Miller Thomson is pleased to announce that Sheldon Silver, Q.C. and Clifford Goldlist have both joined the firm in the Taxation Group in Toronto. We are all very excited to have them on board and extend our warmest welcome to them.
Sheldon’s practice focuses on all aspects of taxation law, advising clients on domestic and international income tax issues. His experience in tax matters, with an emphasis on tax litigation and dispute resolution, includes extensive dealings at all levels with the Canada Revenue Agency and Department of Justice. Sheldon represents clients in tax litigation before the Tax Court of Canada, Federal Court of Canada, and Supreme Court of Canada.
Cliff is a leading expert in planning, structuring and implementing tax-effective business transactions, including mergers, acquisitions and divestitures, and specializes in divisive and other corporate reorganizations. Cliff advises clients on domestic and cross-border tax matters as well as corporate and business law and estate and wealth preservation planning matters.
Professionals involved in the preparation of Wills should be made aware of the potential consequences of the doctrine of ademption. Put simply, the doctrine provides that you cannot bequeath what you do not own. For example, if a testator’s Will gives the family cottage to his son, but the cottage is sold prior to the testator’s death, there is no cottage to give to the son and the gift fails. Although the result may seem harsh, it is logical.
The doctrine has, however, been expanded to more technical levels that many testators would not expect, especially where a testator’s assets are held by corporations.
Using the previous example, if the testator owns a holding company which owns the cottage, a gift by Will of the cottage to his son will also fail. This is because the testator does not own the cottage directly; he owns the shares of a corporation, which, in turn, owns the cottage. The same rule applies to holding companies that own operating companies.
The ademption doctrine has long been the law of the United Kingdom and throughout Canada. Recent cases in British Columbia, Alberta and Saskatchewan have applied the doctrine of ademption in the case of personal holding companies that owned the underlying assets purportedly bequeathed by the testator, thereby causing the gifts to fail.
In Ontario, there is some indication that Courts are unwilling to be so rigid. In the recent case of Re Kaptyn Estate (2010), 102 O.R.(3d)1, the testator owned three commercial malls and a vacation property through corporations that directly or indirectly owned the properties. Justice Brown found that, notwithstanding the bequest in the Will was of the properties and not the shares, Mr. Kaptyn’s intention was clear. Justice Brown determined that the language of the Will could be rectified to permit the transfer of the properties to the named beneficiaries.
In spite of this decision, the law of ademption remains a landmine for the unwary. Given the increasing prevalence of using corporate structures as a means of reducing probate fees and generally organizing one’s affairs, it is important to take the necessary steps to guard against its consequences. It is prudent practice to:
- Update a Will if a significant asset that is the subject of a legacy has been sold or replaced;
- Prepare a corporate chart for the lawyer drafting the Will with the assistance of the corporate lawyer and accountant to ensure that the corporate structure is understood and properly described;
- Ensure that proper language is used to gift any asset that is not owned directly by the person making the Will. In the cottage example, the testator’s Will should provide that the cottage which is owned by XYZ Limited be transferred by the corporation to the son and that the Estate Trustees shall, to the extent possible, cause all necessary corporate resolutions to be passed as officers and directors of XYZ Limited to transfer the cottage to the son. If the cottage is the only asset in the corporation, the shares of the corporation could be the subject of the gift. Discretion with respect to the method of transfer should be given to the Estate Trustees in order to allow the cottage to be transferred in a tax-effective manner.
Clifford Goldlist, Toronto
The Federal Court of Appeal recently ruled on a partnership freeze structure, unanimously dismissing the taxpayer's appeal in Krauss (2010 FCA 284). Krauss is the first reported case dealing with a partnership freeze.
The taxpayer and her adult son (who was described as an able tax lawyer, real property manager, and developer) co-owned certain real properties on Yonge Street in Toronto. They developed a plan to effect an estate freeze by transferring the properties to a partnership in order to accrue future growth in their value to the benefit of a family trust.
On December 31, 1992, the taxpayer and her son rolled their 50 percent undivided interests in the properties into a partnership -- established earlier that day -- in exchange for class A preferred partnership units, redeemable at the properties’ fair market value less the liabilities assumed by the partnership. Their capital accounts were credited with the same amount. The son and the taxpayer’s company also contributed other real property to the partnership for class B units similar to the class A units. On January 2, 1993, the partnership issued class C units (the growth units) to a family trust for the benefit of the son’s wife and children in exchange for a $100 cash contribution. The class A and class B units’ redemption prices were subject to price adjustment clauses.
In 1994, the Yonge Street properties generated a partnership profit of $343,431, of which $216,710 was allocated equally between the taxpayer’s and her son’s class A preferred units, and the $126,721 balance was allocated to the trust’s class C growth units.
