Garron Family Trust v. The Queen

The Canadian Government taxes trusts resident in Canada. How can you tell where a trust is resident? Sometimes it is easy, but sometimes it is not.

The Tax Court of Canada released a significant decision concerning the residence of a trust in September. The case is Garron Family Trust v. The Queen, 2009 TCC 450. This case involves some fairly complex tax, estate and corporate planning. I will simplify it a bit to summarize the decision.

Myron Garron and Andrew Dunin built a very successful business manufacturing components for motor vehicles. They and other family members held interests either directly or through a holding company in a company called PMPL Holdings Inc. (which I will refer to as PMPL). PMPL, in turn, held shares in companies engaged in the active business.

In 1998, Mr. Garron and Mr. Dunin arranged for PMPL to be restructured. They received business valuation advice that the shares of PMPL were worth $50,000,000. These shares were exchanged for other new preferred shares that had a fixed value of $50,000,000 (they could be redeemed by PMPL for that amount). New common shares were then issued to two new holding companies, both incorporated in Ontario. The new common shares were arguably not worth much when they were issued, because all of PMPL’s value at the time was in the preferred shares (worth $50,000,000). But, the new common shares owned by the newly incorporated holding companies would increase in value with any increase in PMPL’s value. In other words, the common shares were growth shares. The preferred shares were frozen shares.

The shares of each of the new holding companies were owned by a trust. One trust, called Fundy, owned the shares of one new holding company. The other trust, called Summersby, owned the shares of the other new holding company. The beneficiaries of Summersby are Mr. Dunin, his wife, children and other descendants. The beneficiaries of Fundy are Mr. Garron, his wife, children and other descendants.

The trustee of each of the trusts is St. Michael Trust Corp., which is a company incorporated in Barbados. The shares of St. Michael Trust Corp. were initially owned by an accounting firm in Barbados.

In 2000, the trusts sold their shares in the new holding companies as part of a sale of PMPL and its subsidiary business to a New York firm, Oak Hill Capital Partners, L.P. The sale was for over $500,000,000. On the sale of the new holding companies’ shares, the shares increased in value by something in the neighbourhood of $450,000,000.

I am not sure how much federal and provincial income tax you would pay on a capital gain of $450,000,000 in Canada. It is not something with which I have ever had to concern myself. It would depend in part on what province you were in. I imagine the tax would be in the range of $90,000,000 to $100,000,000 or thereabouts, but I will let an accountant figure that out.

Whatever the amount of capital gains tax payable, Her Majesty the Queen took an interest in receiving those taxes for Canada. Well, at least Canada Revenue Agency did anyway.

But you will recall that the trustee of each of these two trusts was a corporation in Barbados. Canada and Barbados have a tax treaty. It has the title of “Agreement Between Canada and Barbados for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital.” I think I might just call it the Tax Treaty.

The Tax Treaty provided that each country would only tax its own residents on capital gains on the sale of assets (with some exceptions). The trustee and ultimately the beneficiaries of each trust would prefer that the gain on the sale of the shares be taxed by Barbados than by Canada. This is because apparently Barbados doesn’t tax capital gains on the sale of shares.

The trustee of both trusts argued that because the trustee was a corporation resident in Barbados, the trusts were residents of Barbados. Therefore, under the Tax Treaty, Canada had agreed not to tax the trusts. The trustee found support in its position from an earlier Tax Court of Canada decision Thibodeau Family Trust v. The Queen, 78 DTC 6376, in which the Court held that the residence of the trust for tax purposes was the place where the majority of the trustees were resident.

But Canada Revenue Agency begged to differ. It argued that the real management and control of the trusts were in Canada, rather than Barbados.

In order to decide the case, Judge Woods first considered the tests for determining residency of a trust in respect of the Income Tax Act. She held that the appropriate test was similar to the test for determining the residency of a corporation: where is the central management and control of the trust. She rejected the argument that the residency of the trustee by itself determined the residence of the trust.

Judge Woods based her decision on a number of factors, which she found indicated that the central management and control of the trusts was Canada, rather than Barbados. She found that the role of the trustee was to sign legal documents for the trust and provide some administrative services, rather than to make important decision for the trust. The facts she considered include the following:

1. The terms of each trust provided for a protector, who had the power to remove and replace the trustee of the trust. Mr. Dunin and his wife, in turn, had the power to remove the protector of the Summersby trust, while Mr. Garron and his wife had the power to remove the protector of the Fundy trust. Indirectly, each family had the ability to remove the trustee of its trust.

