Understanding Bare Trusts
What Are The New Tax Reporting Requirements?
Within the past decade, bare trusts have become an increasingly common tool to avoid probate fees and land transfer tax, as well as retaining privacy. However the new tax reporting requirements are critical to understand in order to avoid fees and penalties and to remain compliant with current rules.
The federal government is trying to “counter aggressive tax avoidance as well as tax evasion, money laundering and other criminal activities”.
The rules require the trustee (individual who holds the legal title) of a bare trust to file a T3 trust return every year. With these new reporting requirements, bare trusts will also be required to report the name, address, date of birth, jurisdiction of tax residence, and other information about their trustees, beneficiaries, settlors, and anyone else with direct influence (control) over the trust.
With these new rules, trusts have 90 days after the year end to file their return. There is a late filing penalty of $25 per day (with a minimum penalty of $100 and a maximum of $2500). However in cases of gross negligence or when the trust knowingly failed to file a return, there is a penalty of 5% of the trust’s value (minimum penalty of $2500).
It’s important to note that as of March 28, 2024, the Canada Revenue Agency announced that bare trusts are exempt from trust reporting requirements for 2023. It is expected that bare trusts will be required to report for 2024.
What Is A Bare Trust?
A bare trust is a particular type of trust typically used to hold legal title of real estate. Ownership of the property is split between legal and beneficial ownership, where the original owner of a property transfers the legal title to a bare trustee or nominee, while retaining full control and ownership of the property. The bare trustee does not have any responsibility, discretion, or independent power over the property. Their sole responsibility is to carry out the instructions that the owner has written for them in the bare trust indenture - it is a type of ‘agency’ relationship.
A bare trust is a principal-agent relationship, which means the trustee’s actions are controlled by the beneficiary of the bare trust.
Previously, proper use of a bare trust allowed the trustee to transfer legal title to the beneficiary upon the original owner’s death. Because the trustee already has the legal title of the property, it would avoid probate fees.
Probate Fees are a death tax. Probate is the court process required before a deceased person’s probatable assets can be transferred. A deceased person’s estate must pay these fees after the individual's death, and it’s generally calculated as a percentage of the total estate value.
In British Columbia and Ontario, probate fees on a $2,000,000 property are roughly $28,000. In Nova Scotia, you’d be paying over $33,000. Bare trusts were one method employed to avoid this tax.
Tax Filing Compliance Requirements of a Bare Trust in Canada
Filing A Tax Return
Previously, bare trusts were not required to file a tax return and were generally ignored by the Canada Revenue Agency for income tax purposes. The beneficial owner of the property was required to report any income, gains or losses. All income and capital gains or losses were reported on the beneficiaries’ tax return and taxed in their hands, not in the hands of the trust.
This is a significant difference to (and advantage over) a regular trust such as an inter vivos trust. Although there are tax strategies that can be utilized by an inter vivos trust, any income or capital gains taxed in the hands of the trust will be taxed in the highest marginal tax bracket. In British Columbia, the trust would be giving over half its income to the government (53.5%), though in practice most family trusts will make annual distributions to the beneficiaries, such that the income is taxed in their respective hands (and at their respective marginal tax rates).
However, there are new changes in effect for the tax years ending after December 30, 2023. The trustee (individual who holds the legal title) of a bare trust must file a T3 trust return every year. With these new reporting requirements, bare trusts will also be required to report the name, address, date of birth, jurisdiction of tax residence, and other information about their trustees, beneficiaries, settlors, and anyone else with direct influence (control) over the trust. The CRA has been planning to implement this requirement for several years now, and this was supposed to have been in place for the 2023 tax year, but got scrapped days before the deadline.
There are some very limited exclusions to the filing requirements; the main exclusion will be bare trusts which hold less than $50,000 in assets.
Filing Penalties
With these new rules, trusts have 90 days after the year end to file their return. There is a late filing penalty of $25 per day (with a minimum penalty of $100 and a maximum of $2500). However in cases of gross negligence or when the trust knowingly failed to file a return, there is a penalty of 5% of the trust’s value (minimum penalty of $2500).
It’s important to note that as of March 28, 2024, the Canada Revenue Agency announced that bare trusts are exempt from trust reporting requirements for 2023. It is expected that bare trusts will be required to report for 2024.
What Are The Advantages Of A Bare Trust?
Taxation
Bare trusts do not have their own tax liability, unlike traditional trusts. All income or capital gains and losses are allocated to the beneficiary for tax purposes. With a traditional trust, any income or capital gains and losses that are not made payable to beneficiaries is taxed within the trust in the highest marginal tax bracket.
If the beneficiary made $100,000 of income via the assets in a bare trust, they would be paying $28,076 of taxes (assuming they live in British Columbia and made no other income that year). However if this income was earned and taxed in an inter vivos trust, the total tax payable would be $53,500. Your family would save over $25,000 because you utilized a bare trust, presuming that no distributions were made from the family trust in this example.
Deemed Disposition
If you transfer a property title without beneficial ownership to a bare trustee, it is not a deemed disposition and you won’t trigger any capital gains tax implications.
Trusts are a very effective estate planning tool. However, one of the disadvantages of a trust is that when you transfer assets to a trust, it is deemed that you have sold those assets and you would be responsible for paying taxes on the capital gains. So when you’re utilizing a trust to achieve your estate planning goals of paying less probate fees, reducing your final tax return balance, or planning a seamless transition for your loved ones, you do actually have to pay for it in the moment by way of tax. Bare trusts help in this scenario by not triggering capital gains on the transfer.
