Canada: Supreme Court Of Canada Confirms Corporate Mind And Management Test Applies To Trusts

The Supreme Court of Canada has confirmed that a trust is resident in the jurisdiction where it makes its management decisions. The Supreme Court's decision in St. Michael Trust Corp., as Trustee of the Fundy Settlement v. Her Majesty the Queen and St. Michael Trust Corp., as Trustee of the Summersby Settlement v. Her Majesty the Queen¹, more commonly known as the "Garron" decision, was released on April 12, 2012.

BACKGROUND

Garron involved the residence of two trusts that were established as part of a corporate reorganization in anticipation of a possible future sale of a Canadian company ("Canco"). The terms of the trusts were similar. The settlor for the trusts was a resident of St. Vincent. An unrelated company resident in Barbados was appointed as trustee of both trusts. A second individual from St. Vincent was named as protector and granted the power to replace the trustee. The trusts' beneficiaries, all resident in Canada, had the power to replace the protector. Pursuant to the trusts' deeds, the trustee had full discretion to make distributions of income or capital. However, the trustee had prepared memoranda of intention for the trusts indicating that distributions would be made to one beneficiary or subject to that beneficiary's wishes and how it would deal with the trust assets.

Prior to the reorganization, all of the Canco shares were held, directly and indirectly, by the beneficiaries of the trusts. As a result of the reorganization, the trusts owned shares in two new Canadian holding companies that owned Canco common shares. The trusts realized a capital gain when they later sold the shares of the holding companies. The purchaser of the shares withheld tax on account of the trusts' capital gain. The trusts claimed a refund of the withholding tax paid pursuant to the double tax treaty between Canada and Barbados on the basis that the trusts were resident in Barbados and, therefore, exempt from Canadian tax. The Canadian Minister of Revenue (the "Minister") determined that the trusts were residents of Canada and that the gains were, therefore, taxable by Canada. The trusts appealed to the Tax Court of Canada.

The Tax Court agreed with the Minister and held that a trust's residence, like a corporation's residence, should be determined based on where the trust is managed and controlled. The Tax Court held that the trustee in Barbados did not control or manage the trust. Instead, the trusts were managed in Canada by the trusts' primary beneficiaries. The Tax Court considered many factors, including the fact that the beneficiaries could replace the protector; the trusts' documents provided for a limited role for the trustee; investment decisions appeared to be made at the discretion of the Canadian beneficiaries; and the trustee lacked experience and knowledge in managing and controlling trust assets. The Federal Court of Appeal affirmed the Tax Court's decision.

SUPREME COURT OF CANADA DECISION

The Supreme Court found no valid reason for applying a different residency test to trusts than the test applied to corporations. The Supreme Court found that the beneficiaries, and not the trustee, managed and controlled the trusts from Canada. The trustee was merely given administrative duties to fulfill. Therefore, the Supreme Court upheld the Court of Appeal's decision agreeing that the trusts were residents of Canada for tax purposes.

In the Court of Appeal decision, the court considered alternative arguments of the Minister involving the scope of the general anti-avoidance rule ("GAAR") and various rules that apply to offshore trusts. Some practitioners concluded that the Court of Appeal had tacitly endorsed certain "aggressive" offshore trust structures so long as the taxpayers took care to ensure that the mind and management of the trust was outside Canada. The Supreme Court did not consider these alternative arguments. However, the Supreme Court did state that it should not be understood to be endorsing the reasons of the Court of Appeal in this regard.

PRACTICAL IMPACT

The decision confirms how important it is for trustees to demonstrate that they exercise their powers to manage and control the property of a trust. Trustees cannot allow beneficiaries or other persons to make decisions on behalf of the trust or render mere administrative services. It is critical to ensure that the appropriate paperwork is in place to accurately document the decisions made by the trustees and where these decisions are made. In Garron, the trusts were unable to produce evidence to suggest that the trustee was involved in managing the trusts. Accordingly, it was proper for the courts to conclude that the trustee did not manage the trusts. Unfortunately, the Supreme Court did not provide any guidance as to what steps or actions trustees must take to ensure that they manage and control the trust. As a result, it remains unclear how much involvement other people can have in a trust's affairs before a trustee no longer has management and control.

The impact of Garron will not be restricted to offshore trusts. The mind and management test will also be applied in the context of Canadian trusts when determining in which province a particular trust is resident for tax purposes. The Canada Revenue Agency (the "CRA") has relied on the lower courts' decisions in Garron to support recent audit projects focusing on domestic trusts and high net worth individuals. In these audits, the CRA has relied on Garron to challenge the validity of trusts and structures using trusts beyond the issue of residency. In our view, the Garron decision should be restricted to residency of a trust for tax purposes and does not change the well-established common law of trusts. However, the CRA has won a significant victory with Garron in its ongoing challenge of trust structures involving high net worth individuals.

On a positive note, the decision provides some much needed guidance on a trust's residency for Canadian tax purposes. Before the Garron case, it was thought by some that a trust was always resident where the majority of trustees resided. While the test in Garron requires a more involved factual determination, it may provide greater flexibility when choosing the residency of a trust and may present new planning opportunities.

Footnote

1. Fundy Settlement v. Canada, 2012 SCC 14. The name of the case has changed at each level of court. The Tax Court of Canada decision is cited as Garron et al. v. The Queen, 2009 DTC 1287 (TCC) and the Federal Court of Appeal decision is cited as St. Michael Trust Corp. et al. v. The Queen, 2010 DTC 5189 (FCA).

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