This week on Hull on estates, Ian and Suzana discuss Sham and Secret Trusts.

Comments? Send us an email at hull.lawyers@gmail.com, call us on the comment line at 206-350-6636, or leave us a message on the Hull on Estates blog.

Sham and Secret Trusts - Hull on Estates Podcast #105

Posted on April 8^th, 2008 by Hull & Hull LLP

Suzana Popovic-Montag: Hi and welcome to Hull on Estates. You’re listening to Episode #105 of our podcast on Tuesday, April 8^th, 2008.

Welcome to Hull on Estates, a series of podcasts for the Canadian legal community dealing with issues and insights surrounding estate planning in Canada.   Hosted by the lawyers of Hull & Hull, the podcast will touch on some key considerations when planning estates and Wills.  Now, here are today’s hosts.

Ian Hull: Hi Suzana, its Ian Hull here.

Suzana Popovic-Montag: Hi and it’s Suzana Popovic-Montag. How are you today?

Ian Hull: Just great. We’re celebrating what, 105 now? We haven’t been doing this since 100 so good to be back, good to think about some issues that have been rumbling around in my mind. Just want to remind everyone to feel free to call in to our call-in number at 206-350-6636.

Suzana Popovic-Montag: Or you can drop us an e-mail at our gmail address which is hull.lawyers@gmail.com. Or, of course, you can visit us at our blog which is estatelaw.hullandhull.com.

Ian Hull: So Suzana, I know that when this launches into the internet, we are going to both actually be out of the country. I’m not going to be as nearly as exotic a spot as you are. But you’re off to Vienna and Prague to test the world markets on estate law and on law generally at a great conference. What your trip triggered in my mind was I thought we might have a discussion today about was issues that have, sort of, a broad and international perspective. And that, of course, ties into trust law generally. Where you’re going, both jurisdictions in Prague, it’ll be slightly different, I think it’s more of a civil code, but the Vienna system as well you’re going to be tied into the – learning a lot about the civil code. But the common law and where to cross the border is governed, trust laws are fairly consistent. And one of the things that they use tremendously in planning in Europe is, of course, trusts to avoid what can be very draconian and overwhelming tax liabilities on death. The classic scenario, certainly in the U.K., that a lot is written about and much case law comes out of, is situations where you create a trust that isn’t really a trust and we call it, of course, sham trusts. Another scenario is, of course, where you might have a situation where you created a secret trust or a semi-secret trust. So I thought it might be fun to talk a little bit about those angles on trust law.  And why don’t we start with the sham trust, if that’s ok.?

Suzana Popovic-Montag: That’s great, Ian and I know you’ve written quite a bit on this topic and I think it’s a really interesting one. It doesn’t necessarily – it isn’t necessarily something that we see a lot of but it definitely is something that is on the rise in terms of the literature that’s out there. What a sham trust really is and I guess the best way to, sort of, start with a description of it, is to start with the concept of a bare trust which is a simple trust in that the trustee is a repository of the trust property and he or she or it has no real active management duties to perform.

Ian Hull: And, of course, we’re talking about sham trusts, trying to essentially avoid sham trusts because if it is called a sham trust, then CRA and, of course, the Courts won’t give you the protections nor the tax advantages that may or may not exist. So your comment about the bare trust is crucial because that can be a useful and legitimate tool to create a trust relationship. There are, of course, really the opposite to a trust, proper trust with the three certainties or a bare trust as you’re describing, which is a proper trust with the three certainties only with a see-through flow-through in terms of the responsibilities. The opposite would be the sham trust itself. And that’s where the Courts and CRA get a little fussy about it.

Suzana Popovic-Montag: And on the face of it, it really does appear to be a trust in the sense that there is a trustee, there is a beneficiary and equitable rights are created in those beneficiaries.

