KHAKI LAW

Alter Ego and Joint Partner Trusts

alter ego trust

Table of Contents

What is a Trust?

The concept of a trust dates back to the 17th century when the Courts of Equity in England first recognized the separation of legal and beneficial ownership of property.

The trust is a method of property ownership in which the legal owner (the trustee) holds the property for the benefit of others (the beneficiaries). It is a legal relationship between the trustee and the beneficiaries. However, a trust is a separate legal entity and taxpayer for tax purposes.

To create a valid trust, there must be a certainty of intention, subject matter, and object (beneficiaries). 

A trust can either be a testamentary trust or an inter vivos trust.

A testamentary trust is one that is created on and as a result of death. They are often contained in a will but may also be found in other estate planning tools. The most common types of testamentary trusts are spouse trusts, long-term trusts for children, and disability trusts (Henson trusts). 

An inter vivos trust is one that is created during a person’s lifetime, while they are alive. The most common inter vivos trusts are an alter ego trust and a joint spousal or common-law partner trust (more commonly known as a joint partner trust).

For a full list of trusts, see the Canada Revenue Agency website.

What is an Alter Ego Trust and Joint Partner Trust?

Alter ego trusts and joint partner trusts are inter vivos trusts, meaning they are created during an individual’s lifetime. The only difference between the two trusts is that an alter ego trust is created by and for a single individual, whereas a joint partner trust is created by and for a couple. 

Alter ego trusts and joint partner trusts are, for tax purposes, considered separate legal entities to which you can transfer most or all of your assets on a tax-deferred or rollover basis.  

Upon the death of the creator of the trust, the trust is wound up and the trust property passes to the beneficiaries named in the trust. Since the assets are owned by the trust and not the deceased person, the assets do not form part of the deceased person’s estate on death and are not subject to the probate process in British Columbia.

 

Requirements to make a Alter Ego or Joint Partner Trust

Since January 1, 2000, Canadians who meet the below requirements have been able to create an alter ego trust or joint partner trust under the provisions of the Income Tax Act.

To qualify as an alter ego trust:

  • the creator of the trust (the “settlor”) must be a Canadian taxpayer 65 or older when the trust is created;
  • the settlor must be alive when the trust is created;
  • the trust must be a resident of Canada;
  • only the settlor of the trust must be entitled to income from the trust during their lifetime; and
  • no one other than the settlor must be entitled to receive or otherwise use any of the capital of the trust during the settlor’s lifetime. 
 
The joint partner has similar criteria as above with the exception that the settlor’s spouse must also be a Canadian resident and entitled to income during the spouse’s lifetime.
 
To create a joint partner trust, the settlor’s spouse does not have to be 65 years or older. If only one spouse is 65 years or older, they must be the settlor and the second spouse will not be able to transfer property to the joint partner trust on a tax-deferred basis even after they reach 65 years. If both spouses have reached age 65, one or both of the spouses may be settlors of the joint partner trust. Until both spouses have died, they or the survivor of them alone must be entitled to all income of the trust.

Tax Treatment of Alter Ego Trusts and Joint Partner Trusts

The tax treatment of an alter ego trust and joint partner trust in Canada is as follows:

The settlor has the option to transfer property to the trust on a tax-deferred basis, without incurring capital gains. Upon the death of the settlor (in the alter ego trust) or both the settlor and the settlor’s spouse (in the joint partner trust), there is a deemed disposition of the trust property and any capital gains will be captured in the trust and taxed at the inter vivos trust tax rate. 

Amendments to the Income Tax Act in 2017 substantially limited the kinds of trusts that may claim the principal residence exemption. However, alter ego trusts and joint partner trusts remain eligible to claim the principal residence exemption. 

The 21-year deemed disposition rule applicable to most trusts in Canada does not apply during the lifetime of the settlor (in the alter ego trust) or the settlor and the settlor’s spouse (in the joint partner trust). The 21-year deemed disposition rule applies only after the death of the settlor (in the alter ego trust) or the settlor and the settlor’s spouse (in the joint partner trust).

All income, capital gains and losses are taxable in the hands of the settlor (in the alter ego trust) or the settlor and the settlor’s spouse (in the joint partner trust), although attribution rules will apply to that income.

Benefits of an Alter Ego Trust and Joint Partner Trust

While alter ego trusts and joint partner trusts can be complex and costly to create, there are several reasons why you should consider using them.

1. Avoiding Probate

In British Columbia, a grant of probate must be obtained from the Supreme Court of BC to validate a deceased person’s will. Before the court can issue a grant of probate, probate fees must be paid.

In BC, probate fees are approximately 1.4% of the gross value of a deceased person’s estate.

For example, the probate fees on an estate with a gross value of $1 million are approximately $13,464. For an estate with a gross value of $5 million, the probate fees are approximately $69,464. 

