In Paul Antle and Renee Marquis-Antle Spousal Trust v. The Queen,1 the Tax Court considered a series of transactions implemented by a Canadian resident taxpayer known as a “capital property step-up strategy”. The strategy involved the following steps: the transfer by the taxpayer of shares (the “Shares”) of PM Environmental Holdings Ltd. (“PM”) with an accrued gain to a Barbados spousal trust (the “Trust”) settled by the taxpayer for the benefit of his wife; the Trust’s sale of the Shares to the wife; the wife’s sale of the Shares to a third party purchaser and payment of the sale proceeds to the Trust for the Share purchase; the Trust’s distribution of the Share sale proceeds as capital to the wife; and the dissolution of the Trust. If successful, the strategy would have resulted in no Canadian tax either on the taxpayer’s disposition of the Shares to the Trust, or on the Trust’s subsequent sale of the Shares to the wife, or on the wife’s sale of the Shares to the third party purchaser. The capital gain on the sale of the Shares by the Trust was not subject to tax in Barbados.
The Minister of National Revenue (the “Minister”) assessed the taxpayer for the tax on the capital gains arising on the Share sale on several alternative grounds. The Tax Court denied the taxpayer’s appeal, finding that the Trust was not properly constituted and that the Shares were never legally transferred by the taxpayer to the Trust. In the alternative, the Tax Court held that the general anti-avoidance rule (the “GAAR”) applied to the transactions and denied the taxpayer the tax deferral afforded by subsection 73(1) of the Income Tax Act (Canada) (the “Act) on his transfer of the Shares to the Trust.
The Tax Court’s detailed summary of the facts indicates that the documentation with respect to the transactions was not helpful to the taxpayer’s case. It was unclear when the Trust deed was actually signed by the taxpayer and the trustee and when the Trust was actually formed. Further, timing discrepancies arose in regard to when the Share transfers actually occurred. From the facts it was also unclear at what point the sale of the Shares to the third party purchaser was negotiated and who was the intended vendor. The transactions were also complicated by the fact that the taxpayer was required to seek consent from the preferred shareholder of PM to complete the sale and, in order to obtain that consent, a portion of the purchase price paid by the third party purchaser for the Shares had to be reserved and paid to the shareholder. Subsequent to the Share sale, the taxpayer successfully sued and recovered the payment on the basis that it had been made under duress.
Trust Not Properly Constituted
The Tax Court evaluated the written evidence and oral testimony in light of the “three certainties” required to establish a valid trust: the certainty of intention, the certainty of subject matter, and the certainty of objects. The Court also considered whether there was a valid transfer of the Shares by the taxpayer to the Trust to effectively constitute the Trust.
Regarding the certainty of the taxpayer’s intention to settle the Trust, the Court concluded that it could look beyond the written terms of the Trust Deed to the relevant surrounding circumstances to determine whether the requisite certainty existed. The Court disagreed that paragraph 2.1 of the Trust Deed, which stated that the “purpose of the...Trust is to create a means for holding investment and business interests for the benefit of the Beneficiaries...” reflected the taxpayer’s intention, finding instead that the purpose was for the trustee of the Trust to immediately sell the Shares to the taxpayer’s wife and to distribute the proceeds back to her to perfect the tax avoidance strategy. Based on the evidence, the Court found that the taxpayer did not truly intend to settle the Shares on the Trust, that he never intended to lose control of the Shares or the proceeds resulting from the sale of the Shares: “[h]e simply signed documents on the advice of his professional advisers with the expectation the result would avoid tax in Canada”.2
In addressing the certainty of subject matter, the Court reviewed the evidence and concluded that the taxpayer must have retained an interest in the Shares since he retained some right to, and did, recover the portion of the Share sale proceeds paid to the preferred shareholder of PM. The Court found that the taxpayer did not settle his full interest in the Shares to the trustee of the Trust, thereby creating an uncertainty of subject matter. The Court then considered whether the Trust was properly constituted. After reviewing the irregularities in the timing, sequence and execution of events related to the transfer and sales of the Shares and the lack of explicit wording in the Trust Deed effecting a settlement of the PM Shares on the Trust, the Court found that title to the Shares was never effectively transferred to the trustee of the Trust. The Court concluded:
With certainty of intention and certainty of subject matter in question and, more significantly, no actual transfer of shares, there is no properly constituted trust: the Trust never came into existence. This conclusion emphasizes how important it is, in implementing strategies with no purpose other than avoidance of tax, that meticulous and scrupulous regard be had to timing and execution. …With respect to Mr. Antle’s appeal, with no valid trust he either sold the shares to his wife and triggered a gain in his hands or he rolled the shares to his wife and had the gain attributed back to him. Either way, he has been correctly assessed on the resulting capital gain, and his appeal is dismissed.3
The Court’s GAAR analysis, though subsidiary to its analysis of whether the Trust was properly constituted, has wider implications for future planning for offshore trusts. The Court employed the Supreme Court of Canada’s three-step approach set out in Canada Trustco Mortgage Co. v. The Queen,4 and concluded, as an alternative ground for dismissing the appeal, that the transactions ran afoul of the GAAR.
