Clark Wilson LLP's Your Estate Matters

WINTER
2001

One of the popular "do-it-yourself" estate plans involves gifting property. Many believe it’s the simplest way of avoiding the British Columbia probate process and attendant probate fees (approximately 1.4%). Gifting can be effective to achieve these goals, but pitfalls do exist.

The form of gift often involves the transfer of a 50% interest in property to a family member to be held jointly by the donor and the family member. Upon the death of the donor, the family member receives full ownership in the property. As such, the property is transferred outside of the donor’s estate, thereby ostensibly avoiding probate and probate fees.

This kind of gift is often made without professional advice or any written documentation, except for the instrument of transfer. After the gift is completed, the pitfalls may come to light when the donor files his or her next income tax return or when the donor dies.

Consider the following common gifting strategy:

Mrs. W, a widow, has substantial assets. She has two adult children, Susan who lives in Vancouver and provides a great deal of day-to-day assistance to her mother, and Tom who lives and works in Toronto. Mrs. W, on the advice of her uninformed neighbour, decides that it would be convenient to transfer her condominium and a stock brokerage account to Susan and herself jointly. Mrs. W completes the gifts, leaves no papers setting forth her intention in making the gift, and unfortunately passes away a few years later.

Now consider the potential pitfalls:

did Mrs. W intend that Susan receive the 50% interest in the condo and stock brokerage account as her own property absolutely as a thank you for the caregiving, or did Mrs. W intend that the gift was being made as a matter of administrative convenience only, such that Mrs. W was always the true owner of the property?

under Mrs. W’s Will, her sole beneficiaries are Susan and Tom. Must Susan set-off against her share under the Will, the value of the condo and the stock brokerage account apparently transferred to her through the gift?

if Mrs. W later changes her mind, is she legally entitled to reverse the gift?

if the condo is not Mrs. W’s principal residence, does Susan have to pay property transfer tax on the gift of the condo? Property transfer taxes can exceed the amount of probate fees.

the stock brokerage account contained some old Microsoft shares purchased by Mr. W in the early 70’s for pennies. They were given to Mrs. W under Mr. W’s Will and they are now worth $100,000. Does the gift to Susan trigger a capital gains tax payable by Mrs. W on the $100,000 gain in the year the gift is made?

if the condo is Mrs. W’s principal residence and she lives for another 10 years after making the gift and the condo doubles in value, then upon Mrs. W’s passing and the sale of the condo does Susan have to pay capital gains tax in the increase of her half interest?

until Mrs. W’s passing, who pays the income tax owing on the dividends paid from the stock brokerage account?

upon Mrs. W’s passing, Mrs. W’s 50% ownership in the stock brokerage account passes to Susan outside of Mrs. W’s Will, however, the capital gains tax payable on the disposition of the 50% interest, is payable by Mrs. W’s estate. Did Mrs. W intend that Tom would be indirectly paying for a portion of the tax payable on the gift to Susan?

shortly after the gift is made Susan and her husband part and a bitter dispute arises over their family assets. Can Susan’s husband make a claim against Susan’s apparent interest in the condo and stock brokerage account?

Susan is secure financially and pays income tax at the highest marginal rate. Instead of trying to save probate fees, would Mrs. W have been more prudent to set up a testamentary trust for Susan’s benefit under her Will, thus saving Susan substantial savings in income tax, as a consequence of the income earned on the testamentary trust being taxed at usual graduated rates?

Beyond the above pitfalls, if Mrs. W’s Will must be probated, then in certain circumstances 100% of the value of the condo and stock brokerage account must be included in the probate process, negating Mrs. W’s well intentioned but misguided attempt to avoid probate fees. An ironic conclusion indeed.

COMMON LAW SPOUSES AND THEIR RIGHT TO CHALLENGE A WILL

Literature, theatre and film have long recognized the powerful emotions that are evoked around Wills, and the litigation that can ensue when a family member feels he or she was not been adequately provided for. Charles Dickens’ Bleak House is a good literary example. In this area of practice, reality is not too far from such fiction. Recent changes to British Columbia statutory law have expanded the scope, and therefore the opportunity, for a disgruntled person to challenge the terms of a Will.