The idea of saving thousands of dollars in probate fees, not to mention avoiding the legal costs and delays in obtaining a grant of probate, appeals to many clients.

Alter ego trusts and joint partner trusts effectively bypass the probate process because the assets are owned by the trust, not the deceased person. Therefore, the assets do not form part of the deceased person’s estate.

2. Blended Families

Alter ego trusts and joint partner trusts are especially useful tools in the blended family context. They may be appropriate where spouses have kept their assets separate and one spouse wants to provide ultimately for the children of their first marriage, but the well-being of their spouse is also a priority.

A joint partner trust may also be useful if both spouses want to provide for their respective children out of their commingled estate after both of them have died.

3. Reducing Potential Wills Variation Claims

Another major benefit of using an alter ego trust and joint partner trust is to avoid potential claims under the wills variation provisions of the Wills, Estates and Succession Act (“WESA”).

Under WESA, a spouse or child may challenge the validity of the will if they feel that the will has not made adequate provisions for them. The Supreme Court of BC has the authority to vary the will. However, WESA does not generally apply to alter ego trusts or joint partner trusts.

Transferring all or substantially all of your assets to an alter ego trust or joint partner trust means that when you pass your estate will not own any assets. The trust will be the owner of the assets. Since the wills variation provisions of WESA do not apply to trusts, you can avoid or reduce any potential wills variation claims made by unhappy family members.

4. Asset Protection from Creditors

An alter ego trust or joint partner trust can be used as a means of asset protection. Property held in any trust may be shielded from creditors of a beneficiary.

However, an alter ego trust or joint partner trust may not provide asset protection against a settlor’s general creditors. The creditor could challenge the transfer to the trustee under the Bankruptcy and Insolvency Act or Fraudulent Conveyance Act.

 

5. Privacy and Confidentiality

The probate process is public. Anyone may obtain filed court documents from a court registry in British Columbia. In contrast, alter ego trusts and joint partner trusts do not have to go through the public probate process.

The trust document is private and confidential. Only the individual(s) who created the trust, the trustees. and the beneficiaries are entitled to the trust document.

6. Centralized Asset Management

The probate process can be lengthy. It can take several months or even years if there are any claims made against the estate. Until the grant of probate is issued by the court, the executor cannot deal with the assets of the estate. That is, the executor cannot distribute the assets to the beneficiaries or sell the assets.

With an alter ego trust or joint partner trust, there is no probate required. Therefore, the trustee can immediately distribute the assets as per the terms of the trust document.

Drawbacks of an Alter Ego and Joint Partner Trust

While there are plenty of reasons you should consider creating an alter ego trust or joint partner trust, there are some disadvantages that you should be aware of.

1. Cost

Alter ego trusts and joint partner trusts can have significant upfront legal and accounting costs. Given the complexity involved in drafting these trusts, you will need both legal advice from a lawyer as well as tax advice from an accountant.

There are also ongoing legal fees and accounting fees. The trust may need to file a T3 Trust Income Tax and Information Return with the CRA. These tax returns will require an accountant. The fees for filing T3 vary but are around $300-$600 per year.

The trust will need to maintain records of income allocation and trust distributions.

Despite the upfront and ongoing costs, alter ego trusts and joint partner trusts can help reduce or eliminate probate fees. Therefore, depending on the total value of the estate, it often makes financial sense to create them. If the sole purpose of setting up an alter ego trust or joint partner trust is to avoid probate, we only recommend creating the trusts for individuals with estates worth more than $2 million.

2. Lack of Flexibility

Alter ego trusts and joint partner trusts can be more challenging to alter or amend compared to a will. Changes to the terms of the trust, including the beneficiaries, could result in adverse tax consequences. You will need to consult with both a lawyer and an accountant to provide legal and tax advice.

3. Lack of Ownership of Assets

One of the main benefits of creating an alter ego trust or joint partner trust is the avoidance of probate fees by transferring the assets to the trust. However, this also means that the legal ownership of the assets rests with the trustees.

It is standard practice to include the creators of the trust as trustees but it is also prudent to include another individual, such as a family member, appointed as a co-trustee. Therefore, depending on how the trust is drafted, the creators of the trust will have to share control over the assets with another person.

4. Charitable Donations

Donations to charity from an alter ego trust or joint partner trust may be permitted by the trust document but the applicable tax rules are less flexible than when a donation is made from an estate pursuant to a will.

The CRA generally takes the position if the trust deed provides for a charitable disposition following the death of the settlor, the charitable gift is not a gift but is instead a distribution from the trust. This will restrict the ability of the trust to obtain a donation tax credit.

However, if the trust document merely gives the trustee the discretion to make the gift, the CRA may accept that the trust can claim the donation tax credit. Therefore, if you wish to make charitable donations then the trust must be drafted carefully to ensure that the trust can claim any applicable donation tax credits.