Canada: Trust Residency - A New And Novel Approach

In Garron and Garron, Trustees of the Garron Family Trust v. The Queen, released by the Tax Court of Canada on September 10, 2009, Madam Justice Woods applied a new and novel test to determine the residency of a trust. She rejected the established test in the landmark decision of Trustees of the Thibodeau Family Trust, 78 DTC 6326 (FCTD) that a trust is resident in the jurisdiction in which the trustees reside and exercise their discretion. In fact she held that Thibodeau does not stand for the proposition that the residence of the trustee is always the deciding factor in determining the residence of a trust. In Garron, Madam Justice Woods held that the central management and control test, which is the established test for determining the residency of a corporation, should also apply to a trust. The central management and control test is that a corporation [and now a trust?] is resident where its central management and control actually abides.

The Canada Revenue Agency has taken the position in Interpretation Bulletin IT-477 "Residence of a Trust or Estate" dated May 30, 1980, that a trust will generally be resident in the jurisdiction where the trustee who manages and controls it resides. The reference to management and control echoes the corporate test which was rejected in Thibodeau.

By way of background, Garron involved a determination of the residency of two trusts formed in Barbados (the "Barbados Trusts") and settled by a resident of St. Vincent who was a friend of one of the beneficiaries. There was a protector of each Trust who was resident in St. Vincent and who had the right to replace the trustee of each Barbados Trust. The sole trustee of each Barbados Trust was St. Michael Trust Corp. (the "Trustee") a Barbados resident trust corporation, owned by a major accounting firm. In 1998, two estate freezes were done in favour of the Barbados Trusts in respect of the shares of two Canadian holding companies which, in turn, owned the growth shares of a private Canadian company in the auto parts business. In 2000, the shares of the two holding companies were sold and a capital gain of over $450 million in the aggregate was realized. Twenty-five per cent tax was paid by the Barbados Trusts and section 116 certificates were obtained. The Barbados Trusts subsequently filed Canadian tax returns claiming a refund of the Canadian tax on the basis that the gains realized by the Barbados Trusts were exempt from Canadian tax under Article XIII of the Barbados-Canada Income Tax Convention (the "Treaty"). Barbados does not impose a tax on capital gains and as a result, if the Treaty applied to exempt the gains from Canadian tax, there would be no tax on the gains.

In determining that the Barbados Trusts were resident in Canada, Madam Justice Woods relied on the fact that there was no evidence that the Trustee took an active role in the management of the Trusts. She also suggested that the Trustee had significant expertise in accounting and tax matters but did not have a demonstrated expertise in managing trust assets. She found that there was little evidence that the Trustee had any involvement in the affairs of the Barbados Trusts, other than in the execution of agreements and in administration, accounting and tax matters.

Madam Justice Woods found that, more likely than not, the Trustee "had agreed from the outset that it would defer to the recommendations" of the Canadian resident beneficiaries (who were also the principals of the Canadian operating company) with respect to the purchase and sale of the shares of the holding companies, the investment of cash proceeds received on the sale of the shares, the making of distributions to beneficiaries of the Barbados Trusts and taking appropriate steps to minimize the tax burden of the beneficiaries.

This case is a significant departure from the established Canadian case law dealing with the residency of trusts under Canadian law and may affect the residency of many trusts, both international and domestic. We note that the Canada Revenue Agency has been using the same central management and control argument to challenge the residency of certain Alberta trusts. It will be interesting to see whether the Garron decision will be appealed and what its ultimate impact will be. Perhaps the result would have been different had the Trustee been more involved in the decision making process with respect to the sale of the holding company shares and the subsequent management of the assets of the Barbados Trusts. For now, tax planners should ensure that a trust is centrally managed and controlled in the jurisdiction where the trustees are resident.

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