Garron and Antle: Barbados or Canadian trusts?
Two recent Tax Court of Canada decisions considered both the legitimacy and the residency of Barbados trusts: Garron et al v. the Queen (Garron), and Paul Antle v. The Queen and Renee Marquis-Antle Spousal Trust v. The Queen (Antle). In both cases, the court concluded that capital gains realized by the trusts were taxable in Canada.
In Garron, the court held that the gain was taxable in the trust, on the basis that the trust was a resident of Canada because it was effectively managed by residents of Canada. In Antle, the court held that no valid trust was ever created and the gain was therefore taxable in the taxpayer’s hands. Both cases raise important issues, notably with respect to:
- the residence of trusts;
- the role and powers to be exercised by discretionary trustees; and
- the interaction of the general anti-avoidance rule and treaty provisions.
Mr. Garron and his business partner, Mr. Dunin, both Canadian residents, owned and operated a profitable Canadian company (OPCo). As part of a 1998 reorganization, Mr. Garron and Mr. Dunin each incorporated holding companies and established irrevocable, discretionary family trusts for the benefit of themselves and their families.
Each trust was settled by an individual residing on the island of St. Vincent, and had, as the sole trustee, a corporate trustee resident in Barbados which, at the time of the transactions, was owned by an international accounting firm. Each trust also appointed a “protector” who could be replaced by a majority of the beneficiaries who had attained a certain age. Each trust subscribed for shares of the respective holding company of the appellants. The holding companies, in turn, subscribed for new common shares of OPCo.
In 2000, the business was sold to a private equity fund, which purchased the holding company shares owned by the Barbados trusts, resulting in a capital gain of approximately $450,000,000. The gains realized by the trusts were not subject to income tax in Barbados.
The applicable non-resident withholding tax, under section 116 of the Canadian Income Tax Act (Act), was remitted to the Canada Revenue Agency (CRA). The trusts then filed Canadian income tax returns requesting a refund of the tax withheld, on the basis that they were residents of Barbados and therefore exempt from Canadian income tax under the Canada–Barbados tax treaty. Under Article XIV(4) of the treaty, gains from the alienation of any property may only be taxed in the country of residence. The Minister of Revenue held that the trusts were residents of Canada and the treaty exemption did not apply.
As a protective measure, the Minister also issued assessments against four Canadian residents (including the appellants) with respect to the same gains under the attribution rules of subsection 75(2) of the Act. The Minister also argued that the allocation of the sales proceeds was not reasonable and that a portion of the proceeds should be reallocated from the trusts to these other Canadian residents. Lastly, the Minister invoked the general anti-avoidance rule (GAAR) in support of all the assessments.
The Minister’s primary argument was that the management and control of each trust was situated in Canada. The appellants, relying on Thibodeau, argued that the residence of a trust should be determined with reference to the residence of the trustee and that the central management and control test (historically applied to determine the residence of corporations) was inapplicable to trusts. In the alternative, the appellants argued that the corporate trustee exercised management and control of the trusts.
Justice Woods concluded that Thibodeau does not propose that the residence of a trustee is always the deciding factor in determining the residence of a trust. She noted that in Thibodeau, the ruling was a dismissal of the position that a single trustee resident in Canada with no special authority could override a majority of trustees located in Bermuda.
Further, Justice Woods disagreed that the central management and control test was not appropriate to trusts simply because trustees are fiduciaries at law and so to adopt a “policy of masterly inactivity” would place them in breach of their fiduciary obligations. In her opinion, one cannot presume that trustees will always appropriately discharge their fiduciary obligations, and reference must be made to the particular facts of any situation.
While Justice Woods acknowledged that there are significant differences between the legal natures of a trust and a corporation, she concluded that corporations and trusts share similar characteristics, primarily the management of property. Further, adopting a similar test of residence for trusts and corporations would promote certainty, predictability and fairness in the application of tax law – a clear nod to the Supreme Court of Canada (SCC) decision in Canada Trustco.
