Written By Jared Mackey and Spencer Brown
Bare trusts across Canada could soon be required to file annual returns with the Canada Revenue Agency, or face large penalties for failing to report.
On February 4, 2022, the Canadian federal government released draft legislation to implement a variety of proposed tax measures, many of which are discussed in separate Bennett Jones insights. In this piece, we discuss the government's update to the new reporting regime for Canadian resident trusts first announced in the 2018 Federal Budget. While the bulk of the draft legislation implementing the new reporting regime was anticipated and consistent with prior releases, the current proposals significantly expand the reporting requirements to include bare trusts.
Overview of Bare Trusts
A bare trust is generally a trust relationship with the following characteristics:
- the trustee has no significant powers or responsibilities and can take no action without instructions from the settlor regarding any aspect of the trust;
- the trustee's only function is to hold legal title to the property; and
- the settlor (or settlors) is the sole beneficiary and can cause the property to revert to them at any time.
Bare trusts are frequently used in Canada in variety of commercial and personal contexts, including:
- to minimize property transfer taxes and fees in real estate transactions where there is a change in the beneficial owner but no change to the nominee corporation holding legal title;
- to hold securities and funds in trust, including publicly-traded shares, bonds, or options, legally registered in a broker's name;
- to administer joint ventures and partnerships where a nominee holds legal title to a property on behalf of a group of owners;
- to facilitate corporate reorganizations where the legal ownership of property may otherwise need to be transferred and registered through multiple entities;
- to enable the immediate transfer of beneficial ownership between parties where legal or regulatory impediments prevent a contemporaneous transfer of legal title; and
- in estate planning, to minimize the fees, costs and time associated with probate.
For purposes of the new reporting rules, the government defines a bare trust as "an arrangement under which [the trustee] can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust's property". The scope of the definition is potentially very broad.
The Reporting Requirement
Despite their prevalence, bare trust relationships have traditionally been ignored for income tax purposes and their existence is generally not reported to the CRA. All dealings with the trust property are attributed to the settlor/beneficial owner who is the relevant "taxpayer" and who must personally report all income, losses, terminal losses, recapture, gains, etc. in respect of the property. The proposed amendments deal only with reporting obligations and will not alter the income tax treatment of any bare trust.
The new reporting regime will require most Canadian resident express trusts and bare trusts to file a T3, Trust Income Tax and Information Return, commencing in their first taxation ending after December 30, 2022. It would appear that bare trusts will be required to maintain notional calendar taxation years (even if they are terminated earlier in the year). As a result, assuming the proposed amendments receive Royal Asset later this year, bare trusts would generally be required to file a T3 return by March 31, 2023 (i.e., 90 days after their taxation year ending December 31, 2022).
Under the new rules, the T3 return must include a schedule providing the names, addresses, dates of birth, tax residences, and taxpayer identification numbers for the settlor, the beneficiaries, the trustees and anyone who has the ability to exert influence over the trustees, subject to limited exceptions. In the case of bare trusts, this would include identification of the bare trustee and the settlors/beneficiaries.
Potential Exceptions to Reporting Obligations
As the current and new trust reporting regimes do not extend readily to bare trusts, bare trustees will require additional guidance from the government to confirm the circumstances in which they are not required to file a return. Certain bare trusts may benefit from a carve out from the reporting regime in a particular calendar taxation year if:
- they exist for less than three months in the year;
- they hold no property other than cash, certain government debt obligations and certain listed securities, and the property's value does not exceed $50,000 at any point in the year; or
- they are terminated prior to their calendar taxation year end (bare trustees should exercise caution as this potential relief has not been confirmed by the government).
Notably, under existing trust reporting rules, Canadian resident trusts are required to file a T3 return if they have tax payable, have a taxable capital gain, or dispose of capital property, in a particular taxation year. Since bare trusts are generally disregarded and dealings with the trust property are attributed to the beneficial owners, it is unclear whether these alternative conditions for filing a return will extend to bare trusts.
Penalties for Failure to File
The potential penalties for failing to file a return are severe. Existing penalties for failing to file a T3 return by the due date, and for failing a distribute trust-related information slips, will continue to apply. In addition, the new reporting regime proposes a severe penalty on a person who knowingly, or under circumstances amounting to gross negligence, makes a false statement or omission in a T3 return, fails to file a return when required, or fails to comply with a demand to file a return. This potential penalty is equal to the greater of: (1) $2,500; and (2) 5 percent of the highest fair market value of the trust property throughout the year.
Under the current proposals, the trustee or bare trustee (i.e., the person having "ownership or control" of the property) would be the person required to file a return and thus the one potentially liable for a penalty if the return is not filed. Unless the trustee has obtained an indemnity in the relevant trust declaration document, any CRA imposed penalty could result in a significant unrecoverable loss. For example, in the case of a corporate bare trustee holding legal title to a commercial office building in Vancouver worth $30 million, failure to file a return could potentially expose the trustee to a penalty of $1.5 million.
The new reporting regime remains subject to revision and the government has invited taxpayers to provide comments on the draft proposals by April 5, 2022.
Members of the Bennett Jones Tax Group are available to discuss how the proposed amendments may affect your tax compliance obligations or to assist you with crafting a submission to the Canadian government.