SEPTEMBER 2009 CENTRAL MANAGEMENT AND CONTROL DETERMINES TRUST RESIDENCE By Elinore Richardson and Stephanie Wong In Garron, M. et al. v. The Queen, 1 the Tax Court of Canada considered whether two Barbados trusts (the Trusts ) were entitled to claim the benefit of the capital gains exemption in Article XIV(4) of the Canada-Barbados Income Tax Convention (the TAX LAW BULLETIN Treaty ) on their dispositions to an arm s length purchaser of shares of two Canadian holding corporations which indirectly owned a Canadian automotive parts manufacturing and assembly business. Capital gains of over $450 million realized by the Trusts on the share dispositions were not subject to Barbados income tax. As the shares sold were taxable Canadian property, amounts on account of potential Canadian tax on the capital gains were remitted to the Canada Revenue Agency under Canada s reporting procedures in section 116 of the Income Tax Act (Canada) (the Act ) which facilitate the advance collection of non-resident tax on dispositions of non-excluded taxable Canadian property. The Trusts filed Canadian income tax returns for the year of disposition and sought a refund of the remitted amounts based on the capital gains exemption in the Treaty. The Minister of National Revenue (the Minister ) denied the Trusts the benefit of the Treaty exemption and assessed the Trusts in respect of their capital gains on the sale. 2 On the appeal of the assessments, the Tax Court held in favour of the Minister finding that the Trusts were resident in Canada for the purposes of the Treaty when the shares were sold and, therefore, Article XIV(4) of the Treaty did not apply to exempt the capital gains arising on the share dispositions from Canadian tax. Facts The Trusts were established in 1998 in the course of a reorganization of the share structure of PMPL Holdings Inc. ( PMPL ), which owned shares of a Canadian corporation which manufactured and assembled parts for the automotive industry. Prior to the 1998 reorganization, the shares of PMPL were owned equally by Mr. Dunin and a holding company that was wholly-owned by Mr. Garron, Mr. Garron s wife and the Garron Family Trust. Both Mr. Garron and Mr. Dunin were residents of Canada. 1 2009 TCC 450 (TCC). 2 The Minister also issued assessments to certain of the beneficiaries of the Trusts (Mr. Dunin, Mr. Garron, www.blgcanada.com Mr. Garron s wife and the Garron Family Trust) with respect to the same capital gains, but clarified at trial that the assessments were issued as a protective measure only.
The Trusts were settled under Barbados law, one trust for the benefit of Mr. Dunin and his family, and the other trust for the benefit of Mr. Garron and his family. Both Trusts were settled by a friend of Mr. Garron who was resident in St. Vincent, the sole trustee of both Trusts was a corporation resident in Barbados which provided trustee services, and the protector of both Trusts (who had the power to remove and appoint trustees) was another friend of Mr. Garron who was resident in St. Vincent. As part of the reorganization of PMPL, the existing shareholders of PMPL exchanged their common shares for fixed value preference shares of PMPL. Each Trust subscribed for shares of a newly incorporated Canadian corporation, with each corporation in turn subscribing for common shares of PMPL. The share subscriptions were transacted at nominal consideration. In 2000, when each Trust sold shares of its respective holding corporation to the arm s length purchaser, PMPL was valued at approximately $532 million. A more detailed description of the reorganization and the facts leading up to the sale of PMPL, as well as terms of the Trusts is provided by the Tax Court in its lengthy judgment. Trust Residence The Minister s primary argument was that the capital gains exemption in Article XIV(4) of the Treaty did not apply to the Trusts because they were resident in Canada at the time the shares were sold and were therefore subject to Canadian tax on their capital gains arising from the sale. Pursuant to the definition of resident of a Contracting State in Article IV(1) of the Treaty, the Trusts would be residents of Canada if, under the laws of Canada, they were liable to taxation in Canada by reason of domicile, residence, place of management or any other criterion of a similar nature. Before considering the issue, the Tax Court addressed the appellants submission that the Trusts were resident in Barbados for purposes of the Treaty. The Court noted that the Minister had not expressed a view on the issue and that there was no agreement by the competent authorities of Canada and Barbados to engage the residence tie-breaker provision in the Treaty. On the basis that the matter had not been put in issue by the Minister, the Tax Court stated that it would not decide the appeals on the basis of whether or not the Trusts were resident in Barbados. 