Canada: Recent Jurisprudence Regarding The Provincial Residency Of Trust In Canada

Last Updated: April 4 2016
Article by William J. Fowlis and Troy McEachren

Abstract

 

  • The jurisdiction in which a trust is resident is relevant for Canadian federal and provincial tax reasons because a trust pays income tax to whatever country and province that the trust is resident in.
  • 2012 decision of the Supreme Court of Canada established that the proper test to use to determine the residence of a trust is the place where central management and control of the trust actually takes place.  This decision was made in the context of whether a trust was resident in Canada or in Barbados.
  • The province within Canada in which a trust is resident is also relevant for Canadian provincial tax reasons.
  • The first two decisions regarding the issue of provincial residency of a trust

        for tax purposes have now been released.

  • Both cases confirmed that the central management and control test also applies in the domestic context to determine the provincial residence of a trust.
  • Unfortunately the two different provincial courts applied the central management and control test very differently, resulting in different conclusions as to the province in which the trusts reside.
  • The arguably more well-reasoned decision found the trust to be resident in the province of residency asserted by the trust.  The decision of the court in the other case has been appealed by the trust.

Canada and many other countries have a tax system which levies an income tax on residents of the particular country, including trusts that are resident in that country.  In Canada, an income tax is imposed by both the federal government of Canada and by each province in Canada.  The Canadian federal tax is applicable to trusts resident in Canada and the provincial tax is applicable to trusts that are resident in the particular province.

Given the differing tax rates between Canada and other countries or between the provinces in Canada, the country or province in which a trust resides is key in determining the income taxes applicable to the particular trust.

While domestic tax legislation may contain rules which govern residency of a trust in specific circumstances, the determination of residency status is generally determined based upon applicable jurisprudence of the courts in the particular jurisdiction.

In 2012, the Supreme Court of Canada released its decision relating to the residence of a trust as between Canada and another country in the companion cases of St. Michael Trust Corp., as trustee of the Fundy Settlement v. Canada and St. Michael Trust Corp., as trustee of the Summersby Settlement v. Canada.   These cases will be referred to herein as the Fundy Settlement case.

The Supreme Court of Canada confirmed the decisions of the Tax Court of Canada and the Federal Court of Appeal that the proper test to use to determine the residence of a trust is the place where the central management and control of the trust actually takes place. At issue in the Fundy Settlement case was whether the appellant trusts were resident in Canada or in Barbados.  On the basis of the central management and control test, the appellant trusts were found to be resident in Canada rather than Barbados.

The Fundy Settlement case was handled by the Federal Court system, as it dealt with the residency of the trust as being either in Canada or outside of Canada.  The province within Canada in which a trust is resident is also relevant for Canadian provincial tax reasons as a Canadian resident trust pays income tax to whatever province the trust is resident in at the end of the relevant taxation year.  The Province of Alberta has had lower income tax rates than other provinces in past years.  Following the release of the Fundy Settlement decision, tax practitioners in Canada waited for the decisions of provincial courts regarding residency of trust from a provincial standpoint based upon the new test that had been confirmed by the Supreme Court of Canada.

New Jurisprudence – Discovery Trust and
Boettger, Trustee of Nancy Smith Spousal Trust

The first two decisions regarding the issue of provincial residency of a trust for tax purposes have now been released.

The first case was a decision of the Supreme Court of Newfoundland and Labrador in the Discovery Trust (acting through its trustee, Royal Trust Corporation of Canada) v. Canada (National Revenue)("Discovery Trust").  Discovery Trust was heard in May 2015 with the decision of Justice Carl Thompson being released on 18 June 2015.  At issue was whether the Discovery Trust was resident in Alberta, as the taxpayer contended, or in Newfoundland, as the tax authority contended.  The Court held that the Discovery Trust was resident in Alberta. 

The second case was a decision of the Court of Québec {ntd: as the newsletter is distributed nationally, suggest adding accents} in the Roy Boettger, trustee of Nancy Smith Spousal Trust v. ARC ("Boettger").   This case was heard by the Court in December 2014 with the decision being released on 6 August 2015.  At issue was whether the Nancy Smith Spousal Trust was resident in Alberta as the taxpayer contended or in Quebec as the tax authority contended.  The Court held that the Nancy Smith Spousal Trust was resident in Quebec.