Ian Hull: So in a situation where a sham trust has been held by the Court, a trust has been held to be a sham trust and not legitimate for the purposes being sought, is where the Court finds that the only real duty of the trustee is to do what the settlor says. And I know that’s sort of a bit vague but the Courts often go on and say well, you know, they describe these sham trusts as pretend trusts.

Suzana Popovic-Montag: And they do that because the common intention of the parties in these kinds of circumstances, the Court will find, is that it was not to actually create a trust with its associated rights and obligations.

Ian Hull: And really the Court just gets frustrated and a little cranky with people who create these sort of trust arrangements because they see them as an act or a document that is intended to mislead third parties.

Suzana Popovic-Montag: And I know sometimes the cases will actually go so far as to say and I’m just quoting from one of the cases that I am thinking of, that it’s an illusion basically, that it’s calculated to lead the tax collector, i.e. CRA, away from the actual tax payer. And so what it ultimately does is creates this façade of a reality of a trust, when in fact there isn’t one.

Ian Hull: Alright, so let’s talking about determining if it is a sham trust and what the Courts will look at.

Suzana Popovic-Montag: Well I think the first thing that they start with, of course, is the actual terms of the trust.

Ian Hull: And then they tend to talk about it being really a question of control.

Suzana Popovic-Montag: And in that sense, you know, it seems to be that they’re looking at whether or not the settlor has maintained control notwithstanding the fact that a trust has, on the face of it, been established.

Ian Hull: And one of the tests that I’ve seen in the case law is that the Courts will say, is the trust a mere alter ego of the settlor and that’s all?

Suzana Popovic-Montag: Now, Ian, I think we sort of understand the concept of a sham trust.  And what would you say would be sort of a good example of that, that you’ve seen recently or where people would want to try to create these situations and then ultimately not be successful because a Court finds that, in fact, it’s not a valid trust?

Ian Hull: Well the classic one that we see in Canada is the off-shore trust. Of course, off-shore trusts can be a good idea, they’re not all sham trusts, for sure. They create excellent tax planning, estate planning and creditor protection availability for wealthy clients. But if it’s not done correctly, you do create the difficulties that a Court from another jurisdiction will be looking through the trust and determining whether or not it is a sham.

Suzana Popovic-Montag: And I guess that sort of underscores the importance of working possibly with counsel in the jurisdiction where you’re trying to establish that trust, as well, in order to create something that hopefully will sustain the test by a Court.

Ian Hull: And, of course, and you know again, talking about the positives, is these trusts, the bare trusts in particular, can be a useful tool, these off-shore trusts can be useful tools, they create a tremendous amount of ability for wealthy clients to have confidentiality.  And while they have to in Canada, of course, declare their worldwide income, they don’t necessarily have to have it openly documented for others to see what exists and where it exists.

Suzana Popovic-Montag: And so there definitely are advantages to it. But what would you say would be a consequence of the fact that it’s a Court or someone who would ultimately determine, I guess CRA, that it isn’t in fact a valid trust?

Ian Hull: Well I think the key is, I mean many times these sham trusts are established for tax reasons. But the trust… where the Courts, what the Courts will do is, is that they’ll say, if it is indeed a sham trust, the trust assets are then taxed as if it was in the hands of the settlor. So, you know, any of the advantages that you may have tried to create are lost.

Suzana Popovic-Montag: And I guess most importantly, the creditor protection and, I guess, as well the loss of confidentiality to some extent, as well.

Ian Hull: For sure and I think that’s  – you know, in many situations, a bit of a deal breaker.

Suzana Popovic-Montag: I think if we just spend a couple minutes, we’ve got some time here, Ian, to turn to the concept of secret trusts. And I know I’ve heard you speak about them in the past and you say, you know, what they really amount to is taking the trust concept as we understand it at law and then becoming, you know, agent 007s.

Ian Hull: Absolutely. It’s the James Bond trust. And this trust, if done properly, can be a useful tool to again, it doesn’t elude CRA, but it might elude people who want to keep their assets more confidential and it’s an on-shore opportunity and an off-shore.  But it’s an on-shore opportunity to create a situation where the assets transfer from the settlor or a testator, depending if it’s someone who’s passed away, to a beneficiary, but through a third party.

