Validity of trusts and GAAR applicability: Antle and Garron

Offshore trusts have become an essential element of successful tax planning. Trusts are used as tax planning vehicles as they are considered a separate legal entity from the individual. Thus, the income and assets of the trust are excluded from the individual’s estate for tax purposes. A previously successful, but now uncertain, strategy had used the residence of trust as basis for evading taxes.

The Canada Revenue Agency has taken the position in Interpretation Bulletin IT-477 “Residence of a Trust or Estate” (dated May 30, 1980) that a trust will generally be resident in the jurisdiction where the trustee who manages and controls it resides. The “management and control” test referred to in the Bulletin was rejected in Trustee of Thibodeau Family Trust v Canada, [1978] FCJ No 607 (QL) (FCTD) [Thibodeau], which held that the test was not applicable to trusts. This prevailing test in Thibodeau was challenged and deemed to be obiter in Garron Family Trust v The Queen, 2009 TCC 450 [Garron], and once again, in Antle v The Queen, 2009 TCC 465 [Antle].

Garron: Trust Residence determined based on Location of Central Management and Control, not Residence of Trustee

Canadian residents, Mr. Garron and Mr. Dunin, owned a profitable Canadian company. In 1998, during a reorganization of the share structure of the company, an individual resident in the Caribbean island of St. Vincent set up two trusts with Mr. Garron and Mr. Dunin as the beneficiaries. The sole trustee of the trusts was a resident in Barbados. In 2000, the business was sold to a private equity fund, which purchased the shares owned by the trusts, resulting in capital gains of over $450,000,000.

After remitting the taxes, the trusts sought a refund on the basis of the tax exemption provisions pursuant to the Agreement between Canada and Barbados for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes and Capital (“the Treaty”). As per the Treaty, capital gains may only be taxed in the country of residence. The trusts claimed that they were residents of Barbados whereas the Ministry of Revenue held that the trusts were residents of Canada and, therefore, that the exemption did not apply.

The Argument
Relying on Thibodeau, the trusts argued that the rules that are applicable are those of the jurisdiction where the trustee resides. Furthermore, Thibodeau established that the test for determining residency of corporation as being the place of “central management and control” does not apply to trusts.

The Decision
Justice Woods rejected the trust’s argument stating that the Thibodeau decision was “insufficient authority” to reject the central management and control test for trusts. She stated that the test in Thibodeau was intended to be limited to its particular facts. She further held that the judicial test of residence should apply to trusts with appropriate modifications.

When addressing the meaning of “management and control,” Justice Woods took a number of factors into consideration including the purpose of the trust, the appellant’s ability to replace the trustee, an internal memo setting out the intention of the parties, and the lack of credible witnesses involved in management of trust. She found that the trustee was selected on behalf of the beneficiaries to provide administrative services. The role of the trustee was not expected to extend to beyond administrative services to encompass decision-making responsibility. Therefore, management and control was not established in the Barbados trust. For a more detailed analysis of Garron, I recommend Ahsan Mirza’s article on, Garron: Determining residency of Trusts.

Antle: Court Finds that Trust Was Not Validly Constituted and GAAR Was Applicable

In 1998, Mr. Antle, a Canadian resident, bought shares in a private corporation through another company, Stratos Global Corporation. In 1999, he decided to sell his shares to a third party. To avoid paying taxes on the accumulated gain, he used the “capital property step-up strategy” which involved shifting capital property to a Barbados spousal trust. The trust sold the shares to his wife at fair market value in exchange for a promissory note; then the wife sold the shares to a third party and used the proceeds to pay the trust. Soon after, the trust was dissolved. This strategy resulted in no tax on capital gains.

The Argument
The Ministry of Revenue included the capital gains from the share dissolution in his taxable income, arguing that the trust was fraudulent, and not validly constituted. The Minister also invoked the General Anti-Avoidance Rule (“GAAR”).

The Decision
The court concluded that this was not a case of “willful evasion and intentional deception”, but rather it was a case of “self-deception, albeit innocent, on the part of Mr. Antle.”

Although the trust was not found to be fraudulent, the courts nevertheless held that the trust was not valid. Conducting a fact-specific analysis, the court came the conclusion that the documentation of the transaction was not helpful to the Mr. Antle’s case. There were various discrepancies that undermined the trust’s argument, including timing inconsistencies as to when the shares were sold, and when the trust was formed.