Facts in Discovery Trust

The Discovery Trust was originally established and was resident in Newfoundland, having trustees who resided there.  In 2006, the deed of settlement for the Discovery Trust was amended, the original trustees (being the children of the settlor) resigned, the Royal Trust Corporation of Canada was appointed as the successor trustee of the trust, and the laws governing the trust were changed from Newfoundland to Alberta.  A majority of the beneficiaries of the trust continued to be residents of Newfoundland.  In 2008, the Discovery Trust realised a large capital gain and took the position that it was resident of Alberta resulting in overall taxes being substantially lower than the taxes that would have been applicable had the trust been resident in Newfoundland.

Confirmation of Central Management and Control Test

Justice Thompson applied the rules set out in the Fundy Settlement case, thereby confirming that the central management and control test also applies in the domestic context to determine the provincial residence of a trust.

Application of the Test and Finding of the Court in Discovery Trust

Justice Thompson reviewed the actions of the trustee, the actions of the beneficiaries of the trust and others in his analysis of where central management and control of the trust took place.  His review of the various transactions undertaken by the trust was done in the context of the property held by the trust and the Court found that where the required level of engagement or active management is low, such as where a trust holds only shares of a holding corporation, a trustee's actions in approving straightforward reorganisations and encroachment requests from beneficiaries constitutes central management and control. The Court also found that the involvement of beneficiaries or their advisors in the affairs of the trust does not amount to the trustee not exercising control over the trust in question.  Such consultation was not found to constitute a delegation of authority or responsibility by the trustee.  With respect to requests for distributions made by the beneficiaries, Justice Thompson found:

It is not unusual that the Trustee should require a written request to formally indicate the beneficiaries' desire to take the funds out of the Trust nor for the Trustee to have it in hand on disposition of cash to the beneficiary.  Neither would appear to conflict with the independent engagement of the Trustee's authority and the exercise of its obligations.

With respect to the review of corporate transactions, Justice Thompson found:

Independence of the Trustee is maintained by its review of the transaction, acquiring explanation sufficient that an informed decision can be made, ensuring the decision has no negative consequence and is in the best interests of the beneficiaries.

In the end, Justice Thompson concluded that the evidence did not support that management and control of the trust was directly or indirectly being exercised by the beneficiaries.  He found that "There was no substantial decision by which control could be said to have moved to another party other than is found in compliance with the trust document", and that "the evidence does not support that management and control directly or indirectly being in the beneficiaries."

Tax Motive is Irrelevant

Justice Thompson's analysis also considered a second issue of significance, being whether the outcome of the audit was essentially a foregone conclusion because it was conducted with an "overall negative view of the motive for minimization of tax".  Justice Thompson concluded that "... improper motive entered the discernment process and compromised in an apparent way the integrity of an independent rationale for the findings upon which the reassessment could be based."  In so concluding, Justice Thompson reinforced the basic Duke of Westminster  principle that taxpayers have the right to order their affairs as they see fit to minimize tax payable and that tax motive is irrelevant to the determination of residency. 

Summary of Discovery Trust

In summary, Discovery Trust confirms that the central management and control test applied in Fundy Settlement applies equally in the domestic provincial context, and that tax motive is irrelevant to the determination of residency. The case provides a useful analysis of facts that may be relevant in determining where central management and control of a trust takes place and accordingly where the trust is resident.

The decision in Discovery Trust was not appealed by the Crown.

In contrast, the Quebec Court held in Boettger, that the trust was resident in Québec rather than Alberta.

Facts in Boettger

The Fiducie NS (the "trust") was settled in 2003 by a Québec resident settlor for the benefit of his wife who was also a Quebec resident. The trustee was an attorney resident in Alberta chosen by the Montreal tax advisor of the settlor who was unknown to the settlor and his wife. The trust was drafted in conformity with Alberta law.

The trust was settled by a CAD $10 promissory note. The settlor also donated preferred shares of a private corporation ("Cetco") to form part of the trust's assets.  On the same day that the trust was settled, a series of transactions were carried out by the trustee involving the repurchase of part of the shares by Cetco.