Therefore Justice Woods concluded that one must determine where the central management and control of a trust actually abides. Applying this test, she ruled that the corporate trustee handled very little outside of routine administrative matters for the trust:
Based on the evidence as a whole, I find that St. Michael was selected by Mr. Dunin and Mr. Garron, or advisers acting on their behalf, to provide administrative services with respect to the Trusts. Its role was to execute documents as required, and to provide incidental administrative services. It was generally not expected that St. Michael would have responsibility for decision-making beyond that.
She also noted that the corporate trustee, as an “arm” of a major accounting firm, seemed to be established to provide complementary services to the core tax services offered by the accounting firm, rather than specializing in the management of trust assets. This failure to appoint a “well-recognized trust corporation with significant experience and expertise in managing trusts” seems to have led to the conclusion that one cannot presume that the trustee would act in the best interests of the beneficiaries in the discharge of its fiduciary responsibilities. Justice Woods also focused on a number of other facts:
- the purpose of the trusts, namely to avoid Canadian tax;
- the active role Mr. Dunin played in selling the shares owned by the trust;
- the active role played by the appellants and their personal advisers in developing the investment strategy of the trusts;
- the appellants’ ability to replace the corporate trustee (through the protector);
- the inability to provide documentation showing that the corporate trustee played an active role in managing the trusts;
- an internal memorandum setting out the intention of the corporate trustee (which indicated a more limited role than the trust indenture, notably that the corporate trustee would act in an administrative capacity with respect to the sale of the business and would not make distributions to the beneficiaries without the consent of the appellants); and
- the lack of credible witnesses actively involved in the management of the trusts at the relevant time.
Accordingly, Justice Woods concluded that the real decisions were ultimately made by the appellants in Canada. As the central management and control was exercised in Canada, the trusts were resident in Canada and ineligible to use the treaty to avoid Canadian income tax on the capital gains. Notably, even though Justice Woods concluded the appellants effectively managed the trusts, she did not go so far as to say that the trusts were never validly constituted.
The Minister had argued in the alternative that, if the test of central management and control was not the proper test in determining residency, the trusts would still be ineligible to use the treaty because they would be deemed resident under section 94 of the Act. Section 94 deems a non-resident trust to be a resident of Canada for purposes of Part 1 of the Act where, generally, property is transferred directly or indirectly to a non-resident trust by a Canadian resident who is related to the beneficiary of the trust.
The issue was whether the appellants had transferred property “directly or indirectly in any manner whatever” to the trusts. Mr. Garron argued that the trust subscribed to shares of a holding company and had not received the shares of the holding company from him.
Mr. Dunin’s circumstances were slightly different as he owned the shares directly before transferring the shares into a holding company as part of the reorganization. He argued that, although he transferred the shares to the holding company, which, in turn, issued shares to the trust, the transactions were separate and did not constitute an indirect transfer under paragraph 94(1)(b).
Justice Woods reviewed Romkey and Kieboom and concluded that the reorganization did involve a transfer of property as the 1998 reorganization resulted in a “movement of share rights.” However, she also concluded that neither of the appellants had directly or indirectly transferred property to the trusts. In Mr. Garron’s case, she concluded he merely participated as a shareholder of his holding company. With respect to Mr. Dunin, she stated that “directly or indirectly in any manner whatever” is highly ambiguous and that it was not clear whether Parliament intended this phrase to apply only to the manner in which the transfer is effected or to indirect shareholdings as well. In her opinion, having to look through all transfers and levels of corporations would result in much uncertainty and ambiguity:
I am particularly troubled by the uncertainty that is inherent in the Minister’s position. Determining ownership of property through a chain of corporations is a murky exercise with unclear results. Should one look through more than a first tier subsidiary? Should one look through a corporation that is not wholly owned? Should one look through if the shares are non-voting?
The number of persons that could potentially be caught under a broad reading of “directly or indirectly” could not have been what Parliament intended; therefore, she concluded that “directly or indirectly” should be read narrowly.
