In two recent cases, St. Michael Trust Corp v The Queen and Antle et al. v The Queen, the FCA confirmed the Tax Court of Canada’s earlier decisions, which call into question the validity of the existing trust structures under Canadian law.
In both cases, the trusts at issue were created to avoid Canadian income tax. In St. Michael Trust, the court found the trust was a resident of Canada because its central management and control was located in Canada. This decision established a new test for determining the residency of a trust under Canadian law.
In Antle, the court found a valid formation of a trust had not been made, resulting in the capital gain being assessed against the Canadian settler of the purported trust.
St. Michael Trust
The question before the court in St. Michael Trust was how to properly determine the residency of a trust. The FCA agreed with the lower court’s approach, which embraced a fact-intensive determination of where the central control of the trust is exercised. This approach was analogised to the legal test for determining the residency of a corporation.
Under this new test, the physical location of the person who manages the trust will be determinative as to where central control resides.
The court expanded on the concept of residency even further, rejecting a single set of rules to determine residency for all taxpayers, whether the taxpayer is an individual, a corporate entity, or a trust. Instead, the FCA advocated a careful examination of the facts in each case.
Doug Mathew, tax partner at Thorsteinssons and lead counsel for the appellant in the case, disagreed with the court’s conception of legal residency.
“I am naturally disappointed with the conclusions of the court,” he said. “Our argument was that the proper test for residency of a trust is to look to the residency of the trustee and that this test flows naturally from the statutory mechanism for taxing trusts in the Income Tax Act. In my view, the court did not take sufficient notice of that statutory regime and instead developed a judicial test that is not consistent with that regime.”
The court also rejected the argument that the general anti-avoidance rule (GAAR) might be applicable to the trusts, since a resident of Barbados, where the trust was set up, may lawfully utilise an exemption under the Canada-Barbados Income Tax Agreement, without running afoul of the spirit of the treaty.
The new rules enunciated in St. Michael’s Trust will be applicable to both individual and commercial trusts.
It is not clear yet whether the taxpayer in the case will seek leave to appeal the case before the Supreme Court of Canada.
“We do not yet have instructions from the trustee to seek leave to appeal the decision, but those instructions are being sought and I expect they will be forthcoming,” said Mathew.
Antle
In Antle, the court considered whether the Tax Court was correct in determining that there was a lack of evidence to show the intention to form a trust, despite the existence of a trust deed.
Writing for a majority of the court, Justice Noel concluded that “a test that requires one to look at all of the circumstances, and not just the words of the trust deed, is an approach that appears to have been adopted by Canadian courts generally”.
As Justice Noel noted, this principle has been used by many courts when considering the validity of different sorts of tax-driven transactions. The Antle case only applied this test specifically to trusts.
Additionally, the FCA raised questions as to the scope and applicability of the sham doctrine, which traditionally applies to transactions in which the intentions of the parties have not been correctly reflected in documentation. Normally, finding a sham transaction requires the parties to have the intent to deceive the tax authorities.
The majority opinion in Antle found that the trust at issue was a sham because the parties meant for the Canada Revenue Agency (CRA) to believe that the trustee had control over the trust, when in the court’s view that control did not exist.
The opinion may be read to imply that the court has broadened the applicability of the sham doctrine. Justice Noel ruled that the level of intent to deceive that is necessary to prove the existence of a sham may be less than is required to show criminal deceit, for example.
“We believe, with due respect to the FCA, that the court incorrectly broadened the test for sham beyond what previous cases had decided and should not have overturned the tax court's finding of fact that there was no sham,” said the lawyers at Fraser Milner Casgrain, who represented the appellants in the case.
Still, there is nothing in the case to suggest that it will or should be applicable outside of the context of trusts.
The lawyers also told Tax Disputes Week that they are considering applying for leave to appeal the case to the Supreme Court of Canada.
Consequences of St. Michael and Antle
Though Antle and St. Michael address different legal issues, both cases will likely have significant implications for tax planning in Canada.
Some lawyers argue that the court’s decision in St. Michael signals a sea change in the way that residency is determined for a trust.
“This change in law will have implications to both offshore tax planning and domestic tax planning,” said Mathew. “This is because the taxation of trusts for provincial purposes also relies on the residence of a trust. Tax plans which rely on taxation in a low-tax-rate province based on the trustee being resident in that province will now be subject to increased uncertainty.”
The lawyers in St. Michael argue that the issues presented in that case are of national importance and warrant Supreme Court guidance to ensure proper development of the law.
“I view the central management and control test as not only being inconsistent with the statutory regime, but also ill-suited to the inherent nature of a trust - being an equitable obligation imposed on the trustee who holds legal title to the property,” said Mathew.
Mathew believes that even if the decision in St. Michael Trust does not encourage the CRA to act more aggressively in toward offshore trusts, he thinks “there is little doubt that [the decision] introduces an additional weapon to the Agency's arsenal when reviewing these transactions.”
He suggests that taxpayers intending to set up new trust structures be sure to create a paper trail documenting that the trustee is the one making all relevant decisions.
Still, he believes that this may not be enough to avoid investigation.
“If the court is sceptical of the evidence presented simply because the trust is part of a tax plan then the court may not to put any weight on that evidence,” he said. “Thus, no matter what evidence is available, plans relying on residency will carry some inherent risk.”
