Prior to this case, it was widely believed that the residence of a trust was determined by reference to the residence of its trustee. This conventional wisdom had been challenged by the Minister of National Revenue in its assessment of the Fundy Settlement.

The lower courts agreed with the Minister that the appropriate test was not the residence of the trustee, but the corporate “central management and control” test (CMC test). In a terse 19 paragraph decision, the SCC agreed with the courts below.

The facts of the case are complex, but at its core the case was about a trust that had a Barbados-resident trust company as its trustee and Canadian-resident individuals as the beneficiaries. When the trust disposed of shares of an Ontario corporation, it remitted withholding tax to the Minister of National Revenue on account of the capital gain realized by the trust. The trust then sought to obtain a refund of the Canadian withholding tax on the grounds that the trust was resident in Barbados and, thus, exempt from Canadian capital gains tax under the Canada-Barbados Tax Treaty.

The Minister challenged this position, asserting that the trust was resident in Canada because the role of the trustee was limited and the Canadian-resident beneficiaries were actually managing the trust.

The SCC concluded that, as with corporations, the residence of a trust should be determined by the principle that a trust resides where its real business is carried on, that is, where the central management and control of the trust actually takes place. In reaching its decision, the SCC concluded that corporations and trusts are similar because the function of both is the management of property, and that the application of the CMC test to trusts would promote consistency, predictability and fairness.

The SCC did not reject the possibility that the residence of a trust could coincide with the residence of its trustee, but only when the trustee carries out the function of centrally managing and controlling the trust in the trustee’s place of residence. In the case of the Fundy Settlement, it was found that the Canadian-resident beneficiaries were managing the trust with the result that the trust was resident in Canada.

The decision will raise many questions for tax practitioners going forward. What types of activities will qualify as comprising the “central management and control” of a trust? Will beneficiaries be able to make recommendations to the trustee without being seen to exercise control? Where will the line be drawn? What is certain is that the Canada Revenue Agency will be closely scrutinizing the residence of many trusts in an effort to determine the answers to these questions.

In Craig, the Federal Court of Appeal (FCA) followed its earlier decision in Gunn v. The Queen, 2006 FCA 281, in which the FCA moved away from the Moldowan articulation of the test and determined that the test is satisfied where the taxpayer’s farming business has potential profit and the taxpayer has invested significant time and capital into the business. The FCA supported its decision on the basis that taxpayers ought to be able to rely on the words of the Income Tax Act (ITA) and those words should not be eroded by judge-made rules without statutory foundation.

At the SCC hearing, the Crown argued that the legal doctrine of stare decisis was wrongly applied by the FCA and that, based on that doctrine, the Moldowan case ought to have been determinative of the matter in the Crown’s favour.

During the hearing, Justice Abella and Justice Rothstein challenged the Crown’s reliance on stare decisis making the point that the SCC is the appropriate venue for revisiting legal principles and that it is appropriate for the lower courts to indicate a concern with precedent since that is the only way that such concerns may be brought to the attention of the SCC.

The resulting challenge for the SCC will be to interpret the ITA to make sense of the statutory language while at the same time promoting certainty and fairness for taxpayers.

The SCC reserved its decision.

Warren Mitchell, Michael O’Keefe, Paul Gibney, David Thompson, Ian Gamble, and Michael Colborne.

In this publication, sources say Thorsteinsssons lawyers are “very smart, effective and practical.”

In 2002, TransAlta sold its regulated electricity transmission business to an arm’s length purchaser for the negotiated price of 1.31 times the net regulated book value of TransAlta’s tangible assets. The parties allocated the bulk of the 31% premium to goodwill. This allocation was a standard allocation of purchase price premium for regulated industries and was supported by valuation theory, audited financial statements and long-standing industry practice. The Minister reassessed TransAlta, pursuant to section 68 of the ITA to reallocate the premium to tangible assets on the basis that the practice by regulated industries of allocating purchase price premium to goodwill was unreasonable as it allowed the vendors to avoid recapture of capital cost allowance on its tangible assets.

In determining whether an allocation of purchase price to a particular property is reasonable under section 68 of the ITA, the FCA provided the following guides: (1) an allocation of purchase price agreed to by arm’s length parties is an important (but not determinative) factor to consider and will be given considerable weight where the parties have strong divergent interests concerning that allocation and less weight where one of the parties is indifferent to that allocation or where both parties’ interests are aligned with respect to that allocation; and (2) the reasonableness test under section 68 of the ITA is not what the CRA believes is reasonable but rather “whether a reasonable business person, with business considerations in mind, would have made the allocation”.

In this case, the FCA concluded that the parties’ agreed allocation of the premium to goodwill was reasonable “precisely because of its compliance with industry and regulatory norms and its consistency with standard valuation theory for regulated businesses and standard accounting principles applied in such industries.” The taxpayer’s appeal was allowed.