Giving money -- the smart way
Parents or relatives looking to give assets to
their children, maybe to help them save for an education or buy
a home, need to be careful how they go about it. Otherwise, they
could fall afoul of the Canada Revenue Agency's attribution rules
and find themselves on the hook for taxes owed on the income generated
by their gift.
"The kiddie tax rules prohibit you from income-splitting
with minors," explains Jeff Llewellyn, a partner at the accounting
firm Meyers Norris Penny LLP, in Calgary. So, certain types of income
earned by the gift are attributed to the person who gave it.
That doesn't mean an aunt can't set up a college
fund for her favourite niece or that grandpa can't help his grandson
build a down payment for a home. It simply means there are administrative
hurdles to such good intentions and some decisions to make at the
First, you have to decide what
type of account will hold the asset. You can use an informal in-trust
account or a formal legal trust. "They are really two different
things," says Karen Wilkinson, a chartered accountant at Deloitte
& Touche LLP, in Burlington, Ont., and there are pros and cons
Jamie Golombek, vice-president of taxation and estate planning,
at AIM Trimark Investments, in Toronto, says in-trust accounts can
be set up at most financial institutions and usually have four components:
a donor, a beneficiary, an asset and a trustee. The donor is the
person who makes the gift, while the beneficiary is the person who
receives it. The gifted asset could be cash, a piece of property
or shares in corporation. The trustee is the person who manages
the assets on behalf of the beneficiary until she reaches the age
From a legal perspective, a child can't own the account
if she is a minor. However, once she reaches the age of majority,
which is 18 or 19, depending on where you live, the child has the
right to spend the money on what she wants, despite the donor's
The problem, says Wilkinson, is that many people set
up an in-trust account but continue to treat it as if it's their
own and don't appreciate the ramification of their actions.
there can't be any terms or conditions on such an account. "The child can
come knocking and ask for it." He says there is at least one instance in
Canada where a beneficiary has successfully sued to get access to money in an
That doesn't mean you should dismiss them out of hand.
As Golombek says, they can be a good way to help a child build a
nest egg. However, he says the person making the gift has to be
careful he doesn't run afoul of the Income Tax Act.
The tax impact of such an account depends on the
nature of the payments the gift generates. For example, if a parent takes the
monthly child tax benefit payment, or baby bonus, and contributes it to the account,
any income generated is taxed in the hands of the child. The same is true if the
gifted money comes from an inheritance made to the child.
if the gift comes from a parent or relative, any income it generates must be claimed
by the donor and is taxed in his or her hands. "If the investments generate
interest or dividends, then there is a series of rules that effectively transfers
that income back to the (donor)," explains Wilkinson.
The only exception is a capital gain, adds Golombek,
which is taxed in the hands of the child beneficiary. "Equities
and mutual funds and things that generally produce capital gains
are perhaps the ideal investment when gifting to minors," he
says. The trade off is that such investments are riskier than a
GIC or bond.
Of course, the donor is deemed to have disposed of
the gifted asset at fair market value and will have to pay tax on any gains prior
to giving it away. The informal trust then acquires the asset at fair market value.
government is lenient when it comes to second generation income or income on income,
says Wilkinson. Such money is taxed in the hands of the beneficiary. For example,
if a donor provides $1,000, which earns $100 of first-generation income, that
is taxed in the donor's hands. However, the next year that $100 will earn second-generation
income, which is taxed in the hands of the child.
That's why proper records must be kept in tracking
the income. "The record keeping is not that onerous and most
people can handle it," says Wilkinson. Golombek says the easiest
way to track second-generation income is to move the first-generation
income to a separate account and let it build.
A formal trust is a legal structure created by a trust deed. The
deed identifies the donor, the trustee, the beneficiary and the
assets. The deed sets out how the assets are to be managed and the
conditions under which they may be distributed, unlike an in-trust
account. A trust can be set up and administered while the donor
is alive -- known as an inter vivos trust -- or kick in after the
donor dies -- known as a testamentary trust.
is a legal entity that files a tax return and pays taxes. An inter vivos trust
pays taxes at the top federal and provincial rates, but income can be allocated
to the beneficiaries and taxed in their hands, which can lower the tax impact,
though you still have to watch out for the attribution rules. A testamentary trust
pays tax based on how much it earns using the graduated marginal tax rate structure.
challenge with a formal trust is the cost. There are legal, accounting and administrative
fees. "It's expensive," says Wilkinson, suggesting it isn't worth using
one for a small amount of money.
Middlemiss is a freelance writer and lawyer based in Toronto. He's a frequent
contributor to the National Post, Investment Executive and Wall Street & Technology.