There was no dispute between the parties that there was a tax benefit, i.e., the tax deferral (which became a permanent tax savings) on the transfer of the Shares by the taxpayer to the Trust. The taxpayer admitted that the settlement of the Trust in Barbados was an avoidance transaction, but only to access the capital gains exemption in the Canada-Barbados Income Tax Convention (the “Treaty”). The Court held that the settlement of the Trust itself was also an avoidance transaction, finding that the sole purpose of creating the Trust was to benefit from the deferral afforded by the Act. Moreover, the Court disagreed with the taxpayer and concluded that the Trust’s sale of the Shares to the taxpayer’s wife, the wife’s sale of the Shares to the purchaser and the subsequent distribution of sale proceeds from the Trust were transactions that were “part of a series, the sole purpose of which was to obtain a tax benefit”.5 The Court noted that even if one transaction in the series was an avoidance transaction, then the tax benefit resulting from the series could be denied by the GAAR.
Accordingly, the key issue in the Court’s analysis was to determine whether there was abusive tax avoidance. Applying the Supreme Court’s textual, contextual and purposive approach established in Canada Trustco and reaffirmed in Lipson v. The Queen,6 the Tax Court first interpreted the statutory provisions relied upon by the taxpayer to determine their object, spirit and purpose. The Court noted in its textual review that while Canada taxes Canadian residents on capital gains realized on the disposition of shares held as capital property, the spousal rollover in subsection 73(1) of the Act provides for an automatic tax deferral of gain on a transfer of property to a spouse (unless the transferor elects out of the provision), thereby deferring tax on any accrued gain until the transferee spouse disposes of the property to a third party. However, the Court emphasized that the spousal rollover is not intended to allow permanent tax avoidance, only a tax deferral.
The Court then looked at subsection 73(1) in the context of the spousal attribution rules in sections 74.1 to 74.5, which together, in its view, establish a regime for dealing with spouses under the Act. While the spousal attribution rules ensure that the transferor spouse remains liable to tax on any income or loss on the transferred property, and on any capital gain realized on the disposition of the transferred property outside the marital unit, the Court noted that the provisions did not address the specific circumstances of the taxpayer’s situation where the spousal trust realizes the capital gain on the disposition of the property to the spouse for whom the property is held. The Court concluded that these statutory provisions must be viewed with the anti-avoidance rule in paragraph 94(1)(c) which was designed to prevent Canadian residents from deferring or avoiding Canadian tax by holding property in a non-resident trust established for the benefit of Canadian resident related beneficiaries: “it is the object and spirit of paragraph 94(1)(c) in conjunction with the rollover and attribution regime to ensure that the marital unit, through a trust, not escape taxation in Canada”.7
The Court also considered the interaction of these statutory provisions with the capital gains exemption in the Treaty and the consequent deduction under paragraph 110(1)(f) of the Act for an amount that is treaty exempt. The Court concluded that their intention and purpose was to exempt from Canadian tax gains realized by Barbados residents from the disposition of capital property in Canada. However, this purpose had to be considered in the context of the general purposes of tax treaties. Based on the Commentary to the OECD Model Tax Convention on which the Treaty was based and the preamble of the Treaty itself, the Court concluded that one such purpose was the prevention of tax avoidance and evasion. While Canada may have agreed in the Treaty not to tax Barbadian residents on their capital gains, in the Court’s view that policy did not preclude taxing a Canadian resident on its capital gains in Canada where an arrangement had been made to shift the gain to Barbados:
…The object, spirit and purpose of the Canadian legislation as it pertains to a Canadian resident is not to be swept aside because the policy of the Treaty, as pertaining to a non-resident Trust, might save the Trust, especially when one considers an overarching policy of entering treaties to prevent tax avoidance by Canadian residents.8
In formulating its conclusions, the Court dismissed several arguments put forth by the taxpayer regarding the policy behind the provisions relied upon. In particular, the Court disagreed that changes to the non-resident trust rules and to the spousal rollover rules, and the lack of any specific reservation in the Treaty of Canada’s right to apply the non-resident trust rules, signified any favourable policy or policy change by the Canadian government allowing the taxpayer’s transactions. Instead, the Court suggested that it was more likely that the interaction of the provisions the taxpayer relied upon had created an unintended loophole. Furthermore, the Court concluded that neither the existence of the anti-avoidance rule for capital gains in the Treaty, nor the absence of a limitation on benefits clause in the Treaty had any bearing on whether there was a policy against using the Treaty to shift a Canadian resident’s capital gains to a Barbados trust. Instead, these facts simply confirmed that the Trust was not taxable in Canada on its capital gains arising from the sale of the Shares.