2. The trustee’s internal memorandum indicated that the trustee expected to play a limited role in the trusts transactions and defer to Mr. Dunin and Mr. Garron.

3. The trustee appeared to have a limited role in making investment decisions. The trustee used Mr. Dunin’s and Mr. Garron’s advisors. The investment advisors in turn were given discretion in making investments by the trustee, allowing the investment advisors to take direction from Mr. Dunin and Mr. Garron.

4. Judge Woods found that there was little documentation indicating that the trustee played a large role in managing the trusts. The documentation that was provided indicated that the trustee had a limited role.

5. The trustee was at the time of the sale of the shares owned by an accounting firm, and did not have specialized expertise in managing trusts.

The result is that the trusts will have to pay capitals taxes in Canada on the gains of approximately $450,000,000 on the sale of the shares of the holding companies.

Judge Woods appears to have based her decision on the totality of these and other factors, rather than on any one consideration alone. The decision demonstrates that if you want to set up an offshore trust to take advantage of tax laws in another country, the trustee will need to exercise real management and control of the trust. It can’t just look good on paper.

This case likely also applies to determinations of the residency of trusts within Canada. For example, there may be tax advantages to having a trust resident in Alberta rather than British Columbia or Ontario. If there is a dispute about whether a trust is resident in one province or another, the court could look at where the central management and control is exercised.

Interrogatories In the New B.C. Supreme Court Rules

As I wrote in an earlier post, the new rules of civil procedure in British Columbia will come into effect on July 1, 2010.

One of the changes will be to restrict the use of written interrogatories.

Under the old rules, Rule 29 allowed any party to serve written questions on another party to the lawsuit. The party asked to answer the interrogatories could object to specific questions, or bring an application to court to strike the interrogatories if they were “not necessary for disposing fairly of the action or that the costs of answering would be unreasonable….”

Under the new Rule 7-3, if a party wishes to examine another by written interrogatories he or she must first get the other party’s agreement or apply to court to allow the interrogatories.

This rule change is unfortunate, and will have the opposite effect of what is intended. Instead of reducing the costs of lawsuits, in many cases it will increase the costs.

I have used interrogatories frequently in Wills Variation Act cases, where the financial circumstances of the person making the claim and of the defendants is usually quite relevant to the case. By submitting questions concerning a party’s financial circumstances in writing, the other party has an opportunity to go through his or her records, and review the questions and answers with his or her lawyer, to make sure the responses are accurate. This is much more effective than asking the same questions during oral examinations, where the other party often does not know the answers off-the-top of his or her head.

Furthermore, as often as not, another party to a lawsuit lives in another part of Canada. It is not uncommon in Wills Variation Act cases for other parties to live all over the world. In some cases, written interrogatories can be an inexpensive substitute for paying for them to come to British Columbia to answer questions in oral examinations for discovery.

Under the new rules, if another party does not agree to answer interrogatories, you may be able to get a court order allowing interrogatories (especially when used to elicit information from someone who lives far away), but it is an extra step, which adds to the expense.

Fraudulent Conveyances - Do You Have to Prove Dishonesty?

A recent decision of the British Columbia Court of Appeal confirms that a creditor does not have to prove that a debtor acted dishonestly to set aside a conveyance as a fraudulent conveyance. It is sufficient for the creditor to prove that the debtor did so with intent to delay or hinder creditors, including future creditors.

William Botham was a shareholder and the principal of Botham Holdings Ltd, which held $20 million worth of real estate. After the company sold some of its real estate at a substantial profit, Mr. Botham decided to go into a joint venture car leasing business with a friend.

On the basis of legal and tax advice, Mr. Botham incorporated a new company, Braydon Investments Ltd., and through a series of transactions transferred Botham Holdings Ltd.’s assets to Braydon. Botham Holdings Ltd. went into the joint venture car leasing business. The reason Mr. Botham did not simply incorporate a new company for the car leasing business was that there were tax advantages in using Botham Holdings Ltd.

Unfortunately, the car leasing business failed. Botham Holdings Ltd. went bankrupt. The trustee in bankruptcy sought to set aside the transfer of assets to Braydon so that those assets would be available to the creditors of Botham Holdings Ltd.

