On November 17, 2010, the Federal Court of Appeal ("FCA") released its reasons for judgment in the St. Michael Trust Corp.1 appeal, upholding the judgment of Woods J. of the Tax Court of Canada ("TCC") in the Garron Family Trust2 case. For ease of reference, the trial and appeal judgments will be referred to as "Garron". The Garron case is highly significant as it has established new principles for determining trust residency for Canadian income tax purposes.
Prior to the TCC judgment in Garron, the leading case dealing with trust residency was Thibodeau Family Trust v. The Queen.3 Thibodeau had previously been viewed as authority for the proposition that a trust is resident in the jurisdiction where the majority of its trustees reside. In Garron, the TCC rejected that notion, holding instead that the test for trust residence should turn on the location of a trust’s central management and control.
The essential facts in Garron are as follows:
- prior to a reorganization in 1998, the shares of PMPL Holdings Inc. were held by Andrew Dunin and another holding company owned by Myron and Berna Garron and the Garron Family Trust;
- in 1998, pursuant to a reorganization of PMPL, two trusts with Canadian beneficiaries were settled by a friend of the Garrons who resided in St. Vincent, with the sole trustee being a Barbadian corporation, namely, St. Michael Trust Corp. ("St. Michael");
- the owners of the common shares of PMPL converted their shares to fixed value preference shares;
- the trusts subscribed for shares of newly incorporated Canadian corporations who in turn subscribed for shares of PMPL, all of which took place for nominal consideration;
- in 2000, the trusts sold the majority of their shares pursuant to the sale of PMPL, and realized capital gains of over $450,000,000;
- tax was withheld and remitted pursuant to s. 116 of the Income Tax Act (Canada) ("Act"); and
- the trusts sought a return of the withholdings pursuant to an exemption under the Canada-Barbados Tax Treaty on the basis that the trusts were resident in Barbados.
The Minister of National Revenue ("Minister") took the position that the treaty exemption was inapplicable, leading to the taxpayer’s appeal to the TCC. The Minister’s primary argument was that the treaty exemption did not apply because although the corporate trustee was resident in Barbados, the trusts were resident in Canada because their central management and control was exercised in Canada. As noted, Woods J. accepted the Minister’s argument, and held that the central management and control of the trusts was exercised in Canada and consequently, the trusts were resident in Canada.
In her reasons for judgment, Woods J. considered evidence which established that: the trustee’s powers were more limited than provided for in the trust instruments; the trustee exercised limited powers; the trustee may not have had the necessary expertise to manage trust assets; and the beneficiaries of the trusts were able to control and direct the trust’s investment activities, tax planning and distributions. Ultimately, Woods J. held that the management and control of the trusts was exercised by persons residing in Canada, namely, controlling shareholders and principals of PMPL and not by St. Michael.
On appeal, the issue before the FCA was whether Woods J. erred by applying a central management and control test. The FCA agreed with Woods J. that the case law does not establish a single test for trust residence and held that Woods J. was correct to conclude that "the judge-made test of residence that has been established for corporations should also apply to trusts, with such modifications as are appropriate". In confirming and upholding Woods J.’s reasoning, the FCA stated that although a trust is a "legal relationship" without a separate personality as a matter of law, the Act treats trusts as through they were persons. Consequently, it is consistent with that "statutory fiction" to conclude that a trust’s residence may not always be determined by the residence of its trustees.
Alternative arguments which were not determinative at trial were also raised on appeal and for the most part the FCA agreed with Woods J.’s reasoning. However, on the potential application of the deeming provision in ss. 94(1) of the Act, the FCA disagreed with the trial judgment and stated that the necessary test had been met and that the provision would apply to deem the trusts to be resident in Canada even if the central management and control test was not determinative.
As a result of Garron, it is clear that Canadians may not rely on passive and compliant foreign trustees to structure offshore trusts with a high degree of certainty or comfort. Consequently, it is strongly advised that trustees be invested with, and actually exercise real decision making power, in order to help ensure that the trust’s residency status would not be redetermined pursuant to the central management and control test.
It is worth noting that throughout its judgment, the FCA states that a trust is resident in the country where the central management and control is exercised. This is distinguishable from a test based on where the "managers and controllers" reside. Consequently, it may be advisable for anyone who is being consulted on trust decisions to have their meetings in the jurisdiction where the trustees reside. This "belt and suspenders" approach may further ensure that the trust is not held to be resident in Canada by virtue of a finding that management and control powers have been exercised in Canada.
It is not yet known if the appellants will appeal further to the Supreme Court of Canada, so the final chapter of Garron may not yet be written.