Canada: Beneficial Interests In Discretionary Trusts And The Associated Corporations Rules; Moules Industriels v. The Queen

When two or more corporations are associated for the purposes of the associated corporation rules in section 256 of the Income Tax Act (the "Act"), those corporations are required to share a business limit and, consequently, eligibility for the small business deduction under section 125 of the Act. Where shares of a corporation are held by a trust, the terms of the trust, the nature of a beneficiary's interest in the trust and the description of the class of beneficiaries can trigger the association rules in unexpected ways.

If the interests of beneficiaries of a trust are fixed, that is, a particular beneficiary's interest is not subject to the exercise of any discretionary power, subparagraph 256(1.2)(f)(iii) of the Act deems each beneficiary to own the fixed percentage of shares of a corporation held by the trust that corresponds to that beneficiary's fixed percentage interest in the trust. If the interests of beneficiaries of a trust are subject to the exercise of any discretionary power, subparagraph 256(1.2)(f)(ii) of the Act deems each beneficiary to own all of the shares of that corporation held by the trust.

Consider the example of a discretionary trust that holds a controlling interest in a corporation, Corp 1, the beneficiaries of which include mother, all of the issue of mother and the spouses of all of the issue of mother. Child 1 of mother marries Spouse 1 and, unbeknown to Spouse 1, she becomes, by virtue of marriage, a beneficiary of the trust. Spouse 1 owns her own successful business, Corp 2. Corp 1 and Corp 2 are associated because of the deeming provision in subparagraph 256(1.2)(f)(ii) of the Act. Corp 2 could be denied valuable tax benefits (and be subject to higher rates of tax on its income) as a result of the association. And this can occur even though Spouse 1 may never receive any benefits from the trust.

The association rules extend further. Subsection 256(1.3) provides that if beneficiaries are minor children, then both parents of the minor beneficiary are deemed to own all of the shares held by the trust of which the minor is a beneficiary. If each parent holds a controlling interest in separate corporations, then, without any cross-shareholdings, all three corporations – Parentco 1, Parentco 2 and Trustco – are associated.

There are numerous other instances of the interaction between the attribution rules and trusts, including instances where the association is through either the settlor or the trustees of the trust. But for the purposes of this article, the focus will remain on association through the interests of discretionary beneficiaries.

In CRA Document no. 2003-0052261E5 (January 6, 2004), the Canada Revenue Agency took the position that in a hybrid situation where a clause in a trust deed limits the percentage of income and capital that a beneficiary may receive from the trust, the beneficiary is presumed to hold all of the shares owned by the trust. In Moules Industriels (C.H.F.G.) Inc., Plastech Inc. and 176104 Canada Inc. v. Her Majesty The Queen (2018 TCC 85) released May 3, 2018 ("Moules Industriels"), that issue was considered by the Tax Court of Canada.

The case concerned a discretionary trust, the beneficiaries of which included the descendants (and spouses of descendants) of Mr. Houle. The trust deed provided that if the beneficial interest of any one or more beneficiaries would result in a corporation controlled by Mr. Houle or deemed to be controlled by Mr. Houle and in which the trust held shares becoming associated with another corporation, the share of the capital and income of the trust in respect of which the trustees could exercise their discretion power in favour of that beneficiary would be capped at a maximum of 24.99%. The question posed to the Court was whether the beneficiaries of the trust, whose potential share of the capital and income of the trust did not exceed 24.99% of the trust property, were deemed to hold 24.99% or 100% of the shares held by the trust for the purposes of the association rules.

The clause in question did not remove the trustees' power to exercise their discretion in favour an affected beneficiary; it only limited the extent to which they could exercise that discretion in favour of an affected beneficiary to not more than 24.99% of the income or capital, as the case may be. The trustees retained full discretion to allocate to an affected beneficiary a share of the capital or income of the trust that varied between 0% and 24.99%. In other words, the clause in question did not result in the elimination of the discretionary power of the trustees.

The taxpayers argued that if the affected beneficiaries had a fixed and non-discretionary entitlement to a 24.99% share of the trust, they would, under subparagraph 256(1.2)(f)(iii), have been deemed to own 24.99% of the shares held by the trust; and that a similar result should be obtained when the trustees' discretion is limited to a distribution that cannot exceed 24.99%. The Court described the taxpayers' position as amounting to the insertion of extra wording into the statutory provision (of subparagraph 256(1.2)(f)(ii)), when there is another interpretation which does not require additional wording. The Court refused to accept an interpretation that would treat the affected beneficiaries as having a fixed share that is not subject to a discretionary power when that is not what the trust deed provided.