3 There has been little judicial consideration of the appropriate test for determining the residence of a trust. The Minister argued that a central management and control test should apply to determine trust residence, relying on two U.K. cases, Wensleydale 4 and Smallwood, 5 while the appellants asserted that trust residence 3 Nevertheless, the Tax Court judge summarized the expert evidence presented by the appellants regarding the Barbados residence of the Trusts, which relied partly on the Canadian tax decision in Thibodeau v. The Queen, infra, note 6, and stated (at paragraph 120) that based on the expert opinion and the Court s findings of fact, there appears to be a serious question about the correctness of the appellants position that the Trusts are resident in Barbados for purposes of the Treaty. 4 Wensleydale s Settlement Trustees v. Inland Revenue Commissioners, [1996] STC (SCD) 241 ( Wensleydale ). 5 Smallwood and Smallwood, Trustees of the Trevor Smallwood Trust, et al v. Commissioners for Revenue and Customs, [2008] UKSPC SPC0069 ( Smallwood ). 2
should be determined based on the residence of the trustee(s) in light of the decision in Thibodeau v. The Queen. 6 The Tax Court concluded that the U.K. cases relied on by the Minister did not assist the issue because the relevant test of residence in those decisions was legislative rather than judicial. The Court also rejected the appellants argument that the Thibodeau decision provided a general judicial test of trust residence, stating that it was clear from the reasons in that case that the decision was intended to be limited to its particular facts. Reviewing obiter comments made in Thibodeau rejecting the use of a central management and control test to determine trust residence, 7 the Court disagreed that they established as a general principle that a central management and control test cannot apply to trusts. Such a conclusion would presume that trustees always comply with their fiduciary obligations. The Court, instead, had regard to the case of Robson Leather Company Ltd. v. M.N.R. 8 where, in the context of a different tax issue, the Federal Court of Appeal rejected a presumption supporting residence based on where the trustees resided and found that one trustee had de facto control over a trust despite the fact that there were several trustees. Furthermore, the Court concluded that the judicial central management and control test for corporations where central management and control of the corporation actually abides is the appropriate test for determining the resident of a trust with such modifications as are appropriate. In the Court s view, the basis for applying the judicial central management and control test in the corporate context should be equally applicable in the trust context. While the legal nature of a trust and a corporation are significantly different, the Court noted that from the perspective of determining tax residence, their characteristics are quite similar. Second, the use of a similar test for both trusts and corporations would promote the important principles of consistency, predictability and fairness in the application of tax law. Third, the Court was not satisfied that there were good reasons for developing a different test of residence for trusts than for corporations. The Court also pointed to some early Canadian decisions that had concluded that income from a trust was taxable in Canada if the trustee was resident in Canada and stated that such simplistic conclusions had outlived their usefulness because their focus on trustee residence was based on the relevant tax legislation which at that time did not impose tax on trusts, but only on the trustees or beneficiaries, with respect to trust income. 6 Dill and Pearman, Trustees of the Thibodeau Family Trust v. The Queen, 78 DTC 6376 (FCTD) ( Thibodeau ). The Court considered whether the Thibodeau Family Trust was resident in Canada and therefore liable to Canadian tax. The trust had one Canadian resident trustee, Mr. Thibodeau, and two Bermuda resident trustees. The trust assets and were administration were located in Bermuda, and all decisions with respect to the trust assets and administration were made by the trustees at meetings held in Bermuda. Mr. Thibodeau offered investment suggestions to the trust s financial advisors which, if approved by the Bermuda trustees, would be implemented. The trust deed required a majority decision on all matters of trustees discretion such that approval by at least one of the Bermuda trustees was necessary. The Court found that the trust had a sole residence in Bermuda since the majority of the trustees were resident in Bermuda and a majority decision was required on all matters of trustee discretion. 7 Ibid., at page 6385: The judicial formula for this respecting a corporation, in my view, cannot apply to trustees because trustees cannot delegate any of their authority to co-trustees. A trustee cannot adopt a policy of masterly inactivity as commented upon in Underhill on the Law of Trusts and Trustees, 12th Edition, page 284; and on the evidence, none of the trustees did adopt such a policy. 8 77 DTC 5106 (FCA). 3