From 2003 until 2013, the Court found that the trustee had undertaken no activities of any consequence. Essentially the trust was 'dormant' and the trustee undertook no active administration, such as carrying on business or hiring employees.  These comments by the judge appear to be a misunderstanding of the nature of a trust, both at common law and under Quebec's civil law, and the myriad of purposes for which trusts can be settled.
 
Confirmation of Central Management and Control Test

The question before the Court was whether the trust was resident in Québec or in Alberta.  The difference was important, as the tax rate to which the trust would be subject if it were resident in Quebec was significantly higher.

Similar to Discovery Trust the Court in Boettger also confirmed that the rules set out in Fundy Settlement with respect to the central management and control test apply to determine the provincial residency of a trust in Québec.

Application of the Test and Finding of the Court in Boettger

The Court applied its understanding of Fundy Settlement and found that central management and control was located in Quebec for the following reasons: 

  1. The creation of the trust was motivated by tax planning;
  2. The trust undertook no economic activity in Alberta, such as operating a business or hiring employees. It simply held shares of Cetco, a private corporation;
  3. The trust had no active purpose to increase the value of the trust's assets. It had only a passive purpose;
  4. The trust was settled and a series of initial transactions were implemented by the trustee in accordance with a tax plan created by the settlor's tax advisors in Montreal;
  5. The trustee's fees and the trust's expenses, while paid from the trust's assets, were contributed by the settlor or by Cetco;
  6. The settlor exercised de facto control over the trust because he had the power to appoint a protector who could remove and appoint trustees.  As no protector was appointed, this power could be exercised by the settlor.  (It should be noted that there was no evidence of the settlor ever exercising this power.); and
  7. The main asset of the trust, the shares of Cetco, could be repurchased by Cetco without the consent of the trustee.  Cetco was controlled by the settlor.

It does not appear that during the trust's existence either the settlor or his Montreal based tax advisors gave any directions to the trustee.

Summary of Boettger

Boettger stands in stark contrast with Discovery Trust. First, it appears that the Court in Boettger found that a tax motivated transaction was a relevant consideration in determining a trust's residency. Second, the Court appears to require active business activities or the presence of employees to establish residency of a trust.  Merely holding assets is insufficient.  Third, the residency of the legal and tax advisors of the settlor at the time a trust is settled was found to be a relevant criteria.  Fourth, the power of the settlor to remove and appoint trustees in addition to the power to have Cetco repurchase the shares held by the trust, even though neither of these were done, demonstrated de facto control of the trust.

With respect, it appears that the application of Fundy Settlement by the Court in Boettger is questionable.  Fortunately, the trustee of the trust has appealed the decision to the Québec Court of Appeal.  It is hoped that, on appeal, the principles and approaches applied in Discovery Trust will be considered by the Québec Court of Appeal and the appeal of the trust is allowed.

Conclusion

At present, only two courts in Canada have addressed the residency of a trust in a province since the Supreme Court of Canada issued its decision in Fundy Settlement. In both instances, the courts accepted that central management and control as set out in Fundy Settlement was the correct test to be met in establishing a trust's residence in a province.  Unfortunately, from that point onwards, the courts appear to have applied Fundy Settlement very differently.  In one case the tax motive was found to be an irrelevant factor (with the court even suggesting that such a consideration may have compromised the integrity of an independent rationale for the audit findings), while in the other case the tax motive appears to have been relevant.  Also, in Quebec, the circumstances surrounding the creation of the trust appears to have been more relevant than its subsequent operations, while the Newfoundland court focused on the manner in which the trust was administered since its creation to determine where central management and control of the trust actually took place.  As mentioned above, the Québec Court of Appeal will have a chance to address this issue and hopefully provide a more rigorous analysis more in line with the judgment of the Supreme Court of Canada.

It is also expected that other cases regarding provincial residency of trusts will be heard by provincial courts in the future.

Footnotes

1 Fundy Settlement v. Canada, 2012 SCC 14.

2 Discovery Trust v. Minister of National Revenue 2015 NLTD (G) 86.

3 2015 QCCQ 7517, J.E. 2015-1517, 2015 CarswellQue 7892.

4 IRC v. Westminster (Duke) [1936] AC 1 (HL).

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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Authors
William J. Fowlis
Troy McEachren
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