The Supreme Court of Newfoundland and Labrador is the first court in Canada to rule on the issue of the provincial residency of a trust for tax purposes. In Discovery Trust (Acting Through Its Trustee Royal Trust Corporation of Canada) v. Canada (National Revenue), 2015 NLTD(G) 86, Justice Carl Thompson applied the “central management and control” test articulated by the Supreme Court of Canada in the 2012 decision of Fundy Settlement (Fundy Settlement v. Canada, 2012 SCC 14) (commonly known as Garron Family Trust), which dealt with the issue of the tax residency of a trust in the international context.
The Trust, the Change in Trustee and the Transaction
The Trust was settled in 2002 in Newfoundland. At the time, the initial trustees – who were also the beneficiaries – were (mostly) resident in Newfoundland.
In 2006, the beneficiaries resigned as trustees and Royal Trust’s Calgary office was appointed as successor trustee. The assets of the Trust – which were shares of a holding company (Holdco) – were moved to Alberta.
Between 2006 and 2008, several transactions affected the shares of Holdco and therefore required the Trustee’s approval. In 2008, the main asset of Holdco was sold, leading to a distribution of sale proceeds to Holdco and ultimately to the Trust. These proceeds were taxed at Alberta rates in the Trust’s hands.
Before the sale closed, the beneficiaries submitted formal requests for encroachment, asking the Trustee to distribute the sale proceeds to them. The Trustee approved the requests, and the proceeds were distributed to the beneficiaries.
The CRA reassessed the Trust for the 2008 taxation year alleging that the Trust was resident in Newfoundland, where the majority of the beneficiaries of the Trust resided, and not in Alberta where the Trustee exercised its functions. The CRA’s position was that the beneficiaries displaced the Trustee by approving and consenting to the activity in the Trust. The Trust appealed.
In allowing the Trust’s appeal, the Court provided insight into what should be expected of a prudent trustee that exercises management and control of a trust. The Court also explained that involvement by third parties in the Trust is commercially commonplace and is not sufficient to migrate control of a trust away from the trustee. Finally, the Court concluded that tax motivation should not colour the factual determination of who has central management and control of a trust.
1. Fundy Settlement and the Central Management and Control Test Apply to Determine Provincial Residence
Justice Thompson canvassed the Supreme Court’s decision in Fundy Settlement, which held that a trust is resident where its central management and control is exercised. He then applied Fundy Settlement, confirming that the central management and control test adopted in Fundy Settlement also applies in the domestic context to determine the provincial residence of a trust. This is the first decision in Canada confirming that Fundy Settlementapplies interprovincially as well as internationally.
2. Central Management and Control is Assessed in the Context of the Trust Property
Discovery Trust highlights that the nature of the trust assets informs the level of engagement expected of a trustee. For instance, the Trust held only shares in a holding company, which required minimal active management. Nonetheless, the Trustee’s actions in approving straightforward corporate reorganizations and the encroachment requests constituted central control and management. Justice Thompson concluded on the evidence that such approval “was required and was completed prudently.”
3. Consultation with Beneficiaries is Acceptable and Prudent
In Discovery Trust, the Court also clarified that the involvement of beneficiaries or their advisors in the affairs of the trust do not necessarily result in the trustee abdicating its control over the trust in question. In every instance, it must be determined who has the ultimate power to make decisions.
In addition, obtaining the beneficiaries’ consent to transactions was found to be common commercial practice that supported the Trustee’s view that such transactions were in the best interests of the beneficiaries. Justice Thompson said: “Independence of the Trustee is maintained by its review of the transaction, acquiring explanation sufficient that an informed decision can be made, ensuring the decision has no negative consequence and is in the best interests of the beneficiaries. In these consent requests the record disclosed the Royal Trust carried out this independent function as Trustee.”
Finally, Justice Thompson held that requests for distributions from beneficiaries are not unusual and should not govern the determination of who has control of the trust. Instead, the Court in Discovery Trust suggests that consulting with beneficiaries should not be seen as an abdication of authority as long as the trustee retains the prerogative to make the final decision.
4. Tax Motive is Irrelevant to the Determination of Residency
Justice Thompson determined that the CRA should not have focused on the perceived “improper” motive of moving the Trust to Alberta for tax reasons as part of the technical residency analysis. He held that the CRA’s focus on improper tax motive had “predominated the process by which the [audit] is engaged and completed” and “compromised in an apparent manner the integrity of an independent rationale for the findings upon which the reassessment could be based.”
Discovery Trust cautions tax authorities against allowing a perception of tax motivation to colour the audit, objection and appeal process in the absence of an applicable specific or general anti-avoidance provision.
Discovery Trust is the first Canadian precedent on the specific issue of provincial residency of a trust for tax purposes. The decision confirms that the “central management and control” test applied in Fundy Settlementapplies with equal authority in the domestic context. Discovery Trust also sheds light on which facts will indicate that a trustee actually exercised control of a trust in the context of a trust holding shares of a holding company.