Trust residence ruling upheld

The recent decision of the Supreme Court of Canada in the Garron Family Trust establishes rules on trust residence.

The Court ruled, as reasoned in the lower courts, that central management and control over the trust property, rather than the residence of the trustees, was the appropriate test for determining trust residence for purposes of the Income Tax Act.

The panel of judges unanimously justified application of the central management and control test in determining the residence of a trust, as applicable in the corporate test.

David E. Spiro, a tax litigator at Fraser Milner Casgrain LLP calls it “a triumph of functionalism over formalism.”

Commending the promptness and speed showed by the SCC to reach its decision, Spiro said: “The Court’s alacrity is remarkable, particularly in light of the fact that it had taken nearly eleven months to release its last tax decision (Copthorne Holdings Ltd. v. The Queen).

The case, which involves two trusts, emerged from a “freeze” transaction carried out on a Canadian company for each of its shareholders (who were unrelated Canadian resident individuals) and growth shares acquired, indirectly through a Canadian holding company, by a trust of which the trustee was a trust company resident in Barbados.

The beneficiaries of the trusts were members of the family of each of the individual shareholders who carried out the freeze. The settlor of each trust was a non-resident, and each trust had a “protector” who was a non-resident individual and a friend of the holder of the freeze shares.

The freeze transactions were carried out in 1998, and two years later the shares in the Canadian holding company that held the growth shares were sold for very significant amounts. The trusts claimed that the capital gain was not subject to tax in Canada because the trusts were resident in Barbados and were entitled to the benefits of the Canada-Barbados Income Tax Agreement (1980).

The case is important because it clarifies the principles to be applied to determine trust residence and, as well, provides some comments with broader implications for determining corporate residence.

“The SCC decision on the trust residence point is not particularly surprising, given the factual findings at the Tax Court of Canada (TCC) level and the fact that the Federal Court of Appeal (FCA) had upheld the TCC’s reasoning on this point,” said PwC in a tax memo.

The Court declined to deal with several subsidiary issues dealt with by the lower courts, but clearly stated that it should not be understood as endorsing the reasons of the Federal Court of Appeal on those subsidiary matters.

“It is somewhat disappointing that the SCC declined to comment on the subsidiary issues, which are both important issues in their own right and have some significant implications,” the PwC note said.