The CRA has consistently refused to rule on partnership freezes, dangling the threat of reassessments that reallocate the partners’ income (or loss) from the partnership under subsection 103(1) or (1.1) of the Income Tax Act. Subsection 103(1) may apply if the principal reason for the allocation can reasonably be considered to be the reduction or postponement of tax. Subsection 103(1.1) requires that the allocation between non-arm’s-length partners be reasonable, having regard to their capital contributions and other contributions to the partnership.
The Minister of Finance reassessed the taxpayer, adding 50 percent of the trust’s allocation to the taxpayer’s income. The Minister said that subsections 103(1) and 103(1.1) of the Income Tax Act prevented partnership estate freezes and entitled the Minister to reallocate income between the partners on the basis of what was reasonable: the taxpayer had directly or indirectly invested 50 percent of the capital and was 50 percent responsible for the ongoing conduct of the partnership, and thus should be allocated 50 percent of the income. The Minister also said that subsection 74.1(2) attributed to the taxpayer the trust’s partnership income because she had indirectly transferred property, namely, rights to income from the Yonge Street properties, to or for the benefit of her grandchildren. (The Minister could not plead subsection 74.1(1) to attribute the income of the son’s wife to the taxpayer.)
At trial, the Tax Court (2009 TCC 597) concluded that subsection 103(1.1) applied because the $126,721 income allocation to the family trust was unreasonable; inter alia, the trust contributed only $100 of capital and provided no services to the partnership. “Quite simply, an investment in real estate with no risk of loss that yields a 126,721% return is beyond unreasonable. It is delusive to the point of absurdity, and betrays something more than aggressive . . . tax planning.”
Advisors' attention was captured by obiter in the TCC’s decision to the effect that nothing in the Act prevented an estate freeze through a partnership if it was structured properly to replicate the economics of a corporate estate freeze. But the Tax Court stated that the Krauss partnership structure deviated from a typical estate freeze: (1) the taxpayer could not unilaterally require a redemption of her preferred units; (2) losses from the partnership’s properties were allocated entirely to the preferred units, and the growth units had complete downside protection; and (3) any cash required for partnership operations was to be funded by the taxpayer and her son as the preferred unitholders.
The TCC also said that the attribution rule in subsection 74.1(2) applied for the same reasons as in Romkey (2000 DTC 6047 (FCA)), in which the taxpayers’ divestiture of rights to increased future dividends was an indirect transfer of property to their children and gave rise to attribution. In Krauss, the divestiture in favour of the trust by the taxpayer and her son of rights to receive future rental and other income from the Yonge Street properties (above the class A units’ return) was an indirect transfer of property to the son’s children and gave rise to attribution.
The Federal Court of Appeal unanimously dismissed the taxpayer’s appeal. The taxpayer argued that the trust’s income allocation was reasonable despite its nominal partnership contribution, because the partnership freeze was functionally analogous to a corporate freeze. The FCA said that the TCC was not wrong in law to reject that argument because the partnership structure deviated substantially from a typical estate freeze, and insofar as it was a factual determination it was reasonably open to the TCC on the record. Even though the TCC did not fully appreciate that the taxpayer and her son were entitled to additional partnership units if they were required to meet cash calls, the FCA said that that was not a material error and thus was no basis for it to intervene.
Unfortunately, the FCA’s decision provides no guidance on when a partnership freeze is considered acceptable income tax planning; the Court found that it was not necessary to express any opinion on the issue and declined to do so. The FCA’s support of the Minister’s subsection 103(1.1) challenge in Krauss means that taxpayers cannot expect any softening of the CRA’s position on partnership freeze transactions. A taxpayer bold enough to undertake a partnership freeze after Krauss may be well advised to ensure that income and loss allocations reasonably reflect the partners’ capital and other contributions. Otherwise, he or she risks attack by the Minister under one or more of subsections 103(1) and 103(1.1) and sections 74.1 and 74.2 of the Act.
*A version of this article was originally published in Canadian Tax Highlights, Volume 18, Number 12, December 2010
Amanda J. Stacey, Toronto
A question regarding the use of an alter ego trust (or a joint partner trust) as a charitable remainder trust was raised at the CRA roundtable at the 2010 CALU Conference (CRA document number 2010-0359461C6). Generally speaking, a charitable remainder trust (“CRT”) is a trust that is set up to provide an income stream to one or more individuals, usually for their respective lifetimes, and that names one or more charities as the ultimate beneficiary (i.e. the capital beneficiary), of the property held by the trust. The term “charitable remainder trust” is not defined in the Income Tax Act. As such, CRTs are not currently treated as a separate type of trust for the purposes of the Act. The current tax treatment of CRTs is based on the general rules applicable to charitable donations and the taxation of trusts.
