Transferring cryptocurrency to a bare trustee or holding cryptocurrency as a bare trustee


Introduction: Bare Trusts & Canadian Cryptocurrency Users

David Rotfleisch, CPA, JD
David J Rotfleisch, CPA, JD is the founding tax lawyer of and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm.

The developments in blockchain technology bring about an ever-increasing range of opportunities, arrangements, and assets-smart contracts, cryptocurrency liquidity mining and yield farming, and non-fungible tokens (NFT), to name a few. A bare-trust agreement may offer yet another layer of flexibility for Canadian cryptocurrency traders and blockchain investors.

This article is meant for cryptocurrency-savvy Canadians who may benefit from settling a bare trust concerning their blockchain-based assets and who seek to understand the notion of a bare trust. This article discusses three key topics concerning a bare-trust relationship-namely, its nature, its relevance for Canadian tax purposes, and the indicia proving its existence. This article concludes by offering pro tax tips from our top Canadian crypto tax lawyers to Canadian cryptocurrency users who have created or who seek to create a bare trust.

What is a trust and what is a bare trust?

The trust concept finds its roots in equity, a body of law developed in the English Court of Chancery and adopted by Canadian courts. Equity distinguishes legal ownership from beneficial ownership. A person legally owns a property if his or her name is on title, yet the beneficial owner is “the real owner of property even though it is in someone else’s name.” (Csak v Aumon, [1990] 69 DLR (4th) 567 (Ont. HCJ), at p. 570.)

A trust, then, is a relationship between a trustee, a beneficiary, and a property. And it depends on the distinction between beneficial and legal ownership: the trustee legally owns the property; the beneficiary (unsurprisingly) beneficially owns the property.

The trust’s creator (also known as the settlor) will often burden the trustee with duties to maintain or manage the trust property in the beneficiary’s favour. For instance, the settlor might require that the trustee manage a large sum of money, cryptocurrency, or non-fungible tokens for a child or disabled beneficiary.

A bare trust, however, is a trust in which the trustee has no obligations other than to deal with the trust property in compliance with the beneficiary’s directions. In other words, under a bare trust, the beneficiary retains complete control over the trustee’s dealings with the trust property.

As such, a bare trust is primarily an agency relationship whereby the bare trustee holds title to property as the beneficiary’s agent. An agency relationship exists where parties agree that one person (the agent) shall act in accordance with the directions of the other (the principal). Hence, a bare trust arises when parties agree that one person (the bare trustee) shall act in accordance with the directions of the other (the beneficiary) with respect to a property (the trust property). The trust property is, of course, the property over which the beneficiary enjoys true ownership but to which the bare trustee holds legal title.

How is a trust taxed in Canada?

Although a trust is a relationship between entities and not itself an entity, Canada’s Income Tax Act treats a trust as a separate taxpayer. Subsection 104(2) of Canada’s Income Tax Act deems a trust to be an individual for income-tax purposes. This means that a trust must file a T3 trust income-tax return each taxation year. It also means that the settlement of a trust constitutes a disposition of the trust property to the trust, and the settlor may thereby trigger capital-gains tax.

Moreover, if the trust itself earns income, it pays Canadian income tax at the top marginal tax rate on the income remains in the trust. The trust may claim a deduction for the income that it pays to a beneficiary. The beneficiary accordingly pays tax on amounts received from the trust.

A trust that qualifies as a graduated-rate estate (GRE) doesn’t incur top-rate tax on its income; a GRE’s income is taxed at progressive rates. A “graduated-rate estate” basically refers to a deceased person’s estate during the 36 months after that person’s death.

A trust must also realize all accrued capital gains for income-tax purposes every 21 years. Subsection 104(4) of Canada’s Income Tax Act deems a trust to have disposed of all capital property at fair market value every 21 years. (For spousal trusts, alter ego trusts, and joint spousal trusts, this deeming rule doesn’t apply during the lifetime of the qualifying beneficiary. Instead, the deemed disposition occurs upon that beneficiary’s death, and, if the trust continues, every 21 years thereafter.)

How is a bare trust taxed in Canada?

