Last month, the Supreme Court of Canada released its decision in Garron Family Trust v. The Queen (also known as St. Michael Trust Corp. or the Fundy Settlement). The Supreme Court of Canada upheld the decisions of both the Tax Court of Canada and the Federal Court of Appeal that held the residency of the trust is to be determined on the basis of where “its real business is carried on.” Or, in other words, the residency of a trust is where the “central management and control” of the trust is truly exercised.
What is commonly referred to as the “central management and control” test originated in a House of Lords decision in England in 1906. Lord Loreburn iterated the test as follows:
- In applying the conception of residence to a company, we ought, I think, to proceed as nearly as we can upon the analogy of an individual. A company cannot eat or sleep, but it can keep house and do business. We ought, therefore, to see where it really keeps house and does business. … [A] company resides for purposes of income tax where its real business is carried on. … I regard that as the true rule, and the real business is carried on where the central management and control actually abides.
This test has been used in Canada for decades in order to determine the residency of a corporation. Generally, under Canadian law, wherever the board of directors of a corporation exercises its responsibilities is where the central management and control is exercised. However, the Courts have also found that the central management and control can be located where a shareholder resides, if that shareholder is in fact making the decisions of the corporation. The “central management and control” test, therefore, gets to the heart of who is really making the decisions and where those decisions are being made.
Until the Garron case, the residency of a trust was generally determined on the basis of where the trustee resided, or where a majority of the trustees resided if there were more than one. This made it relatively straightforward to know where a trust would be located and, from an income tax perspective, allowed for tax planning to be done with some degree of certainty based on the residency of the trustee.
Garron has resulted in a decisive shift from the “residency of the trustee” test to the “central management and control” test. In this case, two corporations reorganized their shareholdings so that significant value was held by two trusts (the trustee was the same for both trusts). The trusts then proceeded to sell their shares of the corporations.
Because the trustee of the two trusts was resident in Barbados, the trustee took the position that the trusts were resident in Barbados and therefore that the tax treaty between Canada and Barbados applied. Based on this position, the trustee argued that capital gains tax of approximately $152 million did not apply to the sale of the shares.
The Canadian Minister of National Revenue, on the other hand, took the position that while the trustee was indeed resident in Barbados, it was really the Canadian beneficiaries of the trust who were making the decisions on behalf of the trusts. The Tax Court of Canada agreed with this position, and found as a fact that the central management and control of the trusts was exercised by the Canadian beneficiaries.
Both the Tax Court of Canada and the Federal Court of Appeal considered which test was the proper test to apply in determining residency of a trust – the “residence of the trustee” test or the “central management and control” test – and held that the “central management and control” test should apply.
The Supreme Court of Canada upheld these decisions. In doing so it noted that, while a trust is different from a corporation, there were sufficient similarities between the two to justify applying the corporate “central management and control” test to trusts.
The change in the legal test for determining trust residency for income tax purposes is significant. Now, if trying to establish residency of a trust in a certain jurisdiction, it is more important than ever to ensure that the trust is actually managed in that jurisdiction, that the trustee – not the beneficiaries – is making the decisions on behalf of the trust, and that there are good records are kept.
For more information on related matters, contact Melodie Lind who is part of our Tax Law Group at: [email protected] or (250) 869-1210
