Canadian and provincial income taxes are assessed on worldwide income on the basis of a taxpayer’s residence. Subsection 104(2) of the Income Tax Act (the “Tax Act”) provides that a trust is deemed to be an “individual” for purposes of the Tax Act. Consequently, trusts that are resident in Canada or deemed to be resident in Canada will be taxed on their worldwide income as opposed to only their Canadian source income. Despite the tax implications accompanying a taxpayer’s residency status, the Tax Act provides little in the way of guidance for determining the residency of a trust. As a result, Canadian courts have been tasked with making this determination.
Central Management and Control
In 2009, Garron Family Trust (Trustee of) v. R. changed the long-standing approach to determining the residency of trusts in Canada. The test set out in Garron provides that the residency of a trust is where the central management and control of the trust actually takes place. The court clarified that the assessment into who has central management and control is a question of fact to be examined on a case by case basis. In concluding that the central management and control of the Summersby and Fundy trusts (the “S&F Trusts”) resided with the beneficiaries, the court considered several factors, including:
- Whether the evidence or lack of evidence demonstrated an active or passive role taken by the trustee in its management of the trust;
- The true controlling minds behind investment decisions and management of the S&F Trusts’ assets;
- The use of a protector mechanism to exert control over the trustee;
- The beneficiaries’ demonstrated interest in the trustee’s management of the S&F Trusts;
- The trustee’s expertise in managing trusts; and
- The trustee’s knowledge of the transactions it had been asked to approve.
Recent Applications of the Central Management and Control Test
In Discovery Trust and Boettger, the central management and control test was applied to determine the residency of the trusts. In both cases, the test was applied in the domestic context to determine the provincial residency of a trust. Although some of the facts in Discovery Trust and Boettger allowed for a straightforward application of the Garron factors, the courts also considered facts which were either not present or otherwise not considered by the Tax Court in Garron. Future cases will likely continue to refine the factors considered by the courts in determining where the central management and control of a trust resides. In the meantime, there is likely to remain at least some degree of uncertainty with respect to the outcome of a court’s application of the test.
Discovery Trust v. Minister of National Revenue
In Discovery Trust, the Newfoundland Trial Division Court heard an appeal by the appellant trust (“Discovery Trust”) from an income tax reassessment based on Discovery Trust being a resident in Newfoundland, the place of residence of its beneficiaries and advisor, as opposed to Alberta, the place of residence of the professional trustee (“Royal Trust”). Discovery Trust was assessed at the higher applicable tax rates in Newfoundland. In finding Discovery Trust to be resident in Alberta, the court focused on several instances where it found Royal Trust to have played an active and independent role in managing the assets of the trust in accordance with its fiduciary obligations and commercial reality. The court also rejected several of the respondent’s arguments which, if accepted, would have expanded the factors militating against the finding of central management and control residing with the trustee.
Approval of Corporate Transactions Involving DHI
Discovery Trust’s main asset included shares of a holding company (“DHI”) which in turn held shares of CHC Helicopter Corporation (“CHC”). Royal Trust was called upon to approve several corporate transactions on behalf of Discovery Trust, a shareholder of DHI. Approval was required for, among other things, the continuance of DHI from Ontario to Alberta and the preparation of articles of amendment and articles of amalgamation. Despite the administrative nature of its duties, the court concluded that Royal Trust’s request for additional information and careful review of the documents relating to the transactions evidenced the trustee’s independence and authority over the trust. The court also looked favourably on the evidence indicating that Royal Trust discovered an error in one of the amending documents and awaited its correction before providing its approval.
Compliance with the Beneficiaries’ Encroachment on Capital Direction
Following the sale of CHC to a third party buyer, the beneficiaries executed an encroachment on capital direction requesting that Royal Trust disburse to them the proceeds from the sale. The court concluded that it is customary for a trustee to require a formal, written request indicating the beneficiaries’ desires to have funds removed from the trust. Therefore, Royal Trust’s compliance with the encroachment on capital request was not found to be a derogation of its independence or authority as the trustee.
