What Are They and How Are They Used
Arrangements involving bare trusts are often used in a number of different commercial transactions. This article explains what a bare trust is and lists its common uses.
What is a Bare Trust?
In general, a trust exists when one or more persons (the trustees) hold property for the benefit of one or more persons (the beneficiaries) through a settlement of property on the trust by one or more persons (the settlors). There are three essential characteristics of a trust: (1) the settler must show a clear intention that the person who holds the property is to do so in trust for the beneficiaries, (2) the property must be clearly defined, and (3) the beneficiaries must be clearly identifiable. If these three characteristics are present, it is possible for the settler, the trustee, and the beneficiary to be the same person. Although a trust generally may be created orally, trusts involving land must be evidenced in writing to be enforceable. As a practical matter, a written deed, agreement, or declaration of trust will be very helpful in establishing the existence of a trust, particularly (but not necessarily) if the document is put in place contemporaneously with the formation of the trust relationship.
A bare trust is a specific kind of trust. The definition generally accepted at common law is that a bare trust is a trust under which the trustee has no active duties to perform except to deal with the trust properly as instructed by the beneficiaries.
Tax Treatment of Bare Trusts
A bare trust is generally disregarded for the purposes of the Act. This treatment allows title to be transferred in certain situations without triggering a taxable event. However, a taxable event can arise when beneficial ownership of the bare trust property changes, even if there is no change in legal title.
Subsection 104(1) of the Income Tax Act was amended in 2001 to exclude trusts that may reasonably be considered to be acting as agents for their beneficiaries. Historically, such relationships have been referred to as bare trusts. Although bare trusts are not agency relationships (trust and agency arise under different legal principles), the amendment made it clear that the rights and duties of a trustee of a bare trust are similar to those of an agent in an agency relationship. Since an agency relationship is not taxed as such, bare trusts should similarly be ignored for income tax purposes.
Historically, the Canada Revenue Agency took a more restrictive view of bare trusts. The Canada Revenue Agency said that:
- the trustee has no significant powers or responsibilities, and can take no action without the instructions from the settler;
- the trustee’s only function is to hold legal title to the property; and
- the settler is the sole beneficiary and can cause the property to revert to him or her at any time.
With respect to the third requirement, the Canada Revenue Agency has more recently recognized that there can be multiple beneficiaries of bare trust. This view better reflects the common meaning of “bare trust”, because the beneficiary is no longer limited to being the settler and there can be multiple beneficiaries.
Common Uses of Bare Trusts
A bare trust can be used to hold legal title (often to real property) that is being transferred between multiple parties or that is being used by multiple parties in a joint venture. The use of a bare trustee to hold legal title could avoid multiple land registrations and associated costs.
A corporation may use a “nominee” or a bare trustee to hold certain property, particularly real estate. Some observers are of the view that a bare trust may provide some protection from seizure of property by creditors of the corporation. No taxable event is triggered by the transfer, since it is ignored for the purposes of the Act. Note, however, that the effectiveness of this asset protection planning is subject to various statutory and common law creditor protection rules and may also be subject to contractual agreements, all of which often allow creditors to realize upon property held in a bare trust.
Risk of a Subsequent Taxable Event
Whenever property is held in a bare trust, there is the risk of a taxable event if at a later time the trustee ceases to act as agent for the beneficiary (that is, if the trust becomes a substantive rather than a bare trust). Should this occur, a disposition from the beneficiary to the substantive trust will result under subparagraph (b) (v) of the definition of “disposition” in subsection 248(1). Accordingly, one should ensure that the actions of a bare trustee are consistent with a bare trustee’s role as agent for the beneficiary at all times.
If you have any questions regarding the use of Bare Trusts or any other tax issues, please contact Joseph A. Truscott at 905 528-0234 x. 224 or e-mail Joe at: email@example.com.
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