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for tax purposes have now been released.
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Canada and many other countries have a tax system which levies
an income tax on residents of the particular country, including
trusts that are resident in that country. In Canada, an
income tax is imposed by both the federal government of Canada and
by each province in Canada. The Canadian federal tax is
applicable to trusts resident in Canada and the provincial tax is
applicable to trusts that are resident in the particular
province.
Given the differing tax rates between Canada and other countries or
between the provinces in Canada, the country or province in which a
trust resides is key in determining the income taxes applicable to
the particular trust.
While domestic tax legislation may contain rules which govern
residency of a trust in specific circumstances, the determination
of residency status is generally determined based upon applicable
jurisprudence of the courts in the particular jurisdiction.
In 2012, the Supreme Court of Canada released its decision relating
to the residence of a trust as between Canada and another country
in the companion cases of St. Michael Trust Corp., as trustee
of the Fundy Settlement v. Canada and St. Michael Trust Corp., as
trustee of the Summersby Settlement v. Canada.
These cases will be referred to herein as the Fundy Settlement
case.
The Supreme Court of Canada confirmed the decisions of the Tax
Court of Canada and the Federal Court of Appeal that the proper
test to use to determine the residence of a trust is the place
where the central management and control of the trust actually
takes place. At issue in the Fundy Settlement case was
whether the appellant trusts were resident in Canada or in
Barbados. On the basis of the central management and control
test, the appellant trusts were found to be resident in Canada
rather than Barbados.
The Fundy Settlement case was handled by the Federal Court
system, as it dealt with the residency of the trust as being either
in Canada or outside of Canada. The province within Canada in
which a trust is resident is also relevant for Canadian provincial
tax reasons as a Canadian resident trust pays income tax to
whatever province the trust is resident in at the end of the
relevant taxation year. The Province of Alberta has had lower
income tax rates than other provinces in past years.
Following the release of the Fundy Settlement decision,
tax practitioners in Canada waited for the decisions of provincial
courts regarding residency of trust from a provincial standpoint
based upon the new test that had been confirmed by the Supreme
Court of Canada.
New Jurisprudence – Discovery Trust
and
Boettger, Trustee of Nancy Smith Spousal
Trust
The first two decisions regarding the issue of provincial residency
of a trust for tax purposes have now been released.
The first case was a decision of the Supreme Court of Newfoundland
and Labrador in the Discovery Trust (acting through its
trustee, Royal Trust Corporation of Canada) v. Canada (National
Revenue)("Discovery
Trust"). Discovery Trust was
heard in May 2015 with the decision of Justice Carl Thompson being
released on 18 June 2015. At issue was whether the Discovery
Trust was resident in Alberta, as the taxpayer contended, or in
Newfoundland, as the tax authority contended. The Court held
that the Discovery Trust was resident in
Alberta.
The second case was a decision of the Court of Québec
{ntd: as the newsletter is distributed nationally, suggest
adding accents} in the Roy Boettger, trustee of Nancy
Smith Spousal Trust v. ARC
("Boettger"). This
case was heard by the Court in December 2014 with the decision
being released on 6 August 2015. At issue was whether the
Nancy Smith Spousal Trust was resident in Alberta as the taxpayer
contended or in Quebec as the tax authority contended. The
Court held that the Nancy Smith Spousal Trust was resident in
Quebec.
Facts in Discovery Trust
The Discovery Trust was originally established and was resident in
Newfoundland, having trustees who resided there. In 2006, the
deed of settlement for the Discovery Trust was amended, the
original trustees (being the children of the settlor) resigned, the
Royal Trust Corporation of Canada was appointed as the successor
trustee of the trust, and the laws governing the trust were changed
from Newfoundland to Alberta. A majority of the beneficiaries
of the trust continued to be residents of Newfoundland. In
2008, the Discovery Trust realised a large capital gain and took
the position that it was resident of Alberta resulting in overall
taxes being substantially lower than the taxes that would have been
applicable had the trust been resident in Newfoundland.
