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