On September 10, 2009, the Tax Court of Canada released its decision in Garron v. Canada and several other cases heard on common evidence. The court held that two Barbados Trusts were resident in Canada for purposes of the Agreement Between Canada and Barbados for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital (the “Canada-Barbados Treaty”). Over $450 million in capital gains were realized by the two Trusts on the disposition of shares of Canadian corporations. Under Barbados domestic law, the gains were not subject to tax. The Trusts claimed they were exempt from Canadian tax under the Treaty. The Minister disagreed and assessed accordingly. The Trusts appealed. The Tax Court of Canada dismissed their appeals.
New Test for Residence of Trusts – Central Management and Control
Justice Woods, in this case, rejected that the oft-cited Federal Court decision in Thibodeau stands for the proposition that the residence of the trustee is always the deciding factor in determining the residence of a trust. In Garron, the court adopted a central management and control test for the residency of trusts. Justice Woods concluded that the "judge-made test of residence that has been established for corporations should also apply to trusts, with such modifications as are appropriate. That test is 'where the central management and control actually abides'." Factors in Determining Central Management and Control
In finding that the central management and control of the Trusts was located in Canada with the two Canadian principals, either directly or indirectly through their advisers, rather than with the Barbadosresident Trustee, the court took a number of factors into account. Some of these factors included that:
- The “protector” of the Trusts could replace the Barbados trustee and the Canadian principalswith their spouses could replace the “protector”;
- The internal memoranda of the Trustee evidenced a role actually more limited than the trust documents suggested;
- Investment decisions appeared to be at the direction of the Canadian principals with Canadian investment advisers;
- There was virtually no documentation showing that the Barbados Trustee took an active role in managing the Trusts;
- The documentary evidence was consistent with the Barbados Trustee being involved for the most part only in the execution of agreements, and in administrative, accounting and tax matters;
- At the relevant time, the Barbados Trustee was the arm of an accounting firm which provided significant tax advice regarding the overall offshore structure of the property held by the Trusts. It was questionable whether the Barbados Trustee had expertise in managing trust assets as opposed to the firm’s significant expertise in accounting and tax matters;
- There was no evidence that the Canadian principals were very interested in what the Barbados Trustee was doing and that the persons involved were competent, as would have been the case if the Barbados Trustee was actively involved in the sale of the shares at issue;
- The contact for the bank, the Bahamas branch of which was used for the bank account of one of the Trusts, was made in Toronto;
- The directors of the Barbados Trustee had very little information regarding transactions to be approved before the directors ratified the transactions; and
- One of the Canadian principals oversaw the sale of the shares.
The court indicated that it could not be assumed that the Barbados Trustee did whatever was required to make sure the transactions undertaken by the Trusts were in the best interests of the beneficiaries. On this point, the court found that there was no evidence that the operator of the Barbados Trustee had expertise or significant experience in trust management nor was it a well-recognized trust corporation with significant experience and expertise in managing trusts.
Implications for Other Trusts
The analysis by the court in Garron on determining the residency of a trust is of interest not just for offshore trust planning but also for inter-provincial trust planning where it is intended that the trust be resident in a lower-tax province.
Valuation of Freeze Shares
The court analyzed the difference in opinion between the taxpayers’ valuation expert and the Minister’s expert for the shares which were frozen two years prior to the sale in question. Although preferring the Minister’s opinion, $102 million over $50 million, the court found that it was not necessary to determine an actual value of the common shares at the time of the freeze.
Although the court’s finding that the central management and control of the Trusts was located in Canada was sufficient to dispose of the appeals, Justice Woods commented on several other interesting issues which had been raised and pursued. The court’s comments included that:
- The Trusts would not be resident in Canada by virtue of section 94 of the Income Tax Act (Canada) (the “Act”) and, even if section 94 did apply, that would not disentitle the Trusts to the Canada-Barbados Treaty exemption;
- The attribution rule in subsection 75(2) of the Act would not apply and, even if it might have applied, the Canada-Barbados Treaty would prevail; and
- The General Anti-Avoidance Rule (“GAAR”) would not apply as there had not been a misuse of the Canada-Barbados Treaty. (The taxpayers had acknowledged a tax benefit and an avoidance transaction.)
On the GAAR point, the court observed:
Even if the Minister is correct that the tax base would be severely eroded if Article XIV(4) of the Treaty were considered to override section 94, this is not a sufficient basis to find that the Treaty has been abused.
The question is what the drafters of the Treaty from both countries intended. I would have thought that if Canada had intended that section 94 should override the Treaty, this would have been specifically mentioned in the Treaty.