The final word on offshore trusts

Where does a trust reside? Prior to 2009, lawyers agreed a trust was resident in the jurisdiction in which a majority of its trustees resided. So a trust that was entirely administered by Barbados trustees would be resident in Barbados only.

But, in Garron Family Trust et al. v. The Queen, 2009 TCC 450, the Tax Court deemed the trusts in question, although administered by offshore trustees, were controlled by Canadians and therefore resident in Canada, largely due to the involvement of the Canadian resident beneficiaries in the trusts’ affairs.

That decision was first appealed to the Federal Court of Appeal, and then to the Supreme Court. The Supreme Court’s recent decision in this case, released under the name Fundy Settlement v.The Queen, 2012 SCC 14, puts to rest any doubts regarding residency of offshore trusts for tax purposes.

The details of Fundy Settlement

In Fundy, two new numbered Ontario companies were incorporated as part of the restructuring of a corporation called PMPL. Each corporation subscribed for newly issued common shares in the capital of the reorganized PMPL.

Two separate Barbados trusts were then settled to hold the common shares of the numbered companies.The trusts were settled by non-residents of Canada. The trustee was St. Michael’s Corp., based in Barbados.

Two years after the trusts were established, the trustee sold the trusts’ shares in the two numbered companies to an arm’s-length purchaser, as part of the sale of PMPL. That sale gave rise to a sizable Canadian capital-gains tax liability. Given this liability, the holding companies withheld and remitted approximately $150 million to the CRA, but claimed they were exempt from paying Canadian taxes under the tax treaty between Canada and Barbados, since they were resident in Barbados.

The CRA denied the trusts’ application for a refund of the $150 million of withholding taxes paid, concluding that the trusts were resident in Canada and therefore not entitled to any treaty benefits.

The trusts appealed to the Tax Court, which denied their appeals on the basis that the trusts were being managed by the Canadian resident beneficiaries and not the Barbados trustees. The Federal Court upheld that decision.

And, in a relatively brief judgment, the Supreme Court dismissed further appeals.

Practical implications

Canadian residents can still be beneficiaries of non-resident trusts. The Supreme Court’s decision also means offshore trusts can still be settled legally and tax-efficiently.

But, if your clients want to establish offshore trusts, or if they’re Canadian beneficiaries of existing offshore trusts, they must be particularly careful of their levels of involvement in the trusts’ management and administration.

By regularly involving themselves in offshore trustees’ investment decisions, and/or by providing directions to trustees, Canadian beneficiaries may cause an otherwise offshore trust to become resident in Canada.

In Fundy Settlement, the Canadian beneficiaries’ direct and indirect involvement in the trusts’ decision-making gave rise to an unintended tax liability of more than $150 million. The trusts were otherwise established properly.

However, the Tax Court’s findings suggested that the trusts’ Canadian beneficiaries had never been willing to give up control over the property that was held in the trusts for their benefit. In this regard, the beneficiaries were regularly involving themselves in the management and investment of the trust property, with the Barbados trustees carrying out their instructions.

In light of the Fundy decision, such a level of involvement by Canadian residents risks having offshore trusts deemed to be resident in Canada.

Martin Rochwerg is chair of Miller Thomson LLP’s National Private Client Services Group in Toronto and editor-in-chief of the book Miller Thomson on Estate Planning. Rahul Sharma is an associate in Miller Thomson’s Toronto office and practises in the tax and private client services areas.