The Qualified Disability Trust (QDT) was created in 2016 to temper changes to the tax rules for testamentary trusts (trusts set up by a Will). All testamentary trusts used to benefit from the graduated tax rates, however this was changed to tax all testamentary trusts at the top marginal rate. The QDT is an exception to the new rule that all testamentary trusts are taxed at the top marginal rate. A QDT now has access to the graduated tax rates that previously applied to all testamentary trusts.
Subsection 122(3) of the Income Tax Act sets out the definition of a QDT. In order to be a QDT, the trust must meet the following criteria:
- The trust must be a testamentary trust meaning it must be created in a Will and must arise as a consequence of someone’s death, an inter vivos trust does not qualify.
- The trust must be resident in Canada. Residency of a trust is determined by a variety of factors, but if the trustee resides in Canada, the funds are held in Canada, and the beneficiary is in Canada then the trust will likely be resident in Canada.
- The trust must make a joint election with a “qualifying beneficiary” to be a QDT.
- The qualifying beneficiary must be specifically named as a beneficiary in the trust.
- The qualifying beneficiary must qualify for the disability tax credit.
- There can only be one QDT per beneficiary. If multiple testamentary trusts are set up for the benefit of the same person only one of these may be a QDT; the others will be taxed and the top marginal rate.
Keep in mind that a trust does not have to be a Henson trust in order to become a QDT; a beneficiary of a testamentary trust who later becomes disabled may qualify for the QDT designation.
Potential Issues with the QDT
- The Trustee must ensure the proper timing when making the QDT election. There is no relief for a late election and the trust will have to pay tax at the top marginal rate for that year.
- Not all individuals with significant disabilities qualify for the Disability Tax Credit (please see article entitled The Disability Tax Credit for information on how to qualify for the DTC).
- Capacity of electing beneficiary: the qualifying beneficiary must make an election jointly with the trust to designate the trust as a QDT. If the beneficiary is not capable of doing so, a guardian may need to make the election on their behalf.
- The QDT may be required to pay recovery tax for the previous year if none of the beneficiaries are DTC eligible, the QDT ceased to be resident in Canada or, capital from the QDT is distributed to a non-electing or non-DTC eligible beneficiary.
At Siskinds we understand the complexity of working with Qualified Disability Trusts. If you have any questions please contact Laura Geddes at [email protected] or 877.672.2121.