By Katherine L. Ratcliffe and Glenn ZoBell
In 2018, the Department of Finance Canada (“Finance“) proposed certain amendments to the Income Tax Act (Canada) (the “Act“) to establish new reporting requirements for trusts. As discussed here, the proposed legislation would impose a requirement for most express trusts to file annual tax returns (not currently required for some trusts, such as those with no income or other transactions to report); introduce new obligations to disclose information about settlors, trustees, beneficiaries, and others with a measure of control over trust property; and levy a penalty for non-compliance. By the end of 2021, the year in which the amendments were meant to take effect, the proposed legislation still had not been passed, leaving accountants and other tax advisors in a state of uncertainty as to how to advise trustees on their 2021 tax filing and information disclosure obligations.
Acknowledging the need for clarification, Finance issued an update on January 14, 2022, confirming that the proposed legislation is pending and “the [Canada Revenue Agency (“CRA“)] will administer the new reporting and filing requirements once there is supporting legislation that receives Royal Assent.” Until then, the CRA will continue to administer the existing rules for trusts under current legislation, and the proposed reporting requirements will not be part of the published 2021 T3 income tax return.
On February 4, 2022, Finance posted a further update: a new set of draft legislative proposals and explanatory notes have been released, including revised reporting requirements for trusts, applicable for taxation years that end after December 30, 2022. While the new proposals are largely the same as those announced in 2018, one change that will have a significant impact on both taxpayers and tax practitioners is the newly proposed amendment to subsection 104(1) of the Act.
Among other things, subsection 104(1) currently provides that, with a few exceptions, references in the Act to a “trust” are deemed not to include an 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. This type of arrangement is commonly referred to as a “bare trust” and involves a person (the bare trustee) holding legal title to property on behalf of and for the benefit of another person (the beneficial owner). The bare trustee is not expected to make decisions or take any action with respect to the property, except at the direction and expense of the beneficial owner. Because the relationship between the bare trustee and beneficial owner is closer to that of an agent and principal rather than a trustee and beneficiary, bare trusts are generally disregarded for the purposes of the Act; the property is considered to be owned by the beneficial owner, who must report any income received from the property in their tax returns.
Under the proposed legislation, subsection 104(1) is amended, and new subsection 150(1.3) is introduced, to provide that bare trusts will be subject to section 150 of the Act, which outlines the rules for the filing of returns of income under the Act. Accordingly, if these new proposals are passed, bare trusts will be subject to the new filing and disclosure requirements for trusts.
Bare trusts are commonly used in a variety of situations, including to hold real property, shares of corporations, or other investments in circumstances where a transfer of legal ownership may not be necessary, practical, or beneficial. The proposed changes would reverse the established tax treatment for bare trusts, which many taxpayers have relied upon in structuring their affairs. If the proposals are enacted, a vast number of bare trust arrangements currently in existence will either have to be reorganized or the parties will need to engage accountants to prepare annual tax returns to comply with the new requirements. Of note, these tax returns will duplicate information that will still have to be reported in the beneficial owner’s tax returns, meaning the beneficial owner’s annual compliance costs will be increased essentially to report the existence of the bare trust arrangement to the CRA every year. Failure to comply (which could foreseeably arise from a lack of awareness of these changes on the part of the beneficial owner) may result in the application of material penalties (the greater of $2,500 and 5% of the highest total fair market value of all the property held in the bare trust in the year). Each of these scenarios represents an increased cost to the taxpayer, which begs the question: what is the policy rationale for this change? (a question that is not addressed in the accompanying explanatory notes).
Finance is accepting comments on the proposed legislation until April 5, 2022. We will continue to monitor the evolution of these proposals and provide updates as information becomes available.