Introduction: CRA has the power to reassess based on the actual flow of distribution
A Trust is a vehicle for holding family property and it's typically used to reduce a family's taxes. During the audit of a trust, if the CRA finds the distribution to beneficiaries ends up in someone else's account, they may reassess the recipient of the distribution. This is what happened in Daniel Laplante v The Queen, and it underlines the importance of seeking proper legal advice and assistance from an experienced Canadian tax lawyer.
Trust Beneficiaries used their lifetime captain gains exemption
In 2004, Daniel Laplante created a trust – Fiducie DL which later acquired shares from a qualified small business corporation – DTI Software Inc. Following the disposition of the shares in 2008, the trust realized a capital gain of $5,852,074. The taxable amount, $2,593,412.50, was allocated to the beneficiaries of the trust who were all family members of the trustee – Mr. Laplante. Upon receipt of the distribution cheques from the trust, all the beneficiaries first used their lifetime capital gains exemption, then endorsed the cheques and returned them back to Mr. Laplante by signing deeds of gift. Mr. Laplante paid the alternative minimum tax for each beneficiary and the costs related to filing their income tax returns
Statutory provisions empowering the CRA to make the reassessment outside normal period
Under the Civil Code of Québec, a simulation exists where the parties agree to express their true intent, not in an apparent contract, but in a secret contract. Between the parties, the secret contract prevails.
Mandate is a contract by which a person called the mandator, confers upon another person called the mandatary, the power to represent him in the performance of a judicial act with a 3rd person. Upon termination of the mandate, the mandatory is bound to hand over to the mandator everything he has received in the performance of his duties.
Under subparagraph 152(4)(a)(i) of the Income Tax Act, when the Minister makes a reassessment after the normal reassessment period which is three years from the date on the notice of assessment for individuals, the Minister must prove that the taxpayer has made a misrepresentation that is attributable to neglect, carelessness or willful default in filing his or her income tax return.
Tax Court of Canada found the legal transaction was a sham
Given the principle stated in Shell Canada Ltd. v Canada ( SCR 622), the Court may recharacterize a legal transaction between the parties on the basis of the actual legal effects if the legal transaction is a sham. The Tax Court found that the trustee and beneficiaries participated in a simulation which constitutes a misrepresentation by examining two elements: material element and intentional element. Justice Ouimet found that there was sufficient evidence to conclude all of the beneficiaries accepted a mandate involved each beneficiary receiving a $375,000 allocation from the trust and then returning it to Mr. Laplante after using their capital gains exemption. As consideration, the beneficiaries were able to keep alternative minimum tax recovered in future taxation years. The Court also found there was an intent between the parties to deceive third parties, which was established by the fact that Mr. Laplante and the beneficiaries never intended to disclose the existence of the mandates to the Minister.
Following Shell, the Minister must make the reassessment based on the actual legal effects between Mr. Laplante and the beneficiaries. Although there were apparent contracts such as the dispositions and deeds of gift, the actual legal effects were indicated in the secret contracts – the mandates. Therefore, Justice Ouimet ruled the Minister was correct to make the reassessment based on the actual legal effects of the mandates between the parties. The Minister was also allowed to reassess outside the normal period because a misrepresentation was established by the simulation.
Federal Court of Appeal upheld Tax Court's decision
Justice Boivin of the Federal Court of Appeal affirmed this decision and found that Mr. Laplante was the true beneficiary of the amounts distributed by the trust to the beneficiaries.
Tax Tip – The Importance of Actual Legal Effects of the Transactions
While the taxpayer was unsuccessful, this case is useful as it demonstrates why laypersons should seek tax legal advice before implementing any tax planning scheme as it often involves very complex rules and procedures. An experienced Canadian tax lawyer should be able to point out that CRA will make reassessments based on the actual legal effects when there are both apparent and secret contracts and beneficiaries should never act as straw men to use their lifetime capital gains exemption to help other people avoid paying tax. Our top Canadian tax lawyers can provide invaluable tax planning advice through the consultation process and help you mitigate your tax burdens based on our years of experience.