Asset Protection
Trusts are a great way to protect your assets from creditors. With regards to a bare trust, you may be the beneficial owner in the sense that you benefit from all the income or capital gains earned from this property, but since you are not the legal owner, creditors generally can’t possess this property in a legal battle.
Land Transfer Tax
In British Columbia, you must pay property transfer tax (unless you qualify for an exemption) when you purchase or gain interest in a property.
The tax rate is as follows:
1% of the fair market value up to and including $200,000
2% of the fair market value greater than $200,000 and up to and including $2,000,000
3% of the fair market value greater than $2,000,000
There is a further 2% applied to residential properties with a value of over $3,000,000.
With the average home price in Greater Vancouver being $1,318,617, you would be paying $24,372.34 in property transfer tax. The use of bare trusts may allow you to avoid this tax upon the transfer of the legal title.
What Are The Disadvantages Of A Bare Trust?
Taxation
Because all income is taxed in the hands of the beneficial owner, this can end up increasing your family’s overall tax bill if the beneficial owner is in a high marginal tax bracket.
Income generated in an inter vivos trust can be made payable to its beneficiaries. This is a very common estate planning and income splitting tool. For example, if you are in a high marginal tax bracket while you’re spouse is in a lower one, you can transfer assets to a trust, with your spouse as a beneficiary, and have your spouse pay taxes on the income that is generated by the assets (note there are complicated tax on split income rules, please reach out to us if you need further information on this topic).
With a bare trust, this would not be possible as the income is taxed in the hands of the beneficial owner.
New Filing Rules and Compliance Costs
The new legislation regarding bare trusts now requires trustees to file a tax return. Trust returns can cost $1000-$1500 to prepare, and must be done each year. This will significantly change the cost-benefit analysis when deciding if a bare trust is right for you.
There is also less privacy with these new rules, as bare trusts must disclose the names, dates of birth, addresses, tax residences, and taxpayer identification numbers for the settlor, the beneficiaries, the trustees, and anyone with direct influence over the trustees.
Additionally, trustees must take extra time and care to familiarize themselves with the new compliance rules. As previously mentioned, there are significant penalties if a trustee fails to comply.
The use of Bare Trusts has become more complex. Consequently legal and accounting fees will be higher.
Should You Use A Bare Trust?
There are different situations where you might consider using a bare trust.
Principal Residence Exemption
A pretty common example is when you want to help your child get a mortgage. If your child wants to buy their first home, they may have trouble getting a loan from the bank unless someone else (a parent for example) signs as a joint owner or a 1% owner in a tenants-in-common relationship. You probably don’t intend to be an actual owner of the property, however you would still be responsible for the taxable capital gains on the portion that you own, if your child ever sells the property.
The principal residence exemption allows Canadian homeowners to avoid paying taxes on capital gains when they sell their primary residence. However, for your child to claim this exemption and for you to avoid paying taxes on a house you don’t technically own or live in, you would need to show that you are a bare trustee and your child is the owner. This would be accomplished by entering into a bare trust arrangement where the 1% tenants-in-common share that you hold is as trustee only, with the beneficial ownership resting with your child.
Now, if there is no bare trust agreement, and you pass away while your child still owns and lives in their primary residence, your estate would be responsible for paying probate fees on the value of your ‘ownership stake’ in the property. Additionally, the beneficiaries of your estate could inherit the portion of ownership of your child’s house. This could become problematic depending on your family's relationship dynamics.
Eliminating Probate
Another common example of when you want to consider a bare trust is if you want to add your child as an owner of your property to avoid the probate process and fees when you pass away. When you pass away, you want to claim the principal residence exemption. If you’ve added your child as an owner of your property, you might not have proof you are the owner of the property in order to claim the exemption. A bare trust will clearly outline who the owner of the property is, helping resolve this potential issue.
However a larger issue here is that without a bare trust agreement, it’s becoming very more common to see a litigation battle ensue after death. Let’s say you add your child as an owner of your property without a bare trust agreement. It would not be surprising if the other beneficiaries of your Will sue the child who you named as owner of your property to legally determine who the owner of your property is and if they (the beneficiaries of your Will) are entitled to the property. This can be a costly process with legal and court fees, as well as emotionally costly as family relationships may be permanently severed after a court battle.
Lastly, you may also want to consider using a bare trust when the value of your real estate is large enough to where the probate fee savings are significant. British Columbia, Ontario and Nova Scotia have the highest probate fees ranging from 1.37% to 1.63% of the estate value.
Conclusion
Bare trusts are used to hold a legal title of real estate, where ownership of the property is split between the legal and beneficial ownership. The bare trustee holds the legal title of the property, but does not hold any power. Their sole responsibility is to carry out the instructions that have been written for them in the bare trust indenture. Bare trusts can be a useful tool in tax and estate planning, although care must be taken to avoid fees and penalties and to remain compliant with current rules.
It is crucial to speak with a qualified legal professional if you are considering a bare trust. Here at Parr Business Law, we have qualified lawyers who can provide you with more information and assist you in setting up a bare trust if it’s right for you. We specialize in all areas of estate planning so please don’t hesitate to reach out.