In its Registered Charities Newsletter #27, the CRA states the following concerning setting up a CRT:
Generally, a charitable remainder trust involves transferring property to a trust whereby the donor or beneficiary retains a life or income interest in the trust, but an irrevocable gift of the residual interest is made to a registered charity. A registered charity can issue an official donation receipt for the fair market value of the residual interest at the time that the residual interest vests in the charity.
To qualify as a CRT, the terms of the trust cannot allow for any capital encroachments. The transfer of property to the CRT must also be irrevocable.
An alter ego trust is a trust that is defined in the Income Tax Act. To qualify as such, the settlor of the trust must be at least 65 years of age at the time the trust is created, the settlor must be entitled to receive all of the income earned in the trust during his or her lifetime and the settlor must be the only person entitled to any of the capital of the trust prior to the settlor’s death. A joint partner trust is similar, but the beneficiaries are the settlor and the spouse or common-law partner of the settlor.
Generally speaking, when an individual transfers property to any type of trust, there is a disposition of the property transferred at fair market value and any resulting capital gain is taxable to the transferor. Where property is transferred to a CRT (or to a charity for that matter), there is an election available under the Income Tax Act that allows the transferor to choose the value of the property transferred for the purposes of calculating any gain. The transferor can elect a value between the cost of the property and its fair market value. Where the transferor elects at cost, this will ensure that there is no capital gain on transfer. With respect to alter ego trusts, whether they qualify as CRTs or not, when a settlor transfers property to an alter ego trust, there is a rollover available under the Act which allows the transfer to occur without triggering any capital gains. As such, when a transfer is made to a CRT that is also an alter ego trust, there is no need to make the election discussed above because of the available rollover.
In the question put to the CRA at the CALU 2010 Roundtable, the CRA confirmed that the transfer of property to an alter ego trust that was also a CRT could occur without triggering a capital gain and that a donation receipt could be issued by the charity that is named as the ultimate beneficiary of the CRT. This receipt must be issued for the value of the charity’s residual interest in the trust, and in most cases this will require a professional valuation.
In a later technical interpretation that refers to this question at the CALU 2010 Roundtable (CRA document number 2010-0369261E5), the CRA was asked whether an individual’s claim for a donation tax credit as a result of a gift to a CRT would be limited if immediately after the gift the individual and the trust are affiliated. The concern is the application of what are known as the “non-qualifying security rules” in the Income Tax Act, which the CRA points out were designed to defer the opportunity for certain donors (i.e. individuals not dealing at arm’s length with their corporations) to receive a tax benefit by making gifts to charity of securities in those corporations. Under these rules, the tax benefit associated with making a gift to charity is generally restricted unless the charity disposes of the security or the security ceases to be a non-qualifying security. The CRA states that it is a question of fact whether the non-qualifying security rules will apply to a gift in this context. The CRA provides the following example: the non-qualifying security rules would apply where a donor transferred to an alter ego CRT a share of a corporation that was, immediately after the transfer, a corporation with whom the donor was not dealing at arm's length. Similarly, if a donor transferred a beneficial interest of the donor in a trust that was, immediately after the transfer, affiliated with the donor, the non-qualifying securities rules would also apply.
These are complicated provisions that require careful planning to ensure they are utilized properly. We would be happy to provide advice to both donors and charities dealing with CRTs (whether alter ego or otherwise) and gifts of complicated property to such trusts.
Patrick Déziel, Toronto
In the weeks and months leading up to December 2010, there was great uncertainty in the United States regarding the fate of the politically divisive ‘estate tax.’ US estate tax has traditionally applied to the value of deceased US citizens’ and residents’ (referred to as “US Persons”) estates on death, with exemptions for values below a certain threshold. The estate tax also applies to the value of certain US-situs property owned by non-US residents in certain circumstances.
The uncertainty existed because the legislation governing the estate tax, initially enacted in 2001, was scheduled to sunset starting in 2011. The sunset would have resulted in a reversion to pre-2001 tax rates, which stood at 55%, compared to 45% in 2009, and a $1 million exemption, down from $3.5 million in 2009. (The exemption is pro-rated for non-US Persons regarding their US-situs property.) The 2001 legislation also provided for the repeal of the estate tax in 2010 (subject to the 2011 sunset), such that there was uncertainty regarding the potential retroactivity of any legislation implemented to prevent a return to the comparatively high pre-2001 rates.
Legislation was finally passed in December 2010, extending the estate tax to the end of 2012. The new legislation, The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, signed into law on December 17, 2010, sets the estate tax rate at 35% and the exemption at $5 million for 2011 and 2012. This rate and exemption level has retroactive application for US Persons who died in 2010. For estates of Canadians who owned property in the US at death, the increased exemption means a higher prorated exemption amount.
