- Where Does Your Trust Live? New Developments Regarding the Residency of Trusts
- Quebec Acts to Stop Aggressive Tax Planning Schemes
Where Does Your Trust Live? New Developments Regarding The Residency Of Trusts
By Jennifer Brigandi
The Income Tax Act does not provide a formula for determining the residency of a trust. Instead, the development of a test of trust residence in Canada has been left to the courts. For tax planners, it is important to know where a trust will be deemed to be resident, since a trust that is resident in Canada must pay tax in Canada on its income from business carried on in Canada, on gains from dispositions of Canadian real property, shares in non-listed resident corporations and other capital assets associated with real property or business activity in Canada.
Residency of Trusts;Thibodeau
Until recently, the leading case regarding trust residency has been Trustees of the Thibodeau Family Trust v. The Queen ("Thibodeau "), which ruling has subsequently been endorsed by Revenue Canada in Interpretation Bulletin IT-447. In Thibodeau, a trust was settled in Canada, having two trustees resident in Bermuda, and a third trustee resident in Canada. The Federal Court held that the trust was resident in Bermuda because the majority of the trustees were resident in that location and the trust document permitted governance by majority. As a result of Thibodeau, a trust has typically been found to be resident in the jurisdiction where its trustees reside.
Garron Family Trust v. The Queen
On September 10, 2009, the Tax Court of Canada released what is considered a landmark decision in Garron Family Trust v. The Queen ("Garron"). Garron dealt with two trusts that were settled in 1998 (the "Trusts") by an individual resident in the Caribbean. The beneficiaries of the trusts were Canadians, and the sole trustee of each of the Trusts was a corporation resident in Barbados. The Trusts were settled in the course of a reorganization of the share structure of a company, PMPL Holdings Inc. ("PMPL"). The reorganization involved an estate freeze in favour of the Trusts. The Trusts were the sole shareholders of newly-incorporated Canadian holding companies which subscribed for shares in PMPL for nominal consideration. In 2000, as part of an arm's length sale of PMPL, the Trusts disposed of the majority of the shares that they held in the holding companies, realizing capital gains of over $450M on the sale. Amounts on account of potential tax on these capital gains were remitted to the government pursuant to the withholding procedure set out in Section 116 of the Income Tax Act. In their income tax returns for the 2000 taxation year, the Trusts sought a return of these amounts, claiming an exemption from tax pursuant to Article XIV(4) of the Agreement Between Canada and Barbados for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital, which states that gains from the alienation of property may only be taxed by the state where the alienator is resident. The Minister of National Revenue took the position that the exemption did not apply, and assessed the Trusts in respect of the gains, arguing primarily that the Trusts were resident in Canada.
In assessing the issue of the Trusts' residency, Justice Woods rejected the general common law approach that a trust is resident where the trustees of such trust are resident, noting that the Thibodeau decision had not been intended to state a general test of trust residence, but instead had been intended to be limited to the particular facts of the case. Justice Woods instead favoured an approach similar to that used to determine the residency of corporations, which is, where the central management and control of the trust is located. Based on this test, Justice Woods held that the central management and control of the Trusts was located in Canada, and that the Trusts were, therefore, resident in Canada.
The location in which a trust is held to be "centrally managed and controlled" will be highly fact dependent. However, in Garron, the Court found and noted the following factors in making its decision:
- Internal memoranda setting out the intentions of the trustee evidenced an understanding that the trustee's role would be more limited than that contemplated by the trust indentures. In particular, the memoranda suggested that the trustee would act in an administrative capacity with respect to the sale of PMPL, and that the trustee would not make distributions to the beneficiaries without the consent of certain named beneficiaries.
- Evidence presented to the court revealed that the Trusts often used the same investment advisors as the beneficiaries, and that the beneficiaries, as a result of the investment parameters provided to the advisors, were able to ultimately direct the investment activities of the Trusts.
- The tax-minimization plans developed by the tax advisors to the Trusts were under the direction of the beneficiaries as opposed to the trustee.
- The trustee's involvement in the affairs of the Trusts was generally limited to the execution of agreements, and to administrative, accounting and tax matters.
- The trustee was an arm of an accounting firm from the years 1998 to 2000. Based on this, the Court questioned whether the trustee had expertise in managing trust assets.
- Oral testimony given by witnesses supported the view that the trustee's role was limited.
If the decision in Garron is followed by the Canada Revenue Agency, the residency of a trust, and, therefore, the taxation treatment of such trust, will be based on where the central management and control of a trust is located. This will affect both international and interprovincial trusts. This decision may have particularly significant effects for offshore trusts, which are often used as tax-planning tools to protect assets from taxation, and to defer accrued capital gains. In order for such a trust to truly be effective, however, it must be "offshore" - in other words, the trust cannot be deemed to have Canadian residency; otherwise, as noted above, it may become subject to Canadian income tax laws. Tax planners who wish to avoid a finding by a court that a trust is resident in a jurisdiction other that that in which the trustees are resident would be prudent to ensure that the trust is centrally managed and controlled at the same location in which the trustees are resident.
