by Lisa Collins, QC, TEP | May 20, 2015
A couple of weeks ago I wrote about the reasons why a business family might want to have a family trust. These included minimizing taxes, transitioning business ownership and protecting family wealth.
For the business family that already has a family trust in place, the question for them is are they still making appropriate use of the family trust, does it still make sense or is it time to look at winding it up?
Although a family trust is typically intended to be in place for some time, it is often not envisioned as permanent. Rather it is used to serve a current purpose and to facilitate other steps in the future. The family trust should be reviewed periodically to determine whether the time has come to take those other steps.
Often a major purpose of the family trust is to permit income splitting among family members. This is usually based upon the family’s desire to provide financial support for the family members who may be in lower tax brackets. Is your family trust still being used for that purpose? Perhaps you no longer want to provide that financial support or family members are no longer in lower tax brackets, and the family trust no longer serves any income splitting purpose. Alternatively, perhaps this has been forgotten and the family members’ financial needs and tax positions need to be revisited.
Do the beneficiaries of the trust include a family holding corporation so that excess profits from the business can be flowed there (via the trust) without triggering tax? Are you taking full advantage of that to protect those profits from the risks of the business and/or invest for other purposes? It is not uncommon to see cash accumulate in the business and so this may need to be revisited.
Another reason for the family trust may have been to “park” the future ownership of the business in the trust, until such time as it was clear who the future shareholders should be. The trust may have been set up many years ago as part of an “estate freeze”. This is where the senior shareholders (typically the founders) exchange their shares of the business for a fixed value type of share, and new “growth” shares are issued to the family trust.
Have you now reached the point where those decisions as to future ownership can be made? Should the trust be wound up and the shares of the business transferred to family members? If that is the case, another question is what needs to happen before family members become shareholders? It is often recommended that a Shareholder Agreement be put in place. In addition, in many cases other steps should be taken to support the family members being responsible and effective business owners, such as setting expectations, sharing information and knowledge, and establishing structures for effective communication (such as a family council).
A very important milestone for the family trust is the twenty-first anniversary of the formation of the trust. That is when the income tax rules deem the trust to sell all of its assets for their fair market value. If the assets have appreciated in value, there can be significant tax resulting from that deemed sale. There are ways to plan around this but often planning needs to start well in advance of the twenty-first anniversary in order to do what is needed. Where shares of a business are owned by the trust, this looming date may be the catalyst for making the decisions about the future ownership of the shares of the business. (I have seen the situation where the twenty-first anniversary was missed and the trust was deemed to sell some private company shares, resulting in hundreds of thousands of dollars in income tax being paid.)
A family trust is a very important tool for family members. But its operation and purpose need to be reviewed periodically to determine if it is still doing the intended job for the family or whether it is time to wind it up.