For 2010, estates of US Persons may elect to use the “modified carryover basis” provisions that were to apply in lieu of the estate tax for 2010. The carryover basis option generally involves permitting a limited “step-up” of up to $1.3 million in the cost base of inherited property. An executor will need to consider the value of the estate, the amount of any accrued gain at death and the situations of the beneficiaries and the estate generally when determining whether to elect to use the carryover basis or have the estate tax apply with the increased exemption.
At the end of 2012, the legislation is scheduled to sunset once again. It is entirely likely that a period of uncertainty will again ensue leading up to the end of 2012 and that legislation determining the future of the estate tax will once again be passed at the last possible moment, if at all. At this time, it is impossible to say whether the estate tax will be repealed, reduced, increased, extended or reformed after 2012.
Two related components of the recent legislation are the generation-skipping transfer tax (“GSTT”) and the gift tax, both of which are tied to the estate tax exemption. The gift tax applies to gifts made during a person’s lifetime and prevents the avoidance of the estate tax by simply transferring property during one’s lifetime. For 2010, the gift tax rate is 35% and there is a lifetime exemption of $1 million. For 2011 and 2012, the gift tax will match the estate tax with a 35% rate and a lifetime exemption of $5 million. The gift tax and estate tax are “unified” with respect to the $5 million exemption, meaning the exemption is cumulative in terms of amounts claimed under both taxes. Like the estate tax, the gift tax rates will revert after 2012 unless the US government takes legislative action.
GSTT applies to transfers made to related persons who are at least two generations younger than the transferor. Like the estate tax and the gift tax, the GSTT applies for 2011 and 2012 with a 35% rate and a $5 million exemption. However, the GSTT does not (for practical purposes) apply to 2010; 2010 has a $5 million exemption, but a “0% rate”. Again, if no action is taken prior to the end of 2012, the GSTT will revert to a $1 million exemption and a 55% rate.
The $5 million exemption for all three taxes is indexed starting in 2012. The new legislation also provides for “portability” of the estate tax exemption as between spouses, whereby a deceased spouse’s estate can, under certain conditions, transfer any unused portion of the exemption to the surviving spouse, to be used in addition to the surviving spouse’s $5 million exemption. Where one or both spouses are not US citizens or residents, professional advice should be sought regarding the potential application of the exemption and portability provisions to the spouses’ particular circumstances.
Canadian taxpayers who own US real estate or other US-situs property should carefully consider the potential impact of the new legislation in their estate plans. Although the exemptions in 2011 and 2012 are significant, the continued uncertainty as to the nature and existence of the estate tax and related taxes beyond 2012 makes dealing with these issues a difficult but necessary component of sound estate planning for many Canadians. Flexibility in estate planning devices is the key to being prepared for whatever may lie ahead. Seeking the advice of professionals with experience in estate planning is highly recommended.
Blair Botsford, Kitchener-Waterloo
The Tax Court of Canada’s decision in Paul Antle v. Her Majesty the Queen (2009 D.T.C. 1305) (“Antle”), recently upheld by the Federal Court of Appeal (2010 F.C.A. 280), focused primarily on the residency of a trust purportedly established in Barbados, as well as application of the General Anti-Avoidance Rules (“GAAR”) in the Income Tax Act (the "Act"). The tax aspects of the decision have been commented on thoroughly. One of the elements of the decision that has not received as much attention is the Court’s review of the settlement of the impugned trust and implementation of the planning strategy. In light of the trust audit project that the Canada Revenue Agency ("CRA") has recently undertaken, these administrative issues are taking on greater significance.
The judgment of the TCC is the result of an appeal from the reassessment made under the Act for the 1999 taxation year which was dismissed.
The case involved what could be called a property step-up strategy. Essentially, shares held by Paul Antle of PM Environmental Holdings Ltd. (the "Shares") with an accumulated gain were being transferred from Mr. Antle to a Barbados spousal trust (the "Trust"). The Trust then sold the Shares to the beneficiary of the Trust, Mr. Antle’s spouse, who in turn sold the Shares to a third party purchaser and used the proceeds she received to pay off the Trust. Subsequently, the trust distributed the proceeds to the spouse beneficiary and was wound up.
The desired result was that there be no tax liability in Canada, which would have otherwise resulted if the husband had sold the Shares directly to a third party. Rather, the capital gain was to be triggered in the Barbados Trust, as there is no tax on capital gains in Barbados, there would be no tax on the sale of the Shares. The CRA took exception to this strategy and attacked it on a number of fronts:
- the Trust was a sham;
- the Trust was not properly constituted;
- the requirements of subsection 73(1) of the Act were not met;
- subsection 69(11) of the Act; and
- the application of GAAR.
