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Trusts’ Issues – Trusts Series 3/6

In previous discussions, we covered the basic concepts of trusts and how they can naturally arise in everyday life. This article will focus on potential issues related to trusts and outline some fundamental ways to address them. We’ll explore common challenges that can occur when managing trusts and provide practical solutions to help navigate these situations effectively.

  • Will and Trust Document:

    • The trustee’s investment authority is primarily defined by the will or trust document. Only if the will or trust document is unclear or incomplete should the following rules be used for interpretation.

  • Standard of Care:

    • Trustees are typically required to act with the prudence of a reasonable investor, balancing the need for growth with the duty to preserve capital (Prudent Investor Rule).

  • Restrictions on Risky Investments:

    • Trustees should avoid high-risk investments and are often advised to invest in “blue-chip” stocks, meaning investments in reputable, financially stable companies.

  • Maintaining Pre-existing Investments:

    • Trustees are generally expected to maintain investments acquired by the testator during their lifetime, unless instructed otherwise by the will or trust.

  • Discretionary Authority:

    • Trustees may be given “carte blanche” (full discretion) to make investment decisions, but this must align with their fiduciary duty to the beneficiaries.

  • Professional Advice:

    • Trustees are encouraged to hire professional investment managers to ensure the estate is managed according to the best investment practices.

  • Compliance with Legislation:

    • Trustees must follow relevant legal frameworks, such as trust laws and investment regulations (e.g., Trustee Act in Ontario, which incorporates the Prudent Investor Rule).

The Ontario Trustees Act serves as a key legal framework for guiding trustees in managing trusts and investments. When a will or trust document is silent on certain matters, the Trustees Act provides default rules that trustees must follow. It outlines their duties and responsibilities, ensuring that trust assets are managed prudently and in the best interest of beneficiaries. Below are some of the key features of the Trustees Act that regulate trustee conduct and investment authority.

  • Default Investment Authority:
    • Provides guidelines for investment when the will or trust is silent on the issue.
  • Permissible Investment in Mutual Funds:
    • Trustees are explicitly allowed to invest in mutual funds under the Act.
  • Duty to Diversify:
    • Trustees must diversify trust investments, taking into account the needs of the trust and current market conditions.
  • Managing Business Interests:
    • When a beneficiary holds a significant business interest or investments through a holding company, trustees may need to adjust their duty to diversify according to the specific terms outlined in the will.
  • Delegation of Investment Authority:
    • Trustees are permitted to delegate investment responsibilities to an agent, provided that proper procedures are followed. The agent, however, cannot further delegate this authority.
  • Right to Sue:
    • Trustees and beneficiaries are entitled to sue an agent for any breach of duty in handling investments.

Ontario’s Perpetuities Act addresses the legal limitations on how long contingent interests in property can remain unvested. Its primary goal is to ensure that property does not remain tied up in trusts or estates for excessive periods, ensuring that assets are eventually distributed to beneficiaries. A key aspect of the Act is the “rule against perpetuities”, which requires all interests in property to vest within 21 years.

  • Perpetuity Period:

    • The “perpetuity period” is the time frame in which a contingent interest in property must vest (i.e., become an absolute right). Under the law, this period is generally 21 years, although in the context of a will, the period starts at the testator’s death and runs for 21 years after the death of the last relevant person involved. In other words, this rule allows for the interest in property to vest within another 21 years after the death of the last surviving person (life in being) who was alive when the interest was created. For instance, if a will specifies that property should pass to the testator’s grandchildren when they reach the age of 30, but at the testator’s death, some grandchildren are not even born yet, the clock starts ticking from the death of the last surviving grandchild alive at the time of the testator’s death. Once that grandchild dies, the interest must vest within 21 years.

  • Wait and See Rule:

    • The Act introduces a flexible “wait and see” approach to determine whether contingent interests will vest. This rule eliminates the automatic voiding of gifts due to the mere possibility of vesting outside the perpetuity period. Instead, gifts are treated as “presumptively valid” until actual events demonstrate whether the gift vests within the 21-year period.

      • If the gift cannot vest within 21 years, it becomes void.
      • If the gift can vest beyond 21 years, it remains valid.

      This approach prevents gifts from being voided prematurely based on hypothetical concerns and allows for more practical, event-driven decisions regarding the validity of interests.

Taxes and Deemed Disposition
According to s.104(4) of the Income Tax Act, after 21 years, trusts are deemed to have disposed of their assets at fair market value. This rule triggers capital gains taxes, ensuring that any appreciation in the value of trust assets is taxed by the government at the end of the perpetuity period.

