Bare trusts and the UHT: How tax rules meant for crooks and global elites ensnared thousands of Canadians

Karyn Morris was surprised to learn earlier this year that she would have to file a special tax return for trusts. Until this spring, she had no idea she was a trustee.

But Ms. Morris, a 74-year-old retired teacher in Toronto, and her sister had added their names to their 100-year-old mother’s investment account so they could help her with paying bills and other routine financial matters. That arrangement, Ms. Morris learned, is considered a so-called bare trust under common law and, for the first time this tax season, required filing a tax return under new federal rules.

Even more surprising was the $1,511 fee they were charged for filing the trust’s paperwork by the large accounting firm that usually does their mother’s taxes. But most puzzling of all to Ms. Morris was that, according to news reports, this unprecedented and costly tax headache stemmed from rules Ottawa had rolled out to combat money laundering and tax dodging.

“They may be trying to catch some big fish but they’re just catching a whole bunch of minnows,” she recalled telling her friends.

She was among the many ordinary Canadians who found themselves ensnared in what experts say was a federal push for financial transparency that ran up against the reality that, under common law, a trust and other kinds of legal devices can exist even if people such as Ms. Morris had no intention of creating them.

Over the past six months, Ottawa has taken the rare step of walking back on two separate sets of new tax-filing rules – the bare trust requirements and the equally controversial Underused Housing Tax (UHT). Both contained measures to collect more information on trusts and other legal structures, and both backfired in similar ways.

How did this double tax fiasco come to be?

Critics say the responsibility is widespread. Officials at the Department of Finance failed to adequately consider the possible side effects of the new measures for Canadians who hadn’t intentionally set up a trust or other legal devices, and the officials pressed ahead despite warnings from tax practitioners. The potential implementation issues entirely escaped legislators’ scrutiny when Parliament debated the two bills that contained the measures. And the Canada Revenue Agency did little to spread the word about the new tax obligations or simplify the paperwork for taxpayers with straightforward situations.

Experts have also lambasted the federal government for waiting far too long to reverse course. In the case of bare trusts, the about-face came after a large share – if not most – of the people who were aware that they needed to file had already done so. On the UHT, Ottawa is scrapping tax-reporting requirements that affect Canadians for 2023 and following tax years, but keeping in place an obligation to file for the year 2022, leaving many tax preparers and their clients perplexed.

The dubious exercise cost millions of dollars and countless hours of work for taxpayers, accountants and the government itself.

Yet, Canada direly needs tougher rules around trusts and other legal relationships to combat a festering dirty-money problem, transparency advocates say. And in the world of anti-money-laundering, it may not be possible to weave a regulatory web that catches the big fish – crooks hiding vast amounts of money – without also creating some extra paperwork for the minnows, the honest taxpayers who often can hardly afford expensive tax advice.

The key to move forward, several anti-money-laundering and trust law experts interviewed by The Globe and Mail agree, is to redraft the rules to make them easy and low cost for Canadians such as Ms. Morris to follow.

The basic facts of the two tax boondoggles are all too familiar to many Canadians who were affected by them this spring. Yet, those who weren’t – or didn’t know that they should file – remain largely unaware of them.

The first set of new measures made it mandatory to fill out a specific tax return for almost anyone with a trust, a legal device that separates legal from beneficial ownership. With a trust, someone called a trustee holds property for the benefit of someone else, called the beneficiary.

Crucially, the new rules extended the obligation to file tax documents to bare trusts, which, in common law jurisdictions, are often informal arrangements that aren’t documented in writing. (Common law, which is based on precedent, applies in every province and territory except Quebec, which follows written civil law.)

The second tax change was the introduction of the UHT, a levy on underused or vacant foreign-owned real estate. While primarily aimed at wealthy investors based abroad, the measure also made it mandatory to file a special tax return for Canadians who own homes through certain trusts, corporations or partnerships. (The CRA describes the latter as a relationship between people carrying on a business in common with a view to profit.)

The government’s goal ostensibly was to collect more information about who truly owns property in Canada. In a country known for attracting billions of dollars from criminals and well-heeled tax cheats who conceal ownership behind complex legal structures, it was a worthy and long-overdue effort, anti-money-laundering experts say.

But Canada also has many informal family financial arrangements that can be deemed trusts or partnerships under common law, and the new rules wound up creating a costly bureaucratic nightmare for many Canadians in fairly typical situations who have middle-class incomes and nothing to hide.

