost equal to fair market value, the receipt of the winding-up dividend by the trust, and the capital loss which is created for the trust. The capital loss created may be used to offset the capital gain realized by the trust as a result of the relevant death. This effectively allows up to three years for the wind-up to be undertaken due to the 77 This is not necessarily the same as saying within one year from the date of death in the event that the executors of the estate select a year end prior to the anniversary of death. 78 Para. 69(5)(a). 79 Para. 69(5)(b). 80 Ss. 84(2). The dividend and various corporate tax accounts relevant to the dividend are calculated in accordance with the rules found in ss. 88(2). 81 The "proceeds of disposition" of the investment holding company shares does not include any amount deemed by ss. 84(2) to be a dividend received on the winding-up pursuanlto para. 0) ofthe definition ofthat term found in s. 54. Therefore, a capital loss is created as the proceeds of disposition are less than the high cost base, created by the operation of para. 70(5)(b), of the investment holding company shares owned by the estate. is to be made. 82 Ss. 164(6). See Regulation 1000 for the time within which and the manner in which the election

19 -18- operation ofthe normal loss carry back rules if the shares are owned by an alter ego or joint partner trust. 83 Therefore, while the use of alter ego or joint partner trusts precludes the use of the "bump" strategy for double taxation avoidance, it should not preclude the use of the wind-up strategy to eliminate double taxation on gains realized in securities held by investment holding companies. In mct, a longer period to cause the wind-up to occur is available; however, the wind-up of the investment holding company must be undertaken before the shares of the investment holding company are transferred by the trust, either in accordance with trustee discretion or as a result of the winding-up of the trust. If this is not done the loss created on the wind-up of the investment holding company may not be used to offset the gain incurred by the trust as a result of the relevant death. If investment holding company shares are to be transferred to an alter ego or joint partner trust, it may be prudent to provide in the Trust Indenture that the relevant shares may not be transferred nor may the trust may not be wound-up until such time as the relevant company, or successor in title to the underlying securities if the transfer occurs on a rollover basis, is wound-up. RIGHTS & THINGS PLANNING In the year of their death, an individual is permitted to file a separate return of income with respect to certain amounts receivable. 84 This essentially allows the deceased access to a second set of marginal tax rates in respect of the "rights or things". Furthermore, the executors of the estate may choose to transfer such a "right or thing" directly to a beneficiary, 85 in which case the beneficiary is subject to tax on the value of the "right or thing" once realized. 86 This allows for an even greater deferral of the tax payable. If assets which may be considered an amount receivable for the purposes of ss. 70(2) are transferred to an alter ego or joint partner trust then the ability to file the separate return or make the direct rollover to a beneficiary is lost. CHARITABLE DONATIONS Finally, many individuals make provision in their will for a charitable donation. These charitable donations create a tax credit eligible to be claimed by the individual against their tax payable in the year of death and the immediately preceding year. 87 In those years, the maximum amount claimable 83 Para. III (2)(b). 84 Ss. 70(2). Please see IT-212R3, Income of Deceased Persons - rughts or things, March 21, 1990 as amended by Special Release dated July 26, 1995, for a description of assets which the Canada Customs and Revenue Agency considers as being eligible for this treatment. S5 Which transfer must occur prior to the time for filing an election under ss. 70(2). 86 Ss. 70(3). 87 Ss. \18.1(3) - (5).