The trustee in bankruptcy relied on section 1 of the British Columbia Fraudulent Conveyance Act, which says:

1 If made to delay, hinder or defraud creditors and others of their just and lawful remedies
(a) a disposition of property, by writing or otherwise,
(b) a bond,
(c) a proceeding, or
(d) an order
is void and of no effect against a person or the person's assignee or personal representative whose rights and obligations by collusion, guile, malice or fraud are or might be disturbed, hindered, delayed or defrauded, despite a pretence or other matter to the contrary.

Mr. Botham acknowledged that the assets were transferred out of Botham Holdings Ltd. to insulate them from creditors of the car leasing business. But he argued that there were legitimate business and tax planning purposes for the transactions.

At trial, in Abakhan & Associates Inc. v. Braydon Investments, 2008 BCSC 1547, Mr. Justice Kelleher found that Mr. Botham had not acted dishonestly. But the court held that the transfer of assets was a fraudulent conveyance and was of no effect against the trustee in bankruptcy.

Braydon Investments Ltd. appealed to the British Columbia Court of Appeal. The reasons for judgment are at 2009 BCCA 251.

Chief Justice Finch upheld Mr. Justice Kelleher's decision and dismissed the appeal. He held that it was sufficient if one of the reasons for the transactions were to delay or hinder creditors, including future creditors. The court found that the words “by collusion, guile, malice or fraud” in the Fraudulent Conveyance Act were meaningless. They were likely a holdover from when the Act had penal sanctions. These sanctions were held to be unconstitutional and have been repealed.

Although Mr. Botham could have incorporated a new company to carry out the joint venture car leasing business--in which case the assets of Botham Holdings Ltd. would have been insulated from creditors of the car leasing business—having chosen to use Botham Holdings Ltd. because of some tax advantages, he could not then transfer the assets to delay or hinder creditors.

The result is that the assets Botham Holdings Ltd. transferred to Braydon Investments Ltd. will be available to satisfy the claims of Botham Holdings Ltd.’s creditors.

My Last Wills and Estates Presentation of 2009

I am pleased to be a guest speaker at an estate planning seminar hosted by Shannon Jones, Wealth Advisor, of ScotiaMcLeod in Kelowna, on Monday November 30, 2009 from 5:00 pm to 6:30 pm.

We’ll discuss 3 key strategies that will put your mind at ease:
► Using trusts to lower taxes and protect your beneficiaries
► Minimizing administration costs to leave more in your estate
► Making sure your Executor knows what they are getting into.

The focus of my talk will be on using testamentary trusts both for asset protection for beneficiaries and for tax planning for beneficiaries.

Anyone who is interested in attending may RSVP by November 27, 2008, Shannon Jones at 250.868.5535 or 1.800.663.2609, or by email to shannon_jones@scotiamcleod.com.

Gould v. Royal Trust Corp. of Canada

One of the factors the Supreme Court of British Columbia may consider in a claim by a child to vary her parent's will is whether the parent has made other provision for her during the parent’s life.

In a recent case, Gould v. Royal Trust Corp. of Canada, 2009 BCSC 1528, Mr. Justice Pearlman refused to vary Silvia Gould’s will even though she made little provision in her will for her daughter, Barbara Gould.

In her will, Silvia Gould left some silver, jewelry, paintings and personal effects to her daughter, but left the residue of her estate, worth a net amount of approximately $900,000, to her three sons. She provided her reasons for not leaving anything in her will to her daughter. She and her daughter were at the time she made the will, joint tenants on a recreational property in Ontario. Barbara Gould would receive the property by right-of-survivorship on Silvia Gould’s death. Silvia Gould wrote in her will that Barbara Gould would receive a roughly equal inheritance to each of her brothers.

Before Silvia Gould died she had transferred her interest in the vacation property to her daughter as a gift. At trial the property was worth $210,000 according to an appraisal.

Mr. Justice Pearlman held that Silvia Gould’s reasons for leaving the residue of her estate to her three sons—that her daughter would receive the vacation property—were rational and valid. In light of the gift of the vacation property to her daughter, Silvia Gould’s dispositions in her will “falls within the range of acceptable dispositions made by a judicious parent in the fulfillment of her moral obligation to the plaintiff as one of the four adult children.” Mr. Justice Pearlman then wrote: “Because I am satisfied that the testatrix [Silvia Gould] made just, adequate and equitable provision for the plaintiff and met her moral claim, the testamentary autonomy of the testatrix is entitled to deference.”