Justice Woods also commented on whether a trust deemed resident under section 94 of the Act would be considered to be a resident for treaty purposes. Section 94 subjects trusts to taxation on a formula or source basis whereas a resident of Canada is subject to taxation on their worldwide income. Justice Woods concluded that the drafters of the treaty did not intend to include as “residents” persons subject to taxation on a more limited scope than persons subject to taxation under general principles. The Minister’s position was also determined to be inconsistent with the approach taken by the SCC in Crown Forest. Therefore, the fact that section 94 deemed a trust to be resident in Canada did not result in the trust being a resident for treaty purposes.
Taxation of Canadian residents
In the event that the trusts were not found to be residents of Canada, the Minister made two alternative arguments seeking to tax the gains in the hands of the appellants directly.
The first argument was that the attribution rules under subsection 75(2) of the Act applied. Subsection 75(2) states that where property is transferred, directly or indirectly to a trust, and that property can revert back to the transferor, the capital gains and losses arising from the property are taxable in the transferor’s hands so long as the transferor is alive or resident in Canada.
The appellants again argued that the transfer was not from them but rather from their holding companies. Justice Woods agreed, but also went on to comment that attribution under subsection 75(2) would frustrate one of the primary objectives of the treaty, the avoidance of double taxation, because Article XIV(4) of the treaty clearly reserved to Barbados the right to tax capital gains of trusts resident there. If it was intended that Canada be allowed to tax in these circumstances, such right should be included in Article XXX(2), similar to the override provision of the treaty to allow for the taxation of FAPI earned by non-resident corporations.
The second argument raised by the Minister was that the trusts received an unreasonable portion of the proceeds from the sale of the companies and that a portion should be reallocated to the appellants and the other Canadian residents under section 68 of the Act. The Minister’s position was that the fair market value of the common shares exchanged for the preferred shares in the reorganization was substantially higher than the value assigned to them by the appellants. Justice Woods agreed with the Minister that the common shares were worth substantially more. However, in light of her conclusion on the other issues, Justice Woods declined to make further comments on this point.
Lastly, the Minister argued that the transactions were subject to the GAAR. In accordance with Canada Trustco, the GAAR requires a three-step analysis: there must be a tax benefit; the identification of an avoidance transaction; and a finding of misuse and abuse of the legislative provisions.
As both sides agreed that a tax benefit and avoidance transaction occurred, Justice Woods only considered whether there was a misuse or abuse of legislative provisions or the treaty. The Minister argued that the 1998 reorganization was undertaken solely to minimize Canadian income taxation; in particular, the transactions were undertaken to avoid the application of section 94 and subsection 75(2) of the Act, and that it was an abuse of the treaty to avoid section 94.
With respect to subsection 75(2), the Minister had failed to raise this argument in pleadings and therefore Justice Woods refused to consider it. With respect to section 94, she commented that in accordance with Canada Trustco, the onus was on the Minister to identify an object, spirit or purpose of provisions that are misused or abused. However, she concluded that the mere fact that a transaction is subject to tax under an anti-avoidance provision of the Act, but is relieved by a treaty, does not necessarily result in a misuse or abuse for the purposes of the GAAR. In support of her conclusion, Justice Woods noted that commentary to the OECD Model Tax Convention suggests that countries should adopt language in their bilateral tax treaties to preserve the application of domestic tax avoidance legislation and that Canada had adopted the commentary at the time that the treaty was signed. For the above reasons, the transactions did not constitute an abuse or misuse of the treaty and the GAAR did not apply.
In 1998, Mr. Antle, a Canadian resident, and his business partner, purchased common shares in a private Canadian corporation, through a holding company, PM Environmental Holdings Ltd (PM), from another company, Stratos Global Corporation (Stratos). Under the terms of the purchase and sale agreement, Stratos received preferred shares, debt and a right to a share in the profits in the event of a future sale of the company. In 1999, Mr. Antle and his business partner agreed to sell their PM shares to a third party.
