A recent Tax Court of Canada case (Garron) challenges traditional thinking about the residence of a trust. If the decision is upheld on the appeal, which is almost certain to follow, both off-shore and inter-provincial tax planning designed to take advantage of lower income tax rates through the use of trusts may have to be reviewed.
The residence of a trust is significant because it is the place of residence which determines the national (or provincial) tax regime which applies to the trust. As a trust is not a legal entity, and is not registered with any government authority, the residence of a trust has generally been determined by common law as being determined by the place of residence of the trustees. (This is different from the case of a corporation which at common law is resident where its central management and control resides.)
In Garron, a corporate reorganization in 1998 resulted in two trusts acquiring the shares of holding corporations which in turn owned shares of other Canadian corporations. The sole trustee of each trust was a trust corporation resident in Barbados. In 2000, all of the shares of the holding companies were sold, resulting in over $450 million in capital gains being realized by the two trusts. The gains were not subject to tax under Barbados domestic law. The trustee of each trust claimed that the trusts were resident in Barbados, because the trustee was resident in Barbados, and accordingly the gains were also exempt from Canadian income tax pursuant to the Canada-Barbados income tax treaty. The Canada Revenue Agency disagreed and assessed the trusts on the capital gains. The trusts appealed and the Tax Court of Canada dismissed their appeals.
The Court decided that the principle that the residence of a trust was determined by the residence of the trustee assumed that the trustee was always acting properly as a fiduciary and was in fact managing and controlling the trust property. The Court held that where this was not the case, the trust would be resident, “where the central management and control actually abides,” which, in Garron, was Canada. The factors considered by the Court included the fact that the “protector” could replace the Barbados trustee and the Canadian principals of the holding company could in turn replace the “protector”.
The documentation in the trustee's files showed that the trustee was involved in accounting and tax matters, but not in day-to-day management or investment decisions. There was no evidence that the trustee had expertise in managing trust assets and it did not appear that the trustee had done any due diligence with respect to the significant sale of shares.
As a result of this decision, the appointment of a trustee resident in a off-shore jurisdiction, or in a province other than Ontario, may not be sufficient to ensure the trust is resident in that other jurisdiction, particularly if another person exercises control over the trust assets.