Traditionally, the British Columbia Wills Variation Act allows a deceased’s family member to seek Court ordered compensation if he or she was disinherited or unfairly treated under the deceased’s Will. The governing test is whether the deceased discharged both legal and moral obligations to that family member. Until recently, only a legal spouse or child was considered a "family member" entitled to seek such compensation.

Important legislative changes to the Wills Variation Act in 2000 have extended the concept of "family member" to include a "common law spouse." A "common-law spouse" is defined as a person married to the deceased or who has lived with the deceased in a "marriage-like" relationship for at least two years, including a person of the same sex.

Unfortunately, the new law provides no guidance as to what factors must exist before a couple would be considered "common law spouses" in this context. Existing Canadian judicial authorities suggest the following factors may be relevant:

do the couple refer to and present themselves as spouses or a family unit? One example is how they describe their marital status on income tax returns.

do they share legal rights to their living accommodation?

do they share property, finances and bank accounts?

is there a common intention to make a home together and share responsibilities in and towards that home?

does the couple have a sexual relationship?

Consider some additional Wills Variation Act anomalies that arise from the new law:

The "common law spouse" must have cohabited with the deceased for at least two years, but there is no requirement that this two year period be immediately prior to death. Thus, a person’s long forgotten "marriage-like relationships" in the past can have surprising current effect. For example, assume Doris lived in a "marriage-like" relationship with Sam from 2000 – 2003. Doris and Sam split up and never see each other again. Doris dies in 2008 and leaves nothing to Sam in her Will. Sam would have status to make a claim against Doris’ estate under the Wills Variation Act as he lived in a "marriage-like relationship" with Doris for two years. Whether he would be successful in his claim is another matter.

It is now possible to be a bigamist in British Columbia, for succession law purposes! For example, Tony is married to Linda. After several years of marriage, they separate but do not divorce. Shortly after the separation, Tony meets Alison and begins living in a "marriage-like" relationship with her. After that required two year period of cohabitation has elapsed, Tony will have two legal "spouses": Linda and Alison, both of whom could potentially challenge Tony’s will.

Clearly, non-married couples should consider whether this new law impacts on their personal estate planning objectives.

IMPORTANT DRAFTING TIPS FOR TRUSTS

Many clients wisely choose to hold their accumulated wealth through an inter vivos trust. Previous editions of Your Estate Matters have described common family circumstances when an inter vivos trust can be best utilized. In every case highlighted, the estate planning benefits are clear: centralized asset management, asset protection from third party claims (such as possible creditor, matrimonial, and inheritance claims), tax minimization, and avoidance of the probate procedure and attendant probate fees.

As an inter vivos trust is a legal vehicle intended to operate and provide benefits far into the future, the governing trust indenture must be carefully drafted to accommodate both changing family dynamics and needs, as well as changing tax laws. Here are some crucial drafting points to consider:

1. Trust Investments

Unless the governing trust indenture provides otherwise, the range of assets in which a trustee may invest at law is extremely limited. For example, such common investments as mutual funds, GICs, and real estate will be off-side at law unless the governing trust indenture provides the trustee with expansive powers of investment.

2. Who are the Beneficiaries?

Family trusts commonly identify only immediate family members as beneficiaries, such as mother, father, and children. By confining potential entitlement to such a restricted class of individuals, the intended purpose of the family trust, to provide financial security to all family members in the future, may be defeated. For example, if during the existence of a trust, a child were to die leaving children surviving him or her (i.e. grandchildren), such grandchildren would be denied access to trust assets unless they were named as potential beneficiaries. In effect, one aspect of the family blood-line loses entitlement.

Problems such as this can be alleviated by including in the trust indenture a power to appoint additional beneficiaries in the future. Conversely, it might also be appropriate to include a power to remove beneficiaries in the future, those family members who subsequently become "blacksheep."

