Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, December 2010
After much anticipation, the Federal Court of Appeal (the FCA) recently released its decisions in St. Michael Trust Corp. v. The Queen and Antle et al. v. The Queen. The former case is better known by the name Garron. At the Tax Court of Canada (the TCC), Mr. Garron's appeal was allowed but the related appeal of St. Michael Trust Corp. was dismissed and that decision was appealed to the FCA. A detailed discussion of the facts and the decisions of the TCC in these cases can be found in our October 2009 Blakes Bulletin on Tax: Tax Court of Canada Decisions Relating to Non-Resident Trusts.
In upholding the TCC's decisions in both cases, the FCA found that the capital gain realized in each case was taxable in Canada, notwithstanding the fact that the transactions in question involved offshore trusts that had been created for the purpose of sheltering the gains from Canadian income tax. In Garron, the FCA confirmed the TCC decision that each trust in that case was resident in Canada on the basis that its central management and control was located in Canada. In Antle, it was found that the purported trust that realized the capital gain in question was not validly settled and, as a result, the capital gain was taxable in the hands of the Canadian settlor of the purported trust.
The Garron and Antle decisions have garnered attention in the tax community by bringing to the forefront issues that put into question the validity of both existing international and domestic trust structures. In light of these cases, existing trust arrangements should be reviewed to ensure that the arrangements still achieve the desired outcome.
All statutory references in this article are to the Income Tax Act (Canada) (the Act).
GARRON – DETERMINING TRUST RESIDENCY
In a unanimous decision, the FCA dismissed the taxpayers' appeals. The FCA agreed with the decision of Woods, J. at the TCC as to matters of fact and law with one exception that is described below.
Some broad comments were made by the FCA addressing the determination of residency of any taxpayer, not just a trust:
Some specific legal principles for determining residence may come into play in certain circumstances, but none that eliminate the need for full consideration of all of the relevant facts. [Emphasis added]
This is a rejection of a rigid, "one size fits all" approach to establishing the residency of a taxpayer, whether an individual, corporation or a trust. Although specific legal principles may be brought to bear on the issue – for example, the location of central management and control in the case of a corporation – a careful consideration of relevant facts is still required. To adopt rigid rules would, in the FCA's view, detract from the fundamentally fact-driven nature of the task of determining residency.
The FCA agreed with the TCC that the appropriate approach to determine residency of a trust is to adopt a fact-driven determination of where central management and control of the trust is exercised. In arriving at this conclusion, the FCA adopted the TCC reasoning that the test for establishing the residency of a trust should be informed by analogy to the jurisprudence that has evolved to establish the residency of a corporation. As noted in both the FCA and the TCC decisions, the judge-made tests applicable to determining residency of a corporation evolved by analogy to determining the residency of an individual, being where an individual "keeps house and does business". The FCA stated that a trust keeps house and does business where the powers and discretions of the trustee are really being exercised.
Both levels of court in Garron questioned whether the Federal Court Trial Division's earlier decision in Thibodeau stood for the proposition that the central management and control test applicable to the determination of residency of corporations could not be applied to trusts because trustees could not delegate their authority. In any case, both courts disagreed with this proposition. In addressing this issue, the FCA also rejected the taxpayers' argument that the concept of central management and control cannot apply to a trust, which is a legal relationship and has no separate legal personality except as deemed by the Act.
The agreement of the FCA with the legal test of trust residency used by the TCC meant that the taxpayers were left with convincing the FCA that Woods, J. made a palpable and overriding error in applying the facts in Garron to the test in order for their appeals to succeed. The FCA concluded that no such error was made.
The foregoing was sufficient to reject the taxpayers' appeals. However, in the event that its conclusion that the trusts were resident in Canada was wrong, the FCA went on to consider the possible application of section 94 of the Act, the Canada-Barbados Income Tax Agreement (1980) (the Treaty) and the general antiavoidance rule (the GAAR) in section 245.
The TCC found that section 94 did not apply to the trusts because the trusts did not actually acquire any transferred property from a related Canadian resident. Rather, the trusts subscribed for shares of a company using the trusts own funds acquired from the nonresident settlor. The FCA found that section 94 would apply and did not agree with the TCC's interpretation of the meaning of the expression "acquired property, directly or indirectly in any manner whatever" contained in section 94. Instead, the FCA relied on the Kieboom decision in concluding that, as was the case with the trusts, a shift in value of a corporation from one class of shares to another is an indirect transfer of property from the shareholders of the former class to the shareholders of the latter class.
