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November 2009 - view full issue
The Naked Truth About Bare Trusts
A man visits his lawyer to discuss the estate of his recently deceased mother, who had been residing in Hong Kong. Her estate includes a house in Vancouver, which she acquired 15 years ago when she lived in Canada for several years. When she emigrated back to Hong Kong, she transferred the house into the name of her son, a Canadian resident, who has held the property as bare trustee for her. He assumes that because the property is in his name, there are no tax consequences on her death and the house is not part of her legal estate.
This situation, though fictional, is typical of the confusion that can arise in connection with bare trusts. The client must be advised that his mother remained the owner the property for tax purposes, and that the deemed disposition on her death results in tax liability.
Like other types of trusts, bare trusts involve a separation of the legal title to an asset, held by the trustee, and the beneficial ownership enjoyed by the beneficiaries. What distinguishes bare trusts is that a bare trustee holds the property without any duties except to convey it back to the beneficiary on demand, and to deal with it as the beneficiary directs. Accordingly, the bare trustee is an agent of the beneficial owner, without independent administrative powers or duties.
For income tax purposes, bare trusts are ignored, and the beneficial owner is treated as the owner of the property. While other trusts are deemed to be individuals and required to file a tax return, the definition of "trust" under the Income Tax Act is deemed not to include an arrangement under which the trust can reasonably be considered to act as agent for all of its beneficiaries with respect to all dealings with all the trust's property. As a result, if Smith owns property and transfers legal title to Jones who holds as bare trustee for Smith, the transfer is not considered a disposition at all for income tax purposes, as the beneficial ownership does not change.
Bare trusts are widely used for holding real estate in British Columbia, primarily because of the way the province's Property Transfer Tax is structured. With some limited exemptions, the PTT applies to transfers of title to real property based on fair market value, imposing a tax of 1% on the first $200,000 and 2% on the balance. However, the PTT applies only to transfers of legal title that are registered in the Land Title Office (in contrast to Ontario's counterpart Land Transfer Tax which taxes both legal and beneficial transfers). As a result, PTT is entirely avoided where the beneficial interest in land is transferred without registering a transfer of legal title.
In fact, the use of bare trusts in British Columbia has become common knowledge to the point that people now try to use them without properly considering the implications and consequences. Problems most often arise when, as in the anecdotes set out above, people have multiple competing objectives, some of which can be addressed by the use of a bare trust and others of which cannot. In other cases, the bare trust is not documented and either the bare trustee or the beneficial owner has died or is incapacitated, leaving personal representatives to determine questions of beneficial ownership without proper records.
Another potential problem with bare trusts was highlighted by the recent BC Court of Appeal decision in Graham v. Smith. The case involved two separate situations; in both, an individual transferred beneficial interest in land to an alter ego trust (a substantive trust), but retained title personally as a bare trustee holding for the alter ego trust as beneficial owner. On the subsequent death of the individual, the executors applied to have title registered in their names so that they would take the place of the deceased as the bare trustee. The Registrar of the Land Title Office refused to file the transfer on the basis that the applicants had not established "good safe holding and marketable title" as required under the Land Title Act. The Court of Appeal sided with the Registrar. As a result, in situations where the Land Title Office has notice that the registered owner of land is a bare trustee, it may refuse to register a transfer of the land until the bare trust is first registered (which in most cases will trigger the Property Transfer Tax liability).
In summary, a bare trust can be a useful estate planning tool in the right circumstances, but it must be properly documented, and implemented with due consideration to the legal and tax implications.