Anonymised, illustrative composite. A holding trust drafted with a familiar-looking discretion clause, a settlor who never gave up control, and a rollout that the family's own s.104(4) fix — the same one that works for most family trusts — could not reach.
At a glance
A founder settled a holding trust to hold a 35% block of his operating company's shares for his three adult children, using a template he had been given by a colleague rather than counsel retained specifically for the transfer. The deed gave the trustees discretion over income and capital among the children as beneficiaries — but it also included a clause letting the settlor, at any time during his life, direct the trustees to add or remove beneficiaries or redirect the property among a wider class that included his siblings and their children.
The colleague who supplied the template had used it years earlier for a trust holding a portfolio of marketable securities, where the retained flexibility clause was included mainly so the settlor could add a future spouse or a not-yet-born grandchild without a full resettlement. Nobody revisited the clause's purpose when the template was repurposed to hold operating-company shares instead, where the same flexibility language carries a materially different tax consequence.
ITA s.75(2) applies where a trust holds property on condition “that it or property substituted therefor may…pass to persons to be determined by the person at a time subsequent to the creation of the trust,” or “that, during the existence of the person, the property shall not be disposed of except with the person's consent or in accordance with the person's direction.” Where either condition is present, the income, losses and capital gains on the property “shall, during the existence of the person while the person is resident in Canada, be deemed to be income or a loss…of the person” — not of the trust or its beneficiaries. The settlor's retained power to redirect beneficiaries fell squarely inside the first branch of the test.
For the four years the trust operated under this clause before the drafting error was found, roughly $780,000 of dividend income the trust received on the shares was reassessed as the settlor's own personal income rather than the beneficiaries', adding approximately $310,000 of personal tax across the four years at his marginal rate — income that had already been distributed to and spent by his children, who had reported and paid tax on it themselves under the ordinary trust-distribution rules before the reassessment.
The family's first instinct, once the clause was flagged, was to do what had worked for a sibling company's 21-year-old family trust: distribute the shares out to the children before the problem compounded further. That route was closed. s.107(4.1) provides that the ordinary rollover on a distribution to a capital beneficiary does not apply, and a taxable disposition applies instead, wherever s.75(2) “was applicable…at a particular time in respect of any property” of the trust and the distribution goes to someone other than the person whose power triggered the attribution in the first place. Because the settlor was the one whose retained power caused the s.75(2) problem, and the children were not that person, s.107(4.1) blocked the tax-deferred route out that a s.104(4) file can normally use.
The family resettled the arrangement: the trust was wound up on a taxable basis, the shares were reacquired at their then fair market value by a newly incorporated holding company owned directly by the children, and the settlor formally and irrevocably released every power over beneficiary designation in the process. The tax on the wind-up was real, but it was a one-time cost rather than the ongoing annual attribution the old clause had been producing.
The new holding company's constating documents were drafted from scratch rather than adapted from the same template, specifically to remove any lingering discretion in the settlor's hands over who could receive value from the shares going forward — a deliberate reaction to how the original problem had arisen in the first place.
Leaving the clause in place would have kept attributing the trust's income and gains to the settlor for as long as he lived and remained Canadian-resident — an open-ended annual cost rather than the one-time wind-up tax the family ultimately paid. On a block earning $200,000 or more a year in dividends, a decade of continued attribution at the settlor's marginal rate would have cost several times what the resettlement did.
Any retained power letting the settlor redirect a trust's beneficiaries, consent to or withhold a disposition, or otherwise control who ultimately receives the property, triggers s.75(2) whether or not the power is ever actually used. The clause does not have to be exercised to attribute income back to the settlor — its mere existence is enough. A holding trust drafted from a generic template, rather than one built for this specific transfer, is the highest-risk source of this clause.
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