455 Avenue Road, Suite 100, Toronto, Ontario, M4V 2J2

Tel: (416) 966-9675 Fax: (416) 966-9677


A Trust's 21st Anniversary - A Costly Anniversary to Forget!

Paul McKay, CAE

May 19, 2011

Trusts are well known as a vehicle for tax and estate planning because of their flexibility, tax effectiveness, privacy and long life. However, despite their ability to remain in place for an extended period of time, the Income Tax Act generally deems trusts to have disposed of and reacquired certain types of property at their fair market value at periodic intervals, commonly referred to as the "21-year deemed disposition rule". In this CALU Report Christopher Gandhu and Nadja Ibrahim of PricewaterhouseCoopers in Calgary discuss the scope and impact of the 21-year deemed disposition rule, as well as planning techniques that may be employed to avoid or minimize the tax impact of these rules on trusts and their beneficiaries.

Table Of Contents


As a CALU member, there is a good chance that you have dealt with an estate planning scenario that required the use of a trust. Originally an invention of the English feudal system, trusts, whether created by someone during their lifetime (an "inter-vivos" trust) or on their death (a "testamentary" trust), continue to be routinely used in Canada for estate planning purposes.

Trusts are an excellent vehicle for tax and estate planning because of their flexibility, tax effectiveness, privacy and long life. However, despite their ability to remain in place for an extended period of time, the Income Tax Act[1] generally deems trusts to have disposed of and reacquired certain types of property at their fair market value at periodic intervals, thereby mandating trusts to recognize capital gains or losses and income or losses without an actual disposition. This is commonly referred to as the "21-year deemed disposition rule." It should be noted that a deemed disposition of trust property does not necessarily occur at every 21-year interval because there are other deemed disposition rules in the Act relating to trusts.[2]

This article only concerns itself with the deemed disposition arising on the 21st anniversary of a discretionary inter vivos family trust.[3] Any reference to income arising on the deemed disposition of property also refers to capital gains.

Copyright The Conference for Advanced Life Underwriting, May 2011

Return to top

What Is The 21st Anniversary Rule?

In theory, absent the existence of the 21-year deemed disposition rule, a beneficial interest in trust property could be passed from generation to generation on a tax-free basis.[4] In other words, without this rule, the tax would arise only when the property was actually sold by the trust, potentially postponing the realization of tax revenues for a significant period of time.

In 1972, as part of tax reform which introduced the imposition of capital gains tax, the 21-year deemed disposition rule was enacted.[5] There is nothing magical about the number 21 per se; it is an arbitrarily selected time period when the forced realization of the trust's assets happens.

It is also important to understand that the 21-year deemed disposition requirement not only applies to Canadian trusts but also to foreign trusts that own specific types of Canadian property. Thus non-resident trusts, to the extent they own certain types of Canadian property (i.e. Canadian real estate, and oil and gas properties), will be subject to this rule. Generally speaking, trusts are deemed to dispose of capital property, land inventory, depreciable property and Canadian and foreign resource properties at fair market value and deemed to reacquire the properties at fair market value. Life insurance, for example, is a type of property that will not be subject to the deemed disposition rule.[6]

Some speciality trusts, such as unit trusts, employee profit sharing plans, registered education savings plans (RESPs) and registered retirement savings plans (RRSPs), are specifically excluded from the deemed disposition rule. In addition, trusts in which all interests have vested indefeasibly on or before the 21-year deadline are also excluded.[7] An interest that vests indefeasibly in the beneficiary essentially means that the beneficiary now has an interest that can be valued with certainty. As such, the interest will be taxable when the beneficiary actually disposes of that interest or when the deemed disposition occurs at the beneficiary's death.

There are a number of other exceptions and limitations to these rules; however, a full discussion of same is beyond the scope of this article.

Copyright The Conference for Advanced Life Underwriting, May 2011

Return to top

What To Do When the 21st Anniversary Is Approaching?

Do Nothing

As noted, if no planning is undertaken, the deemed disposition will trigger income or loss[8] that the trust will have to recognize in the specific taxation year.

This may not necessarily be a negative event if the trust does not have much in terms of accrued gains or has capital losses from previous years that can be used to offset any gains. Moreover, it is easy to lose sight of the fact that this is only an acceleration of tax and the trust does get an increase in the adjusted cost base (ACB) of any assets subject to the deemed disposition on the trust's 21st anniversary.

