Attribution rules do not apply to a trust beneficiary who has sold property at fair market value to the trust, according to a recent tax judgment.
The July decision from the Federal Court of Appeal also dealt with the question of double taxation in the context of tax treaties. That issue was also resolved in favour of the taxpayer, with the court holding that the relevant provisions of a tax treaty applied to protect the taxpayer, whether or not income was attributed back to the taxpayer.
The case dealt with significant capital gains generated by the efforts of Canadian/Austrian high-tech entrepreneur Peter Sommerer.
The CRA and offshore trusts, Investment Executive, Mid-October 2011
In 1996, Sommerer’s father, an Austrian citizen and resident, created a private foundation, using the father’s own funds. These foundations enjoy certain tax advantages. Sommerer (the son) and his wife, both Canadian residents, were potential beneficiaries, upon satisfying certain conditions.
Sommerer subsequently sold various shares in high-tech interests to the foundation for fair market value. The shares rocketed in value during the high-tech bubble and were sold, among others, to Nokia and Nortel for large gains.
The Canada Revenue Agency subsequently assessed Sommerer under s. 75(2) of the Income Tax Act. That section is designed to prevent taxpayers from giving (settling) property to a trust of which they are the beneficiaries or which they control. The CRA alleged that the gains realized by the foundation (which it argued should be treated like a trust), should be attributed back to Sommerer and taxed in his hands as a Canadian resident.
The Tax Court of Canada disagreed. It held in a 2011 decision that, while the foundation could be considered a trust, 75(2) did not apply because that rule applies only to settlors, and the settlor of the trust was Sommerer’s father.
The Tax Court further held that even if s. 75(2) did apply, the provisions of the Canada-Austria Income Tax Convention applied. That treaty states that gains would be taxable only in the country in which the seller (the Austrian foundation) was resident. Such provisions are designed to avoid double taxation by preventing more than one jurisdiction from imposing tax on the same income.
On appeal, the Federal Court of Appeal also found for Sommerer, but added more reasons. In holding that s.75 (2) did not apply, the judgment says that the Crown’s position was “based on the incorrect premise that subsection 75(2) can apply to a beneficiary of a trust who transfers property to the trust by means of a genuine sale.”
The appeal court also held that the tax treaty would have applied to protect Sommerer, even in the event that s. 75(2) had applied. That was because the treaty’s relevant provisions make no mention of tax liability that arises because of attribution, while other provisions of the same treaty do refer to attributed income.