Do’s and don’ts for advising trusts

Reader Alert: This is a follow-up story to ‘Puppet Trustees’ Get a Second Chance.

Two lower court rulings in the Garron Family Trust et al. v. The Queen case established central management and control of trust assets, rather than the residence of trustees, as the key test for determining the residence of a trust. That threw a wrench into many tax-planning strategies based on sheltering capital gains in balmy Barbados and other tax havens.

But the Supreme Court of Canada has granted leave to appeal the lower court rulings, and the outcome of their decision will be far-reaching for those planning to use offshore or inter-provincial trusts as an estate planning tool.

Marsha Reid, senior manager, global employer services at Deloitte & Touche LLP, explains some of the practical consequences of the Gerron case for beneficiaries, trustees and investment advisors.

CRA on the prowl

“The Garron decision and the central management and control test put greater scrutiny on what the trustee is doing and the processes they have in place to demonstrate that they are actively in control of the assets,” Reid says.

The Canada Revenue Agency has been concerned about the use of inter-provincial and offshore trusts as a way of minimizing income tax, and the central management and control test has been their weapon of choice in attacking, for example, the validity of many Alberta-based trusts established to take advantage of the province’s lower tax rates.

Reid notes that the Federal Court of Appeal decision in the Garron case addressed the fine line between a beneficiary inappropriately taking effective control of a trust versus simply expressing preferences or making recommendations to trustees for their consideration.

“The court said it’s fine for beneficiaries to make recommendations—even strong ones—as long as it’s clear that the trustee is ultimately making the final decision, because in that case the trustee is managing and controlling the trust.”

Reid emphasizes the importance of documenting the process of arriving at key decisions. “If a beneficiary says they’d a like a particular investment strategy to be pursued, and if the trustee ultimately decides to pursue that strategy, it’s very important for the trustee to document why he or she decided this was the proper course of action. Did they consider other strategies? Did they get independent investment advice from an investment advisor who is not also advising the beneficiary?”

Common advisor?

One of the issues that arose in the Garron case was that the beneficiary and the trust shared the same investment advisor.

It’s easy to see why this type of arrangement is common, if not completely natural. “You may have an advisor who has had a long-standing relationship with an owner-manager. The owner-manager then decides to undertake some estate planning and sets up a family trust. It’s not unusual for the investment advisor to continue to advise the owner-manager personally, but also provide investment advice to the trustee because there’s a relationship there,” Reid said.

Reid suggests that depending on the circumstances, this type of arrangement can be either completely innocuous or highly risky.

A key consideration in determining if sharing a common advisor is a potentially significant risk factor is the question of how important residency of the trust is.

“What is the overall tax planning objective, and is the residency of the trust a critical component? If it’s critical that the trust be resident in Barbados, such that the entire the tax plan hinges on this component, you want to be much more careful about not jeopardizing that residency status. Whereas, if all the beneficiaries are in Ontario and the trust is in Ontario, the residency of the trust may be less critical,” Reid said.

It’s important at the outset to bring together the key parties—the investment advisor, the beneficiaries, the trustees and any legal advisors—to determine whether having a common advisor is a risk factor, and if so, how big a risk factor it may be, and whether it can be managed by setting up clear procedures and ground rules.

“If you start getting into a situation where the advisor calls up the trustee and says, ‘My client thinks this would be a great investment for the trust—let’s talk about it,’ what happens is over time it could start building a body of facts that suggest the trust isn’t really being managed by the trustee,” Reid says. If the tax planning objective behind the establishment of trust depends on offshore trustee residency, this body of facts could spell big trouble, given the standard set by the central management and control test established in Garron.

“Advisors need to get clear direction on what their role is going to be. If they’re going to advise both the beneficiary and the trust, they need to set ground rules and clearly differentiate their roles. One way to do this would be to set up separate agreements for the beneficiary and the trust, so that the advisor is clearly retained by the trust,” Reid suggests.

Advisors should also require that beneficiaries refrain from discussing trust-related matters. But sometimes this is easier said than done, as it may alienate the client, no matter how diplomatically explained. In some cases such a requirement simply can’t be expected to have any teeth—think of the pushy, demanding client who all but pitches a tent in your office. Asking them to refrain from discussing matters of concern to them simply won’t fly.

“That could be a situation where having the same advisor isn’t really the best thing to do,” Reid said, as it may leave a paper trail that indicates the trustee is not really in control.

Advisors who handle trusts and their beneficiaries should reevaluate the relationship from time to time to ensure that as circumstances evolve, the initial ground rules are being adhered to.

“There needs to be a periodic reassessment. You can have the best intentions but often your intentions don’t get executed as ideally as you would like because situations evolve. So it’s important at the outset to set out the parameters and understand what the trustee’s roles are going to be and what the advisor is going to be asked to do, and then it’s a good idea to periodically review the situation and say, ‘Is this working?’ ”