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Personal Trust Audit Issues
Wendy Stewart
Ontario Regional Coordinator – Trust Program
Topics for Discussion
1.
2.
3.
4.
5.
Garron Case – Residency of a Trust
Antle Case – Proper Trust Constitution
Loans to Personal Trusts
“Paid” or “Payable” Amounts
Section 116 Certificates for estates
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Garron Family Trust,
2009 DTC 1287 (TCC); 2010 FCA 309 (FCA)
Trust residence determined based on location of
central management and control, not residence of
trustee.
Trusts
For tax purposes, trusts are deemed to be
taxpayers for the calculating tax, but they are not
a legal person or entity in the same way as
individuals and corporations.
There has always been uncertainty around
determining where a trust is resident for tax
purposes.
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Residence of a Trust
 The residence of a trust is a question of fact
 Historically, a trust’s residence has generally
been determined based on where the majority of
Trustees of the trust are resident.
 There are no statutory guidelines, regulations, or
rules that establish criteria to determine whether
a trust is resident in Canada, or indeed to
determine, if the trust is resident in Canada,
where in Canada it resides.
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Thibodeau Family Trust, 78 DTC 6376 (FCTD)
For Canadian income tax purposes a trust will be
resident where a majority of the trustees are
resident, provided that:
• A majority decision on all matters of the trustees'
discretion is permitted;
• The trustees have full powers of management and
control over the trust; and
• The trustees actively exercise those powers.
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Garron Family Trust, 2009 DTC 1287 (TCC)
 Owners of a CCPC decided to implement an
offshore “estate freeze’ in 1998
 Canadian owners retained value and new shares
were issued to Barbadian trust corporation
 The plan was any new growth would escape
Canadian taxation, as the trusts were not
resident in Canada
 The tax treaty with Barbados would exclude the
gain on the private company shares from
Canadian taxation
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Garron Facts…con’t
 In August 2000 an arm’s length purchaser
acquired all the shares for proceeds equal to
$532 million with the bulk of proceeds paid to the
Barbadian trusts
 Capital gains do not attract tax consequences in
Barbados
 Trust position - they were not subject to
Canadian tax either because they were nonresident and the gains were treaty-protected
under the Canada-Barbados Income Tax
Agreement.
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Justice’s Decision
Justice Woods in Garron decided that the residency test
for corporations, management and control, ought to apply
equally to trusts because;
• The characteristics of a trust and a corporation are quite
similar in that, at a basic level they both manage property;
• Adopting a similar test of residence in Canada for trusts
and corporations promotes the important principles of
consistency, predictability and fairness in the application of
tax law; and
• The judge was not satisfied that there were any good
reasons for adopting a totally different test of residence for
trusts than there is for corporations.
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TCC Decision
 Justice Woods in Garron concluded that the
trustee was not exercising the main powers and
discretions of the trustees under the trust
indentures.
 Rather its true role was “to execute documents
as required, and to provide incidental
administrative services”, and it was not expected
to “have responsibility for decision-making
beyond that”
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Meaning of Management and Control
 Effective management occurs where key
decisions are made notwithstanding that a
Trustee may be making certain low level
decisions elsewhere
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Federal Court of Appeal
 November 17, 2010 FCA upheld the decision
found in TCC, in particular
• “that where a question arises as to the residence of a
trust for tax purposes, it is appropriate to undertake a
fact driven analysis with a view to determining the
place where the central management and control of
the trust is actually exercised.”
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Implications
 the residence of a trustee will not suffice to
establish the trust's residence for tax purposes.
 relevant for determining trust residency not only
at the federal level, but also with respect to interprovincial trust arrangements
 Canada Revenue Agency and Canadian courts
will now be applying a test of central
management and control.
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Role of the Practitioner
 it will be necessary to ensure that the trustee has
sufficient independent decision-making power.
 Be prudent to compile express evidence to
support this arrangement
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Antle et al. v. The Queen,
2009 TCC 465; 2010 FCA 280
Court finds that trust not validly constituted and
concludes that GAAR would have applied
Justice Miller TCC
“If the capital property step-up strategy [used by the
taxpayers in this case] is considered acceptable tax
planning, then there would be two tiers of taxation of
capital gains in Canada:

one tier for those whose capital gain can justify
professionals’ fees to implement the strategy, in
which case there is no tax on a capital gain in
Canada;

the second tier for everyone else, in which case
capital gains are subject to tax in accordance with
Part I of the Act.
This is an unacceptable result to the Respondent. The
real question before me is whether it is for the legislators
to introduce legislation to defeat such a result, or can
existing legislation and jurisprudence be relied upon by
the Courts to do so?”
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Antle Facts
 A Canadian resident husband purported to sell his shares
in the capital of a corporation to a trust resident in
Barbados
 He purported to transfer his shares to a spousal trust on
a rollover basis.
 The trust, in turn, sold the shares to the wife for a note.
 The wife then sold the shares to a third party purchaser
for cash and paid off the note to the offshore trust.
 The offshore trust would make a distribution of capital to
the wife of the note proceeds, again theoretically so that
the wife could receive that distribution of capital on a taxfree basis.
 Since Barbados does not tax capital gains, no tax would
be paid on any of the transactions.
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Three Certainties Test
• Intention
• Subject Matter
• Object
AND there must be a a completed transfer of the
subject property by the contributor to the Trust
This is why we always ask to view the settled
property!!
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What to review
 Conduct of the Parties will help to determine the
Settlors true intent
• Does the Settlor’s actions demonstrate the use of the
Trustee as Agent to reach the desired result eg.