In addressing the application of the central management and control test in the trust context, the Tax Court referred to the decision of the U.K. Special Commissioners in Smallwood, which was reversed by the U.K. High Court on unrelated grounds and which is currently under further appeal. The case concerned a trust created by a U.K. resident, the trustee of which was changed to a Mauritius corporation for a short period of time in order to avoid U.K. tax on a sale of shares by the trust. The treaty tie-breaker test for determining residence was engaged, and required the determination of the place of effective management of the trust. The U.K. Special Commissioners concluded that the effective management of the trust remained in the U.K. because although the administration of the trust had moved to Mauritius, the trust s key decisions were made in the U.K. Interestingly, the Tax Court noted that the decision was useful for its consideration of effective management of a trust where the choice of trustee was purely a tax-driven decision, 9 but concluded later in its analysis that the facts of that case were so different that it was of little assistance in determining where the central management and control of a trust should be located. Considering the written evidence and the oral testimony as a whole, the Tax Court found that the Barbados corporate trustee was selected by Mr. Dunin and Mr. Garron (or their advisors) to execute documents as required and to provide incidental administrative services. It was not generally expected that the trustee would have any further responsibility for decision-making. Instead, the Court found that, more likely than not, the trustee had agreed from the outset that it would defer to the recommendations of Mr. Dunin and Mr. Garron with respect to the Trusts general decision-making, including any decisions as to the sale of the Trust s indirect interests in PMPL, the investment of the sale proceeds, the making of beneficiary distributions and the taking of action to minimize the tax burden of the Trusts. The Court noted that the trustee s limited role was effectively enforceable through the mechanism of the protector s power to replace the trustee, and the beneficiaries power to replace the protector. Furthermore, although there was no explicit evidence establishing the limited nature of the trustee s role with respect to the Trusts, in the Court s view such evidence would not be expected since it was a tax-motivated arrangement which appears to have been carefully planned and implemented with considerable assistance from lawyers. 10 The Court then analyzed the written documentation and oral testimony which it had taken into account in reaching its conclusions, questioning the credibility and completeness of certain aspects of the evidence presented. It noted that the appellants had led very little evidence as to the formation and operation of the Trusts. In the Court s view, there is no basis for concluding that [the trustee] did not agree to assume a limited role in the management of the Trusts. 11 Based on its findings of fact, the Court concluded that the central management and control of the Trusts was located in Canada and, therefore, that the Trusts were resident in Canada for purposes of the Treaty. Accordingly, the Minister s assessments were upheld. 9 Supra, note 1, at paragraph 185. 10 Supra, note 1, at paragraph 190. 11 Supra, note 1, at paragraph 185. 4
Other Important Considerations Although not required to consider the Minister s alternative arguments for dismissing the appeals, the Court made some interesting obiter comments on some of the other issues raised at trial. The Court rejected the Minister s argument that if the non-resident trust rules in paragraph 94(1)(c) of the Act (as they read in the 2000 taxation year) deemed the Trusts to be resident in Canada, then the Trusts were not entitled to the Treaty exemption. As a trust which is deemed resident in Canada under paragraph 94(1)(c) is taxable in Canada only on specific sources of income (in contrast to a trust resident in Canada under common law principles which is fully taxable on its world-wide income), the Court concluded that it would not meet the Treaty s test of Canadian residence in Article IV(1). The Minister s arguments that the general anti-avoidance rule applied to the transactions involved in the 1998 reorganization of PMPL were also dismissed. The Court rejected the Minister s assertion that the Treaty had been abused merely by reason of the fact that the taxpayers had been formed in Barbados to access the Treaty exemption for capital gains in Article XIV(4) and to avoid the anti-avoidance rule in section 94. 