12 Mar Family Trusts: Legislative Changes and Continuing Benefits

Family Trusts: Legislative Changes and Continuing Benefits

Family Trusts remain an important planning tool for many Canadian families despite legislative changes introduced in recent years. This article outlines key tax rule changes, ongoing reporting requirements, and the planning benefits that still make Family Trusts valuable for business owners and succession planning.

Legislative changes introduced by the federal government in 2017 prompted many individuals to reconsider the benefits of establishing a Family Trust (“FT”). This article outlines several of these legislative changes and highlights the key advantages that continue to make FTs a valuable planning tool.

Although this article focuses primarily on the tax benefits associated with FTs, it is important to note that trusts also offer several significant non-tax advantages, including:

• Confidentiality
• Control over assets
• Reduction of probate fees
• Succession planning flexibility

Dividend Streaming / Income Splitting

Prior to the introduction of the Tax on Split Income (“TOSI”) rules, it was common for private corporations owned by a FT to pay dividends to the trust and allocate those dividends among adult family members. In many cases, family members who were not actively involved in the business were able to receive dividends. This allowed families to shift income from higher-income earners to lower-income earners, thereby reducing the overall tax burden of the family unit. This strategy was commonly referred to as “income sprinkling.”

Effective January 1, 2018, however, the TOSI rules were expanded to apply to individuals over the age of 18. These rules significantly limit the ability of private corporations to split income with family members who do not meaningfully contribute to the business or who are not actively involved in its operations.

While certain limited exemptions remain available, the ability to income split has been substantially reduced (though not entirely eliminated) following the implementation of these rules. Any income subject to TOSI is taxed at the highest personal marginal tax rate, effectively eliminating the tax advantage previously achieved through income sprinkling.

Multiplication of the Lifetime Capital Gains Exemption (“LCGE”)

As of January 1, 2026, the Lifetime Capital Gains Exemption (“LCGE”) is $1,250,000 and is expected to be indexed for inflation in future years. This means that up to $1,250,000 of capital gains arising from the sale of shares of a qualifying small business corporation (“QSBC”) may be received tax-free by an individual. Each individual taxpayer is entitled to claim their own LCGE.

Where QSBC shares are held by a FT and subsequently sold by the trust, the realized capital gains may be allocated to one or more beneficiaries. Each beneficiary may then claim their own LCGE, to the extent that it has not previously been used.

Example Scenarios

Scenario 1
Assume an individual disposes of shares of A Co. (a QSBC) for proceeds of $2,500,000, with a nominal adjusted cost base. Subject to certain limitations, the individual may apply the LCGE of $1,250,000 to reduce the taxable capital gain from $2,500,000 to $1,250,000.

Scenario 2
Assume the same facts as above, except that the shares of A Co. are held by a FT with two beneficiaries, Individuals A and B. If the FT sells the shares for $2,500,000, the resulting capital gain may be allocated to the beneficiaries at the discretion of the trustee. If Individuals A and B each receive $1,250,000 of the capital gain, they may each apply their LCGE. As a result, the total capital gain of $2,500,000 may be fully sheltered.

Maintaining QSBC Status

To access the LCGE described above, certain criteria must be met, including the requirement that the corporation qualify as a QSBC. QSBC status is also important because taxable capital gains from the sale of QSBC shares are generally exempt from the expanded TOSI rules.

A FT may also assist in maintaining QSBC status by facilitating the management of a corporation’s asset composition in a tax-efficient manner—a process often referred to as “purification.”

For example, a private corporation with excess cash may distribute a dividend to the FT, which can then allocate the dividend to a corporate beneficiary. This strategy may assist the corporation in meeting the asset composition tests required for QSBC status.

Generally, dividends paid from a private corporation through a FT to a corporate beneficiary are treated as inter-corporate dividends and may therefore be received on a tax-free basis.

Succession Planning

Family Trusts are commonly used as part of a comprehensive succession plan, as they can facilitate the transfer of wealth to future generations in a tax-efficient manner.

The use of a discretionary FT within a private corporate structure offers several advantages, including control over trust assets (such as shares of a private corporation), potential reductions in estate taxes upon death, and the ability to distribute trust assets to beneficiaries on a tax-deferred basis.

Control

When a discretionary FT is established, trustees are appointed to administer and manage the trust. The trustees exercise control over the trust and its assets in accordance with the trust deed.

Deemed Disposition on Death

Upon death, individuals in Canada are generally deemed to have disposed of their assets at fair market value (“FMV”) for tax purposes. Where the FMV exceeds the asset’s adjusted cost base, this deemed disposition may trigger a capital gain and corresponding tax liability in the estate. Assets held within a FT are not subject to this deemed disposition in the same manner, which may reduce the tax burden on an individual’s estate.

Transfer to Beneficiaries

Capital property (including shares of a private corporation) may generally be distributed to Canadian-resident beneficiaries of a FT at its tax cost, allowing the transfer to occur on a tax-deferred basis.

Together, these features enable a structured and tax-efficient transfer of wealth to future generations while helping to mitigate estate tax exposure.

New and Ongoing Trust Reporting Requirements

Beginning in the 2023 calendar year, expanded reporting requirements were introduced for trusts. These changes include:

1. Reduced exemptions from filing a T3 Trust Income Tax and Information Return (“T3 Return”), resulting in most trusts being required to file annually.
2. Mandatory disclosure of additional information, including personal details of the settlor, trustees, and beneficiaries.
3. New penalties for failure to file or comply with these reporting requirements.

In addition, while administrative relief was temporarily provided for the new reporting rules applicable to Bare Trusts introduced in 2023, these rules are expected to apply fully beginning in the 2026 taxation year. As a result, Bare Trusts will generally be required to file a T3 Return together with the applicable disclosure schedules.

Learn More

Interested in learning more about Family Trusts and whether they are appropriate for your situation? Curious about the new trust reporting requirements or what constitutes a Bare Trust?

Contact us to discuss your circumstances with our team.