However, if the triggered gain is expected to be large, the trust may owe significant tax and not have sufficient liquid assets to meet this liability. In that case, taking steps to avoid the deemed disposition rules may be the only viable option. The trust also has the ability to elect to pay the tax in equal instalments over 10 years with respect to the gain arising on capital property.[9] The trust can file the election using Form T2223 and by posting acceptable security with the Canada Revenue Agency (CRA). The election only applies for capital property and cannot be used to defer tax arising on the deemed disposition of depreciable property or Canadian resource property. The deferred payments are subject to interest.[10]

Alternatively the trust can allocate the income to the beneficiaries and claim a corresponding deduction in computing its income.[11] With such an allocation the beneficiary reports and pays tax on the income allocated. For the income to be allocated to the beneficiary the amount must be paid or payable in the year.[12]

Distribute Trust Property to Beneficiaries

The usual planning involves distributing the trust assets to the beneficiaries ahead of the 21st anniversary date.[13] The Act generally permits a transfer of assets to its beneficiaries to take place on a tax-deferred basis.[14] The beneficiaries are deemed to receive the property at the trust's cost base and will eventually recognize any income or loss when the property is sold during the beneficiaries' lifetime or on their death. This distribution planning eliminates a potentially large tax consequence to the trust. Moreover, the tax liability is now deferred to a future date and possibly at lower rates since any income will be taxed at the graduated tax rates applicable to each beneficiary.

There are many circumstances in which a simple distribution of property to beneficiaries prior to the 21st anniversary may not make sense or may cause other complications. Listed below are some of these circumstances:

Capital distributions to non-resident beneficiaries cannot be undertaken on a tax-deferred basis. Only limited types of property (i.e., Canadian real estate, oil and gas properties, and certain property used in a business carried on through a permanent establishment in Canada) can be transferred to non-resident beneficiaries without immediate tax consequences to the trust.[15]

If the trust is subject to the reversionary trust rules in subsection 75(2), then the assets cannot be rolled out at cost except to the person who transferred the property to the trust or the transferor's spouse, while the transferor is alive.[16] The reversionary trust rules could apply where the transferor is a capital beneficiary of the trust, if the transferor is the sole trustee of the trust or the transferor has to be part of the majority for trustee decisions. A discussion of these rules is beyond the scope of this article.

Distribution planning is dependent on the trustees having adequate powers which permit such a distribution. An early distribution may violate the terms of the trust. A trust for the benefit of minor children which limits payout until the beneficiary reaches age 35, for instance, may have no choice but to reckon with the deemed disposition of assets if the children are under the age of 35 on the 21st anniversary date.

Even if the trust property can be distributed it may be that the beneficiary is considered too young to receive such substantial assets from a trust. This is often a problem when an estate freeze is completed when the children are very young and a family trust is established to hold growth shares. The 21st anniversary can roll around and the trustees must contemplate transferring assets worth millions of dollars to a 24 year old!

The beneficiary's personal situation may make it unattractive to distribute assets to this person. For example, the beneficiary could be going through a marital breakdown or a bankruptcy. The beneficiary may also have other personal issues such as substance abuse issues.

Copyright The Conference for Advanced Life Underwriting, May 2011

Return to top

A Planning Example

On Jan. 1, 1991, Mr. Brown established the Brown family trust (the "Trust"), a fully discretionary inter vivos trust resident in Alberta. The Trust was settled as part of an estate freeze whereby the Trust also acquired newly issued common shares of the family business for a nominal amount. In addition, Mr. Brown transferred certain publicly traded securities and a Canadian family vacation home into the Trust. Mr. Brown, Mrs. Brown (his wife) and their friend Mr. Black are the trustees of the Trust (with trustee decisions made on a majority basis, and Mr. Brown is not required to be part of the majority). The beneficiaries of the Trust are Mrs. Brown, Mr. Brown's three minor children Paris, Denver and Florence (then aged 5, 7 and 10) and future grandchildren.

It is now 20 years later. Paris is single and in her final year of law school at McGill. Denver is separated and lives in Toronto where he has started a new career. Florence has been living with her U.S. husband and their two children in Phoenix for the past five years.

The Trust is less than a year from its 21st year anniversary and the trustees are concerned about the inherent tax liability in the trust. As shown in Table 1 below, the shares, securities and the vacation home have grown in value tremendously over the past 20 years and are expected to generate a significant capital gain on the deemed disposition.

In this case, doing nothing and paying the tax in the Trust is not an attractive option. Even if the publicly traded securities were liquidated, there would not be enough cash to meet the tax liability.

