Trusts in Canada: How They Work and Are Taxed – A Complete Guide by a Montreal CPA Firm Near You

Introduction

A trust is one of the most powerful and flexible tools in Canadian tax planning, estate planning, and asset protection. Yet many people misunderstand what a trust actually is. A trust is not a corporation, not a bank account, and not a legal entity in the traditional sense. It is a legal relationship in which a trustee holds and manages property for the benefit of one or more beneficiaries. Trusts can reduce taxes, protect family wealth, manage inheritances, support disabled family members, and control how assets pass from one generation to another. But trusts also face strict tax rules, high tax rates, and annual filing requirements. This guide explains how trusts work, the main types, and how they are taxed in Canada.

Legal and Regulatory Framework

Trusts are governed by provincial trust law and federal tax rules under the Income Tax Act. A trust is created when a settlor transfers property to a trustee to manage for beneficiaries. Trusts must file an annual T3 Trust Income Tax and Information Return unless specifically exempt. Most trusts are taxed at the top marginal tax rate, unless income is paid or made payable to beneficiaries. Income that is paid to beneficiaries is taxed in their hands instead of at the trust level. Certain trusts, such as Graduated Rate Estates (GREs) and some testamentary trusts, may access graduated tax rates for a limited time.

Key Court Decisions

In Garron Family Trust v. Canada, the Supreme Court emphasized the importance of determining the trust’s central management and control to assess residency. In Antle v. Canada, the court invalidated a trust because it lacked genuine intention and proper trust formalities. In Somerville v. Canada, CRA successfully challenged a trust’s allocations due to improper documentation. These cases show that trusts must be structured and administered properly to be respected by CRA and the courts.

Why Trusts Are Useful

Trusts can reduce taxes by income splitting, protect assets from creditors or divorce, help transfer wealth, maintain privacy (trusts are not public like wills), manage inheritances for minors or vulnerable individuals, and hold investments or business shares. Trusts also help families control how and when beneficiaries receive funds and can be used to freeze estate values for succession planning.

Common Types of Trusts in Canada

1. Inter Vivos Trusts (Living Trusts)

Created during a settlor’s lifetime. Examples include family trusts, alter ego trusts, joint partner trusts, and bare trusts. These must file annual T3 returns.

2. Testamentary Trusts

Created upon death through a will. For the first 36 months after death, a testamentary trust may qualify as a Graduated Rate Estate (GRE) and access graduated tax rates.

3. Family Trusts

Used in corporate and estate planning to hold shares, income-splitting, and freeze business value.

4. Bare Trusts

Trustees hold property for beneficiaries with no independent discretion. These now face mandatory reporting under new trust disclosure rules.

5. Spousal or Common-Law Partner Trusts

Used for tax-efficient transfers and to support a spouse after death.

6. Henson Trusts

Used to protect disabled beneficiaries’ access to government benefits.

How Trusts Are Taxed

Trusts are generally taxed at the highest marginal rate unless: income is paid or made payable to beneficiaries, the trust qualifies as a GRE, or special rules apply (e.g., certain spousal trusts). Trusts must file annual T3 returns, report income, claim deductions, and issue T3 slips to beneficiaries receiving allocations. Trusts must also track and report capital distributions, capital gains, and adjusted cost base (ACB) for property disposals.

When Trusts Must File a T3 Return

A trust must file a T3 return when: it earns income, distributes capital, sells property, owes tax, holds investments, or is mandated under new trust reporting rules. Even bare trusts—previously exempt—are now required to file unless specific exemptions apply. CRA requires disclosure of settlors, trustees, beneficiaries, and controlling persons under new rules.

Risks and Compliance Issues

Trusts face high audit risk if poorly documented, used for aggressive tax planning, or lack proper trust deeds, trustee resolutions, or accounting records. New trust reporting rules require significant disclosure, and penalties for non-filing can be severe. Improper distributions may trigger attribution rules or kiddie tax (TOSI).

Mackisen Strategy

At Mackisen CPA Montreal, we help families and business owners establish, maintain, and optimize trusts. We prepare trust deeds, handle T3 filings, ensure compliance with new reporting rules, structure income-splitting properly, manage trust accounting, plan estate freezes, coordinate with legal counsel, and defend trust strategies during CRA reviews. We also help identify when a trust is appropriate—or when another structure may work better.

Real Client Experience

A Montreal family used a discretionary trust to freeze their business value and transfer future growth to children; we handled the tax and trust reporting. A client’s trust faced CRA review due to poor documentation; we rebuilt accounting records and avoided penalties. A disabled beneficiary received long-term support through a properly structured Henson trust we helped administer. Another family used a bare trust for real estate and required new T3 reporting under updated rules—our team handled compliance seamlessly.

Common Questions

Are trusts only for the wealthy? No—many ordinary families use trusts for minors or estate planning. Can a trust own a business? Yes—family trusts often hold company shares. Do trusts avoid probate? Some do, such as alter ego and joint partner trusts. Are trusts public records? No—trust arrangements remain private.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps taxpayers use trusts effectively and responsibly. Whether your goal is tax planning, asset protection, business succession, or supporting family members, we ensure your trust is structured properly, compliant with CRA rules, and optimized for long-term success.