An in-trust-for (ITF) account is a convenient way for parents and grandparents to set aside funds for minor children, allowing the account holder to make binding investment decisions on behalf of minor beneficiaries and potentially split income for tax purposes. An ITF can also be helpful with inheritances because minors can’t directly accept a gift under a will.
An ITF may be preferable to a formal trust due to the time and cost of creating and executing a formal trust deed.
Which tax slips1 are issued and who reports the income for tax purposes depends on the legal relationship underlying the account and whether the attribution rules of the Income Tax Act (ITA) will apply.2
An ITF may be a trust, a gift or neither
A trust requires three certainties: certainty of intention to establish the trust; certainty of object, which is the trust beneficiaries; and certainty of subject, which is trust property. In common-law jurisdictions, the certainties aren’t required to be set out in writing, but a written trust deed is proof of a trust’s existence and terms.
An ITF, often referred to as an informal trust, lacks the documentation helpful to prove the intention to set up the trust in the first place. Still, it may be considered a trust depending on the facts of each case. The Canada Revenue Agency (CRA) will consider intention at the time the property was transferred to the ITF and how the account was dealt with to determine whether a trust relationship exists and who is liable for taxes payable on any income or gains earned from the account.
If the CRA determines that any of the three certainties required for a trust aren’t present, contributions to an ITF account may be considered a gift to the beneficiary.
When an ITF account represents a gift or is set up to hold an inheritance or insurance settlement for a minor, the account holder acts as an agent for the minor’s property.
Absent clear evidence of irrevocable property transfer, there is neither a trust nor a gift.
Consider a hypothetical example. Barbara opens a bank account in her name, in trust for her minor grandchild Stacey. The account opening documents clearly identify Barbara as contributor and trustee, and Stacey as beneficiary. The funds are legally owned by Barbara as trustee until Stacey reaches the age of majority in her province (18 in Ontario and 19 in B.C., for example). The account would be considered a trust.
If Barbara had opened the account in Stacey’s name, there would be an immediate gift of both legal and beneficial ownership to Stacey.
If the account had been opened in Barbara’s name with no clear intention that it be for Stacey, the account would be neither a trust nor a gift.
To help clarify the account’s status — particularly when questioned by the CRA or where claims are made by beneficiaries — it’s helpful to document the contributor’s intention to irrevocably transfer property for the benefit of the named beneficiary and to maintain records regarding the source of funds.
Taxation of ITF accounts
Non-spouse transfers of beneficial ownership (whether indirectly through a trust or directly by a gift) are taxable dispositions to the transferor for the year of transfer. Transferring cash or unappreciated assets will alleviate exposure to tax on capital gains.
Trusts are taxed as separate individuals under the ITA. The CRA makes no distinction between formal trusts and informal trusts for tax purposes, including the requirement by the trustee to annually file a T3 Trust Income Tax and Information Return.
Trust income and taxable capital gains that aren’t paid or payable to a beneficiary or attributed back to the transferor are taxed in the trust at top marginal rates.
Because Stacey is related to Barbara, income other than capital gains will attribute back to Barbara until Stacey turns 18, whether the transfer is in respect of immediate gift or a trust. If instead, Barbara created a discretionary trust for Stacey, then subject to the same attribution rules for minors and also subsection 104(18) of the ITA, for a particular year when no amount from the trust was paid to Stacey, trust income and capital gains would be taxed in the trust.
Income not subject to attribution and capital gains paid or payable to a beneficiary are taxed in the beneficiary’s hands at the beneficiary’s graduated tax rates. Losses generally can’t be allocated to a beneficiary.
If, upon review of the facts, the CRA determines the ITF isn’t a trust, all income and capital gains may attribute back to the contributor from account inception, resulting in arrears taxes and penalties.
In Blum vs. the Queen, a grandfather successfully appealed a CRA reassessment wherein the CRA attributed capital gains to him that were previously taxed in the hands of his grandchildren. Even though there was no formal trust agreement, he won his appeal as it was determined that all three certainties were present. The trust property (shares of his own companies) was identified and clearly delivered to his name as trustee for the benefit of his grandchildren as named beneficiaries.
Attribution rules and transfers to related minors
ITA subsection 74.1(2) provides that first-generation income other than capital gains, from property gratuitously transferred to a related minor either indirectly through a trust or directly by gift attributes back to the transferor for tax purposes. Second-generation income and taxable capital gains are taxed in the minor’s hands.
ITA subsection 75(2) may apply where a trust allows the contributor to maintain control over trust property after the trust is set up — including, for example, if Barbara named herself sole trustee of the account she opened for Stacey. When 75(2) applies, all trust income, capital gains or losses attribute back to Barbara for tax purposes. Barbara could mitigate exposure to 75(2) by naming someone other than herself as trustee or appointing multiple trustees.
Attribution ceases if the contributor dies or becomes a non-resident of Canada, and attribution doesn’t apply to inheritances or to most arm’s-length transfers.
Other considerations and alternatives
Whether a gift or a trust, contributions to an ITF can’t be redirected or returned to the contributor without tax consequences, including the risk that a beneficiary may make a claim for the capital and earnings of the account since inception.
Alternatives to an ITF include an RESP, paying for certain expenses for the child, or setting up a formal trust and using a prescribed rate loan strategy to avoid attribution rules while the beneficiaries are minors. Whether an ITF account is the best alternative depends on the family’s resources and goals.
1 A T3 Statement of Trust Income Allocations and Designations identifies beneficiaries and reports income and capital gains that the trust designates to them. A T5 Return of Investment Income is issued in respect of investment income and capital gains earned in a client named, nominee or agency account.
2 For purposes of this article, all parties are assumed to be residents of Canada in provinces other than Quebec.