A friend tells me that he used a family trust to multiply the use of the lifetime capital gains exemption and saved a lot of tax on the sale of his business. Is a family trust useful for my business?
There are many types and uses of trusts. In essence, a trust is a contractual relationship in which one or more persons (trustees) hold property on behalf of another group of persons (beneficiaries). Family trusts, also known as discretionary family trusts, are a particular type of trust widely used to hold shares of private business corporations.
In the typical discretionary family trust, the trustees are the parents (and often one additional trusted friend or relative) and the income and capital beneficiaries are the parents, their children, grandchildren and remoter relatives, if desired. The trust acquires shares of the active business corporation pursuant to a corporate re-organization, resulting in income to the trust out of dividends from the corporation, and capital gains on disposition of the shares of the corporation. Since income and capital gains retain their character for tax purposes when distributed through a trust, significant tax savings may be realized when proceeds are distributed among family members whose marginal tax rates are lower, or to family members who have not previously used their lifetime capital gains exemption.
Discretionary family trusts also serve other purposes, including business succession and asset protection. If properly set up, a discretionary family trust may also be “unwound” simply and without adverse tax consequence. Under the Income Tax Act, a discretionary family trust is deemed to have disposed of its property every 21 years. This deemed disposition gives rise to a taxable capital gain within the trust, if the property has appreciated in value. Typically a discretionary family trust is wound up before 21 years to avoid the application of the deeming provision.
There are significant tax and legal complexities and traps associated with setting up and using discretionary family trusts. Legal and accounting advice should be obtained.