Confirmation of Central Management and Control
Test
Justice Thompson applied the rules set out in the Fundy
Settlement case, thereby confirming that the central
management and control test also applies in the domestic context to
determine the provincial residence of a trust.
Application of the Test and Finding of the Court in
Discovery Trust
Justice Thompson reviewed the actions of the trustee, the actions
of the beneficiaries of the trust and others in his analysis of
where central management and control of the trust took place.
His review of the various transactions undertaken by the trust was
done in the context of the property held by the trust and the Court
found that where the required level of engagement or active
management is low, such as where a trust holds only shares of a
holding corporation, a trustee's actions in approving
straightforward reorganisations and encroachment requests from
beneficiaries constitutes central management and control. The Court
also found that the involvement of beneficiaries or their advisors
in the affairs of the trust does not amount to the trustee not
exercising control over the trust in question. Such
consultation was not found to constitute a delegation of authority
or responsibility by the trustee. With respect to requests
for distributions made by the beneficiaries, Justice Thompson
found:
It is not unusual that the Trustee should require a written request to formally indicate the beneficiaries' desire to take the funds out of the Trust nor for the Trustee to have it in hand on disposition of cash to the beneficiary. Neither would appear to conflict with the independent engagement of the Trustee's authority and the exercise of its obligations.
With respect to the review of corporate transactions, Justice Thompson found:
Independence of the Trustee is maintained by its review of the transaction, acquiring explanation sufficient that an informed decision can be made, ensuring the decision has no negative consequence and is in the best interests of the beneficiaries.
In the end, Justice Thompson concluded that the evidence did not
support that management and control of the trust was directly or
indirectly being exercised by the beneficiaries. He found
that "There was no substantial decision by which control could
be said to have moved to another party other than is found in
compliance with the trust document", and that "the
evidence does not support that management and control directly or
indirectly being in the beneficiaries."
Tax Motive is Irrelevant
Justice Thompson's analysis also considered a second issue of
significance, being whether the outcome of the audit was
essentially a foregone conclusion because it was conducted with an
"overall negative view of the motive for minimization of
tax". Justice Thompson concluded that "... improper
motive entered the discernment process and compromised in an
apparent way the integrity of an independent rationale for the
findings upon which the reassessment could be based." In
so concluding, Justice Thompson reinforced the basic Duke of
Westminster principle that taxpayers have the right to
order their affairs as they see fit to minimize tax payable and
that tax motive is irrelevant to the determination of
residency.
Summary of Discovery Trust
In summary, Discovery Trust confirms that the central
management and control test applied in Fundy Settlement
applies equally in the domestic provincial context, and that tax
motive is irrelevant to the determination of residency. The case
provides a useful analysis of facts that may be relevant in
determining where central management and control of a trust takes
place and accordingly where the trust is resident.
The decision in Discovery Trust was not appealed by the
Crown.
In contrast, the Quebec Court held in Boettger, that the
trust was resident in Québec rather than Alberta.
Facts in Boettger
The Fiducie NS (the "trust") was settled
in 2003 by a Québec resident settlor for the benefit of his
wife who was also a Quebec resident. The trustee was an attorney
resident in Alberta chosen by the Montreal tax advisor of the
settlor who was unknown to the settlor and his wife. The trust was
drafted in conformity with Alberta law.
The trust was settled by a CAD $10 promissory note. The settlor
also donated preferred shares of a private corporation
("Cetco") to form part of the
trust's assets. On the same day that the trust was
settled, a series of transactions were carried out by the trustee
involving the repurchase of part of the shares by Cetco.
From 2003 until 2013, the Court found that the trustee had
undertaken no activities of any consequence. Essentially the trust
was 'dormant' and the trustee undertook no active
administration, such as carrying on business or hiring
employees. These comments by the judge appear to be a
misunderstanding of the nature of a trust, both at common law and
under Quebec's civil law, and the myriad of purposes for which
trusts can be settled.
