- Loss of Graduated Rates, GREs and QDTs
- March 13, 2015 | Authors: Pamela L. Cross; Colin Poon
- Law Firms: Borden Ladner Gervais LLP - Ottawa Office ; Borden Ladner Gervais LLP - Calgary Office
- On December 17, 2014, Bill C-43 received Royal Assent, ushering in a new era of estate planning with proposed changes to the Income Tax Act (the “Tax Act”). As long anticipated, testamentary trusts will generally be subject to flat top rate taxation at the highest marginal rate, rather than at graduated rates as is currently the case. Exceptions to this general rule are available for graduated rate estates (“GREs”) and qualified disability trusts (“QDTs”) where necessary criteria are met. The new rules will apply as of January 1, 2016.
Loss of Graduated Rates
Commencing in the 2016 tax year, existing and future testamentary trusts (other than GREs, discussed below) will be subject to the same rules as currently apply to inter vivos trusts. This means that non-GRE testamentary trusts will no longer be able to access a large number of benefits which previously applied, including:
- Ability to access graduated tax rates. Testamentary trusts will be subject to the highest federal tax rate, which is currently 29%. We anticipate the Provinces will align their tax legislation accordingly resulting in an effective combined tax rate approaching 50% in many Provinces.
- Exemption from remitting tax instalments.
- Exemption from Alternative Minimum Tax.
- Ability to allocate investment tax credits to beneficiaries.
- Ability to have a non-calendar year end.
- Extended period for filing a notice of objection to a tax assessment. Testamentary Trusts must now file the notice of objection within 90 days of receiving the notice of assessment.
- Relief from the application of the stop loss rules, which relief allows for certain loss carry-back post mortem planning to avoid double taxation. Where the deceased individual held private company shares and post-mortem loss carry back planning is desirable, it will be necessary in many cases to ensure the estate qualifies as a GRE.
- Increased flexibility in claiming tax credits associated with charitable donations on death.
Graduated Rate Estates
If an estate qualifies as a GRE, it may continue to access the above listed benefits for a limited time. An estate will be a GRE if:
- No more than 36 months have passed since the date of death,
- The estate is a testamentary trust under the Tax Act,
- The estate designates itself as a GRE in its first tax return that ends after 2015,
- No other estate of the individual designates itself as a GRE, and
- The deceased individual’s SIN is provided.
Further, estates which take over 36 months to administer will face a loss of GRE status and a deemed year end when the 36 month threshold is reached. Estates in existence as of January 1, 2016 may qualify as GREs provided all of the above conditions are met.
Qualified Disability Trusts
Another exception to the taxation of testamentary estates at the top marginal rate can be found in the QDT regime. In order for a trust to be a QDT:
- The trust must be a testamentary trust under the Tax Act,
- The trust must be resident in Canada for the particular year,
- The trust must jointly elect with one or more beneficiaries (the “electing beneficiary”) who is named under the Will or beneficiary designation,
- The electing beneficiary must qualify for the disability tax credit, and
- The electing beneficiary cannot have made that joint election with any other trust. As there is a limit of only one QDT per beneficiary, all other trusts established for the beneficiary of a QDT will be taxed at the highest marginal rate.
The tax relief granted to QDTs is not absolute. QDTs are subject to a recovery tax triggered in a year where (i) the trust ceases to qualify as a QDT, or (ii) a capital distribution is made to a non-electing beneficiary. This tax is intended to “recover” tax savings obtained by the QDT due to the application of graduated rates in prior years. The recovery tax is calculated by determining the amount that would have been payable if the income of the trust which is never ultimately distributed to the electing beneficiary had been taxed at the highest marginal rate.
These new rules represent a significant change for taxpayers and their advisors. Everyone should be encouraged to review their estate planning before 2016 to ensure that it is still appropriate and will achieve the intended objectives.