Negotiations Between Beneficiaries and Trustee Over Holdback Amount
Subsequent to the sale of CHC and the disbursement of its proceeds, the beneficiaries and Royal Trust engaged in negotiations over the appropriate holdback amount to cover the resulting income tax liabilities. Initially, Royal Trust requested a 25% holdback and the beneficiaries wanted none of the funds held back. The parties eventually settled on a compromise, whereby Royal Trust agreed to hold back an amount equal to an estimate of the tax liability approximated by the beneficiaries, in exchange for a release, discharge and indemnity executed by the beneficiaries in favour of Royal Trust. The court held that each party’s interests were capable of co-existing “without engaging a diminution of [Royal Trust’s] authority.”
Discussion of Holdback Investment Strategy with Beneficiary Representative
Following the agreement to hold back a certain amount of funds to cover income tax liabilities, Royal Trust entered discussions with a representative of the beneficiaries to determine the best short-term investment strategy for those funds. Despite the short duration and minimal risk accompanying the proposed investment, the court found Royal Trust’s collaborative demeanour to be both prudent and appropriate in the circumstances. The court placed considerable weight into the fact that the investment of the holdback funds marked the first time Royal Trust had exercised its power to invest funds held by the trust, and that a discussion of its proposed investment strategy with the beneficiaries was therefore acceptable and not a derogation of authority or independence.
Lack of Knowledge of the Value of Discovery Trust’s Assets
Prior to the sale of CHC, the 100 common shares (“Shares”) in DHI were issued to Discovery Trust in exchange for $100. Following the sale of CHC, there was a substantial appreciation in the value of the Shares, such that their post-sale value approached $30 million. Although the closing of the sale of CHC required the Shares to be returned to counsel for CHC and DHI, the beneficiaries wanted to continue the trust and requested that Royal Trust return the Shares to the trust. Royal Trust lacked an operational knowledge of CHC and the manner in which it chose to distribute its value. Consequently, Royal Trust was unaware of the Shares’ appreciation in value and opposed the beneficiaries’ request claiming its fees and expenses would not be secured by the Shares. It was not until counsel for CHC and DHI confirmed the post-sale value of the Shares that Royal Trust agreed to return them to the trust. Siding with the appellants, the court held that “[w]hile … [Royal Trust] may be criticized for not having recorded changed values or sought this information, this feature cannot support a delegation of authority in … [Discovery Trust].” The court noted that Royal Trust’s interest in the value of the Shares was not engaged until it had to consider the beneficiaries’ request to have them returned to the trust, at which time it was informed of their true post-sale value and exercised its independence and authority in deciding to return the Shares to the trust.
Boettger c. Quebec (Agence du Revenu)
In Boettger, the Court of Quebec heard an appeal by the appellant trust (“NS Trust”) from an income tax reassessment based on NS Trust being a resident in Quebec, the place of residence of Jean-Pierre Gibeault (the “Settlor”) and Nancy Smith (the “Beneficiary”), as opposed to Alberta, the place of residence of Roy D. Boettger (the “Trustee”). NS Trust was assessed at the higher tax rates applicable to Quebec. In finding NS Trust to be resident in Quebec for provincial tax purposes, the court relied primarily on the Trustee’s lack of control over the main assets held by NS Trust, provisions of the trust deed (the “Deed”) demarcating each of the Trustee’s responsibilities and the overarching role played by the Settlor’s legal and accounting representatives in implementing an elaborate tax minimization plan (the “Plan”) that underpinned both the creation of NS Trust and the subsequent transactions carried out by the Trustee. In the court’s opinion, these factors collectively confirmed the limited and passive role of the Trustee in its management of NS Trust.
