An in-trust for (ITF) account is a convenient and popular tool for parents, grandparents and other adults to set aside funds for minor children. It can:
- Allow the account holder to make investment decisions on behalf of minor beneficiaries
- Enable the splitting of income for tax purposes
- Protect assets for a child
- Help inheritance arrangements because minors cannot directly accept a gift under a will.
How an ITF account is taxed can depend on a variety of factors. To help explain, we’ll run through what an ITF account is—and isn’t—before jumping into the tax implications and other important details.
What is a trust?
A trust outlines a relationship between three different parties, each with a specific role:
- A settlor: Transfers property to the trust and appoints a trustee
- A trustee: Has legal ownership of the property for the benefit of the beneficiaries
- A beneficiary: Is the beneficial owner of the property
For a trust relationship to exist, there must be proof of three certainties:
- Certainty of intention to establish the trust
- Certainty of trust property (subject)
- Certainty of beneficiaries (object)
How you provide evidence of each certainty depends on how the trust is set up.
ITF accounts vs. formal trusts.
The chart below highlights the differences between a formal trust and an ITF account (which can be an informal trust). With a formal trust, a written and properly executed trust deed evidences the three certainties and defines the terms of the trust. An ITF account on the other hand, can lack proper documentation around the certainties and how the funds will be managed. This can create confusion for the parties involved and make it difficult to prove the three certainties if required to do so by the courts or the Canada Revenue Agency (CRA).
|How is it established?||When does the beneficiary get the assets?|
|Formal trust||Through a written and properly executed trust deed that evidences the three certainties and includes the terms and conditions of the trust.||This depends on the terms of the trust, which will provide any discretionary powers of the trustee, as well as the age and other conditions the beneficiary must meet to be entitled to income of the trust.|
|ITF account||Through an investment or bank account. Often the account owner (settlor) is also the trustee. This can create unintended tax consequences for the settlor.||Once the beneficiary reaches the age of majority in their province.|
A note on inheritances
If an ITF account is set up to pass an inheritance to a minor beneficiary under a will, the terms of the will determine when the assets pass from the trust to the beneficiary, so the trust may be distributed to the beneficiary at date later than when the beneficiary reaches the age of majority. The one exception is for residents of Quebec, where the beneficiary is required to take ownership of the ITF assets at age 18.
How are ITF accounts taxed?
The CRA makes no distinction between formal trusts and informal trusts for tax purposes. Both are subject to the same tax rates and the same attribution rules under the Income Tax Act (ITA). Absent a formal trust deed, the CRA relies on available evidence, including the conduct of the parties, to determine whether the three certainties are present and a trust relationship exits. This is why documenting the certainties and terms of the trust is so important.
To get an understanding of how an ITF account is taxed, let’s first take a look at the attribution rules and then run through the scenarios.
The attribution rules of the ITA prevent income splitting with spouses and minor children where property is gifted to these family members directly or indirectly through a trust. With respect to minors, attribution applies to first generation income, but not to second generation income, income from third parties or capital gains. Where attribution applies, the income is taxed in the hands of the contributing adult as opposed to the minor child. Attribution ceases where the contributor passes away or becomes non-resident of Canada. Attribution does not apply to gifts under a will.
1. If a trust relationship is not established (all three certainties are not present) …
All income and capital gains will remain taxable to the original owner (the settlor).
This also includes situations where the CRA conducts a review and determines the ITF account is not a trust after the fact. If this occurs, all income and capital gains may attribute back to the settlor, resulting in arrears taxes and penalties in their hands.
2. If a trust relationship is established (all the three certainties are present) …
Income that is paid or payable to the beneficiary is taxed in the beneficiary’s hands at their marginal tax rates, unless it is subject to attribution rules under the ITA. Capital gains paid or payable to the beneficiary are taxed in the beneficiary’s hands at their own tax rates. Any income or where attribution applies, the amount is taxed in the hands of the contributor, at their marginal tax rates. Amounts neither paid or payable to the beneficiary nor subject to attribution are taxed in the trust at top marginal rates.
What happens upon the death of the settlor, trustee or beneficiary?
In the unfortunate scenario where one of the parties passes, the following rules will apply to determine ownership and who is responsible for any taxes:
1. If the settlor passes…
All future income earned in the account is taxable either in the trust or in the beneficiary’s hands where it is paid or payable to the beneficiary.
2. If the trustee passes before the beneficiary reaches the age of majority…
The trustee’s will should be reviewed to determine if an alternate trustee is named. If a new trustee is not found, the estate could maintain authority over the account until the beneficiary reaches the age of majority and takes control of the account.
3. If the beneficiary passes before reaching the age of majority…
The property falls to the beneficiary’s estate (assuming they don’t have a will). This means if someone opened an account for a minor who is not their child, they could lose control over the funds if the beneficiary dies.
Not having the proper documentation to establish the intentions of an ITF account can expose the various parties to unforeseen tax liabilities, or even legal action if the beneficiary feels the account has not been properly managed. Contributions into an ITF account are also irrevocable, meaning they cannot be returned to the settlor without serious consequences, so it’s best to make sure all parties have a clear understanding of their roles and responsibilities.
It’s worth noting there are alternatives to an ITF account, each with their own merit. These include:
- Setting up an RESP for education savings
- Simply paying for certain expenses for the child or grandchild during your life
- Contributing to a TFSA once the beneficiary turns 18.
Whether an ITF account or the above alternatives are best depends the resources, goals and objectives of all parties involved.
If you’re looking for more tax and estate planning tips, CI Global Asset Management’s Tax, Retirement and Estate Planning Team has a variety of online tools and resources.
This communication is published by CI Global Asset Management (“CI GAM”). Any commentaries and information contained in this communication are provided as a general source of information and should not be considered personal investment advice. Facts and data provided by CI GAM and other sources are believed to be reliable as at the date of publication.
Certain statements contained in this communication are based in whole or in part on information provided by third parties and CI GAM has taken reasonable steps to ensure their accuracy. Market conditions may change which may impact the information contained in this document.
Information in this communication is not intended to provide legal, accounting, investment or tax advice, and should not be relied upon in that regard. Professional advisors should be consulted prior to acting based on the information contained in this communication.
You may not modify, copy, reproduce, publish, upload, post, transmit, distribute, or commercially exploit in any way any content included in this communication. You may download this communication for your activities as a financial advisor provided you keep intact all copyright and other proprietary notices. Unauthorized downloading, re-transmission, storage in any medium, copying, redistribution, or republication for any purpose is strictly prohibited without the written permission of CI GAM.
CI Global Asset Management is a registered business name of CI Investments Inc.
©CI Investments Inc. 2021. All rights reserved.