The FCA and the TCC were in agreement that the tax imposed on the trusts under section 94 was not a comprehensive tax on worldwide income of the trusts because the income base for such tax excluded foreign active income from Canadian taxation. Consequently, the trusts would not be considered resident in Canada for purposes of the Treaty, based on the Supreme Court of Canada (SCC) Crown Forest decision.
The FCA dismissed the application of the GAAR on the basis that it was not an abuse of the Treaty for a trust resident in Barbados to utilize an exemption available under the Treaty. It is unfortunate that the FCA did not consider whether the arrangements involving the trusts might be considered an abuse of the provisions of subsection 75(2) even though such analysis would have been obiter. At the TCC, the Crown was not permitted to argue that the arrangements involving the trusts represented an abuse of subsection 75(2) because it had not been pleaded by the Crown that subsection 75(2) was abused under the arrangements.
IMPLICATIONS OF GARRON
In Interpretation Bulletin IT-447, "Residence of a Trust or Estate", the Canada Revenue Agency (the CRA) takes the position that a trust is generally considered to reside where the trustee or other person who manages the trust resides. While the trust residency test established under Garron is similar to the foregoing, the primary difference between the two tests is that the physical location where such person exercises its discretion is the determinative factor under the central management and control test.
While the test for trust residency, based solely on residency of the trustees which may have been suggested by the Thibodeau decision, was rejected in Garron, there is a lesson to be learned from Thibodeau. The determination of residency is a fact-driven exercise. This means that facts must exist that support the residency of a trust (or other taxpayer). In this area, Garron and Thibodeau are distinguishable. In Thibodeau, the taxpayer was able to adduce evidence that trustees resident in Bermuda played an active, decision-making role in the activities of the trust and examples were given where the two Bermuda resident trustees overrode proposals of the single Canadian trustee. Furthermore, failure to call relevant witnesses and to address important factual issues may significantly weaken a taxpayer's case.
With respect to the interplay of section 94 and the residency of a trust under the Treaty, the TCC's and FCA's findings regarding this matter have been superseded by recently announced amendments to the Income Tax Conventions Interpretation Act, which, if enacted, provide that a trust that is resident in Canada pursuant to the amended version of section 94 (which will enact new "non-resident trust" rules) will be considered to be a resident of Canada for tax treaty purposes.
Because the application of the principles established in Garron are new and widely applicable to both commercial and family trust structures, it is possible that leave to the SCC will be granted if sought by the taxpayer.
ANTLE – DETERMINING THE VALIDITY OF A TRUST
In appealing the TCC's decision, the taxpayers submitted that Miller, J.'s conclusions in the TCC regarding the valid formation of the Barbados spousal trust (the Antle Trust) were erroneously based on circumstances that were external to the trust deed, which otherwise evidenced the parties' intentions in a clear and unambiguous manner.
In a brief judgment, Noel, J.A. dismissed this argument on the basis that it was open to the TCC to consider the actions of the purported settlor of the Antle Trust, and the circumstances surrounding the formation of the Antle Trust, in determining whether the three certainties required to validly establish a trust were present, notwithstanding the existence of a clear trust deed. In reaching this conclusion, Noel, J.A. reviewed the jurisprudence and concluded that "a test that requires one to look at all of the circumstances, and not just the words of the trust deed, is an approach that appears to have been adopted by Canadian courts generally". Consequently, the FCA upheld the TCC's finding that, contrary to the trust deed, the surrounding circumstances evidenced a lack of certainty of intention, with the result that the Antle Trust was not validly constituted.
Although the foregoing conclusion was sufficient to dispose of the appeal, Noel, J.A. went on to address, in obiter, the TCC's finding that the Antle Trust was not a sham. In disagreeing with Miller, J.'s conclusion, Noel, J.A. held that a sham can be found to exist where the parties to a transaction give "a false impression of the rights and obligations created between them". Consequently, Noel, J.A. concluded that the Antle Trust was a sham because the parties involved had signed a trust document that indicated that the trustee had discretion and control over the trust property while the parties knew with sufficient certainty that the trustee possessed no such discretion or control. The finding of the TCC that the parties involved could say "with some legitimacy" that such discretion existed was not sufficient, in the view of the FCA, to avoid sham characterization given the weight of other evidence.
