When creating a new discretionary family trust to own shares of a private corporation, the question is always asked:
Who should the income and capital beneficiaries be?
After going through the usual list of parents, children and possible grandchildren, the naming exercise typically grinds to a halt. But what if a corporation (“BenCo”) was added as an income and capital beneficiary?
Let’s take the situation where Dad is undergoing an estate freeze of his operating company (“Opco”). For estate purposes, Dad wishes that all of the future growth of Opco accrues to his family. Dad’s estate lawyer advises using a fully discretionary family trust to hold new Opco non-voting equity shares. To ensure Dad continues to run the show, he receives new Opco voting non-equity shares and Opco preferred shares that represent his current value in Opco. This can create a number of concerns that could be solved by allowing the trust to add BenCo as an income and capital beneficiary now or at a future date.
In general terms, if two corporations are connected (there are a number of income tax tests to meet), dividends can be paid between them on a tax-free basis. So, if Opco is connected to BenCo, dividends can be paid from Opco to the family trust and then on to BenCo free of tax. This achieves several advantages.
First, income splitting only goes so far. A plan could be put in place to pay the most tax advantageous amount of dividends to the family, with the residual being allocated tax-free to BenCo.
Second, if Opco generates significant amounts of cash that Dad doesn’t want to retain in Opco and also doesn’t want to pay it all to his family, BenCo could help. Opco could pay large dividends to the family trust, allocate the desired amount to the family and then pay the residual tax-free to BenCo.
Third, for the family to benefit from the capital gains exemption, Opco has to remain a “small business corporation”. This means that Opco cannot have excess non-operating cash. Paying excess cash as dividends to the family trust and then allocating them to BenCo tax-free would allow Opco to remain a small business corporation without the need to pay excessive dividends to the family.
The family trust has a taxable disposition of its Opco shares every 21 years. In order to avoid this disposition, the family trust could distribute its Opco shares to family capital beneficiaries on a tax deferred basis immediately prior to its first 21st year anniversary. But, this requires the family to now directly own Opco non-voting equity shares. Our experience is that this is often not the desired outcome for a variety of reasons.
However, if the family trust distributed its Opco non-voting equity shares to BenCo instead of the family, direct family ownership in BenCo may be deferred indefinitely. Depending on who owns BenCo, additional opportunities may also be available.
So what does all this cost?
BenCo is a corporation, so the additional annual costs include financial statements, tax returns and corporate filings such as an Annual Report.
21 years goes by fast – building greater flexibility into your corporate structure from the beginning provides for greater optionality when it is needed the most. Also, don’t forget about the additional protection from adding an arms-length corporate co-trustee – we discussed this in our February 14, 2017 blog post.
CrossonVoyer Trust Company brings an independent and informed perspective on trust and estate planning combined with the security of a regulated trust company.
CVTrustCo’s team of seasoned professionals work with you and your advisors to design and execute a tailored estate plan. CVTrustCo provides a range of fiduciary services and can act as the executor and trustee of your legacy, carrying out your estate plan as you intended.
The result: you will have a clear understanding of your options, a practical plan for your legacy, and the security and reliability of a financial institution acting as your power of attorney, executor and trustee.
Our estate planning posts consider estate planning issues at a high level. Before you commence any form of estate planning, please consult with tax and legal advisors