Blog: Allocation of a Capital Gain to a Beneficiary of a Trust

November 30th, 2016 GST/HST/QST and taxable benefits – The 2016 deadline is approaching

Overview

The use of a discretionary family trust is a common tool to multiply the lifetime capital gain deduction ($824,176 for 2016) available upon the sale of Qualified Small Business Corporation Shares (“QSBC shares”).  In general, since the trust is a conduit, it allows a capital gain to retain its source when allocated to a beneficiary.  More specifically, flow-through treatment applies in respect of taxable capital gains realized by a trust and then designated as taxable capital gains to its                                                                                                    beneficiaries.

Where such capital gain represents gains from the disposition of QSBC shares, access to the life time capital gain deduction can be multiplied in respect of each such beneficiary eligible to claim the deduction.  Therefore, the use of a trust provides the conduit through which to flow or designate such capital gains and thereby multiply the tax savings associated with the capital gain deduction.

An owner of a QSBC may freeze in favour of a family trust.  The freezor’s spouse and children may be beneficiaries of the family trust (the discussion of the income attribution rules which may be applicable in such situations is beyond the scope of this article).

In a situation when a “freezor” of a QSBC wants his or her spouse or children to use their own lifetime capital gain deduction to minimize the trust’s overall tax bill and thus benefit from the multiplication of the capital gain deduction, it should be noted that the taxable capital gain must be paid or payable to the spouse or child.  The spouse or child then becomes the owner of 50% of the gain.  The spouse or child can, therefore, claim from the trust an amount of up to 50% of the capital gain.

Example

 

Trust Beneficiary (Child A) Beneficiary (Child B)

 

$ $

$

Proceeds – sale of QSBC shares

1,600,000

Adjusted Cost Base

Capital Gain

1,600,000

Designation to Beneficiary

(1,600,000) 800,000

800,000

Capital Gain Deduction

(800,000)

(800,000)

Taxable Income

nil nil

nil

Taxes Payable nil nil

nil

 

As stated above, the tax legislation requires only  the taxable portion of a trust’s capital gain be paid or payable to a beneficiary in order to permit the beneficiary to utilize their lifetime capital gain deduction.

Accordingly, in the above example, $800,000 of the $1,600,000 capital gain must be paid or payable to the two beneficiaries in order for both beneficiaries to fully access their capital gain deduction. The remaining $800,000 of the capital gain forms part of the capital of the trust to be distributed at the discretion of the trustees.  Thus the trustees of the trust can allocate and distribute the non-taxable portion of the capital gain to the freezor.

About the Author:

Sergio Di Marco, CPA, CGA, D. Tax. is a Senior Tax Manager at Crowe BGK.

Connect with him: s.dimarco@crowebgk.com

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