A New Chapter in Taxation of Trusts: The Residency of a Trust

Below is an excellent article published by Collins Barrow, Chartered Accountants.

A New Chapter in Taxation of Trusts

The recent decision of the Tax Court of Canada in Garron Family Trust v. R (2009 DTC 1568) has cast doubt on some common international and inter-provincial tax planning structures that involve the use of trusts. Generally, these trust structures reallocated income to jurisdictions that had either lower tax or no tax at all on certain types of income. This was accomplished by implementing a tax strategy that involved a trust and relying on the residency of that trust to determine the jurisdiction in which the trust's income would be taxed.

For over thirty years, tax professionals have relied on the principles set out in the well-known Thibodeau Family Trust case (78 DTC 6376) to determine the residency of a trust. Now, as a result of the decision in the Garron Family Trust case, we appear to have a new set of rules for determining the residency of a trust. These new rules can have a serious impact on any trust tax planning strategy that relies on the old residency rules of the trust to minimize or eliminate taxation.

Pursuant to the Thibodeau case, the residency of a trust was based on the residency of the managing trustees. The Thibodeau trust had three trustees, one resident in Canada and two in Bermuda. The trust was administered in Bermuda and the books and records of the trust were in Bermuda. The Court concluded that the trust resided in Bermuda because the trust document required that a majority of trustees agree on all matters of trustee discretion, and the majority of trustees resided in Bermuda. The Court rejected the notion that the residence of a trust should be similar to that of a corporation, and therefore disregarded the "management and control" test used for corporations. The Court then concluded that the residence of a trust should be determined based on residency of the trustees.

Just over thirty years later, we now have a different opinion from the Tax Court regarding this issue. With the Garron Family Trust decision, the Court has now embraced the notion that the residence of a trust should be similar to that of a corporation. The Court will look to the management and control of the trust to determine residency of the trust. The Court concluded that adopting a similar test of residence for trusts and corporations promotes the important principles of consistency, predictability and fairness in the application of tax law.

With an update in the jurisprudence related to the residency of trusts, the Canada Revenue Agency (CRA) is now aggressively reviewing tax planning structures involving trusts to reduce tax avoidance through international and inter-provincial tax planning.

The CRA recently hired additional auditors to review the residency of Alberta trusts. During the past several years, it has been attractive and popular for individuals located in provinces other than Alberta to set up an Alberta resident trust to access Alberta's low provincial tax rates. With this review of Alberta Trusts, the CRA is seeking to determine the "management and control" over the trust assets. As a result, it has distributed questionnaires to Alberta trustees, requesting the following information:

•a list of the duties and responsibilities as the trustee;
•the signing and/or contracting authority of the trustees; and
•the responsibility of the trustees for the management of any business or property owned by the trust, the banking and financing arrangements for the trust, and the preparation of the trust's accounts and reporting to the beneficiaries.
If the CRA determines that the management and control over the trust assets rests with any person(s) other than the Alberta trustees, it may determine the residence of the trust to be other than Alberta and reassess the provincial taxes accordingly.

Based on the 2010 Federal Budget, and the Department of Finance's desire to close various loopholes in the Income Tax Act, and to try to find ways to generate revenue to assist in reducing the deficit, we can anticipate the CRA will also apply the same aggressive nature toward international tax planning strategies involving trusts.

This may be a new chapter in the taxation of trusts, but the story is not over yet. The Garron Family Trust has requested leave to appeal to the Federal Court of Appeal. We will have to wait for the outcome of that appeal to see whether a new chapter is written once again, or if the book is closed for the foreseeable future.