This article will review the analysis with respect to items 1 and 2 above. In doing so, it is helpful to review the rather lengthy facts of the case. These may be found in paragraphs 4 through 35 of the decision.
The validity of the Barbados Trust was the first issue the Tax Court addressed. Writing for the majority, Justice Miller reiterated the well-established rules for creating a trust – namely, that there must be certainty of intention, of subject matter and of objects. He further commented that because a trust is simply a means for holding property, “there must be a transfer of property to the trust to effectively constitute the trust.”
Respectfully, this is not entirely accurate and somewhat circular. A trust is not a legal entity. Therefore, it is not possible to transfer anything to it. The transfer is to the trustee to be held according to the terms of the trust for the benefit of the beneficiaries. This is not an additional step. It is the settlement process whereby a settlor intends for a particular trustee to hold certain property for the benefit of ascertainable beneficiaries (or a permitted purpose) and thereby transfers or conveys the property to the trustee upon the happening for which the trust is created. Depending on the actual property to be settled, there may or may not be formalities for completing the transfer from the settlor to the trustee.
Justice Miller opined that the arrangement before him lacked both certainty of intention and certainty of subject matter.
With respect to intention, he commented that the Respondent took the position that Mr. Antle never intended the trustee, Mr. Truss, to have discretion to deal with the Shares that were being sold, but rather intended to use the Trust as a conduit to avoid tax.
This reasoning is somewhat flawed. The intention that is required is the intention to create a trust: for one legal entity to hold property for the benefit of another, or for a purpose. How much discretion a trustee has or does not have is a related, but not necessarily determinative, issue. Bare trusts are valid trusts, albeit where the trustee does little if anything other than hold title to the property until the distribution date. Whether a particular trustee is exercising the necessary discretion to administer a given trust properly is a different issue from that of intention to have property held on trust. A failure to exercise discretion appropriately would be a breach of trust rather than striking at the heart of the trust’s existence.
The trust deed was dated December 5th but not signed until December 14th. Justice Miller concluded that the latter date is the only one on which the Trust could have been created. That is not necessarily true. As long as the subject of a trust is not real property to which a statute like Ontario’s Statute of Frauds (R.S.O. 1990, c. S.19), applies, or property otherwise requiring formalities for transfer to be observed, it is possible to establish a trust verbally. Therefore, it is possible that the execution date of the trust deed is simply that: the day on which the terms of the Trust were reduced to writing with the actual settlement having taken place previously.
On these particular facts, or where there would be trust terms of some complexity, it is difficult to infer that the Trust was established entirely verbally. The later reduction to writing could be seen as a resettlement of the Trust if more expansive terms were included, at least from a tax perspective.
As suggested above, real property is not the only type of property where formalities are required to effect a transfer. Certificated securities or shares are another example in some Canadian jurisdictions, such as Newfoundland and Ontario. At the time of the impugned trust settlement, Newfoundland’s Corporation Act provided in section 124 that “Endorsement of a security…in blank does not constitute a transfer until delivery of the security.” This section was repealed in September of 2007. Transfers of shares are now governed by the Securities Transfer Act and Ontario has similar legislation.
The requirement of endorsement and delivery is only a problem if Mr. Antle was intending to settle on trust all his right, title and interest in his Shares. However, that may not have been the case. He arguably did not have complete right, title and interest in the shares and, therefore, could not have settled his full interest in the Shares in trust. Mr. Antle, supposedly under duress, agreed to pay Stratos, which also owned shares of PM Evironmental Holdings Ltd., additional consideration over and above the payments for his preferred shares. As security for this payment, Stratos was holding the Shares. If Mr. Antle was successful in suing Stratos to challenge the claim for additional consideration, the Shares would have supposedly been worth another $1.38 million.
This situation gives rise to several relevant questions:
- What, if any, security interest did Stratos have?
- What property did Mr. Antle own with respect to the Shares, assuming a valid security interest in favour of Stratos?
- What property was available to settle on trust and were there any formalities required?
Another consideration is the fact that Mr. Antle did not have to give possession of the shares to Stratos in order for him to gain a security interest. That could have been accomplished by means of a chattel mortgage. In that case, possession of the Shares could have been given to Mr. Truss but this would still raise the issue of endorsement as well as that of what property was intended to be settled. Since Mr. Antle was not attempting to effect a fair market transfer with a third party having no knowledge of a potential security interest, all that Mr. Truss could acquire was the interest in the Shares that remained with Mr. Antle following the granting of the security interest. It is possible that a trust could still have been settled, albeit not for all the Shares.