On the advice of his tax advisers, Mr. Antle decided to implement a tax planning strategy to avoid paying Canadian income tax on the accumulated gain on the sale of his PM shares. He settled a qualifying spousal trust for the benefit of his wife, selecting a trustee resident in Barbados. He then gifted the PM shares to the trust, a transaction that occurred on a tax-deferred “rollover” basis. The trust then sold the shares to Mrs. Antle at fair market value, and she completed the transaction with the purchase. Shortly thereafter the trust was wound-up. As a result, the cost base of the shares was stepped-up to fair market value prior to the ultimate sale so no capital gains would be taxable in Canada. Further, no tax was payable by the trust in Barbados.
During the sale transaction Stratos invoked the profit sharing clause which resulted in a portion of the proceeds realized on the sale of the PM shares being paid to Stratos. Following the closing of the sale, and the implementation of the trust, Mr. Antle successfully sued Stratos for the return of the consideration paid. This fact was found important to the analysis, as discussed below.
The Minister reassessed Mr. Antle to include in his income the taxable capital gain arising from the sale of the PM shares, arguing that the trust was not validly constituted or, if found to be validly constituted, was a sham, and that the requirements of subsection 73(1) of the Act were not met.
In the alternative, the Minister took the position that the taxable capital gain should be included in the trust’s income, on the basis that it was a resident of Canada. The Minister, as in Garron, relied on paragraph 94(1)(c) of the Act.
Lastly, the Minister invoked the GAAR in respect of the transactions.
Validity of trust
Justice Miller examined the requirements necessary for a valid trust. To establish a valid trust, the “three certainties” must be present, namely: certainty of intention; certainty of subject matter; and certainty of objects. In addition, there must be a transfer of property to effectively constitute a trust.
With respect to the certainty of intention, Justice Miller concluded that Mr. Antle never intended to settle a trust. In assessing whether the intention to create a trust was present, Justice Miller held that it was proper to look beyond the trust deed to take into account all relevant facts, including the actions of the parties. Justice Miller reached the “inevitable conclusion” that Mr. Antle “did not truly intend to settle shares in trust…He simply signed documents on the advice of his professional advisors with the expectation that the result would avoid tax in Canada” and “[H]e knew when he purported to settle the Trust that nothing could or would derail the steps in the strategy. This is not indicative of an intention to settle a discretionary trust.”
Certainty of subject matter was also found to be absent, on the basis that the retained right to receive the disputed amount from Stratos suggested that there was some element of Mr. Antle’s ownership of the PM shares that did not pass to the trustee.
Justice Miller noted many inconsistencies and inaccuracies in the documentation and mechanics of the transactions and concluded that title to the shares was never effectively transferred as the entire purported sequence of steps was “only a shell with no legal significance.”
Because the certainties of intention and subject matter were not satisfied and no property (in the form of the PM shares) was transferred, Justice Miller concluded that the trust never validly came into existence. His concluding comments illustrate the importance of proper execution to any planning strategy:
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.
Was the trust a sham?
Given that Justice Miller concluded that the trust was not validly constituted, it was not necessary for him to rule whether or not the trust was a sham; however, he did make a number of noteworthy comments.
Under Canadian law, a “sham” transaction requires an element of deceit as manifested by a misrepresentation to a third party of the actual transaction that took place. In particular, with respect to trusts, both the settlor and the trustee must be parties to the sham. While Justice Miller concluded that Mr. Antle never intended to settle a discretionary trust, and despite the limited role played by the trustee, he was not comfortable in finding that the requisite level of intentional deceit was shared by both to constitute a sham transaction. Thus, Antle suggests that quite a high standard of intentional deceit will be required in order to conclude that a transaction is a sham.
In the alternative, Justice Miller held that if his conclusion on the validity of the trust was incorrect, the transactions were subject to the GAAR. As in Garron, both parties agreed that there were tax benefits resulting from the transactions.