The trustees have considered rolling out the assets ahead of the 21st year anniversary but face several major hurdles. First, Mr. Brown is concerned about distributing shares in the family business to the children and losing the control he currently exercises as a trustee under the Trust. The cottage is very important to Mr. and Mrs. Brown and they want to continue to have the ability to use it when they wish and ensure it remains in the family. Florence's U.S. resident status will also complicate any rollout planning. As well, they are hesitant to distribute any property to Denver as they are afraid his separated spouse will try to lay claim to a portion of that property.

Shares in the Family Business Mr. Brown is concerned about losing control over the business. In many estate freezes, the owner takes back preferred shares that carry voting control over the business. If Mr. Brown holds such shares then a distribution of the common shares to the beneficiaries should not affect his control of the company.

If there is a legitimate concern over losing control of the business by distributing the shares to his children, the following options can be considered:

The Vacation Property Distributing the cottage to the children can be troublesome because it may complicate Mr. and Mrs. Brown's ability to use the cottage as they please or eliminate their use completely if the children decide to dispose of the cottage.

As with the shares of the family business, the trustees may consider distributing the cottage to Mrs. Brown if it is critical that Mr. and Mrs Brown retain control of the cottage. Alternatively, the trustees could retain the cottage and pay tax inside the Trust.[18] If the Trust liquidates its securities, it will have sufficient assets to pay the tax arising on the 21-year deemed disposition.

An additional concern is that if the children own the property, they may not be able to agree on such items as funding the expenses and allocating the time allowed at the cottage. The trustees could consider establishing a binding co-ownership agreement that would outline the issues that generally cause friction with such cottage ownership. Children wishing to receive a share of the cottage would need to agree to be bound by the agreement.

What To Do About Florence? There are many issues surrounding a possible distribution of trust assets to Florence. The first issue as previously discussed is that the assets (other than the vacation property) cannot be transferred to Florence on a tax-deferred basis. Equally troubling are the U.S. tax implications to Florence. For example, the onerous U.S. income tax rules surrounding a U.S. person's ownership of shares in a non-U.S. private company may apply to Florence.[19] Also, if Florence owns such assets directly the property will form part of her estate for U.S. estate tax purposes and will be subject to U.S. taxation on her death.

What are the trustees to do? There is no one answer for every situation and a "perfect" solution may not be attainable. However, before becoming disheartened, the following options could be considered. Some of these solutions can be used in combination with one another to arrive at the most appropriate result.

Assuming the Trust contains such a provision, Florence could incorporate a Canadian company ("Canco") which would receive her share of the Trust's assets. Since the company is Canadian, the distribution should qualify for a tax-deferred distribution. This does not resolve some of the U.S. tax implications but does provide for an opportunity to avoid the 21-year tax liability.[20]

Unfortunately it is not uncommon to find trust deeds which do not allow for these additional classes of beneficiaries. In these instances, varying the trust terms (and the legal and tax implications of variation to add a new beneficiary) must be canvassed. In doing so the advisor must be cognizant that CRA may attack any trust amendment that is done solely to avoid the 21-year deemed disposition rule.

What to do about Denver? Denver's matrimonial issues are troublesome because the trustees are concerned his separated spouse may try to claim Trust property which was intended to be part of his inheritance. In this situation family law advice is required to determine how such an amount can be distributed to Denver while still ensuring it is protected property for family law purposes.

For example, if the trust beneficiaries could include a trust established for Denver's benefit then it may make sense to distribute Denver's share of the trust assets to this new trust rather than to Denver outright. Of course the terms of the new trust would need to be reviewed from a family law perspective to ensure it provides Denver with the necessary protection. We caution that such a transfer will likely not avoid the 21-year deemed disposition rule on the property distributed to the new trust.[21]

There may be other options to review such as whether Denver can be equalized through an inheritance received directly from his parents rather than the Trust. This may not be an attractive proposition for Denver as he may not be entitled to such assets for a long period of time. His parents could also consider creating a family trust for Denver's benefit now that could hold other assets for his benefit. However, if Mr. and Mrs. Brown are transferring assets with an accrued gain to such a trust it will trigger a Canadian income tax liability.

Any proposed planning being implemented for Denver should balance the tax issues with the family law implications and the family's personal views on his entitlement.

Copyright The Conference for Advanced Life Underwriting, May 2011

Return to top


A trust's 21st anniversary and the resulting deemed disposition of the trust's property can present the trustees with many challenges if the disposition is expected to lead to a significant tax liability. However, because tax inside the trust can be avoided by a tax-deferred distribution of assets to the beneficiaries, the deemed disposition rules is not always seen as a major impediment.

