Call Us At 519.672.5666
Insights & Articles
Personal and Prescribed Trusts for Employees

This article was published by the Canadian Tax Foundation in 2023 Vol. 23, no. 1 Tax for the Owner-Manager.
As the case of McNeeley v. Canada (2021 FCA 218) made clear, caution should be exercised when a trust is used to compensate employees, especially when the plan is to use the trust to transfer shares to employees. McNeeley was discussed in the October 2022 issue of this newsletter. The particular trust in that case was determined to be an employee benefit plan, but can trusts ever be used in an employee context in the same way as they are used in the family context? In the right context, with the appropriate choice of settlor, trustees, and beneficiaries, a trust functions effectively for tax planning because of how it is treated under the Act. A trust established for family members is a “personal trust” pursuant to the definition of that term in subsection 248(1). It also meets the definition of a “trust” pursuant to subsection 108(1). A trust meeting either of these definitions provides access to the beneficial tax-planning opportunities provided by sections 104 to 107—although careful attention should be paid to each section and subsection, because they include rules that are unique to personal trusts and prescribed trusts.
Subsection 108(1) Definition of “Trust”
However, not all trusts are treated equally under the Act. Notably, the definition of “trust” in subsection 108(1) excludes a number of trusts from subsections 104(4), (5), (5.2), (12), (13.1), (13.2), (14), and (15), and sections 105 to 107. These exclusions are found in paragraphs 108(1)(a) to (e.1), with additional exclusions in paragraphs (f) and (g). Most of the exclusions found in paragraphs 108(1)(a) to (e.1) are defined structures under the Act (for example, an employee life and health trust). However, paragraph (a.1) represents a very broad exclusion.
It refers to a trust (other than a trust described in paragraph (a) or (d), a trust to which subsection 7(2) or (6) applies or a trust prescribed for the purpose of subsection 107(2)) all or substantially all of the property of which is held for the purpose of providing benefits to individuals each of whom is provided with benefits in respect of, or because of, an office or employment or former office or employment of any individual.
This broad language includes any established trust in which the beneficiaries have an interest because they are employees. There are four exceptions to this exclusion, three of which are set out in the parentheses in paragraph (a.1). The first two exceptions—described in paragraphs (a) and (d)—are already excluded from the subsection 108(1) definition of “trust.” The third exception is for employee stock option plans, which have their own taxing provisions. Three kinds of trusts, then, cannot be used to achieve the same tax treatment as a family trust. The fourth exception is for subsection 107(2) prescribed trusts, which are defined in regulation 4800.1. Therefore, it may be possible for a subsection 107(2) prescribed trust to meet the subsection 108(1) definition of “trust.”
Personal Trusts
Given that the subsection 108(1) definition of trust applies to subdivision k of the Act while the definition of “personal trust” is found in subsection 248(1), it may be possible to have a trust that is excluded under the subsection 108(1) definition of “trust” but is nonetheless a “personal trust.”
However, the personal trust definition excludes “a trust in which no beneficial interest was acquired for consideration payable directly or indirectly to (i) the trust, or (ii) any person or partnership that has made a contribution to the trust by way of transfer, assignment or other disposition of property” (emphasis added). This language is very broad. It would seem that when the corporate employer issues shares to the trust, it has “made a contribution to the trust by way of transfer,” even if the corporation did not settle the trust.
Notably, the consideration and the contribution appear not to contemplate a single transaction (that is, the purchase of an interest in the trust). Rather, there need only be consideration payable directly or indirectly to a person that makes a contribution to the trust. There does not appear to be any temporal or contractual connection between the consideration and the contribution.
If the trust is established for employees, the beneficiaries have acquired their beneficial interest as a result of their employment with the employer. Essentially, they would not be beneficiaries if they were not employees (in contrast to family trusts, where the beneficiaries are family members who may or may not work in the business). This employee-employer relationship involves consideration flowing both ways (that is, money for labour and labour for money). Therefore, there may be consideration passing from the employee-beneficiary to the employer.
Subsection 108(7) provides a relieving provision in situations where the interest in the trust is deemed not to have been acquired for consideration. However, it applies only to beneficiaries with a right to enforce payment and to a person (or two or more related persons) who has contributed to an inter vivos trust and has a beneficial interest in the trust.
The CRA has in the past provided favourable commentary regarding this consideration issue. In CRA document no. 9432135 (February 8, 1995), as cited in CRA document no. 2015-0596841E5 (July 30, 2015), the CRA confirmed that an employee profit-sharing plan (EPSP) can meet the definition of “personal trust” pursuant to subsection 248(1) because the fact that an employee is a beneficiary under an EPSP alone does not constitute consideration payable to acquire an interest in the EPSP.
It appears, however, that this CRA interpretation dealt with an earlier version of subsection 144(4) (the provision governing EPSPs), predating its amendment (by SC 1995, c. 3, section 42) to include a reference to section 110.6. The taxpayer may have been looking to confirm that the beneficiaries could use their lifetime capital gains exemption on distributions from the EPSP. A question arises: Will the CRA adhere to this position regarding consideration when the original impetus for the position has been resolved through an amendment to the Act?
Prescribed Trusts
As indicated above, a “prescribed trust” is an exception to the paragraph (a.1) exclusion under the subsection 108(1) definition of a trust. The relevant prescribed trust under regulation 4800.1 would be one that is maintained primarily for the benefit of the employees of a corporation and that has, as one of its main purposes, the aim of holding interests in shares of the capital stock of the corporation.
However, such a trust would have to contend with the McNeeley decision. Presumably, any trust established on the basis of similar facts could be considered an employee benefit plan as defined in subsection 248(1). To avoid meeting the definition of “employee benefit plan” otherwise than through the paragraphs 108(1)(a) to (e) carve-outs, the following elements will be required: (1) an arm’s-length settlor, and (2) no contributions by the employer or other non-arm’s-length parties.
With respect to the first requirement, I would observe that although it may be difficult to find someone who is willing to provide their own money to the trust yet not be considered factually non-arm’s-length, it is not impossible. If such a settlor can be found, the elements of the second requirement (contributions by the employer or other non-arm’s-length parties) will need to be avoided. This could be difficult: how does the value of the company get to the beneficiaries other than through some kind of contribution from the company to the trust? The definition of “settlor” in subsection 108(1) has a definition of “contribution” for an inter vivos trust: “the transfer, assignment or other disposition of property.” The court in McNeeley did not address the issue of making a contribution, other than to state that the initial trust settlement was a contribution. That being the case, what constitutes a contribution for the purposes of an employee benefit plan? Would paying a dividend or redeeming the shares held by the trust be a contribution? More importantly, would issuing the shares to the trust be a contribution?
Conclusion
In light of the discussion above and the McNeeley decision, care should be exercised when a trust is used to compensate employees or to move ownership of the business to employees. In particular, such a trust may not be a “personal trust” or it may be excluded under paragraph (a.1) of the definition of “trust.” From the perspective of business growth and succession planning, the use of a trust works well for family members. However, a trust raises issues when it is used in connection with persons who are beneficiaries because they are employees. It is hoped that the employee ownership trusts announced in the 2022 federal budget can be designed to provide relief against this disadvantageous treatment of employees.
This article was written by Tax Lawyer R. Graham Morton.