Overview—The 21-Year Deemed Disposition Rule
For Canadian tax planners and trust beneficiaries, the “21-year rule” is a critical milestone. Under the Income Tax Act (ITA), most personal trusts, such as family trusts, spousal trusts, alter ego trusts, or testamentary trusts, are deemed to have disposed of their capital property at fair market value at the 21-year anniversary of the date the trust was created or the date the settlor dies. The trusts continue to be deemed to have disposed of the trust properties every 21 years after the first 21st anniversary. This rule is designed to prevent the indefinite postponement of capital gains on property held within a trust.
To maintain the integrity of this timeline, subsection 104(5.8) of the ITA contains an anti-avoidance rule for “trust-to-trust” transfers. When property is transferred directly from one trust to another on a tax-deferred basis, the recipient trust “inherits” the 21-year anniversary of the original trust. This ensures the property remains subject to the same deemed disposition period that applied to the initial trust.
The “Indirect Transfer” Loophole
However, experienced Canadian tax lawyers have made use of a well-known method to indirectly transfer trust property in order to avoid both the 21-year rule and the existing anti-avoidance provisions. A common example of this tax planning involves a trust distributing property on a tax-deferred basis to a beneficiary that is a corporation owned by a new trust.
By inserting a corporate layer, taxpayers sought to do indirectly what the tax law prohibited directly: resetting the 21-year clock by moving assets to a fresh trust structure without triggering the “inheritance” of the old trust’s anniversary. The Canada Revenue Agency (CRA) had previously designated such indirect transfers as “notifiable transactions” and threatened to apply the General Anti-Avoidance Rule (GAAR) to these arrangements.
The Budget 2025 Proposal: broaden anti-avoidance rules for trust-to-trust transfers, other trusts
In a significant move to codify the CRA’s position, Budget 2025 proposes to broaden the current anti-avoidance rule for trust-to-trust transfers. Under the new proposal, the rule will be expanded to include indirect transfers of trust property to other trusts.
Key aspects of this change include:
- Expanded scope: the rule will now capture transfers made through intermediaries, such as a corporation owned by a new trust.
- Resulting treatment: the new (recipient) trust will be subject to the 21-year deemed disposition on the same date as the original trust. That is the 21-year anniversary date of the original trust will also be the 21-year anniversary date of the new trust.
- This measure applies to transfers of property occurring on or after November 4, 2025.
Pro Tax Tip—Strategic Planning and Compliance
To navigate these expanded anti-avoidance rules, trustees and their Canadian tax lawyers must carefully review any proposed distributions or reorganizations involving corporate beneficiaries.
- Review existing structures: assets recently moved to corporations owned by trusts should be evaluated to determine if they will now be subject to an accelerated 21-year deemed disposition.
- Timing of distributions: any planning intended to manage the 21-year rule must now account for the “look-through” nature of these new provisions.
- Consultation: trusts should consult with an experienced Canadian tax lawyer to ensure that corporate and trust reorganizations do not inadvertently trigger the expanded 21-year rule “trap.”
FAQ
What is the primary tax risk of transferring trust assets to a corporation owned by a second trust?
Under the Budget 2025 proposals, this “indirect transfer” will no longer reset the 21-year clock. The second trust will be deemed to have the same 21-year anniversary as the original trust, potentially triggering a massive capital gains tax hit much sooner than anticipated.
When did these new rules regarding indirect trust transfers take effect?
These rules to apply to any property transfers occurring on or after November 4, 2025. Transactions completed before this date may still be subject to scrutiny under GAAR or “notifiable transaction” reporting requirements.
DISCLAIMER: This article provides broad information. It is only accurate as of the posting date. It has not been updated and may be out-of-date. It does not give legal advice and should not be relied on as tax advice. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.