Elimination of Graduated Tax Rates for Testamentary Trusts

The Department of Finance have recently released a consultation paper expressing their intention to eliminate graduated tax rates for testamentary trusts.

A testamentary trust is created in a Will and becomes effective on the date of the Will Maker’s death. The arrangement is that the Executor appointed in the will acts as Trustee to hold and manage the Will Maker’s property for the benefit of the beneficiaries named in the will. From a tax perspective, a testamentary trust is a taxable entity and, as such, must pay tax on the portion of its annual income that is not distributed to the beneficiaries. The current income tax regime allows for testamentary trusts to be taxed at graduated rates depending on which income tax bracket it falls under. For 2013, the graduated rates are as follows:

15% on the first $43,562 of taxable income
22% on the next $43,562 of taxable income
26% on the next $47,931 of taxable income
29% on taxable income over $135,054

Traditionally, testamentary trusts have been used as effective tools to minimize estate income tax and allow for income splitting by beneficiaries. A common example is the creation of multiple testamentary trusts in a will. The effect is that, on the Will Maker’s death, the estate income is split between a number of testamentary trusts so that each testamentary trust will have a minimal annual income and thus be placed in the lowest tax bracket possible.

The Department of Finance have expressed concerns that current tax planning around testamentary trusts raises issues of fairness and negatively affects government tax revenues. Accordingly, the Department of Finance have proposed to replace the graduated tax rates with a flat top-rate taxation for testamentary trusts. It is important to note that these proposals will not affect the tax roll over provisions for testamentary trusts to spouses and common law partners, nor will they affect the special tax rules applicable to testamentary trusts for the benefit of disabled persons and minor children.

The Department of Finance is inviting people to submit their comments regarding this change by email to trusts-fiducies@fin.gc.ca. The deadline for your submissions is December 2, 2013. We encourage you to voice your opinion.