Watch out for residence of trusts

The SCC’s ruling affects estate planning across provincial borders and the use of strategies such as the Alberta-resident trust, in which the taxpayer has established a trust in Alberta to take advantage of that province’s lower tax rates.

“There are ongoing audits now of Alberta trusts alleging that control is asserted from some other jurisdiction,” says tax lawyer James Murdoch of Toronto, whose firm,

Thorsteinssons LLP, had represented taxpayers in the SCC case generally known as either Fundy Settlement or Garron.

“It’s going to be an issue for any trust in Canada where you have cross-provincial boundary issues,” he says.

The Fundy Settlement case dealt with two Ontario residents who were co-owners in a highly successful automotive parts manufacturing firm. A few years before selling the firm, the co-owners had set up family trusts in Barbados. The beneficiaries of those trusts, which held shares in the firm, were family members. The autoparts company then was sold, resulting in more than $450 million in capital gains. Capital gains taxes were withheld and remitted by the purchaser to the Canadian government. The Barbados trustees filed income tax returns and sought to have that money refunded, claiming exemption under the tax treaty between Barbados and Canada. (Barbados taxes income but not capital gains.)

The SCC, however, sided with the lower courts and upheld the initial ruling from the Tax Court of Canada (TCC), which concluded that the trusts were not resident in Barbados because the main beneficiaries lived in Canada and had exercised central management and control of the trusts. The trustees, which were located in Barbados, had merely carried out administrative functions and, the TCC stated, “little or no responsibility beyond that.”

The Federal Court of Appeal agreed, and so did the SCC, whose decision adds: “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.”

Tax experts say the SCC ruling means trust structures must be reviewed to ensure that central management and control takes place in the province (or country, for offshore trusts) in which the trustee is located.

Says Jamie Golombek, managing director, tax and estate planning, in the private wealth-management division of Toronto-based Canadian Imperial Bank of Commerce: “You really have to pay attention, not just to the residence of the trustee [in order to] make sure you don’t fall into the [Fundy Settlement] trap.”

@page_break@ This means reviewing a wide range of actions to ensure that trustees exercise central management and control within the proper jurisdiction.

Murdoch says his law firm is “giving more concrete and specific advice to trustees on what steps they need to take to build their file to ensure that if there is ever a challenge to residency of the trust, they are able to demonstrate they were both in control and exercising control, and doing so in the jurisdiction in which the trustee resides and not receiving that control from another jurisdiction.”

So, trustees will have to do a better job of documenting their decision-making. It also means beneficiaries will have to back off. “Active oversight is fine,” Murdoch says, “but it’s not a decision-making role.”

In addition, Murdoch says, “immigrant trusts” may also be ensnared by the SCC ruling. Wealthy immigrants moving to Canada legally are allowed to set up a trust to shield taxes on foreign assets for a specified period of time. “It means,” he says, “that immigrants will have to relinquish control, for the most part, of the trust funds.”

One of the first things trustees need to do, Golombek advises, is to make sure that all meetings involving the trust are held in the province in which the trustee is located, which, Golombek says, “makes it cleaner.”

Documentation is essential. Murdoch says the old days, in which “the less records, the better” are over; trustees should document everything, in the same way that corporations do. That means keeping records of all meetings and actions taken with respect to the trust assets. Murdoch recommends that trustees keep “the sort of minute book normally associated with a corporation.”

For instance, document when and where meetings take place, who attends and what decisions are made by the trustees.

In a paper Murdoch has prepared about the case, he identifies seven critical areas that trustees should discuss annually to assert control, including:

– Discussion and adoption of the investment policy.

– Discussion about the performance of investments in relation to the investment policy and asset diversification.

– Whether investments should be retained or sold.

– If voting shares in a company are held in the trust, then trustees should conduct a review of the company directors’ performance and discuss their re-election.

– Consideration of the beneficiaries’ circumstances and distribution decisions.

– Appointment of financial advisors, accountants, lawyers, bankers or other professionals and service providers.

– Review and approval of the financial statements.

Murdoch recommends that the beneficiaries, protectors of the trust and investment managers not be present at the meeting discussing trustee decisions related to those factors in order to diminish the argument that the trustee is not in control.

Trustees still can have regular meetings with the various parties involved in the trust, but it’s best that those meetings be held in the trustee’s jurisdiction or on “neutral” ground.

Some problems may lie ahead. For example, if one of the trustees lives in Ontario and one in Manitoba, in which place does the trust reside? As Murdoch says: “We don’t know the answer to that.”

© 2012 Investment Executive. All rights reserved.