Turning to the purposive analysis, the Court considered whether the avoidance transactions frustrated the object, spirit and purpose of the provisions relied upon by the taxpayer. The Tax Court referenced the Supreme Court’s approach in Lipson which looked to the overall result of the taxpayer’s transactions and cautioned that motivation and purpose are relevant only to the extent that they establish whether the transactions frustrated the purpose of the relevant provisions. The Court concluded that the overall result of the transactions for the taxpayer was the elimination of the capital gain that he would have realized if the Treaty and paragraph 110(1)(f) did not apply: either the Trust would have been taxed in Canada on the gain, or the taxpayer would have been taxed as a result of the spousal attribution rules. In either case, the object, spirit and purpose of the spousal rollover and attribution rules would have been maintained. However, the Court concluded that:
…by relying on paragraph 94(1)(c) to deem the Trust to be a Canadian resident to take advantage of the subsection 73(1) rollover, and then escaping Canadian tax liability by invoking paragraph 110(1)(f), due to what I would describe as the quirky nature of the tax treatment of trusts and the conflicting resident status treatment under the Act and the Treaty, Mr. Antle has blatantly frustrated the object, spirit and purpose of the rollover/attribution regime. …
…It is an outcome that subsection 73(1), the attribution rules and paragraph 94(1)(c) specifically sought to prevent; that is, the marital unit cannot escape liability by using an offshore trust. …
Further, the outcome also defeats the underlying rationale of these particular provisions and indeed Canada’s policy of taxing capital gains generally. Canadian residents and deemed residents are to be taxed on their capital gains in Canada. Rules to capture the gain on disposition of capital property by the marital unit, in keeping with the Canadian policy, are rendered meaningless simply by finding a willing Barbados trustee.9
In addition, the Court held that the underlying rationale of the capital gains exemption in the Treaty was frustrated, not with respect to the Trust, but with respect to the taxpayer who used the Treaty to avoid taxation, thus circumventing a general objective of the Treaty to prevent tax avoidance. Accordingly, the Court concluded that the transactions abused both the Act and the Treaty and were subject to the GAAR. The Court applied the GAAR to deny the taxpayer the ability to access the spousal rollover on the transfer of the Shares to the Trust, which resulted in the taxpayer realizing a capital gain on the disposition of the Shares which was subject to Canadian tax.
Although the Court was not required to address arguments regarding the residence of the Trust, it should be noted that, similar to obiter comments made in the recent case of Garron, M. et al. v. The Queen (please click here to read our tax bulletin), the Court indicated that paragraph 94(1)(c), which deems a non-resident trust to be resident in Canada for certain purposes of the Act, would not cause the Trust to be a resident of Canada for purposes of the Treaty. Relying on the Supreme Court of Canada’s decision in The Queen v. Crown Forest Industries Ltd.,10 the Court concluded that since the Trust would not be taxed on its worldwide income by the application of paragraph 94(1)(c), it would not be considered to be a resident of Canada within the meaning of the Treaty.
The Court also rejected the Minister’s argument that the Trust was a sham, concluding that the evidence did not support the conclusion that there was intentional deceit by the taxpayer and the trustee of the Trust which was necessary to establish a sham based on the relevant case law.
Although the outcomes in both Antle and Garron were adverse to the taxpayer, the Tax Court’s approach and analysis in the two cases differed, likely due to the particular facts. However, these cases could have implications beyond their particular facts.
The Court in Antle went farther than the Court in Garron by conducting a GAAR analysis as an alternative ground for dismissing the appeal rather than confining itself to comments in obiter. The Tax Court’s conclusions on the GAAR, together with the Supreme Court’s decision in Lipson, should serve as a cautionary warning to taxpayers and their advisors that using the spousal rollover and attribution rules in conjunction with other tax planning to achieve a tax benefit may run afoul of the GAAR. The Court’s decision in Garron puts into question some arrangements commonly used by trust planners in Canada, and may also have implications for how offshore holding companies are held and administered in light of the Court’s use of the central management and control test. Together, t
ese decisions may signal a more proactive approach by Canadian courts in addressing tax planning. While it is expected that both Garron and Antle will be appealed, pending the outcome of the appeals, offshore trust and holding company arrangements should be reviewed in light of the Court’s findings in these cases.