Among those caught in the new trust-reporting requirements were many people who, as in Ms. Morris’s case, had joint accounts with elderly family members to help them with money management. Many Canadian couples who own rental property together discovered they may be deemed a partnership, subject to the tax-filing requirements of the UHT. Parents whose name had been added to the title of an adult child’s home because they guaranteed their mortgage found out they may be among those obliged to file a trust as well as a UHT return.

The new trust rules and the UHT both generally demanded more information – rather than more taxes – from Canadians, but there were also severe penalties for non-compliance. And the requirements were hard to decipher, often forcing those affected to spend hundreds of dollars, if not thousands, on accountants and lawyers for help.

Eventually, public uproar forced the government to backtrack. In November, Ottawa announced it would largely scrap the need for Canadians to file UHT returns for 2023 and following years, even as it kept in place an obligation to send in returns for 2022. And this past March, the CRA said it would largely suspend filing requirements for bare trusts for the 2023 tax year, while it consults with the Department of Finance on how to simplify its guidance on the rules.

But by the time the federal government dropped or paused the complex new requirements, they’d already drained millions of dollars out of public coffers and Canadians’ pockets. On the UHT, documents tabled in the House of Commons show that, as of early March, the CRA had spent $59-million to administer the new measure and assessed just $49-million in taxes owing.

On the new trust rules, a survey of small and medium-sized accounting firms estimated that tax preparers and their clients may have spent almost $1-billion to complete 2023 tax returns for bare trusts that are now obsolete. According to documents tabled in the House, the CRA had received nearly 44,000 bare trust returns as of early April.

It’s a two-pronged debacle that many tax professionals say undermined public confidence in the tax system. Its origins span the halls of government.

The first time Finance officials circulated a draft of stricter rules to gather more information about trusts and their beneficiaries was in 2018. During the previous two years, the Panama Papers scandal, a leak involving millions of documents that detailed international money laundering and tax evasion, had shone a light on Canada’s role as a sought-after tax haven for the global elite.

With the legislation, Ottawa was following international best practices for increasing governments’ visibility into who truly owned assets held through trusts. That version of the rules, as described in the 2018 federal budget, expanded the kinds of trusts that would have to file annually to the CRA and the type of information they’d have to disclose.

For years, though, that draft legislation languished. Then, in early 2022, federal regulators presented for public consultation another draft that extended the reporting obligations to bare trusts, a type of trust in which the trustee has no significant power or responsibilities and can only act on the instruction of the beneficiary.

Tax professionals looking at the new iteration of the draft law were quick to spot potential trouble ahead. Bare trust arrangements are common in Canada and “can often arise unintentionally,” the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada, which represents lawyers and CPAs, warned in a letter to Finance officials.

The rules would require taxpayers to determine which situations involve a bare trust, the group flagged, adding also that the tax forms were designed for different types of trusts and that the paperwork would likely result in extra accounting costs for Canadians.

The government, though, pressed ahead. Asked to comment on the feedback provided by the Joint Committee, Caroline Thériault, a spokesperson for the Department of Finance, said the group also acknowledged in its submission that financial transparency is an important policy issue. “The collection of beneficial ownership information on trusts, including bare trusts, remains an important part of Canada’s international commitments in this regard,” Ms. Thériault said in an e-mail.

The new rules were added to an omnibus bill that included provisions to eliminate the interest on federal student and apprentice loans, and create the first home savings account, among several other measures.

In the House, the new rules on trusts received a single, cursory mention as the legislation wound its way through Parliament. In the Senate, the debate focused primarily on concerns about the impact of the measure on attorney-client privilege. The bill received royal assent in December, 2022.

The legislation underpinning the UHT, which imposes an annual 1-per-cent levy on foreign-owned residential real estate that is deemed underused or vacant, may have also received an unusually low level of scrutiny. While the Trudeau government announced the measure in its 2021 budget, Finance didn’t post a backgrounder on the proposed design of the tax until Aug. 6 of that year, just days before Parliament was dissolved ahead of a federal election.

Some MPs later expressed concern that the government didn’t receive enough feedback from the public because of the timing of the consultation process.

Ottawa has variously portrayed the UHT as a tax to raise revenue for housing affordability initiatives and a measure meant to deter foreign real estate investors from leaving their Canadian properties empty.

But the issue of foreign-owned vacant homes has ties to money laundering as well.