The decision in this case is less than illuminating in terms of understanding the law concerning the proper settlement of a trust. There is a range of troubling facts that are partly the source of the difficult trust analysis and they can serve as a cautionary tale for those who might be inclined to treat the use of a trust as part of a complex planning strategy in a perfunctory manner. For example, Mr. Truss had already signed a Bill of Sale on December 13th to transfer shares to Mrs. Antle as well as a Capital Property Distribution and Direction to Pay even though the trust deed was not executed until December 14th. This process of signing in advance was likely borrowed from corporate practice but is not appropriate regarding trusts.
Some other facts cited as raising concern may not be relevant. Apparently, Mr. Antle never spoke to Mr. Truss. While prudent, speaking with the Trustee is not necessarily required. You do not have to meet and engage in any form of exchange with a person to intend that they hold property in trust. It is quite common currently for the settlor and trustees to have little interaction regarding the settlement of a trust although this case calls the practice into question.
Also, it was noted that there was nothing in the body of the Trust Deed itself settling the Shares on the Trustee. Justice Miller states at paragraph 48 of the decision that in the circumstance, Mr. Antle signed on December 14th a Trust Deed dated December 5th claiming, in the preamble, to have transferred the Shares. He further states that this is not illustrative of an intention to settle a trust and that if Mr. Antle intended any role for Mr. Truss, it may at best have been as agent in a gift from him to his wife.
In reality, this is standard form language in many trusts. It is preferable to state that property is being transferred to the trustees and that they accept the property on the terms of the trust, the expectation being that the transfer and execution are all occuring virtually simultaneously. However, some trust precedents are not worded this way and state, alternatively, that the property has been transferred presumably the instant before execution. This is not nor should it be fatal to the issue of intention.
The decision goes on to state that Mr. Antle did not truly intend to settle shares in a trust with Mr. Truss. He simply signed documents on the advice of his professional advisers with the expectation that it would avoid tax in Canada. Mr. Justice Miller found that on December 14th, Mr. Antle never intended to lose control of the Shares or the money resulting from the sale. He also stated that Mr. Antle did not fully appreciate the significance of settling a discretionary trust and is not saved by the language of the Trust Deed itself, no matter how clear it might be.
It is not necessary to intend that a trust endure for an extended period to find that one exists. It is also not inconsistent with the existence of a trust that the settlor have further or other intentions beyond property being held in trust. A trust is a vehicle for managing property. If it is lawfully settled and the terms observed, the issue becomes whether its use was an abuse of tax or other laws. However, the perception that a trust was used primarily to achieve a goal other than longer-term asset management does not negate the validity of the trust. This is a GAAR analysis and is not founded in trust law.
The TCC, in its decision, attacks the very foundation on which Mr. Antle attempted to implement his planning strategy, which involved, at its heart, the use of a discretionary trust. The decision may serve as a template for the CRA to probe trust transactions and CRA is currently reviewing trusts with enthusiasm.
The following are some suggestions that may help avoid difficulties with CRA:
- Be clear about what property is being settled and describe it accurately in the trust deed if it is the initial settlement object. For later property being settled on the same trust, all documentation transferring the property to the trustee should clearly describe the property.
- It should be noted that even while much commentary seems to distinguish between the initial settlement on a trust and later contributions to a trust, a trust is not a legal entity, so all “contributions” are settlements and each “contributor” is a settlor. Beware subsection 75(2) of the Act.
- If the property being transferred is a right attaching to another form of property, extra care needs to be taken to verify the transferor’s entitlement to ensure the right is described and transferred properly.
- Formal requirements for transfer should be reviewed and complied with, such as the provisions of the Securities Transfer Act (2006, S.O. 2006, c. 8), to ensure that the property is actually settled on trust. For simple subjects such as a coin or $20 bill, the subject matter must be owned by the settlor at the time the trust is settled. The settlor can enter into a contract for the purchase of the property and pay later, but they must have the requisite rights in the property at the time of settlement capable of effective transfer. If cash is used, it must belong to the settlor and the settlor cannot be paid back for the gift from a trustee who is in a control position or from other trust property.
- Ensure that notice is given to third parties with whom the property may be registered or held even if notice of the trust is not a technical requirement. This can avoid challenges and confusion at a later date when, for example, there are accounts at a financial institution.
- Prepare a closing agenda for the transaction and set realistic deadlines for the completion of each step if some parties are in other locations. Do not complete steps out of order, especially the execution of the trust deed and transfer of property from the settlor to the trustee. There is no doctrine of substantial compliance for the settlement of trusts.
- Have the execution of the trust supervised by a lawyer who can then swear an affidavit as to the due execution of the trust deed and delivery of the trust property to the trustee.
- If a trust is going to be signed in counterpart, make sure the settlor signs first and has transferred the settlement object to at least one of the panel of trustees who should acknowledge receipt on behalf of the others.