With respect to whether there was an avoidance transaction, Mr. Antle argued that only the settlement of the trust in Barbados was an avoidance transaction and that it was undertaken solely to take advantage of Article XIV(4) of the treaty. However, Justice Miller quickly dismissed this argument, noting, in accordance with Canada Trustco, that even if one transaction in a series is an avoidance transaction, then the resulting tax benefits may be denied under the GAAR.
Thus, the focus of Justice Miller’s GAAR ruling was on whether the transaction was abusive. In accordance with Canada Trustco, this required the identification of the object, spirit and purpose of the relevant legislative provisions. Justice Miller concluded that the relevant legislative provisions were the spousal rollover rule in section 73, paragraphs 94(1)(c) and 110(1)(f), the attribution rules in sections 74.1 to 74.5 of the Act and Article XIV(4) of the treaty.
With respect to sections 73 and 74.1 to 74.5, Justice Miller found that they needed to be read together, and a contextual analysis suggested that subsection 73(1) recognizes the economic mutuality between spouses by allowing tax to be deferred on transfers of property between them until such time as the property is disposed of to a third party. However, these provisions were never intended to allow the marital unit to escape taxation altogether, and this objective is accomplished by sections 74.1 to 74.5 of the Act, which attribute any gain realized on the ultimate disposition by the transferee spouse back to the transferor. Further, the use of a spousal trust does not inherently frustrate this purpose: if the taxable gain is designated by the trust to be taxed in the hands of the beneficiary, the attribution rules apply; if not, the trust pays tax on the capital gain. In either case, the deferral is ended and the gain is subject to Canadian income tax.
Justice Miller further concluded that the marital unit tax regime was intended to apply to paragraph 94(1)(c) of the Act. Since it was clear that the tax deferral ended when property was disposed of to a third party, whether or not a spousal trust is used, it could not have been intended to allow Canadian taxation to be avoided all together through the use of a non-resident spousal trust.
Justice Miller then concluded that Article XIV(4) of the treaty was clearly intended to exempt capital gains realized by residents of Barbados, including trusts, from Canadian income taxation. However, in his opinion, Article XIV(4) did not preclude Canada from taxing a Canadian resident in the circumstances where that individual has arranged to shift the gain to a Barbados trust:
The 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.
As in Garron, the appellant argued that because the treaty contained no specific clause reserving to Canada the right to tax deemed resident trusts under section 94, as it did with respect to section 91 and the FAPI regime, there must be an implied policy not to subject Barbados trusts indirectly to Canadian taxation. In contrast to Justice Woods, Justice Miller dismissed this argument, stating simply that, at best, Article XXX(2) of the treaty clarifies that the treaty does not affect Canada’s FAPI regime.
Mr. Antle also argued that because there is no limitation of benefits article in the treaty, it was inappropriate to read one into the treaty through the application of the GAAR. Again, Justice Miller dismissed this argument saying that the absence of a limitation of benefits clause sheds no light as to the object, spirit and purpose of Article XIV and its relationship with relevant legislative provisions of the Act.
Lastly, Justice Miller considered the overall result of the transaction. In Lipson, the SCC held that the overall result of a transaction may be taken into account in determining whether a transaction is abusive. In this case, the overall effect was that Mr. Antle avoided Canadian taxation on the capital gains arising on the sale of the PM shares. In Justice Miller’s opinion, this result was blatantly abusive and a textbook example of where the GAAR should apply:
I disagree with the Appellant that nothing in the text, context or purpose of sections 73 and 94 or Article XIV(4) suggests setting up a Spousal Trust to transfer wealth to one spouse is abusive. Quite the contrary – everything suggests it is abusive….
The Income Tax Act and the Canada-Barbados Treaty contemplate payment by Canadian residents of Canadian income tax on the gain arising on the sale of property held by the Canadian marital unit. They do not contemplate, figuratively, running property through Barbados and returning it to the Canadian marital unit for the sole purpose of escaping that Canadian payment of tax. It is an abuse of the Act, of the Treaty and of the joint operation of both.