Canada’s income-tax law ignores the bare trustee. Although subsection 104(2) of Canada’s Income Tax Act deems a trust to be an individual for income-tax purposes, this deeming rule doesn’t apply to “an arrangement under which the trust can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust’s property” (see: subsection 104(1)). As a result, if a person retains beneficial ownership of cryptocurrency, non-fungible tokens, or other blockchain assets while transferring legal title to a bare trustee — e.g., by transferring the assets to the bare trustee’s wallet — the transaction does not constitute a disposition for income-tax purposes, and the settlor does not thereby trigger capital-gains tax.

Subsection 104(1) also deems a bare trust to not be a trust for income-tax purposes. For that reason, a bare trust needn’t file a T3 trust income-tax return. In addition, a bare trust isn’t subject to the 21-year deeming rule under subsection 104(4) of Canada’s Income Tax Act. So, the bare trust isn’t forced to realize all accrued capital gains for income-tax purposes every 21 years.

And if, in accordance with the beneficiary’s directions, the bare trustee sells some or all of those blockchain assets to a third party, the transaction is taxed as though the beneficiary had dealt directly with the third party. That is, the beneficiary must report the resulting gain or loss as income. (The resulting gain or loss will be reported either on capital account or on income account, depending on the facts surrounding the transaction.)

The same is true for the foreign-reporting rule requiring a Canadian-resident person to file a T1135 form if that person owns “specified foreign property” with a total cost exceeding $100,000. Cryptocurrency, NFTs, and other blockchain-based assets are “intangible property,” and, because they exist on decentralized digital platforms, they’re “situated, deposited or held outside Canada.” As such, they typically meet the definition of “specified foreign property.” Although the bare trustee holds legal title to the digital assets by means of the bare trustee’s wallet, those digital assets truly belong to the bare trust’s beneficiary. If the beneficiary’s total cost for those cryptocurrency, non-fungible tokens, and other blockchain assets exceeds $100,000, the beneficiary must file a T1135 form disclosing those assets.

For the most part, a bare trust’s GST/HST treatment reflects its income-tax treatment. That is, courts will generally ignore a bare trust when applying the provisions of Canada’s Excise Tax Act. This is relevant to Canadians who create, sell, and trade non-fungible tokens. Commercial sales of non-fungible tokens might bring about GST/HST obligations because commercial NFT sales qualify as a taxable supply under the Excise Tax Act. Thus, if you engage in commercial NFT sales through a bare trust in which you’re the beneficiary, you may need to register for GST/HST and to charge, collect, and remit GST/HST on your NFT sales in Canada.

There are exceptions to the Canadian tax treatment of a bare-trust relationship. For example, a bare trustee isn’t ignored for the purposes of the GST/HST New Housing Rebate (see: The Queen v Cheema, 2018 FCA 45). Thus, while Canadian tax law typically ignores bare trusts, this treatment isn’t universal. The lesson is that, before entering a bare-trust relationship, you must first confirm that the bare trust will indeed bring about the desired tax consequences in your particular circumstances. 

How do you determine whether a bare trust has been created?

As with a conventional express trust, a bare trust must exhibit the so-called three certainties: (1) certainty of intention, (2) certainty of subject, and (3) certainty of object. The certainty-of-intention requirement deals with the settlor’s intention to create a trust, and this requirement demands that the settlor demonstrate an intention to create a trust by obligating the trustee to hold a property for the beneficiary’s benefit. The certainty-of-subject requirement deals with the property that the settlor intends to put in trust, and it demands three things. First, the settlor must own the property-at least beneficially-that the settlor intends to put in trust. Second, the trust property must be ascertainable when the trust comes into existence. Third, each beneficiary’s entitlement to the trust property must be sufficiently defined. Finally, the certainty-of-object requirement deals with the trust’s beneficiary or beneficiaries. Under this requirement, it must be possible to ascertain each beneficiary (if the trust is a fixed trust) or to determine the beneficiary status of a given individual (if the trust is a discretionary trust).

But the principles of agency law also prove relevant in a bare-trust relationship. This is because a bare trust is essentially a principal-agent relationship in which the agent holds legal…

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