In other words, according the Court, it is not the extent to which a discretionary power may be exercised but rather whether there exists a discretionary power that determines the applicability of subparagraph 256(1.2)(f)(ii). That provision does not contain a pro-rating feature, and the Court was not prepared to read in such a pro-rating feature.

In the result, the Court confirmed the Minister's assessment that the affected beneficiaries are deemed to hold 100% of the shares held by the trust, thus resulting in association with corporations controlled by Mr. Houle.

The decision is consequential for a number of reasons (including those pertaining to the Court's rejection of the taxpayer's submissions respecting the application of Quebec civil law, which are not addressed in this article). The Court emphasized a literal interpretation of the statutory provision in question, suggesting that taxpayers can interpret the Act in accordance with its clear terms. In this respect, it is interesting that the Court did not engage in a textual, contextual and purposive (TCP) analysis of the Act as set out by the Supreme Court of Canada in Canada Trustco.1 While that approach to statutory interpretation was propounded as a device to resolve uncertainty around the meaning of particular provisions of the Act in the context of the General Anti-Avoidance Rule, it remains a question whether that approach is relevant more generally in interpreting the text of the Act even when questions about tax avoidance are not at issue. The Court in this decision seems to confirm that where the words of a provision are clear on their face, there is no need to engage in that interpretive analysis.

The decision also raises important planning issues for trust planners and, in particular, emphasizes that a thorough analysis and consideration of subsection 256(1.2) must be part of the planner's role. For example, in circumstances where association may be a risk the trend towards defining broadly a class of discretionary beneficiaries may not always be advisable. Although settlors and their advisors may prefer the flexibility of including a broad class of beneficiaries, consideration should be given to whether certain remoter persons should, or would want to, be included.

Some other solution might be considered to avoid association issues:

  • avoid discretionary powers in trust deeds and provide for fixed entitlements. So long as a beneficiary's entitlement is not subject to the exercise of a discretionary power, subparagraph 256(1.2)(f)(ii) would not be applicable, and greater certainty in analyzing potential association issues could be achieved. Such an approach will not only be considerably less flexible but will also result in the creation of a fixed income inclusion to that beneficiary that may not be desirable. Such an approach runs the risk of exposing beneficiaries' interest in the trust to matrimonial and creditor claims.
  • it may be possible to include in the trust deed a clause similar to the one used in Moules Industriels but that removes the trustees' discretion entirely in respect of a particular beneficiary who, by virtue of his or her control of a separate corporation, would cause to be associated that corporation and a corporation the shares of which are held by the trust. Consideration would need to be given to whether the deeming provisions in the Moules Industriels clause, deeming when the discretion is removed and restored, are effective to render subparagraph 256(1.2)(f)(ii) inapplicable in all circumstances. Consideration would also need to be given to whether such a clause could result in an inadvertent breach by the trustees of the terms of the trust deed if they are not aware of a particular beneficiary's interests outside the trust and, nonetheless, exercise or purport to exercise their discretionary powers in favour of that beneficiary.
  • a trust could be structured to hold not more than 24.99% of the shares of a particular corporation and grant to the trustees full discretionary powers in favour of a class of beneficiaries. Although every beneficiary would be deemed to own 100% of the shares held by the trust, that deemed ownership would not be sufficient (in and of itself) to cause an association. It may even be possible, with careful planning, to create multiple trusts with different beneficiaries (overlapping beneficiaries would need to be avoided). Note that this planning could also be used to avoid a particular beneficiary falling within the definition of a "specified shareholder" for the purposes of the corporate attribution rule in subsection 74.4(2); but in that case, the percentage of shares to be held by the trust would need to be limited to not more than 9.99% of the shares of the particular corporation.

It should be pointed out that, while an important consideration in some situations, avoiding association may not be the overriding concern for all trust planning. The tax tail should not wag the trust planning dog if in doing so, more important planning considerations might be compromised.


1 The Queen v. Canada Trustco Mortgage Co., 2005 SCC 54.

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.

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