12 The Court was not satisfied that an abuse of the Treaty could be established if section 94 was found to be applicable to the transactions, since Canada had not explicitly preserved in the terms of the Treaty the overriding application of section 94. The Court also disagreed with the Minister s argument that the Treaty capital gains exemption was not intended to apply to the Trusts because they had very little connection with Barbados and, thus, its application would facilitate tax avoidance. The acceptance of such an argument would have resulted in a selective application of the Treaty to Barbados residents based on criteria other than residence, which was contrary to the object and spirit of the Treaty which entitles Barbados residents, as defined in the Treaty, to the benefits of Article XIV(4) as long as they are not also Canadian residents. Conclusion This decision marks the first time that a Canadian court has established a general test for determining a trust s residence for Canadian tax purposes. The decision could have significant implications for planning for offshore trusts arrangements which may have relied upon a concept of the residence of a trust based solely on the location of the trustee without regard to the actual extent of the trustee s management and control of the trust s assets. It is expected that the decision will be appealed to the Federal Court of Appeal. 12 This conclusion is consistent with the Court s prior decision in MIL (Investments) S.A. v. The Queen, 2006 DTC 3307 (TCC); aff d 2007 DTC 5437 (FCA), in which the Court (at paragraph 72) responded to the Minister s argument that treaty shopping is an abuse of bilateral tax treaties with the following statement: There is nothing inherently proper or improper with selecting one foreign regime over another. [Minister s] counsel was correct in arguing that the selection of a low tax jurisdiction may speak persuasively as evidence of a tax purpose for an alleged avoidance transaction, but the shopping or selection of a treaty to minimize tax on its own cannot be viewed as being abusive. It is the use of the selected treaty that must be examined. 5
If you have any questions on this topic or would like to know how these rules will apply to a particular corporation or transaction or would like to discuss any other tax matters, please do not hesitate to contact one of the professionals in the Tax Group. BLG s national Tax Law Group consists of approximately 62 tax professionals including several Chartered Accountants. We serve clients across Canada from our six regional offices. Our experience spans corporate tax, international tax, personal tax and estate planning, tax litigation and commodity tax. Tax Law Group Borden Ladner Gervais LLP Lawyers Patent & Trademark Agents Calgary 1000 Canterra Tower 400 Third Avenue S.W. Calgary, Alberta, Canada T2P 4H2 tel: 403 232-9500 fax: 403 266-1395 Montréal 1000 de La Gauchetière Street West Suite 900, Montréal, Québec, Canada H3B 5H4 tel: 514 879-1212 fax: 514 954-1905 National Leaders Elinore Richardson Toronto (416) 367-6204 erichardson@blgcanada.com Larissa V. Tkachenko Toronto (416) 367-6037 ltkachenko@blgcanada.com Regional Leaders Lindsay J. Holmes, Q.C. Calgary (403) 232-9605 lholmes@blgcanada.com Charles P. Marquette Montréal (514) 954-3121 cmarquette@blgcanada.com Pamela Cross Ottawa (613) 787-3559 pcross@blgcanada.com Stephen J. Fyfe Toronto (416) 367-6650 sfyfe@blgcanada.com Douglas J. Powrie Vancouver (604) 640-4097 djpowrie@blgcanada.com This newsletter is prepared as a service for our clients and other persons dealing with Tax Law issues. It is not intended to be a complete statement of the law or an opinion on any subject. Although we endeavour to ensure its accuracy, no one should act upon it without a thorough examination of the law after the facts of a specific situation are considered. No part of this publication may be reproduced without prior written permission of Borden Ladner Gervais LLP. This newsletter has been sent to you courtesy of Borden Ladner Gervais LLP. We respect your privacy, and wish to point out that our privacy policy relative to newsletters may be found at http://www.blgcanada.com/home/website-electronic-privacy. If you have received this newsletter in error, or if you do not wish to receive further newsletters, you may ask to have your contact information removed from our mailing lists by phoning 1-877-BLG-LAW1 or by emailing subscriptions@blgcanada.com. Ottawa World Exchange Plaza 100 Queen St., Suite 1100 Ottawa, Ontario, Canada K1P 1J9 tel: 613 237-5160 1-800-661-4237 legal fax: 613 230-8842 IP fax: 613 787-3558 Toronto Scotia Plaza, 40 King Street West Toronto, Ontario, Canada M5H 3Y4 tel: 416 367-6000 fax: 416 367-6749 Vancouver 1200 Waterfront Centre 200 Burrard Street, P.O. Box 48600 Vancouver, British Columbia, Canada V7X 1T2 tel: 604 687-5744 fax: 604 687-1415 Waterloo Region Waterloo City Centre 100 Regina Street South, Suite 220 Waterloo Ontario N2J 4P9 tel: 519 579-5600 fax: 519 579-2725 IP fax: 519 741-9149 2009 Borden Ladner Gervais LLP www.blgcanada.com Borden Ladner Gervais LLP is an Ontario Limited Liability Partnership Printed in Canada