[author: David Spiro]
Earlier today, the Supreme Court of Canada heard arguments in the Garron appeal. The reasons for judgment of the Tax Court of Canada and the Federal Court of Appeal, as well as the factum of each party, may be found at our earlier post.
Appellants’ Oral Argument
Counsel for the Appellants argued that the Income Tax Act contemplates that the residence of a trust is to be determined by the residence of the trustee. It does so through a combination of subsections 104(1) and 104(2). As a trust itself has no legal personality, Parliament has created a ”deemed individual” character for trusts in the form of the trustee under subsection 104(2). In the Appellants’ view, subsection 104(1) is critical as it provides the “linkage” between the trust and the trustee.
Justice Abella wondered whether the phrase “ownership or control” in subsection 104(1) suggests that Parliament intended that the “control” test apply in the context of determining the residence of a trust, as the Crown contends.
Justices LeBel and Karakatsanis wondered why one would look to the residence of the trustee when, under subsection 104(2), the trust is considered a separate person.
Justice Rothstein wondered why a trust should be treated differently than a corporation in the sense that both are created in similar ways and both have similar “locational attributes”. In other words, why can’t we locate the trust outside the place the trustee resides?
Justice Moldaver wondered whether the phrase “unless the context otherwise requires” in subsection 104(1) suggests that Parliament did not want trustees to be set up as straw men outside Canada simply to avoid tax. Counsel for the Appellants responded that the phrase “unless the context otherwise requires” means that in a provision where it makes no sense for “trust” to mean “trustee” it does not mean “trustee” (e.g. subsection 108(6)). He also responded that Parliament addresses avoidance concerns elsewhere in the Income Tax Act, including section 94. He submitted that the rule for the determination of residence of a trust is not the answer to tax avoidance.
Counsel for the Appellants drew to the Court’s attention the (a) affiliated persons rule and (b) qualified environmental trusts rule as both deal with the residence of trustees (as opposed to the residence of trusts). This makes it clear that the residence of the trustees is what really matters and confirms the “linkage” between trust and trustee.
Counsel for the Appellants also noted that the plan undertaken in this case would not work today in light of the amendments to section 94 of the Income Tax Act and the provisions of the Income Tax Conventions Interpretation Act.
Justice Abella asked whether, in light of the fact that both corporations and trusts manage property, the test ought to be the same for each (i.e. the central management and control test) and where they manage the property should be determined in the same way for both. Counsel for the Appellants characterized such an approach as “superficial”.
Finally, counsel for the Appellants argued that adoption of the “formalistic” central management and control test will not eliminate the possibility of manipulation. One could arrange that all meetings at which substantive decisions are made occur outside Canada. Accordingly, there is no reason to prefer that test over the traditional residence of the trustee test.
Crown’s Oral Argument
Counsel for the Crown argued that the central management and control test is the proper test for determining the residence of a trust for income tax purposes. She argued that such a test is consistent with the legislative scheme. She also argued that the rationale for the application of the test in the trust context is the same as the rationale for the application of the test in the corporate context.
Justice Moldaver asked, if Parliament intended the same rule to apply to trusts as to corporations, why the Income Tax Act did not provide that a trust is deemed to be a corporation rather than an individual. Crown counsel responded that someone has to be assigned responsibility for administrative functions, as noted by the Federal Court of Appeal, and that is the trustee under subsection 104(1). Such administrative functions include filing returns, receiving assessments, filing objections and appeals and paying tax debts of the trust.
Citing De Beers Consolidated Mines, Justice Rothstein asked what the result would be if those who actually controlled the trusts met in Barbados and that is where they made all the substantive decisions (i.e. the key decisions affecting the trust property). After noting that you can’t just leave Canada in order to “paper” such decisions if they were actually made in Canada, Crown counsel admitted that such a trust would be resident in the Barbados if indeed all substantive decisions were made in Barbados.
Justice LeBel asked whether one would have to perform a complete factual enquiry in order to make such a determination. Crown counsel said yes, just as one would do in the case of a corporation in order to determine the place of central management and control.
Crown counsel listed a number of similarities between corporations and trusts particularly with respect to the managment of property as a function of each. The question then becomes: where is that management exercised?
Justice Deschamps asked Crown counsel about the two statutory examples cited by counsel for the Appellants, namely, the affiliated persons rule and the qualified environmental trust rule. She argued that those rules simply dictate where the trustees must reside and nothing else.
Counsel concluded by noting that the central management and control test has been applied for one hundred years and that test should now be adopted to determine where a trust is resident.
The Crown’s Alternative Arguments: Section 94 and GAAR
Junior counsel for the Appellants and the Crown spent approximately ten minutes each arguing the section 94 and GAAR points. There were no questions directed to the Appellants on these points, but several questions were directed to the Crown.
The Crown contends that even if the trusts were resident in Canada (under either test), the trusts should be deemed not to have been resident in Canada under paragraph 94(1)(b) (the “contribution test”), as the Federal Court of Appeal concluded, on the basis that the trusts “acquired” property without actually “owning” it. Junior counsel for the Crown was challenged on this point by Justice Rothstein. He was also challenged when he argued that the GAAR applied. Justice LeBel admitted that he had “some problems at this stage” with the application of the GAAR under the circumstances. In addition, Justice Rothstein questioned whether there could be a GAAR case if all substantive decisions had actually made in the Barbados and, therefore, the trusts had satisfied the Crown’s central management and control test. Junior counsel for the Crown responded by contending that there would be a GAAR case as such trusts, in light of the fact that they have no function to serve, would be artificial entities and devoid of economic substance.
After a very brief reply by counsel for the Appellants, judgment was reserved.