Suzana Popovic-Montag: And the advantage there is that, of course, trusts can remain private documents, whereas Wills are potentially very public. And so if you’re trying to create an arrangement where you’re providing for a beneficiary-trustee relationship without it necessarily being known by everyone, you try to create this kind of secret trust arrangement.

Ian Hull: That’s right. And I mean, so the client really in this situation wants to make a gift but the nature of that gift they do not want to make public for whatever reason. And I think of an easy illustration was one that I ran into on a case that talked about a situation where the individual had a lot of wealth, wanted to pass on some of that wealth to the child after death, didn’t want the child really – not that the child should know, but didn’t want the public to know just how wealthy that child was going to be, because he feared people would prey on that child and try to take advantage of that child’s financial circumstances.

So the steps were to leave it through to a third party, hold it on a secret trust, the terms of which we’ll talk about in a moment here.  But the terms of which are disclosed properly and then the identification of the terms of the trust can, sort of, hold their own.

Alright, so we’re just about winding up, but I just want to remind, sort of, when I think about it, I’m reminded of the secret trust because the key is, is that the trust is typically not reduced in writing, the trustee will typically keep the money for him or herself, which obviously creates its own problems, but it is one that you need to have in some way, either through provisions of the Will or some way, articulated what the terms of the trust are.

Suzana Popovic-Montag: And that really is the key because this arrangement, by very virtue of the fact that it is a secret one, has to somehow be, as you say, reduced to provide the settlor with as much guarantee or as much protection as possible, in light of the fact that, you know, there are these inherent difficulties with it.

Ian Hull: So, in conclusion, you need, sort of, the essential ingredients to pull off a secret trust, is of course, you need a trust with the three certainties.

Suzana Popovic-Montag: And you also need an intention of the deceased to actually benefit the secret beneficiaries.

Ian Hull: You need communication of the trust terms to the trustee and/or the beneficiary.

Suzana Popovic-Montag: And thirdly, you want to have acceptance by the trustee or the beneficiary which is going to be sufficient to actually induce the testator not to execute a Will to that effect.

Ian Hull: Terrific. Okay well, thank you very much, Suzana, good to be back on Hull on Estates. Hope that was certainly interesting for me to review these reasonably unique trust questions, but they do pop up from time to time and can be an important part of an estates practice. So I remind everyone to feel free to call in to our call-in number, 206-350-6636.

Suzana Popovic-Montag: Or, of course, feel free to send us an e-mail at hull.lawyers@gmail.com or visit our blog and webpage at estatelaw.hullandhull.com. Thanks very much, Ian

This has been Hull on Estates with the lawyers of Hull & Hull.  The podcast you have been listening to has been provided as an information service.  It is a summary of current legal issues in estates and estate planning.  It is not legal advice and you are reminded to always talk with a legal professional regarding your specific circumstances.

To listen to other podcasts, or to leave a question or comment, please visit our website at www.hullandhull.com.

Our theme music is Upper Structure by DJ AKid  and is courtesy of the Podsafe Music Network.

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Rolling Assets Into Trust - Hull on Estate and Succession Planning Podcast #84

Posted on October 30^th, 2007 by Hull & Hull LLP

Suzana Popovic-Montag:  Hi, and welcome to Hull on Estate and Succession Planning.  You’re listening to Episode #84 of our podcast on Tuesday, October 30^th, 2007.

Welcome to Hull on Estate and Succession Planning, a series of podcasts hosted by

Ian Hull and Suzana Popovic-Montag, that will provide information and insights into estate planning in Canada, from the offices of Hull Estate Mediation in Toronto, Ontario, Canada.  Here are Ian and Suzana.

Ian Hull:  Hi Suzana.