The Trustee’s Lack of Control and its Overly Demarcated and Passive Role
The main asset held by NS Trust were non-voting shares of Cetco Capital Inc. (“Cetco”). These shares possessed a redemption feature exercisable at the option of Cetco or the shareholder. The court noted that, as a result of this arrangement, the Settlor, as shareholder and director of Cetco, was capable of redeeming the shares at any time without requiring the Trustee’s approval and without the Trustee being able to oppose the redemption. The court also noted that the Deed mandated that the Trustee distribute the amounts it received to the Beneficiary within 30 days of such a redemption. Lastly, it took issue with the provision in the Deed prescribing the frequency of subsequent distributions to be made to the Beneficiary from the gross revenues of NS Trust. The court concluded the Trustee was only tasked with holding the shares passively and complying with its pre-fixed duties as set out in the Deed, which was in and of itself a part of the elaborate Plan devised by the Settlor’s representatives to minimize tax liabilities.
The Protector Mechanism
The Deed also included a protector mechanism which permitted a protector to appoint or remove the Trustee of NS Trust. If no protector had been appointed, the Deed provided the Settlor with the authority to appoint a protector. Since no protector was named in the Deed, the court concluded that the Settlor possessed de facto control over the Trustee.
No Previous Relationship Between the Alberta Trustee and the Quebec-based Beneficiary and Settlor
Neither the Settlor nor the Beneficiary knew the Trustee prior to the settling of NS Trust, and had not met the Trustee in person until after the Deed was signed. The court noted that but for the Trustee’s status as a resident of Alberta and the professional relationship between the Trustee and the Settlor’s representatives, the Trustee would not have been chosen to act as trustee of NS Trust, given the limited scope of its management powers under the Deed.
The Payment of Fees by Settlor and Cetco rather than NS Trust
Lastly, the court noted that the Trustee’s fees, the costs related to putting in place NS Trust and the fees subsequently incurred by NS Trust were all billed directly to Cetco and paid by Cetco or the Settlor. It also noted that the Settlor’s accounting representatives did not have a separate client file for NS Trust. Although it is difficult to discern how much weight was placed into the billing and payment system employed by NS Trust and the Settlor, the court did find the billing and payment methods employed by NS Trust militated against a finding of central management and control residing with the Trustee.
Discovery Trust and Boettger contribute in several ways to our growing understanding of the central management and control test as it applies to determine the residency of a trust. In Discovery Trust, the Supreme Court of Newfoundland and Labrador indicates that:
- Courts will likely look favourably on evidence indicating the trustee took an active role in managing the trust, even if its tasks could be considered administrative in nature;
- A trustee’s compliance with a standard direction from a beneficiary, such as a request for the disbursement of proceeds held by the trust, is not determinative in the assessment of residency;
- A trustee’s negotiations or consultations with beneficiaries regarding the affairs of the trust does not necessarily evidence a derogation of its control or management over the trust; and
- A trustee’s lack of knowledge of the value of the assets held in the trust, while not helpful, does not necessarily evidence a lack of the trustee’s authority or independence in its management of the trust.
In Boettger, the Court of Quebec indicates that:
- A trustee’s scope of authority could evidence a lack of authority and control if:
- the trustee’s duties are overly prescribed by the trust’s governing documents; or
- the trustee is not given a meaningful opportunity to exercise any discretion it has been given;
- Courts may look unfavourably on protector mechanisms which provide the settlor or a beneficiary with de facto control over the trustee. It should be noted, however, that the court in Boettger places greater emphasis on the use of protector mechanisms than either the Tax Court of Canada or the Federal Court of Appeals in Garron. In its appeal decision, the court in Garron expressly noted the appointment of a protector is “a common safeguard in a trust indenture and would not by itself be enough to find the beneficiaries to be in control…”[;
- The courts may consider the relationship between the trustee and the settlor or beneficiary when gauging the parties’ interest in how the trust is being managed; and
- The billing and payment methods employed by a trust may be considered in future cases in assessing the degree of independence and authority exercised by the trustee in its management of the trust.