Introduction
Prior to the Tax Court of Canada’s decision in Garron Family Trust et al. v. The Queen, 2009 TCC 450 [Garron], according to many legal professionals, a trust was resident in the jurisdiction in which a majority of its trustees resided. As such, a trust that was entirely administered by trustees who were resident in Barbados, including a professional trustee incorporated or licensed in that jurisdiction, would be resident in Barbados and nowhere else.
Unlike trusts, prior to Garron, corporations were subject to the “central place of management” test for the purposes of determining their jurisdiction of residence. The central place of management test is a question of where a corporation conducts a majority of its business—the jurisdiction, for example, in which decisions are made and directors’ meetings are held. In Garron, Woods J. of the Tax Court of Canada applied the central place of management test, previously reserved for corporations, to trusts that were otherwise operated by a professional Barbados trustee. She held that the trusts, although administered by offshore trustees, were controlled by resident Canadians and therefore resident in Canada due to the involvement exercised by the Canadian resident beneficiaries in the trusts’ affairs.
Woods J.’s decision was first appealed to the Federal Court of Appeal, and then to the Supreme Court of Canada. The Supreme Court’s recent decision in this case, released under the name Fundy Settlement v. The Queen, 2012 SCC 14 [Fundy], puts to rest any doubts regarding the application of the corporate central place of management test to offshore trusts in order to determine their residence for tax purposes.
Facts
Following a corporate restructuring, or a series of estate “freeze” transactions undertaken in 1998, the value of a corporation known as “PMPL” was “frozen” in redeemable preference shares. Two new numbered Ontario companies were incorporated as part of the corporate transactions. Each holding company subscribed for newly issued common shares in the capital of the reorganized PMPL. Two separate Barbados trusts, known as the “Sommersby” and the “Fundy” settlements, were settled. Each trust subscribed for the shares of one of the numbered holding companies, with each trust subscribing for the shares of a different holding company than the other.
The trustee of the Barbados trusts was St. Michael’s Corp. and the trusts were settled by non-residents of Canada for the benefit of resident Canadians. Two years after the trusts were settled, the trustee sold the trusts’ shares in the capital of the two holding companies to an arm’s length purchaser, as part of the sale of PMPL. The sale of the holding company shares gave rise to a Canadian capital gains tax liability of approximately $450 million. The holding companies withheld and remitted $150 million in taxes to the Receiver General in respect of this capital gains tax liability under the Income Tax Act (Canada) (the “ITA”). However, following the remission of the capital gains taxes, the trusts claimed that they were exempt from the tax liability under 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 (the “Treaty”) on the grounds that they were resident in Barbados and not in Canada.
The Canada Revenue Agency (“CRA”) denied the trusts’ application for a refund of the withholding taxes paid, concluding that the trusts were resident in Canada and therefore not entitled to any Treaty benefits. The trusts’ appeals to the Tax Court of Canada were denied by Woods J. who, in considering the evidence before her, concluded that the professional Barbados trustee occupied a purely administrative role and that the trusts were, in reality, being managed by the Canadian-resident beneficiaries. Sharlow J.A. of the Federal Court upheld Woods J.’s decision, holding that there was no reason in law why the central place of management test could not be applied to the trusts to determine their tax residence.
Supreme Court of Canada Decision
In a relatively brief judgment, the Supreme Court of Canada dismissed the trusts’ appeals. The Court agreed with Sharlow J.A. that there was no case law, nor any rule, which precluded the central place of management test from being applied to determine the resident of a trust. The Supreme Court also held that trusts and corporations were similar in many ways: both corporations and trusts hold assets that are to be managed, both may require the management of a business, both require banking and financial arrangements and both may distribute income to one or more persons, either by way of dividend or distributions. At their core, the directors of a corporation and the trustees of a trust hold fiduciary roles. There is, therefore no valid reason in law why the same legal tests should not be applied to corporations and trusts to determine their residence for tax purposes.
Practical Implications of the Supreme Court’s Decision
The decision in Fundy Settlement does not mean that Canadian residents cannot be beneficiaries of non-resident trusts. Nor does the Supreme Court’s decision mean that offshore trusts cannot be settled in a legal and tax-efficient manner in appropriate and acceptable circumstances. However, the decision does mean that those seeking to establish offshore trusts, or the Canadian beneficiaries of existing offshore trusts, must be particularly careful of their level of involvement in the trusts’ management and administration. Practitioners can no longer assume that non-resident trusts will be safe from Canadian tax consequences because they are administered by offshore trust companies.
In Fundy, the Canadian beneficiaries’ direct and indirect involvement in the trusts’ decision-making gave rise to an unintended tax liability of over $150 million. The trusts were otherwise properly established so as to not give rise to any negative consequences under the provisions of the ITA. Woods J.’s findings of fact made it clear that the beneficiaries had never been willing to give up control over the property that was held in trust for their benefit, and that they were regularly involving themselves in the management and investment of the trust property. As understandable as Canadian beneficiaries’ concerns may be with respect to the management of offshore trust property, as a result of the decision in Fundy, special cautions may need to be put into place and steps may need to be taken to ensure that costly, unintended and unanticipated tax liabilities do not take Canadian beneficiaries by surprise.