- The trust deed and any
supporting documentation should be clear about everyone’s roles,
particularly where the business owner may have specialized knowledge on
which the trustee would be expected to rely. This was an important issue
that arose in the Garron case also decided by the TCC around the
same time as Antle. It is unrealistic to think that any
professional trustee, no matter how sophisticated, could or would take
charge of selling a company worth $500 million without substantial input
from the key directing minds of the company who likely are also going to
be shareholders. No one, including the trustee, is going to have the same
level of knowledge to make recommendations regarding how the trust
property is to be managed.
The trust deed could define an advisor role for the key employee/shareholder but make it clear that final decisions will rest with the trustee. Just because someone with superior knowledge makes a recommendation and it is carried out, does not make them the directing mind of a trust or the trustee. A professional trustee is supposed to be an expert at acting as trustee, not running a corporation.
Alternatively, there could be a requirement for the consent of the majority of adult beneficiaries to approve certain types of decisions by the trustees. The trustees must weigh the evidence and prepare a resolution that they wish to make a particular decision. The trust deed would prohibit the decision from being implemented if the beneficiary consent was not received.
The danger in this is that the beneficiaries start to look like de facto trustees. However, since there is a division between decision-making and implementation, it may work.
- Frequently the settlor is not
the client of the lawyer who is putting together the trust structure. It
is often the business owner who wishes to use a trust but, because of subsection
75(2) of the Act, cannot be the
settlor. Here, proving intention and consent to all of the terms of the
trust is more difficult. One option to overcome the appearance that
there is no intention is to include more recitals in the trust deed
outlining the intention of the settlor. Coupled with this, the settlor
could obtain independent legal advice from a lawyer acting solely for the
settlor who can review the trust deed with the settlor and confirm that
the person understands it, intends to settle property on trust and has
knowledge of the terms of the trust.
Lack of knowledge of certain terms should not invalidate the trust as long as there was intention. The problem is rectification. Whole portions of the trust to which the settlor did not have knowledge or consent could be struck out severaly, impairing its operation and effectiveness. (See, for example, Balaz v. Balaz, 2009 CanLII 17973 (Ont. S.C.J.).)
- Subsection 104(24) of the Act contains the rule for being
able to deduct income that was paid or payable to a beneficiary in a year.
Timing is everything here. The amount, to be deductible in the trust’s T3
return for the year, must be either paid to the beneficiary before the
year end of the trust or it must have been “payable”. The CRA’s current
interpretation of “payable” is that there must be an enforceable right on
the part of the beneficiary.
CRA arguably takes the notion of enforceability further than the law necessarily requires. It is their preferred position that not only do the trustees have to declare an income distribution but they must also issue a promissory note on behalf of the trust to create a debt. The irrevocable declaration of the income payment creates the obligation. The promissory note, while perceived as additional assurance or recognition of an obligation already created, is a potentially problematic duplication.
Since inter vivos trusts have a calendar year end and it takes some time to calculate the net income, the pool of income available for distribution may not be known until after the year end. As a result, the trustee resolution may only be able to specify percentages rather than amounts.
- To clearly establish the
entitlement to income, the following trustee procedures may be helpful:
- Meet prior to year end to review the operation of the trust. Take minutes of the meeting particularly regarding income or capital distributions. There is debate about whether the reasoning for decisions must be recorded and if beneficiaries can gain access to that information. Get legal advice before deciding on the precise content of the minutes to be sure.
- If distributions are declared at the meeting, a resolution should be passed confirming the declarations – one for income and one for capital if the beneficiary pools are different.
- A copy of the resolution should be served on each beneficiary, possibly as an attachment to a written notice, or acknowledgment of the notice could be included at the end of the resolution with a statement regarding how notification was provided.
- Acknowledgment from the beneficiaries should be received. This can be by means of an acknowledgment card sent with the notice and resolution. A return envelope should be provided including a stamp to make compliance easy or return by facsimile which serves to date the document.
- The resolution and notice should be filed in the trust minute book.
- Record keeping generally is an often overlooked chore with respect to trusts. However, legally trustees are obligated to maintain records not just for income tax compliance purposes but as a matter of trust law. The easiest way to ensure everything is kept together is to use a minute book like the ones for corporations. All the key sections are set out and require only a small amount of amending. Next, the trustees need a routine for regular meetings: at least annually or as otherwise specified in the trust deed. Care should be taken in selecting the place of meeting, and any communications, to avoid criticism from the CRA that the place where the trust is managed is not a jurisdiction that is not authorized by the trust nor has tax disadvantages.
Antle Case Post-Script
There were two appeals brought in the Federal Court of Appeal challenging the Tax Court of Canada’s decision discussed above. One appeal was brought by Mr. Antle and the other by the Spousal Trust. These appeals were subsequently consolidated.
