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.

[Since I wrote this post, both the Federal Court of Appeal and the Supreme Court of Canada have upheld Judge Woods's decision. See my post on the Supreme Court of Canada decision here.]