On April 12, 2012, the Supreme Court of Canada (SCC) released its decision in Fundy Settlement v. Canada (2012 SCC 14). This case was the SCC’s first opportunity to consider the appropriate test for determining the residence of a trust for tax purposes.
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.