Application in Wills and Estate Planning

  • Flexibility in Gifting:
    • The “wait and see” rule is particularly useful for estate planning, as it gives trustees time to evaluate whether a gift can vest within the legal period, avoiding the strict consequences of voiding gifts based on uncertainty.
  • Managing Contingent Interests:
    • Trustees are encouraged to be mindful of the perpetuity period when managing estate assets. If the interests don’t vest within the 21-year period, they must be treated as void.
  • Accumulation of Income:
    • Trustees may reinvest trust income, but they must be careful not to accumulate income for more than 21 years, as doing so would violate the rule and render the accumulation void.

In summary, the Perpetuities Act ensures that contingent interests are resolved within a reasonable time frame while offering flexibility with the “wait and see” rule. This prevents unnecessary invalidation of gifts and aligns trust management with real-world events, ensuring fairness for beneficiaries. At the same time, trustees must be aware of tax implications and the limits on accumulating income to manage trusts effectively.

“Accumulations” in a trust context refers to the practice of reinvesting excess income generated by trust assets rather than distributing it to beneficiaries. While this is a common practice, there are legal limitations on how long trustees can accumulate income, particularly in Ontario, governed by the Accumulations Act.

Key Points on Accumulations in Trusts:

  • Reinvestment of Income:

    • Trustees may be instructed to distribute a portion of the trust income and reinvest the remaining portion.

  • Legal Limitations:

    • Under Ontario’s Accumulations Act, income cannot be reinvested beyond the 21st anniversary of the testator’s death. Any instruction to reinvest income beyond this period is void.

  • Void Directions:

    • If directions to reinvest income violate the legal limit, the excess income will pass as if there were an intestacy, meaning it is distributed as per intestate succession laws.

  • Drafting Wills:

    • To avoid legal breaches, will drafters should include specific limiting clauses that ensure trust income is distributed after the maximum accumulation period ends.

    • Example wording in a Will: “After the legal maximum accumulation period, the trustee shall distribute the net income to the beneficiaries.”

  • Income Tax Considerations:

    • Post-2016 tax reforms impose the top marginal tax rate (currently 53.53%) on accumulated income in trusts. This means if the trustee accumulates income, the trust may face significant tax liabilities unless distributed.

  • Exceptions:

    • Testamentary trusts for beneficiaries eligible for the disability tax credit are exempt from the top marginal tax rate rule.

Practical Example:

  • A trustee invests $200,000 in a GIC generating $10,000 annually.
  • If $2,000 is paid as an admin fee and $8,000 is distributed as a dividend, no tax is owed by the trust.
  • If the entire $10,000 is reinvested, the trust will owe tax at the top marginal rate of 53.53%, paying $5,353 to the CRA and reinvesting the remaining $4,647.

Understanding these rules ensures that trustees effectively manage trust assets without breaching legal accumulation limits or incurring unnecessary tax burdens.

The Saunders v. Vautier (1841) rule allows beneficiaries to collapse a trust if they are of legal age and have full ownership rights. In this famous British case, the court ruled that if all beneficiaries agree, they can demand the trust assets before the trust’s designated termination date, effectively bypassing any trust restrictions. This principle has been upheld in Canadian law, including Robinson v. Royal Trust Co. (1939) and Guest v. Lott (2013).

  • Beneficiaries’ Rights:

    • If all beneficiaries are adults and agree, they can demand the immediate distribution of the trust assets, even if the trust document specifies a later distribution date.

  • No Delayed Enjoyment:

    • Under the rule, beneficiaries cannot be forced to wait for the specified event (such as reaching a certain age) to receive their inheritance if they have absolute ownership rights.

  • Avoiding the Rule:

    • A smart method the testator can do is to provide the same gift to another beneficiary if the original beneficiary dies before a date or event. This clause creates a condition making the gift not absolute. This means, to prevent beneficiaries from using the Saunders v. Vautier rule to gain early access to trust assets, the will or trust document should include a condition that:

      If the primary beneficiary dies before a certain date or event, the assets will then go to someone else (a gift over).

      This means the beneficiary doesn’t have full control or an absolute gift, because their right to the assets is conditional. If something specific doesn’t happen (like them surviving until a certain time), the assets will pass to another person or group. This setup creates a situation where the beneficiary’s interest is contingent upon certain conditions, and other people also have potential interests in the trust assets, which blocks the beneficiary from claiming the entire asset prematurely.

Important Notice:

This blog series offers readers a basic understanding of the concept of “Trust.” It does not constitute legal advice from our firm. If you encounter any trust-related matters, it is essential to consult your lawyer. As always, it is best to leave professional matters to the professionals.