CRA national project regarding domestic trusts

The past six weeks have been very busy with attending and speaking at various conferences.  At three of the conferences (Institute of Chartered Accountants of Alberta Tax Roundtable, Canadian Tax Foundation Prairie Provinces Conference and the STEP National Conference) the CRA was in attendance answering various questions posed by practitioners.  The topic of domestic trusts was high on the agenda for questions posed by practitioners.

In the midst of attending the above-noted three conferences, the CRA made it known that a national project on the review of domestic trusts commenced in 2005 and ended in the 2007 and 2008 fiscal year.  The CRA noted, from its review, the following recurring issues involving domestic trusts:

  1. Domestic trusts had inappropriately deducted trustee/investment fees in the computation of its taxable income;
  2. Certain of the domestic trusts had entered into transactions whereby the character of its income had been changed so as to avoid the incidence of “kiddie tax”.  Often times this would involve an otherwise dividend being characterized as a capital gain, since capital gains are not subject to the “kiddie tax” (the “kiddie tax” is an informal phrase to describe certain income that is ultimately taxed at the highest tax rate to the extent that it is allocated from a trust, in this example, to a minor beneficiary);
  3. Certain of the trusts had entered into transactions whereby the capital gains deduction applicable for qualified small business corporation shares or a qualified farm property had been multiplied amongst various beneficiaries;
  4. The trust did not have any evidence of paying income or making the income payable to the beneficiaries.  To the extent that such income is not paid or made payable to the beneficiary then the trust would not be able to deduct such income in the computation of its income; and
  5. Certain of the attribution rules (such as sections 74.1, 74.2 and subsection 75(2)) applied to the trusts.

The CRA made it known that they would be taking a national approach to their review of trusts once again and, in particular, looking for the above noted issues.  Accordingly, practitioners and clients should be aware and be prepared. Trust records should be immaculate and attention paid to detail when entering into tax planning involving domestic trusts.

This subject will get more attention in the coming months and years and, accordingly, Moodys is exploring the possibility of having a special seminar to discuss the pending audits of domestic trusts in the fall.  Stay tuned…