Quebec Acts To Stop Aggressive Tax Planning Schemes
By Laura-Emanuela Gheorghiu
On October 15th, 2009, the Québec Government issued an Information Bulletin (the "Bulletin") introducing a new set of tax measures targeted at aggressive tax planning ("ATP") transactions in Québec. The Bulletin comes on the heels of a working paper released January 31st, 2009, and follows three months of public consultations.
In response to concerns that ATP undermines the integrity and fairness of the tax system and threatens the Quebec tax base, the announced measures institute a mandatory disclosure requirement for ATP transactions, extend application of the general anti-avoidance rule (the "GAAR") to transactions deriving tax benefits from any Canadian provincial or federal law, and implement penalties, for both taxpayers and promoters, for failing to disclose and for carrying out transactions covered by GAAR. These measures are expected to discourage promoters of ATP packages from serving the Quebec market, and reduce the number and scope of ATP transactions carried out in the province. However, tax planning advice given by legal professionals in Quebec is not targeted by the announced measures.
Indeed, the announced measures only target transactions involving conditional remuneration for the tax advisor, and/or confidential agreements aimed at protecting the value of the tax product being promoted by the advisor. Taxpayers or partnerships involved in such transactions will be required to disclose the facts and tax consequences of the transaction to Revenue Québec whenever the tax benefit generated is $25,000 or more, or the income generated is over $100,000. Transactions involving claims for tax credits (R&D), analysis and review of interest pursuant to tax assessments, and review of tax returns after they are filed, will not be subject to disclosure. However, consumption tax recovery reviews will be subject to disclosure if they result in a tax benefit.
The deadline for making this mandatory disclosure will coincide with that for filing tax returns, or information returns, in the case of partnerships. A failure on the part of a taxpayer or partner to disclose the transaction by this deadline will result in a monetary penalty of between $10,000 and $100,000. Although in the case of limited partnerships, it is the general partner who must make the disclosure, the limited partner will also be subject to the penalty if a required transaction is not disclosed. A defence of "due diligence" will be available, but it is uncertain what types of actions, short of disclosure, would be sufficient to successfully raise this defence. A failure to disclose where required will also result in the indefinite suspension of the limitation period for reassessment with respect to any tax consequences arising from the transaction. Revenue Québec would then be able to reassess the taxpayers involved, and any person related or associated to that taxpayer, at any time.
Also announced is an enlargement of the scope of the general anti-avoidance rule (the "GAAR") to deny the tax benefits generated by a broader range of transactions. The notion of an avoidance transaction will now include those transactions whose primary purpose is to obtain a tax benefit under any Québec law, federal law, or the law of any other Canadian province. Until now, the definition only covered tax benefits generated by the application of the Québec Taxation Act.
The consequences of GAAR applying will be intensified where the transactions are not disclosed either through mandatory or preventive disclosure. In addition to interest, for the taxpayer application of the GAAR will also generate a penalty of 25% of the tax benefit denied. The transaction promoter will also be liable to a penalty of 12.5% of the consideration received. Revenue Québec will have an additional three years to reassess both these parties, thus extending the usual reassessment period to six or seven years.
Given that the definition of tax benefit under the mandatory disclosure rule will be restricted to only those benefits generated with respect to the Québec Taxation Act, as compared to the much broader scope of application of the GAAR, not all transactions which may be subject to GAAR will fall under the mandatory disclosure rules. However all transactions, irrespective of the amounts involved, or laws relied on will risk triggering the penalty and extended limitation period where GAAR applies. In practice, therefore most transactions involving tax benefits will now require preventive disclosure.
Taxpayers will have a very short time to make a preventive disclosure; only until the deadline for their first tax return after the transaction begins to be carried out. Under the mandatory rules, however, a transaction will only have to be disclosed once it has been carried out and has generated tax consequences. Obviously some transactions involving a series of steps may begin to be carried out long before they generate a tax benefit. Consequently, transactions involving ATP, as defined by the Finance Minister, may offer a longer delay for disclosure than transactions not involving such planning.
There are also other issues raised by the announced measures. More precisely, the extension of the period of limitation by three years where GAAR applies, effectively removes a taxpayer's ability to raise prescription as a complete defence to the Minister's assessment, and requires him instead to prove the more difficult argument that GAAR does not apply. Despite the comments to the contrary in the discussion paper, the extended limitation period also runs the risk of making GAAR, rather than any specific section of the Taxation Act, the weapon of first resort for assessment where the Minister's action is otherwise prescribed. Finally, the announced measures do not offer any protection for Québec clients in situations where promoters of tax schemes operate outside of Québec to avoid being subject to penalties. In such cases, although their Québec clients will continue to be subject to these new rules, constitutional jurisdiction issues may protect such promoters from being taxed.
The rules announced by the Bulletin have immediate effect. However detailed rules apply to each transaction depending on the date on which it is begun and completed, and on the rules which are triggered. Before a transaction is undertaken, a tax professional should always be contacted for advice on whether disclosure is necessary.
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.