The s. 94 rules contain potential traps for U.S. citizens

To provide a sampling of a broader coverage of s. 94 issues that U.S. citizens may face:

• It is common for U.S. citizens to settle irrevocable trusts for the benefit of descendants and make gifts to those trusts in in amounts equal to the U.S. federal gift tax applicable exclusion amount (currently, $13.61 million per donor), thereby allowing for gifts to be made tax-free for the benefit of the trusts’ beneficiaries while maintaining the flexibility of using a trust.
• However, the s. 94 rules potentially may apply to such a trust even if none of the beneficiaries was ever resident in Canada and the contributions to the trust by a resident contributor were immaterial. This would occur for instance if a U.S. resident and citizen who has never been resident in Canada established a discretionary U.S.-resident trust in 2010 for his U.S.-resident children and contributed an aggregate of $10 million to the trust over the following 10 years – but his brother, a U.S. citizen and Canadian resident, over the same 10-year period gave an aggregate of $100,000 cash to the trust to take advantage of his applicable credit (part of the $13.61 million amount) or his annual exclusion limit (currently, $18,000).
• The adverse consequences of s. 94 applying can be ameliorated by making a resident portion election under s. 94(3)(f) – but this election cannot be made if the trust has already filed a return for a year in which it was deemed resident pursuant to s. 94.
• Given that the definition of “contribution” includes transfers and loans that form part of a series of transactions that includes a transfer or loan of property by another person to the relevant trust, to the extent the transfer or loan to the trust can reasonably be considered to be made “in respect of” the transfer or loan at issue, an outright gift by a Canadian resident to a nonresident donee should be appropriately documented and care should be taken that any subsequent dealing with the donated property by such donee, such as a transfer to a U.S. trust for the benefit of that individual, is independent from the original gift.
• No Canadian foreign tax credit is available to a U.S.-resident trust that is a grantor trust but is deemed to be a resident trust under s. 94 for the U.S. tax not paid by the trustee but instead paid by the grantor.
• However, this mismatch can potentially be addressed by having a resident contributor elect to have s. 94(16) apply to the trust. For example, if a U.S. citizen and Canadian resident who is the sole contributor to a U.S.-resident grantor trust, elects to have s. 94(16) apply, all the trust’s income will be allocated, and the foreign tax credit will be available, to the individual regarding such foreign income designated to that individual pursuant to s. 94(16)(c).

Neal Armstrong. Summaries of Mark Brender and Marc Roy, “Canadian Tax Trap Arising from Cross-Border Gift Tax Planning,” Tax Notes International, Vol. 111, 4 September 2023, p. 1217 under s. 94(3), s. 94(1) – contribution, s. 94(16), s. 104(7.01), s. 94(2)(a) and s. 94(2)(k).