A question regarding the use of an alter ego trust (or a joint partner trust) as a charitable remainder trust was raised at the CRA roundtable at the 2010 CALU Conference (CRA document number 2010-0359461C6). Generally speaking, a charitable remainder trust (“CRT”) is a trust that is set up to provide an income stream to one or more individuals, usually for their respective lifetimes, and that names one or more charities as the ultimate beneficiary (i.e. the capital beneficiary), of the property held by the trust. The term “charitable remainder trust” is not defined in the Income Tax Act. As such, CRTs are not currently treated as a separate type of trust for the purposes of the Act. The current tax treatment of CRTs is based on the general rules applicable to charitable donations and the taxation of trusts.
In its Registered Charities Newsletter #27, the CRA states the following concerning setting up a CRT:
Generally, a charitable remainder trust involves transferring property to a trust whereby the donor or beneficiary retains a life or income interest in the trust, but an irrevocable gift of the residual interest is made to a registered charity. A registered charity can issue an official donation receipt for the fair market value of the residual interest at the time that the residual interest vests in the charity.
To qualify as a CRT, the terms of the trust cannot allow for any capital encroachments. The transfer of property to the CRT must also be irrevocable.
An alter ego trust is a trust that is defined in the Income Tax Act. To qualify as such, the settlor of the trust must be at least 65 years of age at the time the trust is created, the settlor must be entitled to receive all of the income earned in the trust during his or her lifetime and the settlor must be the only person entitled to any of the capital of the trust prior to the settlor’s death. A joint partner trust is similar, but the beneficiaries are the settlor and the spouse or common-law partner of the settlor.
Generally speaking, when an individual transfers property to any type of trust, there is a disposition of the property transferred at fair market value and any resulting capital gain is taxable to the transferor. Where property is transferred to a CRT (or to a charity for that matter), there is an election available under the Income Tax Act that allows the transferor to choose the value of the property transferred for the purposes of calculating any gain. The transferor can elect a value between the cost of the property and its fair market value. Where the transferor elects at cost, this will ensure that there is no capital gain on transfer. With respect to alter ego trusts, whether they qualify as CRTs or not, when a settlor transfers property to an alter ego trust, there is a rollover available under the Act which allows the transfer to occur without triggering any capital gains. As such, when a transfer is made to a CRT that is also an alter ego trust, there is no need to make the election discussed above because of the available rollover.
In the question put to the CRA at the CALU 2010 Roundtable, the CRA confirmed that the transfer of property to an alter ego trust that was also a CRT could occur without triggering a capital gain and that a donation receipt could be issued by the charity that is named as the ultimate beneficiary of the CRT. This receipt must be issued for the value of the charity’s residual interest in the trust, and in most cases this will require a professional valuation.
In a later technical interpretation that refers to this question at the CALU 2010 Roundtable (CRA document number 2010-0369261E5), the CRA was asked whether an individual’s claim for a donation tax credit as a result of a gift to a CRT would be limited if immediately after the gift the individual and the trust are affiliated. The concern is the application of what are known as the “non-qualifying security rules” in the Income Tax Act, which the CRA points out were designed to defer the opportunity for certain donors (i.e. individuals not dealing at arm’s length with their corporations) to receive a tax benefit by making gifts to charity of securities in those corporations. Under these rules, the tax benefit associated with making a gift to charity is generally restricted unless the charity disposes of the security or the security ceases to be a non-qualifying security. The CRA states that it is a question of fact whether the non-qualifying security rules will apply to a gift in this context. The CRA provides the following example: the non-qualifying security rules would apply where a donor transferred to an alter ego CRT a share of a corporation that was, immediately after the transfer, a corporation with whom the donor was not dealing at arm’s length. Similarly, if a donor transferred a beneficial interest of the donor in a trust that was, immediately after the transfer, affiliated with the donor, the non-qualifying securities rules would also apply.
These are complicated provisions that require careful planning to ensure they are utilized properly. We would be happy to provide advice to both donors and charities dealing with CRTs (whether alter ego or otherwise) and gifts of complicated property to such trusts.