Suzana Popovic-Montag:  Hi there Ian.  How are you?

Ian Hull:  Just terrific thanks.

Suzana Popovic-Montag:  That’s good.  Already for Halloween?

Ian Hull:  Almost.

Suzana Popovic-Montag:  That’s good.

Ian Hull:  Nothing like leaving it till the last minute.

Suzana Popovic-Montag:  That’s what we do these days.

Ian Hull:  Well, we were in the last podcast, we were sort of rounding up on our issues relating to inter vivos trusts but we also talked a lot about designations of beneficiaries.  So why don’t we talk a little bit about RRSPs and some tax issues surrounding them.

Suzana Popovic-Montag:  That’s a great idea, Ian, because we know basically that RRSPs and RRIFs, the Registered Retirement Income Funds, are deemed at law to be disposed of on death at fair market value.  And it’s the Income Tax Act that provides for that, that says, you know, on death, there’s a disposition.

Ian Hull:  So to be clear then, the value at death is the fully taxable income of the year in the year of death itself.  So it can be a big hit in terms of the tax burden and from that standpoint, the tax burden is typically paid out of the residue of the estate.

Suzana Popovic-Montag:  That’s right.  There is, though, an exception that arises in circumstances where the proceeds from the RRSP can qualify as a refund of premiums.

Ian Hull:  Well that’s right, and that’s a good point.  That doesn’t always arise in these situations but something we should also consider. 

Alright, so now just talking about this deferring tax with RRSPs.  The proceeds themselves qualify as refunds of premiums only though if they’ve been paid to a surviving spouse or common-law spouse or a financially dependent child or grandchild.  So that’s how we get into this area of exceptions where we don’t have to pay this, what can be an enormous deemed disposition tax.

Suzana Popovic-Montag:  And if there is a beneficiary designation that’s actually in favour of one of those eligible persons that you talked about, Ian, the surviving spouse, the common-law partner, or some financially dependent child or grandchild, then the proceeds are actually going to be paid directly to that beneficiary as this refund of premiums.

Ian Hull:  Well that’s interesting.  And that’s a really important, almost akin to the rollover idea.  They call it as income tax can only do something different but it’s the same in terms of its effect.  So if the RRSP proceeds paid to the estate qualify as a refund in premiums and if they’re allocated to and are distributed by the executor to the eligible person, then we aren’t looking at that draconian and quite painful deemed disposition payment.

Suzana Popovic-Montag:  And what will happen in those circumstances is that the refund of the premiums is going to actually be included in the income of the recipient in the year that it’s received, as opposed to being included in the estate.

Ian Hull:  Okay. Now you were talking about the spouse or common-law partners and I mentioned this whole rollover idea.  How does that work again?

Suzana Popovic-Montag:  Well the spouse or common-law partner can put that refund of premiums into their own RRSP if they are under the age of 69, or into an RRIF or other annuity contract and then defer the tax, pursuant to the provisions of  the Income Tax Act.

Ian Hull:  And one thing that is not always considered and a bit little known, so to speak, is that dependent children or grandchildren may also use this refund of premiums to purchase a fixed term annuity to the age of 18 or something of that nature in terms of a financial instrument product and again, hopefully deferring this tax.

Suzana Popovic-Montag:  And Ian, when we talk about children or grandchildren who are dependent on the deceased, what are we talking about?

Ian Hull:  Well, it’s a good question because there’s a lot of to and fro on this issue and there’s certainly a lot of cases out there.  But in terms of looking at it from Revenue Canada’s standpoint and CRA’s standpoint, a child or a grandchild who is dependent because of a physical or mental infirmity is one that has to qualify in that sense.

Suzana Popovic-Montag:  I see.

Ian Hull:  So that kind of a situation, of course, and, you know, we can identify physical or mental infirmity fairly broadly, then that child can transfer the refund of premiums into this RRSP or the RRIF or the life or term annuity.  And all of this allows us to give some good tax deferral for someone who clearly would greatly benefit.