3. The Nature of Beneficial Entitlement

Great care and thought should be given to the manner of framing beneficial entitlement under the trust indenture. By far the most versatile and flexible form of beneficial entitlement is "discretionary entitlement." Under a "discretionary" trust, the trustee is given the power to distribute trust income and assets to any person identified as part of the beneficial class.

Some trusts, however, are created to access specific tax preferred planning strategies allowed by the Income Tax Act. For example, the "spousal" trust, the "common-law partner" trust, the "alter-ego" trust, and the "joint partner" trust. The economic benefits accruing from these tax motivated trust structures have been reviewed in previous editions of Your Estate Matters. The Income Tax Act imposes strict restrictions on the nature of beneficial entitlement under these trusts, and these restrictions must be fully and completely recorded under the governing trust indenture. For example, none of these structures allows for initial discretionary entitlement to income derived from trust assets. A trust will lose its tax-preferred status if the beneficial entitlements under the trust fail to comply with the requirements under the Income Tax Act.

4. The Power to Amend

The transfer of property to a trust is a conveyance at law. As such, the terms of the conveyance (i.e. the terms of the governing trust indenture) can only be amended if the trust indenture itself reserves that power to the trustee, or some other party. Otherwise, the ability to seek Court amendment of a trust indenture is extremely restricted. A power to amend should be considered an essential feature of a trust, as unforeseen changes in family circumstances or relevant statutory laws (notably, income tax laws) may necessitate fundamental alterations to the trust.

5. Reducing Onerous Fiduciary Presumptions

A Trustee’s fundamental fiduciary duty requires him or her to observe certain over-riding rules of conduct when administering a Trust, unless the trust indenture otherwise provides. Such rules include:

the prudent person rule (a Trustee must use the skill, care, and attention that a reasonably prudent business person would demonstrate while administering another’s funds for the benefit of others);
the even hand rule (a Trustee who exercises a discretionary power must maintain a balance among Beneficiaries whose interests may not only differ but conflict); and

the principle of delegatus non potest delegare (the prohibition against delegation of authority, particularly "policy" decisions).

To enhance flexibility in trust administration, a carefully drafted trust will include various protective clauses, including:

A general exculpatory clause to protect the Trustee from errors and omissions which do not amount to gross negligence or actual fraud.

A direction that the Trustee is not required from time to time to consider whether or not a power should be exercised and if such a power is exercised, the Trustee may have regard to one or more Beneficiaries to the exclusion of others.
Express permission for the Trustee to delegate his or her authorities. Some common delegation examples are:

delegating investment decisions to a duly qualified investment advisor;

delegating corporate governance of a corporation owned by the trust to an independent Board of Directors of which the trustee does not serve as a director; and

delegating future trust administration through the transfer of assets to a new trust controlled by a different trustee.

Each trust is unique as it reflects the unique objectives of each client. The above discussion highlights some typical drafting considerations, but it is certainly not exhaustive.

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Doug Howard
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E. mdh@cwilson.com

Ross Tunnicliffe
Tel. 604.643.3167
E. rdt@cwilson.com

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Tel. 604.643.3101
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Tel. 604.643.3113
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Wills and Estates
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Lawyer	Direct Telephone & Email Info
Doug Howard	T. 604.643.3110 mdh@cwilson.com
Ross Tunnicliffe	T. 604.643.3167 rdt@cwilson.com
William Ruskin	T. 604.643.3101 war@cwilson.com
Mark Weintraub	T. 604.643.3113 msw@cwilson.com

Clark Wilson LLP's Your Estate Matters is published periodically by the Wills and Estates Group at Clark Wilson LLP. The
information contained in this newsletter should not be treated by readers as legal advice and ought not to be relied on
without detailded legal counsel being sought. Editor: Ross Tunnicliffe © 2001, Clark Wilson LLP. All Rights Reserved.