On July 13, 2012, the Federal Court of Appeal released its
decision in The Queen v. Peter Sommerer 2012 FCA 207
("Sommerer") in favour of the taxpayer. The
decision was eagerly anticipated as it dealt primarily with the
scope of subsection 75(2) of the Income Tax Act (Canada)
(the "Act"). Broadly speaking, subsection 75(2) of the
Act applies where a person transfers property to a trust and the
property or substituted property may revert back to the person,
pass to persons to be determined by that person after the creation
of the trust, or be disposed of only with that person's
consent. Where it applies, subsection 75(2) attributes any income
or loss and any capital gains or capital losses associated with the
transferred property back to the transferor. Unlike other
attribution rules in the Act, subsection 75(2) does not contain an
exception for fair market value transfers. The Canada Revenue
Agency ("CRA") had historically taken the position that
subsection 75(2) could apply even if property was transferred at
fair market value.
In Sommerer, Peter Sommerer was a beneficiary of an
Austrian private foundation ("APF") set up by his father.
Peter Sommerer sold certain shares at fair market value to the APF,
and the APF later sold these shares, earning substantial capital
gains. The Minister of National Revenue (the "Minister")
reassessed Peter Sommerer on the basis that subsection 75(2)
applied and the capital gains realized by the APF were taxable in
his hands. The Minister took the position that subsection 75(2)
applied because it was possible when Peter Sommerer sold the shares
to the APF that the shares or property substituted for the shares
may one day be distributed to him as a beneficiary of the APF. The
Tax Court of Canada disagreed with the Minister's position and
held that 75(2) should not apply in these circumstances.
The Federal Court of Appeal held that subsection 75(2) did not
apply to attribute the gain realised by the APF to Peter Sommerer.
The court confirmed that the only person that subsection 75(2)
could apply to is the settlor of a trust or a subsequent
contributor to a trust who could be seen as a settlor. Subsection
75(2) could not apply to a person that transfers property to a
trust in a genuine sale even if that person may one day be entitled
to that property by way of a distribution by the trust. The Federal
Court of Appeal found that this was consistent with the purpose of
subsection 75(2) which was to ensure that a taxpayer does not avoid
the income tax consequences of the use or disposition of property
by transferring it to a trust while retaining the right of
Subsection 75(2) had always been a concern to trust advisors due
to its potentially broad scope. Moreover, the CRA's position
that fair market value transfers could be caught by subsection
75(2) only increased the uncertainty. The Federal Court of
Appeal's decision in Sommerer clarifies that
subsection 75(2) applies to "endowments" of trusts and
not to fair market value purchases. Accordingly, potential
beneficiaries of a trust can now engage in transactions involving
bona fide sales to the trust with greater certainty.
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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