Suzana Popovic-Montag:  And thinking in turning to the next, we have sort of a deferring tax, there’s also a tax that arises on capital gains, and I thought maybe we could just talk about that a little bit.

Ian Hull:  For sure, because this is the thing we talked about trusts and those other instruments that we were using before.  But this is an important consideration because the deemed realization of capital property at fair market value is done immediately prior to death in terms of the calculation.

Suzana Popovic-Montag:  So you’re saying, Ian, then that when someone passes away, there’s this deemed, you know, realization of a capital property. So everything they own suddenly is deemed to have been disposed of, and if it was disposed of at a value greater than what it was purchased for, then that’s that capital gain we’re talking about taxing?

Ian Hull:  That’s right.  And it’s, I mean, it really is, it’s a bit of an artificial moment in time because obviously when you die, you haven’t got a fair market value, you haven’t got an instant value there but, you know, say you own a cottage property or a chalet in addition to your house because the house is a principal residence and treated slightly differently.  But say you’ve got a second property, the deemed disposition occurs on the date of your death.  Well, this cottage may not be sold for another three generations, who knows.  So you have to go back and work up what that is, as you say, in terms of the growth and the capital tax payable.

Suzana Popovic-Montag:  And in these circumstances, the deferral of the tax or a rollover of the property could be done.  And I think in that case then, it’s adjusted cost base, which is available to people so that on these transfers to a spouse or to a qualifying spousal trust, there is this deferral essentially of tax.

Ian Hull:  Right.  And we talked about in earlier podcasts why we would set up trusts.  Well this is one of those situations where you are essentially rolling the asset into or assets, say there’s an investment account or a bank account, and then a cottage.  You’re rolling it into this spousal or qualifying spousal trust, therefore, and as you say, it’s at the cost base, the adjusted cost base.  So you’re really allowing for an important deferral and one that can be very important because spouses and certainly when you want to do some estate planning, maybe one spouse has more assets than the other or the like.  And you want to make sure that that surviving spouse isn’t hit with a heavy burden of tax or too heavy of a burden of tax.  And this rollover goes a long way to avoiding that.

Suzana Popovic-Montag:  And so the idea then, just so I understand it, really is that on the date of a spouse’s death, there’s a deemed realization of all property.  So capital property in this case, which will generate either a capital gain or a capital loss.  And instead of paying tax on it at that moment of time, provided that the deceased has planned his or her affairs properly, then that gets transferred over to the surviving spouse, or to that surviving spouse’s trust?

Ian Hull:  That’s right.

Suzana Popovic-Montag:  Oh, that’s great.

Ian Hull:  So now, let’s sort of talk a little bit about what that is.  I mean, we’ve talked about the concept generally but let’s talk about what it is to be, how do you qualify as a spousal trust?

Suzana Popovic-Montag: Well in that situation, the surviving spouse has to be entitled to all of the income during his or her lifetime.  So we talked about previously that a trust usually has a breakdown between the income beneficiaries and the capital beneficiaries and to be a qualifying spousal trust, there is that requirement that all the income specifically goes to the spouse and no one else.

Ian Hull:  And that is so crucial.  I mean what CRA says is that if you’re going to do this and you’re going to take advantage of it, we’re only going to give it to certain situations and that is to a surviving spouse.  So if you allow for anyone else to get at the income from this trust, you’re going to create problems.  We’ll talk about those problems in a few minutes but the idea is, is that you restrict who gets the benefit.

Suzana Popovic-Montag:  And I’m presuming that’s what they refer to as “tainting” the spousal trust.

Ian Hull:  That’s right.  And because as the rules are clear in the Income Tax Act, only the surviving spouse can have use of the income or the capital, to be fair.  You can also, the surviving spouse if the trust is set up properly, you can also use the income and then maybe you need another $10,000 or something to buy a new car or something, you’re allowed to pull capital out as well.  But the key is, is that it’s only the person…the question is, is that whose benefit is the money going to?  And like you say, this whole idea of tainted and it will be tainted or it will not be an effective, proper spousal trust if you have anyone else able to access that money.

