TAX COURT SETS NEW RESIDENCY RULES FOR TRUSTS
A new Tax Court case has changed the ground rules for determining the residence of a trust. These changes will be of interest where the trustees of a trust are in a different jurisdiction than the people who set up the trust or the trust beneficiaries.
For tax purposes, trusts are deemed to be taxpayers for the purposes of calculating tax, but they are not a legal person or entity in the same way as individuals and corporations. So, there has always been more uncertainty around determining where a trust is resident for tax purposes. This is an important concept, as tax rates vary from province to province and country to country. Historically, a trust’s residence has generally been determined based on where the trustee(s) of the trust are resident. For example, if all trustees of a given trust are resident in Alberta, the trust will usually be considered to be resident there even if the settlor of the trust and the trust beneficiaries are resident somewhere else.
A recent Tax Court of Canada case (if it is not reversed on appeal) has added a new test which must be considered when determining where a trust is resident. In particular, the Court has stated that the “mind and management” test used for corporate residency should also apply to trusts. A brief review of the facts of the case will help shed some light on this issue.
In the Garron Family Trust case, the owners of a corporation decided to implement what was referred to as an offshore estate freeze. That is, the Canadian owners retained the value of the corporation that had accrued to date as fixed value preferred shares, and trusts with trustees resident in Barbados subscribed for new growth shares (of holding companies owning the corporation) for nominal consideration. The planning was very similar to many domestic estate freezes except that the trusts were formed outside Canada. On the eventual sale, the plan was that any new growth would escape Canadian taxation, as the trusts were not resident in Canada and the tax treaty with Barbados would exclude the gain on the private company shares from taxation (these shares are “taxable Canadian property” under our tax rules).
When the growth shares held by the trusts were later sold for a substantial gain, tax was withheld on the sale proceeds by the purchaser. When a request was made by the offshore trusts for a refund of the tax, the Canada Revenue Agency (CRA) denied the request on the basis that the gain on the growth shares was subject to Canadian tax. The CRA presented several arguments for this, one of which was that the trusts were resident in Canada. It should be noted that specific rules have since been implemented that block this planning.
When the Tax Court Judge rendered her decision, she concluded that although trustees resident in Barbados acted on behalf of the trusts, they only did so at a superficial level. That is, they signed the necessary legal documents but they did not possess a working knowledge of the assets they held as trustees and they did not make decisions in the usual manner that the Judge would have expected from bona fide trustees. She believed that the mind and management of the trust remained with the Canadian business owners and they were making the important decisions.
In her case decision, the Judge has essentially set out a two-part test for determining the residence of a trust. First, you need to assess the trustees. Are they acting in a full and prudent manner, or at the other end of the scale, are they simply acting as a custodian for the property? If they are acting in a manner expected of trustees, then their residency will continue to be a key factor in determining the residency of the trust. If the trustees are acting more as a custodian, then the residency of others providing mind and management over the trust property will be a key factor in determining where the trust is resident.
The Garron Family Trust case has been appealed to the Federal Court of Appeal, and that court will presumably decide if it agrees with the new residency tests set out in the Tax Court decision. If the decision is confirmed, then this new mind and management test will be an important issue that must be considered when taxpayers set up a trust in another jurisdiction.
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The information in this publication is current as of February 1st, 2010.
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