Was the trust resident in Canada for treaty purposes?
On the application of paragraph 94(1)(c), Justice Miller agreed with Justice Woods in Garron, that a trust deemed resident in Canada by paragraph 94(1)(c) is not a resident for treaty purposes as a resident for treaty purposes must be subject to tax on worldwide income.
Implications of Garron and Antle
The decisions in Garron and Antle have very important implications for taxpayers and their advisers, notably in relation to the use of trusts and the interaction of tax treaties and the Act. It is too early to know, but we anticipate that the Garron decision may be appealed in light of the amounts involved and the complexity of the issues at hand.
The fact that the trustee was determined to have little independent decision-making authority and that other persons exercised considerable influence over the management of the trust was critical to the conclusions reached in Garron. The inattention to matters of execution and legal substance was fatal in Antle. It is clear from both decisions that the actual conduct and intention of the parties will be taken into account and not simply the trust agreement and related transaction documentation.
Both decisions are heavily fact dependent. It remains to be seen how the central management and control test will be applied in other scenarios. For example, many trusts may only hold shares of an investment holding corporation. What level of active management and control is realistic to expect when that is the only asset of the trust? Did it matter in Garron that the trustee was a corporation and might a different conclusion have been reached with compelling testimony from an individual trustee?
These decisions appear to strengthen the CRA’s position in relation not only to offshore but also interprovincial trust arrangements. Garron suggests that, depending upon the facts, a trust may be resident in the jurisdiction in which the contributor or beneficiary resides, on the basis that that central management and control does not in fact rest with the trustee. Further along the spectrum, Antle is authority that in more questionable situations, the degree of control exercised by the beneficiary or settlor may be a factor that is inconsistent with the very existence of the trust.
Garron is also arguably consistent with the approach adopted by the CRA in determining the residency of trusts with corporate trustees (i.e., trust companies).
The decisions in Antle and Garron are also important for comments relating to the GAAR. Justices Woods and Miller reached different conclusions as to whether reliance on a Treaty provision to avoid the application of an anti-avoidance provision of the Act was inherently abusive. A factor for the difference in their GAAR conclusions might have been the manner in which taxation of capital gains was avoided. In Antle, the appellant tried to avoid subjecting to Canadian tax the full gain resulting from the sale. In Garron, the avoidance was limited to the increase in value of the shares from the date of the reorganization to the date of sale.
The decisions are also significant in that both Justices concluded that a trust deemed resident under section 94 of the Act is not considered resident of Canada for treaty purposes, and, as such, is not precluded from invoking the benefits of a treaty. This is a significant blow to the CRA and raises further doubt as to the effectiveness of the long-standing proposed amendments to section 94.
Transfers of property – Directly or indirectly
In Garron, Justice Woods’ interpretation that the phrase “directly or indirectly” (which appears throughout the Act) is to be applied in a narrow manner is a pragmatic approach that provides greater comfort for various tax planning strategies that could otherwise be considered to involve an indirect transfer of assets. Previous decisions have generally interpreted “directly or indirectly” to look at the substance of the transaction.
 In paragraph 7 of Interpretation Bulletin IT-477 “Residence of Trusts” it is noted that
Where a corporation exercises the management and control of a trust, the residence of that corporation is determined based on the normal factual tests for determining residence of a corporation. An exception to the general rule may be encountered where the management and control of a trust is exercised by a branch office, for example, a branch of a trust company. In these circumstances, the trust may be determined resident in the jurisdiction where the branch office is located even though the corporation itself is resident outside that jurisdiction.
 One might reasonably conclude – particularly in light of the comments of Justice Miller − that Antle was simply viewed as far more abusive. Indeed, the facts in Antle combine two elements, each of which was independently considered problematic in earlier GAAR jurisprudence: the avoidance of taxation on accrued capital gains (OGT Holdings Ltd., 2009 CarswellQue 527 (Que.CA); and abuse of the interspousal rollover provisions (Lipson, supra).
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