Having tenants is often a risk for lawbreakers who’ve parked dirty money in real estate, according to Kevin Comeau, a corporate lawyer who has written on policy and legislative proposals to combat money laundering. That’s because it usually means collecting monthly rent payments that are routed through banks.

“These criminals from around the world know that they don’t want to go through the Canadian banking system. So it’s just easier to leave those houses, townhouses and condominiums empty,” Mr. Comeau said.

Testifying before the House finance committee on the UHT, James Cohen, the then executive director of the Canadian chapter of Transparency International, a non-governmental anti-corruption organization, described how foreign buyers could easily conceal funds invested in real estate by using Canadian corporations and legal structures such as trusts.

“Canada has had weak beneficial ownership laws, which have allowed individuals to hide their identity behind anonymous corporations, trusts and nominees,” he told MPs, according to a transcript of his testimony. “A foreign buyer of Canadian property could funnel their funds, whether licit or illicit, through various jurisdictions, ultimately landing in an anonymous Canadian incorporated company with nominee directors signing for it.”

The UHT legislation included certain corporations, trusts and partnerships in the reporting requirements. Homeowners holding real estate through those structures would now have to file a return.

But Mr. Cohen still sounded skeptical that the UHT would have a significant impact on foreign owners’ behaviour. The government would likely still struggle to identify non-Canadian owners. And a 1-per-cent tax was likely too low to dissuade wealthy criminals from laundering their money in Canada’s real estate market, he said.

Unlike the rules on trusts, the UHT received plenty of attention from MPs and senators. But what received little attention was the fact that the broad filing requirements demanding a tax return from people owning property through a corporation, trust or partnership would also apply to Canadians.

While domestic homeowners were largely exempt from the tax, those affected by the rules would still have to file – if only to claim an exemption from the levy – or risk penalties of thousands of dollars.

Finance officials who described the rules to Parliament failed to highlight this aspect of the rules. Testifying before the House finance committee in February, 2022, for example, Pierre Mercille, director-general responsible for legislation in the sales tax division at the ministry, told MPs: “Canadian citizens, permanent residents of Canada and certain Canadian entities would not be subject to the tax or required to file an annual return.”

That statement was accurate for the vast majority of Canadians – but not for everyone, as a significant minority of the country’s homeowners would soon discover.

Allan Lanthier, a retired partner at international accounting firm EY, pins a lot of the blame for both tax blunders on the Department of Finance. Mr. Lanthier, who has been an adviser to Finance and the CRA, believes the core issue is a growing focus by bureaucrats who draft tax laws for Parliament on what he dubs “legislative perfection.”

“We’ve got to make everybody report so we can make our best effort to get the 1 per cent of terrorist financing and Russian oligarchs, etc. …” Mr. Lanthier said, describing the thinking that was likely behind the sweeping tax-filing rules for trusts and the UHT.

It’s a kind of tunnel vision that Mr. Lanthier said he’s observed through the years in several instances and not just for tax policy aimed at money launderers and tax cheats. Usually, he said, the outcome is extremely complex legislation that even professionals struggle to understand – with little attention paid to the unintended effects on the 99 per cent of taxpayers who, while not the main target of the abstruse rules, are nonetheless swept in by them.

Mr. Lanthier recalled an instance in which Finance officials told him they weren’t just closing current tax loopholes, they were also writing tax rules to try to pre-empt creative tax schemes that no one had thought of yet.

“This particular provision that we have in there – and it’s complex – we agree that we can’t see what mischief it’s going to catch right now. But what about the mischief on the horizon that we can’t contemplate yet,” Mr. Lanthier said, recalling that conversation.

But closing loopholes and anticipating potential new ones is the name of the game when you’re going after money launderers and tax dodgers with sophisticated financial and legal advice, Mr. Comeau said.

“When you’re trying to plug the holes in which money launderers from around the world are sending their dirty money to Canada, you really have to be cognizant of all the ways in which they can bring money in,” he said. “If you only plug the ones that are common to business – like corporations, partnerships, limited partnerships – they will just move their structures in a way that will use the one that you haven’t plugged.”

And hiding ill-gotten gains in Canada has been exceedingly easy, experts say. In a 2020 report, the Canadian Security Intelligence Service estimated that the scale of money laundering in this country ranges from $45-billion to $113-billion annually.

Canada is known for allowing individuals to hold assets through a variety of legal structures with no obligation to disclose beneficial owners, a trait that continues to make it a popular destination for fraudsters hiding illicit funds, a 2022 report by Transparency International warned.