The tax issues surrounding the 21-year deemed disposition can be cumbersome where the tax-free distribution is limited or unavailable because of the beneficiaries' residency, citizenship, marital status, age or spending habits, or the settlor of the trust is concerned with losing control of the trust property. In these instances, professional advice should be sought to consider the various planning options.

As with all important anniversaries in our life, it is always better to be proactive and have a plan in place ahead of time.

Copyright The Conference for Advanced Life Underwriting, May 2011

Return to top

About the Authors

Christopher Gandhu, LLB, and Nadja Ibrahim, LLB, are in the Calgary office of PricewaterhouseCoopers. You can reach them by phone at (403) 509-7500, or e-mail them at Christopher.S.Gandhu@ca.pwc.com.

Return to top


[1] Income Tax Act, RSC 1985, c.1 (5th Supplement), as amended, hereinafter referred to in this article as the "Act." Unless otherwise noted all statutory references in this article are to the Act.

[2] For example, alter ego trusts recognize gain on the death of the contributor and spouse trusts recognize gain on the death of the spouse. See subparagraph 104(4)(a)(iv) of the Act.

[3] This is generally a trust where the beneficiaries include the spouse, children and/or grandchildren of the settlor, and the trustees retain discretion as to which beneficiaries receive allocations of income and capital under the trust.

[4] This assumes the trust is in a jurisdiction where there is no common law "rule against perpetuities" or other legislation limiting the duration of a trust, and also assumes that the fair market value of the trust interest is nominal.

[5] Subsections 104(4), (5) and (5.2) of the Act.

[6] Subsection 54(b) defines capital property to include any property the gain or loss from the disposition of which is treated as a capital gain or loss. Subparagraph 39(1)(a)(iii) of the Act excludes gains or loss arising from disposition of certain insurance policies from capital gain and loss treatment. Therefore, a life insurance policy would not be considered to be a capital asset of the trust.

[7] The definition of trust in subsection 108(1) excludes certain trusts for the purposes of subsection 104(4). The exclusion for a trust that vests indefeasibly is found in paragraph (g) of that definition. Vested indefeasibly is defined in subsection 248(9.2) but is not a complete definition. The CRA's administration definition of vested indefeasibly is found in archived IT-449R: Meaning of "Vested Indefeasibly."

[8] Generally, a loss arising from a disposition and immediate reacquisition of property would be denied under the "superficial loss" rules found in section 54. That section, however, specifically excludes losses arising from the 21-year deemed disposition.

[9] Subsection 159(6.1) of the Act.

[10] In reality this election is seldom used, primarily due to the high rate of interest charged on the unpaid balance (the prescribed rate plus 4% compounded daily (as per Regulation 4301(a)) and the fact that such interest is not deductible. It would generally be easier and less expensive to borrow from another source to pay this tax liability.

[11] Subsection 104(6) of the Act.

[12] It is important that the trust terms allow the allocation of this type of phantom income in order to be able to have the trust allocate the income to the beneficiaries.

[13] Note that there may also be planning available by vesting the interests of the beneficiaries in the assets prior to the 21st anniversary. A discussion of this option and its benefits are beyond the scope of this article.

[14] Section 107(2) of the Act.

[15] Section 107(5) of the Act.

[16] Subsection 107(4.1) of the Act.

[17] It should also be noted that if Mrs. Brown disposes of the property prior to the death of Mr. Brown any gain or loss will be attributed to Mr. Brown by virtue of the income attributions rules in section 74.1 of the Act.

[18] If certain conditions are met as set out in the definition of "principal residence" in section 54 of the Act, the trust may be able to claim the principal residence exemption in respect of part or all of any gain arising from the deemed disposition of the cottage. This will affect the ability of specified beneficiaries to claim their own principal residence exemption on another property. A discussion of the applicable rules is beyond the scope of this article.

[19] In general, the U.S. "anti-deferral" rules can apply when U.S. individuals have an interest in foreign corporations. These rules require the U.S. person to include certain types of income in their U.S. taxable income even though the corporation may not have made an actual distribution or may impose an interest charge. Moreover, additional U.S. income tax compliance is usually required. We note that it is possible that these rules already apply to Florence. This analysis is complicated and beyond the scope of this article.

[20] Specialized tax advice should be obtained when dealing with a U.S. beneficiary as the use of a company controlled by a trust for the beneficiary may provide some U.S. estate tax planning opportunities.

[21] Subsection 104(5.8) of the Act.

Return to top