While Miller, J. had considered whether the GAAR would have applied to deny the tax benefit had the Antle Trust been properly constituted, the FCA expressed no view on GAAR.
IMPLICATIONS OF ANTLE – A NEW OR EXPANDED CONCEPT OF SHAM?
It is a well-accepted principle that surrounding circumstances will generally be considered by courts in reviewing tax-driven transactions, even where unambiguous documentation exists. The Antle decision is an application of this principle in the context of determining the existence of a trust.
The FCA's decision in Antle also gives rise to questions regarding the application of the sham doctrine and whether the FCA's comments relating thereto effectively expand the scope of circumstances in which the CRA can utilize sham as an assessment tool. By way of background, the doctrine of sham is a wellestablished judicial doctrine that generally requires an element of intentional deceit, applying where the legal substance of the transaction, as intended by the parties, is not correctly represented by the documentation. The TCC's decision in Antle considered whether the Antle Trust was a sham based on the assumption that it was validly constituted. By making this assumption, it would then be difficult for a court to conclude that the Antle Trust was a sham. On the other hand, the FCA did not bind itself for purposes of determining whether the Antle Trust was a sham by assuming that the trust existed. In fact, the FCA relied on a definition of sham in a trust law context which stated that a sham trust was void. The FCA found that the intention of the parties was to deceive the CRA into thinking that the trustee had discretion and control over the trust property while, in the FCA's view, there was sufficient evidence to establish that no such discretion or control existed. Thus, the Antle Trust was a sham and, based on the definition of sham relied on by the FCA, void. The analysis of the FCA demonstrates that a thin line may exist between a sham and a legally ineffective transaction. In some cases, this could be a distinction without a difference. In others, the distinction may be critical, such as in cases involving reassessments of statute-barred years based on the existence of misrepresentation.
The FCA's comments in Antle pertaining to the degree of intention required to establish a sham have raised questions as to whether the FCA has effectively expanded the concept of sham. Particularly, Noel, J.A. found that the required state of mind to evidence sham is not equivalent to that of criminal or tortious deceit, but rather requires that the parties give "a false impression of the rights and obligations created between them". Interestingly, Noel, J.A. recently discussed the concept of sham in Faraggi et. al. v. The Queen, wherein Noel, J.A. affirmed the scope of the sham doctrine based on his review of the case law and rejected an expanded concept of sham that was applied by the Tax Court judge in that case. While one may take the view that the degree of intention to deceive, as found in Antle, to evidence sham is a departure from the classic definition of sham under Canadian law, it is difficult to see how the FCA's comments, which were made in obiter and were fact-driven, could override the long line of well-established jurisprudence regarding the doctrine of sham. Additionally, it is arguable that the FCA's comments may not have general application as they are based on the definition of sham in the context of trusts, and therefore may be restricted to this narrow area.
The Garron and Antle decisions have broad implications. The FCA established in Garron that the appropriate test for determining the residency of a trust is to be based on the location of the central management and control of the trust. In Antle, the FCA reaffirmed the importance of sufficiently demonstrating, both through documentation and execution, the valid formation of a trust. Additionally, the FCA's comments in Antle have raised questions pertaining to the scope of the sham doctrine and its future application by the CRA as an assessment tool.
A point of distinction between Garron and Antle is the question of whether the three certainties required for the existence of a trust were established. While this issue was central to the decision in Antle, the Crown conceded in Garron that the three certainties were present. It is clear from Garron that control of trust property can ultimately be held by someone other than the trustee; however, when such control is maintained by the settlor, it is unclear as to the degree of control that can be maintained by the settlor before evidencing a lack of intention to settle the trust. In light of the Garron and Antle decisions, one may expect the CRA to take an aggressive stance in auditing both offshore and domestic trust arrangements on the basis of residency and validity. Consequently, existing trust arrangements should be examined to ensure their effectiveness in light of this new jurisprudence.
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.