Furthermore, a valid trust has to have three certainties: intention, subject matter, and object. It must also have a complete transfer of subject property to trust. The court concluded that the trust was not validly constituted as it did not meet the certainty of intention and of subject matter.

The court held that the actual conduct of the parties is a relevant consideration when determining the intention and should not be limited to consideration of the trust document alone. It held that the intention was not to settle the trust, but that the trustee was an agent in the transaction, giving the gift to Mr. Antle’s wife.

In terms of subject matter, the court found that Mr. Antle retained an interest in the share when disposing the shares to recover a portion of the sale proceeds. Because the full interest was not transferred to the Trustee, the trust created an uncertainty of subject matter.

GAAR Analysis in Antle
Going a step further than Garron, the courts in Antle conducted a GAAR analysis. Justice Miller in Antle stated that even if his conclusion on the validity of trust was incorrect, the trust would fail under a GAAR analysis. The court found that relying on a treaty provision to avoid application of an anti-avoidance provision of the Act was inherently abusive. Though disappointing for taxpayers, this decision has wide-ranging implications for what constitutes as “abuse” under the GAAR, advancing development in this area of law.

The courts and the Mr. Antle agreed that there had been a tax benefit and an avoidance transaction. However, the courts found that the avoidance was abusive within the meaning of section 254(4) of the Income Tax Act, RSC 1985, c 1 (5th Supp) [Act]. Using the textual, contextual and purposive test in Canada Trustco Mortgage Co v The Queen[2005] 2 SCR 601, the court considered the object, spirit and purpose of the relevant provision (section 73(1)of the Act).

As per Justice Miller, “[t]he object, spirit and purpose of the Canadian legislation as it pertains to a Canadian resident is not to be swept aside because the policy of the Treaty, as pertaining to a non-resident Trust, might save the Trust, especially when one considers an overriding policy of entering treaties to prevent tax avoidance by Canadian residents.”

The policy underlying section 73(1) of the Act is to recognize spouses as a single economic unit allowing for an automatic tax-deferral on a gain on transfer of property between the spouses. The Court held that the object, purpose and spirit of this section was not to allow permanent tax avoidance, but only a tax deferral. The gains would be taxed when property leaves the marital unit.

The court concluded that the transactions abused the Act and the Treaty and were subject to the GAAR. Applying the GAAR analysis, the court denied Mr. Antle the ability to access the spousal rollover and transfer of shares to the Trust, subjecting the transaction to capital gains tax on disposition.

Tax planning strategies have always been important to corporations and individuals alike. However, there is a fine line between tax planning and illegal tax avoidance. Justice Miller stated:

This conclusion emphasizes how important it is, in implementing strategies with no purpose other than avoidance of tax, that meticulous and scrupulous regard be had to timing and execution. Backdating of documents, fuzzy intentions, lack of transfer documents, lack of discretion, lack of commercial purpose, delivery of signed documents distributing capital from the trust prior to its purported settlement, all frankly miss the mark – by a long shot. They leave an impression of elaborate window dressing. In short, if you are going to play the avoidance game, it is not enough to have brilliant strategy, you must have brilliant execution.

Implications of Garron and Antle
Disregarding current industry norms, the courts in Garron and Antle held that the residence of the trustee is not sufficient to establish the trust’s residence for tax purposes. The implications of these decisions cannot be ignored.

It is evident from the decision in both cases that courts will not be limited by the document of the transaction, but will take into consideration the intention and conduct of the parties. Although both cases are fact-dependent, it is an eye-opener for those using trusts to understand the court’s standpoint with regard to such transactions. The only way to avoid liability is to overtly conduct the transaction in a manner that establishes management and control. The more a transaction blurs the line between tax planning and illegal tax avoidance, the better the documentation and implementation. Mere documentation is not enough. Mere documentation is not sufficient proof to establish management and control. The burden of proof is higher, requiring tax professionals to demonstrate control through intention and actual conduct.

Because of this unplanned development in tax law, as well as the large monetary figures involved and complexity of the issues, there is a strong possibility that these cases will be appealed. Taxpayers and adviser alike wait in anticipation for the appeal and the aftermath of this decision.

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