Suzana Popovic-Montag:  So either the income or the capital during the spouse’s life?

Ian Hull:  Right.  Now, it’s interesting, like for example, what a lot of trusts will have is a contingent interest which is that there’s a possibility of someone else getting access to it.  And say you say, well the income and capital can go to my surviving spouse or my daughter, Betty.  And if you have that kind of language in the trust, you’ve changed it.  It is no longer a truly spousal trust in the mind of CRA.

Suzana Popovic-Montag:  And so the idea really is to be careful when those trusts are being drafted so that, as you say, a contingent interest doesn’t somehow taint the trust.  And I imagine the same would be the situation if there’s a direction in the trust to pay the income until death or remarriage, which is kind of language that we see typically in situations where a spouse survives another spouse.  And that kind of direction would also taint the trust, I imagine.

Ian Hull:  That’s right because you’re allowing other events to transpire.  Alright, well I know this is sort of a bit heavy in terms of the tax side, but it’s such an important part of the planning that we, you know, when we were sitting back and trying to plan our next 50 podcasts, we thought one of the things that we maybe have glossed over which is fine, but we may have glossed over a little bit was some of the detail on these tax issues.  And because we keep talking about the fact that it is so tax-driven, most estate planning.  Well, in fact, it is for a good reason and so we are going to continue to spend a little bit more time on some of these basic tax concepts so that we understand what is, you know, probably 75% of the planning that goes behind estate planning is tax-driven and why.

Suzana Popovic-Montag:  Well, that’s great Ian.  Thanks very much.  I look forward to our next podcast.

Ian Hull:  Thanks Suzana.

You’ve been listening to Hull on Estate and Succession Planning with Ian Hull and Suzana Popovic-Montag.  The podcast you have been listening to has been provided as an information service.  It is a summary of current legal issues in estates and estate planning.  It is not legal advice and you are reminded to always talk with a legal professional regarding your specific circumstances.

To listen to other Hull On podcasts, or to leave a question or comment, please visit our website at www.hullestatemediation.com.

Our theme music is UpTempo14 by Gary and is courtesy of the Podsafe Music Network.

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In “Awaiting Certainty on Jointly Held Assets,” Christopher Guly considers the debate over how to adjudicate challenges to jointly held accounts. He examines two decisions of the Ontario Court of Appeal, Saylor v. Brooks and Pecore v. Pecore. Both were recently heard by the Supreme Court of Canada.

The facts in Saylor and Pecore are somewhat similar in that both involve challenges brought by beneficiaries to accounts that were jointly held between a Deceased and his daughter. In both cases, the beneficiaries argued that the Deceased did not intend for the surviving daughter to acquire the entire account and that the funds should be returned to the Deceased’s estate.

In considering the beneficiaries’ claims, the Court diverged from the historic reliance on presumptions. In the past, a transfer of money or property between strangers was presumed to be a loan, while a transfer between a father and his wife and/or children was a presumed gift. Of course, the presumptions only operated as starting points and were rebuttable.

In Saylor and Pecore, the Court ruled that it must first consider the totality of the evidence and determine the intention of the Deceased at the time the joint account was created. Only if intention cannot be clearly determined will the Court then turn to the presumptions.

Sounds simple? Well, as Guly points out by reference to discussions with practitioners, including Ian Hull, the decisions raise numerous concerns. Namely, what evidence do you use to prove intention? What if you do not have available evidence? How much evidence is necessary to avoid the presumption?

I will be interested in reading the Supreme Court’s answers to these difficult questions.

For more background information on legal issues surrounding joint accounts, check out Ian and Suzana’s previous blogs found in the "Joint Accounts" category on the blogpage.

Thanks for reading.

Jason