Barbara Gould was, however, entitled to an award of $75,000 for her expenses and the care she provided her mother during the last few years of her mother’s life. Mr. Justice Pearlman awarded the $75,000 for unjust enrichment.

Silvia Gould’s three sons opposed the claim for unjust enrichment in part because Barbara Gould had removed their mother from British Columbia to Guatemala at a time when their mother had dementia, and did not have capacity to consent. She did so without telling her brothers, and despite the fact that her mother had made one of her brothers her representative under a representation agreement.

Although Mr. Justice Pearlman was critical of Barbara Gould’s conduct, he found that she did spend funds on her mother, and took good care of her. She had a reasonable expectation that her mother’s resources would be used for her expenses. Her mother would have had to incur similar expenses if she had remained in British Columbia.

Accordingly Mr. Justice Pearlman found that Barbara Gould had met the criteria for proving unjust enrichment.

The Prescribed Affidavit of Executor in B.C. is Outdated

In British Columbia, one of the forms required in an application for probate of a will, or letters of administration, is an affidavit of executor, with a schedule of the deceased’s assets, liabilities and distribution. This schedule is often referred to as the “disclosure document.”

The form of affidavit required is set out as Form 69, in Appendix A, of the Supreme Court Rules.

The disclosure document requires the executor to state whether an asset is “within” or “without” British Columbia. This is not always as straightforward as it may seem. It is pretty easy to tell if certain kinds of assets such as land are within British Columbia. But it is much more complex to determine if other kinds of assets, such as financial investments, are within British Columbia.

You can distinguish between physical assets, or “tangible assets,” such as cars and tables, from “intangible assets,” such as bank accounts, shares in corporations, and mutual funds. If the deceased owned mutual funds that are made up of securities of companies located all over the world, where are the funds located?

In law, how do you determine whether intangible assets are within or without British Columbia? This question was answered in respect of securities by Mr. Justice Ehrck, in Re: The Estate of Bessie Bloom, 2004 BCSC 70. The securities are situated in the place where “the financial investment intermediary on whose books the interest of the deceased is recorded and where her personal representative must go to effect the transmission.”

To set out whether an intangible asset is within or without British Columbia, the executor will often have to make inquiries of financial institutions to determine where the deceased’s interest is recorded.

What is the point of requiring an executor to say whether an intangible asset is within or without British Columbia? None.

The Probate Fee Act used to provide that British Columbia probate fees were calculated on assets situated in British Columbia (but not on the value of assets situated outside of British Columbia). Accordingly, it made sense to require executors to disclose whether an assets was within or without of B.C. so that the probate fees would be calculated only on assets within British Columbia.

But the effect of the decision in Re: Bloom was to significantly reduce the probate fees the government collected. Many British Columbians hold investments through financial institutions that keep their books recording the interests of their customers in Toronto or other cities outside of British Columbia.

So the Provincial Government amended the wording of the Probate Fee Act so that probate fees were payable in respect of all “intangible personal property of the deceased, wherever situated,” if the deceased was ordinarily resident in British Columbia immediately before death. This was done by amending the definition of “value of the estate” in section 1. (The constitutionality of taxing assets outside of British Columbia is open to doubt, but it has not as yet been challenged.)

Accordingly, now that the probate fees apply to intangible assets of British Columbia residents, irrespective of the location of those assets, there is no point in making the executor find out and disclose whether those assets are within or without B.C.

But in its haste to protect its tax base, the British Columbia did not amend the prescribed form of the disclosure document so that it is in keeping with the information required to calculate the probate fees. I note that new Supreme Court Civil Rules that will come into affect on July 1, 2010, keep the outdated form of disclosure document (Appendix A, Form 91). In fairness, the reform of the Supreme Court Rules was directed toward law suits, rather than estates. The British Columbia Law Institute has a Probate Rules Revision Project. I hope it will look at this issue.

The probate forms could be amended to require the applicant to state whether to the best of his or her knowledge the deceased was “ordinarily resident” in British Columbia immediately before death. The disclosure document would then deal with intangible assets separate from tangible assets. The applicant would disclose whether each of the tangible assets is within or without B.C., but would not be required to state the location of intangible assets.

San Francisco Hall of Justice

I took these photographs of the Hall of Justice in San Francisco during my summer trip with my sons. In addition to housing court rooms, a jail and police station, the Hall of Justice has appeared in my favourite movies.