Both appeals took a very narrow approach and focused on Justice Miller’s reliance on external circumstances to reach his conclusion that the Trust was not validly constituted. Both appellants maintained that this amounted to an error of law as the trust deed was otherwise clear and unambiguous.
Justice Noël, writing for a unanimous majority of the FCA, disagreed that external factors could not be considered. He cited several cases on point, the details of which are not significant for this discussion. He found this to be sufficient to dispose of the appeals.
It is curious that the appeals were brought on such a narrow ground, and one not likely to succeed, given that the trial decision made many assumptions about basic elements of trust law and did not appear to examine in detail the provisions of the trust deed. There seemed to be a misapprehension at the trial level that a trust is a trust is a trust.
The ratio of the FCA’s decision is unfortunate for trust and tax practitioners, but what is more disturbing are the comments made in obiter challenging the trial court’s obiter comments regarding the issue of “sham.” Justice Noël felt that Justice Miller had been too lenient in his reasoning and had misconstrued the notion of intentional deception in the context of a sham.
He went on to state that the required intent or state of mind is not equivalent to mens rea and need not go so far as to give rise to what is known at common law as the tort of deceit. In his opinion, it was sufficient that the parties to a transaction present it as being different from what they knew it to be and that was what the Tax Court judge found without declaring the Trust a sham. Justice Noël then stated that Justice Miller was bound to hold that the Trust was a sham based on the findings he had made. In light of the indictment this decision delivers, I will restate my warnings about getting trusts right from the start and maintaining them diligently.
Leave to appeal to the Supreme Court of Canada has been sought.
1 Garron Family Trust v. The Queen, 2009 TCC 450 (CanLII).
2 Paul Antle v. The Queen, F.C.A. docket A-428-09 and Renee Marquis-Antle Spousal Trust v. The Queen, F.C.A. docket A-429-09, 2010 FCA 280.
Martin Rochwerg of our Toronto office is presenting at the 6th Canadian Private Family Invitational on "Top Ten Cross-Border Tax and Estate Planning Ideas” on June 17, 2011 in Banff, AB.
Wendi Crowe spoke to RBC Wealth Management advisors on "Tax Planning Opportunities for Professional Corporations" on July 22, 2010. Wendi also spoke at a Lunch & Learn held November 25, 2010 on "Trustee Investment Powers: Prudent Investor Rule Compliant Portfolios" and on November 29, 2010 spoke at a Metro Continuing Education class on "Being an Executor".
Cheryl Teron presented at the Canadian Tax Foundation, BC Tax Conference, a paper entitled “Commercial Real Estate in BC -- Selected Issues” on September 20, 2010.
Blair Botsford presented at Miller Thomson's seminar entitled "The Audit is Coming: Are you ready?" on September 29, 2010. This was a seminar focused on educating and advising on the Canada Revenue Agency's compliance review of inter-vivos/ family trusts currently underway across Canada. Blair spoke on Insurance Trusts at the Waterloo-Wellington Estate Planning Council on February 3, 2011. As well, Blair chaired a 1/2 session for the OBA's Trusts, Estates and Third Parties: Compliance Issues in Modern Practice on April 1, 2011 in Waterloo speaking on "Access to Client Information".
Richard Fontaine addressed a group of Financial Advisors in a seminar on "Transfer of a Family Business" in October 2010.
Donald Carr co-presented at the Miller Thomson Charities Group seminar in Toronto on December 7, 2010 entitled "A Year in Review".
Joe Yurkovich participated as a panelist for the Solicitors' Shorts session at the CBA Alberta branch Alberta Law Conference on January 28, 2011 and presented a paper entitled "2012 Alberta Business Corporations Act Amendments".
Gail Black presented to Estate Planning Council of Calgary on New Alberta and BC laws on wills and estates on February 7, 2011. She's also co-teaching the Wills and Estates course at the University of Calgary Law Faculty for the current winter term.
William Fowlis presented to the Wills and Estates subsection of the South Alberta Branch of the CBA on "Estate Freezes - Planning Considerations, Current Issues and Opportunities" on February 8, 2011; as well as being course leader of the Federated Press Tax Planning for the Wealth Family Course on March 22 and 23, 2011 and presenter on Advanced Income Tax Planning for Maximizing Asset Protection.
Nathalie Marchand presented at the APFF seminar on trusts for acquiring US residential real estate on February 24, 2011.
Rachel Blumenfeld presented on Wills and Powers of Attorney on March 22, 2011 for the Toronto East Christian Women's Club.
Rachel Blumenfeld spoke on US-Canada Cross-border Planning on March 23, 2011 and April 13, 2011 for Canaccord and to the professional advisors for the Canadian Shaare Zedek Hospital Foundation.
James Rhodes spoke at the OBA on April 1, 2011 on "Tax Compliance and Derivative Assessments".
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