Over the past several years, the country has made slow progress in plugging some of the regulatory holes through which dirty money has been flowing in.

British Columbia has created a public ownership registry that gathers information on people who own or control land indirectly, such as through corporations, partnerships or trusts. The province is also in the process of rolling out a similar registry for businesses, something that is already up and running in Quebec. The federal government started requiring information about beneficial ownership for certain corporations earlier this year. And discussions are also under way among provinces and territories to form a pan-Canadian corporate registry of beneficial ownership.

While stopping short of creating a public registry, the stricter rules on trusts, which include listing all beneficiaries, were a step in the same direction.

The idea behind these initiatives isn’t that criminals and tax fraudsters will rush to write down their names on government forms, Mr. Comeau said. But broad requirements to register the true owners of various assets make life harder for the intermediaries – such as rogue lawyers, accountants and corporate service providers – who often act as nominees on corporations, trusts or partnerships to shield the identity of their corrupt clients, he added.

“Now they can’t be registering themselves for 300 corporations in Canada, saying they’re the beneficial owner because right away, it’s red flags,” he said.

Eventually, those blanket registration rules will make Canada a less hospitable place for money launderers, said Sasha Caldera, campaign director at Publish What You Pay Canada, an anti-corruption and natural resource governance non-profit organization.

“It’s deterrence,” he said. “When you make it that much more difficult for someone to launder money in a country, they’ll think twice and they’ll likely try to do business elsewhere.”

But imposing catch-all reporting requirements can get tricky when it comes to trusts in a country such as Canada, said Adam Hofri-Winogradow, a law professor at the University of British Columbia whose research focuses on trusts. Under common law, many trusts can be created informally.

“In many cases, you don’t need any written document to create a trust,” Prof. Hofri said. “You can create trusts orally, you can create them by way of behaving a certain way.”

The ability to establish a legal structure, such as a trust, without having to pay a lawyer or other professional is a strength of common law systems, Prof. Hofri said. But it also makes it possible for people to create trusts without meaning to do so, he added. (In Quebec, a trust can only be established by a contract, by a will or, in certain cases, by law, according to Jeffrey Talpis, a law professor at the University of Montreal.)

“You end up with people being trustees who have no clue that they are,” Prof. Hofri said, which can become a headache for anti-money-laundering rules.

Yet other common law countries have managed the task. Britain, for example, has had a trust registry for a few years that includes reporting obligations for bare trusts. And it did not trigger the mayhem over accidental trusts that ensued in Canada.

The key difference is that registering a trust for people with simple situations is a much more straightforward exercise in Britain, said Ian Roxan, associate professor of law emeritus at the London School of Economics.

While the national tax authority collects the information on trusts in Britain, as the CRA does in Canada, trustees register their trusts through a separate online portal rather than by filling out a tax return, he said. And, crucially, there is no requirement to provide a trust document.

“That’s one of the big headaches to the bare trusts under the Canadian system,” said Prof. Roxan, who is both a non-practising solicitor in England and a barrister and solicitor in Ontario.

British citizens may still want to get professional advice on whether or not they have a trust subject to the reporting rules, added Prof. Roxan, who also served in the tax policy branch of Canada’s Department of Finance working on trust and tax law in the 1980s. But when it comes to registering the trust, “there’s no obvious reason why someone who has a really simple affair can’t just do it themselves.”

Ottawa might still want to use tax returns to gather ownership information on trusts instead of setting up a separate online registry, especially if the goal is also to crack down on tax evasion and aggressive tax planning, he said.

But the tax-filing process the CRA tried to extend to informal trusts was clearly designed for legal structures that had been deliberately created, Prof. Roxan said. That sort of paperwork is unnecessarily complicated and onerous for people with the kinds of informal arrangements that can be unintentional trusts, he added.

“I think that’s where the problem came from, asking for too much information,” he said.

All anti-money-laundering experts interviewed by The Globe agreed that dropping reporting requirements entirely for bare trusts and other types of unintentional trusts might carve too big a hole in the new information-sharing regime.

But any system for submitting beneficial ownership should be “cheap and easy” for Canadians with simple circumstances, Prof. Hofri said.

Ultimately, the esoteric rules created by Ottawa misfired even in the fight against dirty money, Mr. Caldera said.

“Introducing legislation without proper guidance will just be a mess in terms of compliance, and compliance is what we’re really after here,” he said.