Confirmation of Central Management and Control
Test
The question before the Court was whether the trust was resident in
Québec or in Alberta. The difference was important, as
the tax rate to which the trust would be subject if it were
resident in Quebec was significantly higher.
Similar to Discovery Trust the Court in Boettger
also confirmed that the rules set out in Fundy Settlement
with respect to the central management and control test apply to
determine the provincial residency of a trust in
Québec.
Application of the Test and Finding of the Court in
Boettger
The Court applied its understanding of Fundy Settlement
and found that central management and control was located in Quebec
for the following reasons:
- The creation of the trust was motivated by tax planning;
- The trust undertook no economic activity in Alberta, such as operating a business or hiring employees. It simply held shares of Cetco, a private corporation;
- The trust had no active purpose to increase the value of the trust's assets. It had only a passive purpose;
- The trust was settled and a series of initial transactions were implemented by the trustee in accordance with a tax plan created by the settlor's tax advisors in Montreal;
- The trustee's fees and the trust's expenses, while paid from the trust's assets, were contributed by the settlor or by Cetco;
- The settlor exercised de facto control over the trust because he had the power to appoint a protector who could remove and appoint trustees. As no protector was appointed, this power could be exercised by the settlor. (It should be noted that there was no evidence of the settlor ever exercising this power.); and
- The main asset of the trust, the shares of Cetco, could be repurchased by Cetco without the consent of the trustee. Cetco was controlled by the settlor.
It does not appear that during the trust's existence either
the settlor or his Montreal based tax advisors gave any directions
to the trustee.
Summary of Boettger
Boettger stands in stark contrast with Discovery
Trust. First, it appears that the Court in Boettger
found that a tax motivated transaction was a relevant consideration
in determining a trust's residency. Second, the Court appears
to require active business activities or the presence of employees
to establish residency of a trust. Merely holding assets is
insufficient. Third, the residency of the legal and tax
advisors of the settlor at the time a trust is settled was found to
be a relevant criteria. Fourth, the power of the settlor to
remove and appoint trustees in addition to the power to have Cetco
repurchase the shares held by the trust, even though neither of
these were done, demonstrated de facto control of the
trust.
With respect, it appears that the application of Fundy
Settlement by the Court in Boettger is
questionable. Fortunately, the trustee of the trust has
appealed the decision to the Québec Court of Appeal.
It is hoped that, on appeal, the principles and approaches applied
in Discovery Trust will be considered by the Québec
Court of Appeal and the appeal of the trust is allowed.
Conclusion
At present, only two courts in Canada have addressed the residency
of a trust in a province since the Supreme Court of Canada issued
its decision in Fundy Settlement. In both instances, the
courts accepted that central management and control as set out in
Fundy Settlement was the correct test to be met in
establishing a trust's residence in a province.
Unfortunately, from that point onwards, the courts appear to have
applied Fundy Settlement very differently. In one
case the tax motive was found to be an irrelevant factor (with the
court even suggesting that such a consideration may have
compromised the integrity of an independent rationale for the audit
findings), while in the other case the tax motive appears to have
been relevant. Also, in Quebec, the circumstances surrounding
the creation of the trust appears to have been more relevant than
its subsequent operations, while the Newfoundland court focused on
the manner in which the trust was administered since its creation
to determine where central management and control of the trust
actually took place. As mentioned above, the Québec
Court of Appeal will have a chance to address this issue and
hopefully provide a more rigorous analysis more in line with the
judgment of the Supreme Court of Canada.
It is also expected that other cases regarding provincial residency
of trusts will be heard by provincial courts in the future.
Footnotes
1 Fundy Settlement v. Canada, 2012 SCC 14.
2 Discovery Trust v. Minister of National Revenue 2015 NLTD (G) 86.
3 2015 QCCQ 7517, J.E. 2015-1517, 2015 CarswellQue 7892.
4 IRC v. Westminster (Duke) [1936] AC 1 (HL).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