Income splitting to minimized taxation
• Is the Trustee just a player in the transaction or does
he/she have real decision making powers
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First Position – Trust not properly
constituted
 Settlor (Antle) did not properly settle the shares
 Director’s resolution to effect the transfer of the
shares was backdated
 Share certificate did not indicate a transferee
 Share certificate was not delivered until after the
purported settlement of the trust
 Share certificate was not delivered to the Trustee
but directly to the Third Party purchaser
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Second Position – Trust was a Sham
 The Trustee not have any real discretion as the
matters were pre-ordained
 The trustee received the shares on the basis that
the sole beneficiary had already agreed to buy
them and the transaction was therefore void of
discretion
 The sole purpose of the transaction was to avoid
tax
 Sham’s require an element of deceit and it is
necessary for the Settlor and Trustee to be
parties to the sham – Trustee was a pawn and
therefore not a Sham
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Third Position - GAAR
 Effectively applied due to the fact the Act and the
Treaty contemplate payment by Canadian
residents of Canadian Income Tax on a gain
arising on the sale of property held by a
Canadian marital unit, however, did not
contemplate running property through a
Barbados and returning it to the Canadian
marital unit for the sole purpose of escaping the
Canadian payment of tax.
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Implications
 Where a trust is perceived as having been
settled for tax purposes, CRA auditors and the
courts will scrutinize the arrangements and
transactions very closely
 CRA now adopts the “Antle doctrine” of false
impression as another line of inquiry in audits
and another ground for assessment.
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Audit Procedures
Mandatory audit steps include:
1. ensuring all formalities are strictly complied
2. with and the timing of various steps are given
due attention and
3. executed accordingly
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Court Comments
“ This conclusion emphasizes how important it is, in
implementing strategies with no other purpose than
avoidance of tax, that meticulous and scrupulous regard
be had to timeing 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 it’s purported settlement, all frankly miss the mark by a
long shot. They leave the 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”
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Amounts Paid or Payable
104(24) compliance allows 104(6) deduction
Income of a Trust
The CRA has strict interpretations as to what is
considered payable, and legal documents must
be in place prior to the end of the year to meet
these requirements.
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General Rule on Income of Trust
Income, including taxable capital gains will be taxed in
the trust unless one of four conditions is satisfied:
1.The income is paid or payable to a beneficiary
2.The income is deemed payable to an infant
3.A preferred beneficiary elects to pay tax on accumulating
income
4.The trustee makes payments in respect of property,
which he or she is required, under the terms of the trust
instrument, to maintain for the use of a beneficiary
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Allowable Deductions
Paragraph 104(6)(b) of the ITA allows income
allocations to beneficiaries to be deducted from
the income of the trust.
Such amounts deducted must be included in the
beneficiary’s income pursuant to subsection
104(13).
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Meaning of “Amount Payable”
The meaning of "an amount payable in a taxation
year" is defined in subsection 104(24) as an
amount:
(a) that is paid in the year to the person to whom
it was payable, or;
(b) with respect to which the person to whom it
was payable is entitled in the year to enforce
payment.
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Payments made to Third Parties
 In the case of minor beneficiary, the trustee may decide
to make payments to third parties or to the parent as a
reimbursement for an expenditure.
 CRA will accept certain third parties payments as
payments made directly to a beneficiary, provided that
the expenditures were incurred for the benefit of the
beneficiaries.
 In order to ensure that third party payments are
deductible, the trustee must consider the nature of the
payment and maintain proper books and records to
substantiate the deduction.
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Loans to a Personal Trust
General Rules
 In general, the trust is established when a
person (the settlor) transferred a property to
the control of trustees to hold for the benefit of
one or more beneficiaries.
 The settled property is usually kept separately
from all assets of the trust.
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Certainty of Subject Matter
 Common Law requires a valid trust must meet
the Three Certainties in order to be considered a
valid trust.
 Failure to provided evidence of the settled
property would void the trust agreement due to
the trust failing to meet the Certainty of Subject
Matter under common law.
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Non Arms Length Loans
The Income Tax Act provides attribution rules will
NOT apply provided:
• Interest is charged at a rate equal to or
greater than the lesser of:
(i) the prescribed rate as described in
regulation 4301(a).
(ii) the rate that would be been agreed
upon between parties dealing with
each other at arm’s length.
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Borrowed Funds
 To provide the necessary financing to purchase
income generating property, the trust would
normally borrow the monies from arm’s length or
non-arm’s length party.
 It is important to keep in mind the type of loan the
trust wishes to obtain as this may trigger tax
implications (For example, attribution rules).
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Payment of Interest
In order to avoid the attribution rules the interest
payable in respect of the loan must be paid no
later than 30 days after the taxation year end of
the trust.
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Section 116 Certificates for Estates
Resident Trust and Resident
Beneficiaries
No necessity to apply for section 116 certificate
as estate is not distributing to non resident
beneficiaries
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Resident Trust and Non Resident
Beneficiary
 The non resident beneficiaries ONLY may be required to
apply for a Section 116 Certificate depending on the
source of the capital interest:
 Based on the changes to the definition of Taxable
Canadian property, March 4, 2010 a capital interest in a
trust is no longer taxable Canadian Property unless if at
any time in the previous 60 month period, 50% of the
FMV of the capital interest in the trust is derived from any
combination of:
•
•
•
•
Canadian real or immovable property
Canadian resource property
timber resource property
options or interests in any of the above
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Non Resident Estate with Canadian Taxable
property and Non Resident Beneficiary
The non-resident beneficiary may be required to
apply for a Section 116 Certificate depending on
the source of the capital interest (see above)
The non-resident beneficiary will be required to
apply for a Section 116 Certificate as the cash
will be derived from the sale of real property.
www.cra-arc.gc.ca/tx/nnrsdnts/menu-eng.html
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Discussion and Questions