The Supreme Court of Canada Applies "Central Management and Control Test" in Determining Residency of a Trust
July 18, 2012
A recent decision of the Supreme Court of Canada (SCC) may have significant tax implications for real estate ownership structures that involve a trust and that were implemented on the assumption that the trust is resident in a jurisdiction outside of Canada, or in a particular province within Canada, due to the trustee being resident in such jurisdiction or province.
In Fundy Settlement v. Canada (Fundy) (also known as St. Michael Trust Corp. and Garron), the SCC confirmed the reasoning of the lower courts, which favoured a central management and control test typically applied in determining residency of a corporation under common law, over residence of the trustee in determining the residency of a trust for purposes of the Income Tax Act (Canada) (ITA). While there had not been a significant amount of jurisprudence on the issue of how to determine the residency of a trust, the prevailing view had generally been that it is determined by the residence of the trustee. Any tax planning or tax structure that relies on determining the residency of a trust based on the residency of the trustee, particularly where the trustee does not exercise discretion over substantive decisions in relation to the trust, should be revisited in light of the ruling by the SCC.
St. Michael Trust Corp. (St. Michael) was a trust company resident in Barbados and the trustee of two trusts, Fundy Settlement and Summersby Settlement. The trusts were settled in Barbados by an individual resident in the Caribbean. The beneficiaries of both trusts were resident in Canada. After the sale by the trusts of shares in two Canadian-resident holding corporations, St. Michael claimed refunds of the portion of the purchase prices withheld by the purchaser and remitted to the minister of National Revenue (Minister) under section 116 of the ITA on the basis that:
- the trusts were resident in Barbados because the trustee was resident in Barbados; and
- capital gains realized by the trusts on the disposition of the shares were exempt from Canadian tax under the Canada-Barbados tax treaty since the treaty provides that tax is payable only in the country in which the trusts are resident.
The Minister reassessed St. Michael, in its capacity as trustee, and denied the refunds on the basis that the trusts were resident in Canada. The appeals from the reassessments were dismissed by the Tax Court of Canada in Garron Family Trust v. The Queen and by the Federal Court of Appeal in St. Michael Trust Corp. v. Canada on the basis that, because all the substantive decisions in relation to the trusts were made in Canada by the beneficiaries (and not in Barbados by the trustee, which exercised a limited role in an administrative capacity), the trusts were resident in Canada.
On appeal to the SCC, the primary issue was whether the trusts were resident in Barbados, as was argued by the appellant, or in Canada, as was argued by the Minister. St. Michael submitted that the residence of a trust must be the residence of the trustee for two reasons:
- since a trust is not a legal person, the central management and control test for determining residency of a corporation, which is a legal person, is inapplicable to trusts; and
- subsection 104(1) of the ITA links the trustee to the trust for all attributes of the trust, including residency.
In contrast, the Minister submitted that since the central management and control of the trusts were carried out in Canada by the beneficiaries, the trusts were resident in Canada. If the trusts were found not to be resident in Canada, the Minister submitted two alternative arguments:
- the trusts were deemed to be resident in Canada under subsection 94(1) of the ITA; and
- the general anti-avoidance rule (GAAR) applied to deny treaty benefits.
In a short, unanimous judgment, the SCC dismissed the appeals and agreed with the lower courts that the trusts were resident in Canada for purposes of the ITA because the beneficiaries exercised the central management and control of the trusts in Canada.
In respect of the appellant’s first proposition, the SCC held that, while a trust is not a person at common law, subsection 104(2) deems a trust to be an individual under the ITA. The Court added that the reference to a "person" in subsection 2(1), which provides that income tax is to be paid on the taxable income for each taxation year of every person resident in Canada at any time in the year, must be read as a reference to the taxpayer whose taxable income is subject to income tax which, in the present case, was the trust and not the trustee. In respect of the appellant’s second proposition, the Court held that, although subsection 104(1) provides that a reference to a trust in the ITA must be read to include a reference to the trustee, there is no provision in the ITA that links the trust and the trustee for purposes of determining the residency of the trust or that requires that the residence of a trust must be the residence of the trustee.
The Court concluded that the established test for determining the residency of a corporation (i.e., where the exercise of central management and control actually takes place) is to be used in determining the residency of a trust. The Court provided two key reasons for its conclusion. First, the Court observed that there are many similarities between a trust and a corporation, which justify treating them in the same manner for determining residence, including that both:
- hold assets that are required to be managed;
- involve the acquisition and disposition of assets;
- may require the management of a business;
- require banking and financial arrangements;
- may require the instruction or advice of lawyers, accountants and other advisors; and
- may distribute income.
Second, the adoption of the central management and control test for determining the residency of a trust promotes consistency, predictability and fairness. The Court held that:
As with corporations, residence of a trust should be determined by the principle that a trust resides for the purposes of the [ITA] where "its real business is carried on" […], which is where the central management and control of the trust actually takes place. As indicated, the Tax Court judge found as a fact that the main beneficiaries exercised the central management and control of the trusts in Canada. She found that St. Michael had only a limited role — to provide administrative services — and little or no responsibility beyond that […]. Therefore, on this test, the trusts must be found to be resident in Canada. This is not to say that the residence of a trust can never be the residence of the trustee. The residence of the trustee will also be the residence of the trust where the trustee carries out the central management and control of the trust, and these duties are performed where the trustee is resident. These, however, were not the facts in this case.
Since the SCC held that the trusts were resident in Canada by applying common law principles, it did not consider the Minister’s alternative arguments.
Given the SCC’s conclusion in Fundy, it is important to ensure that the trustees or other persons who in fact control a trust actually exercise their powers (i.e., carry out the central management and control of the trust) in the jurisdiction in which the trust is intended to be resident. Although the decision was made in the context of non-resident trusts, it may also have an impact on interprovincial tax planning involving trusts (e.g., the use of Alberta-resident trusts to access Alberta’s lower tax rates). The lessons learned in respect of ensuring corporations are resident in non-Canadian jurisdictions for common law purposes will be useful in ensuring trusts are resident and subject to tax in the appropriate jurisdictions.