Tax Filing Obligations For Bare Trusts

Bare trusts are an effective tool commonly used for estate planning and real estate purposes. It is typically a simple strategy to deploy that requires little maintenance or cost. However, new tax rules have increased the number of tax filing obligations applicable for a bare trust, including trust and underused housing filing requirements. Failure to comply with the requirements may also result in hefty penalties.

What is a bare trust and what is it commonly used for?

Ownership of a property is broken up into two components: legal and beneficial ownership. In a bare trust arrangement, the trustee holds the legal title, and has no obligation other than to deal with the property as instructed by the beneficiary. Beneficial ownership of the property remains with the beneficiary. From an income tax perspective, all income and gains realized on the trust property are taxed in the beneficiary’s hands. Bare trust arrangements are commonly used for, but not limited to, the following:

• Maintaining anonymity of the owner of the property when ownership information is of public record (i.e., land registration records);
• Simplifying ownership of real estate where there are multiple owners of a single property; and
• Facilitating efficient property transfers to minimize land transfer tax or probate fees as legal title of the property never changes from the trustee¹.

Example

Leslie is a resident of Ontario and a widow who owns her Toronto home solely under her own name. Leslie’s neighbour recently sold their home for $3,000,000 and Leslie estimates that her home would be worth the same. As Toronto real estate prices continue to soar, Leslie begins to worry about the Ontario Estate Administration Tax (EAT) that will be due upon her death. She is hoping to keep the home within the family and is concerned about how the EAT of $44,250² will be funded.

She meets with an estate lawyer who indicates a bare trust arrangement could help eliminate the EAT on the home. She will need to incorporate a corporation (“BareCo”) and transfer legal title of her Toronto home to the corporation. There shouldn’t be any immediate tax implications as Leslie continues to be the beneficial owner.^3,4

What are Leslie’s filing obligations?

Corporate Income Tax Return

A typical bare trust arrangement may be set up with a nominee corporation and, historically, this simple arrangement required little maintenance other than maintaining the corporate minutes and the filing of an annual nil T2 corporate income tax return (T2). The T2 is due 6 months after the corporation’s year-end and failure to file a return will result in late filing penalties equal to 5% of the unpaid tax due and 1% of the unpaid tax for each complete month that the return is late, up to a maximum of 12 months.

Trust Income Tax and Benefit Returns and Enhanced Trust Reporting Rules

Starting for taxation years ending on December 31, 2023, the trust reporting rules have expanded to capture bare trust arrangements.⁵ In Leslie’s case, even though BareCo is a corporation, it will be obligated as a bare trust to file a T3 trust income tax and benefit return (T3). In addition, enhanced information reporting will require BareCo to disclose the name, address, date of birth, jurisdiction of tax residence, and tax information number of the bare trust’s settlor, trustee, and beneficiaries (including contingent beneficiaries) annually. The T3 is due 90 days after the trust’s taxation year-end. Bare trusts that have been in existence for less than 3 months or hold less than $50,000 in assets (limited to deposits, government debt obligations, and listed securities) throughout the year may be exempt from the filing requirements.

Failure to file the T3 will result in penalties of $25 per day (minimum of $100, maximum of $2,500). An additional penalty equal to the greater of $2,500 or 5% of the maximum value of the trust could be applied if the trust failed to file a return knowingly or due to gross negligence.

Underused Housing Tax Rules

Bare trust arrangements used to hold legal title of residential real estate property will also be subject to the Underused Housing Tax (UHT) rules which went into effect as of January 1, 2022. The UHT regime imposes a 1% annual tax on the value of a residential property which is located in Canada, owned by neither Canadian residents nor citizens, and considered vacant or underused. The annual tax filings are due April 30th of the following calendar year. CRA has provided administrative relief for this first year’s filing such that no late-filed penalties will apply if the return is filed and tax is paid by October 31, 2023. Tax filings may still be required even if there are no taxes due.

Individuals who are either a Canadian citizen or resident are “excluded owners”⁶ and exempt from the taxes and the tax filing. In our example, it was noted that Leslie is a Canadian citizen and resident, so how could these new rules impact her? The filing obligation resides with the legal title owner and as such, the onus is on BareCo to file the UHT return, which is not considered to be an excluded owner. Exemptions to the tax are available and, in general, a tax exemption should be available where the beneficial owner of the residential property is a Canadian citizen or resident. However, even if an exemption applies and no taxes are owing, so long as the owner is not an “excluded owner” a UHT return must still be filed.

Failure to file the required UHT return will result in a penalty equal to the greater of:

1. $5,000 where the legal title owner is an individual or $10,000 for all others; or
2. the total of:
   1. 5% of the UHT tax payable in respect of the residential property for the calendar year, and
   2. 3% of the UHT tax payable multiplied by the number of months after the due date that the balance is paid.

If a return is not filed by December 31st of the following calendar year, the penalty is determined as if the exemptions were not available such that part 2 of the calculation will be determined as if the property was subject to the tax.

Takeaway

Bare trust arrangements are still an effective tool, but the new rules could create a significant administrative burden to this simple arrangement. In Leslie’s case, while no taxes may be due, BareCo is still expected to file 3 different returns annually: (1) T2, (2) T3, and (3) UHT return. Those who are implementing or already have such arrangements in place should take extra care in ensuring all annual filings are completed given the significant late filing penalties which can be imposed. Some may also consider whether it is appropriate to wind-up the structure if the ongoing maintenance costs outweigh the expected benefits and tax savings of such arrangements.

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¹ Note the use of bare trusts to minimize land transfer tax or probate fees may not be appropriate for all provinces.
² The Ontario EAT is calculated as 1.5% on the value of the estate in excess of $50,000.
³ Note this probate planning is commonly used in Ontario but may not be appropriate for all provinces.
⁴ Estate planning lawyers should be consulted when implementing this strategy as additional steps and documents may be required in conjunction.
⁵ Bare trust arrangements are defined in the Income Tax Act as “an arrangement under which a trust can reasonably be considered to act as agent for all beneficiaries under the trust with respect to all dealings with the trust’s property”. The scope of this definition could be very broad.
⁶ Except when the person is a trustee of a trust, a nominee, or a partner of a partnership. The UHT Act also includes various other entities and individuals as excluded owners.