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CRA Provides Update on Audit Priorities and Activities

At the Canadian Tax Foundation’s recent Ontario Tax Conference (October 29-30), the Canada Revenue Agency provided an update on its current audit priorities and activities as part of the conference’s “Tax Administration Panel“.

The CRA was represented by Fiona Harrison, Manager of the Resources Section at the CRA’s Income Tax Rulings Directorate, and Jeff Sadrian, National Director of the CRA’s Large Business Audit Programs.

In the course of the presentation, the CRA discussed a variety of issues (see the “Tax Administration Panel” conference slides), including “red tape” reduction, the CRA’s trust audit project, Regulation 105 waivers, ABIL claims, and omission penalties under s. 163(1). The CRA confirmed that it determines audit priorities based on the “highest risk”, and that it is continuing its “intelligence-based risk assessment” of taxpayers to determine which files will be selected for audit.

Other highlights included:

  • Folios – The CRA considers many existing Interpretation Bulletins to be out of date. The CRA intends to reorganize the information in the existing publications in new Folio chapters (i.e., all information relating to specific subjects will be “grouped” together). The CRA plans to update the Folios on an on-going basis, and the first 10-12 Folio chapters are likely to be published before the end of 2012.
  • Entity Classification - In a reversal of an earlier position (see, for example, CRA Document No. 2011-0415141E5 “Tax status of a German Family Trust” (August 4, 2011)), the CRA will once again accept requests for rulings on the classification of foreign entities.
  • Inter-Provincial Trusts – Where a trust claims to be resident, and pays tax, in one province, and the trust is later reassessed as resident in another province, the CRA will reassess the trust only for the difference between the tax paid in the first province and the tax owing in the second province.
  • U.S. LLCs – The CRA continues to disagree with the Tax Court’s decision in TD Securities (USA) LLC. v. The Queen (2010 TCC 186). The CRA’s view is that a fiscally-transparent U.S. LLC does not qualify as a resident of the U.S. for the purposes of the Canada-U.S. Tax Treaty, and is not a “qualifying person” under Article XXIX-A of the Treaty.
  • Section 56(2) – The CRA stated that it is aware of “elaborate arrangements” utilized to divert business income to family members. The CRA stated that, where such arrangements include the use of a trust, section 56(2) may be applied in respect of distributions from the trust provided the requirements of the provision are otherwise met (see Neuman v. The Queen (98 D.T.C. 6297 (S.C.C.)). In other words, the CRA may apply s. 56(2) to the actions of a trustee.

(The Tax Administration Panel conference slides are republished with permission of the Canadian Tax Foundation.)

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CRA Provides Update on Audit Priorities and Activities

Further thoughts on the Fundy Settlement decision: Supreme Court offers a nuanced view of trust residence

In Garron Family Trust v. The Queen (2009 TCC 450), Justice Judith Woods of the Tax Court of Canada came down with a very broad new rule for determining the residence of trusts.

[162]  I conclude, then, that the judge-made test of residence that has been established for corporations should also apply to trusts, with such modifications as are appropriate. That test is “where the central management and control actually abides.”

This was viewed widely as a repudiation of the historic test based on the residence of the trustee. Many tax professionals thought that the test for residence of a trust required a determination of the residence of the majority of the trustees and where their functions were performed, and that it was not necessary to go beyond this test.

The Federal Court of Appeal in St. Michael Trust Corp. v. Canada (2010 FCA 309) appeared to endorse Justice Woods’ new legal test but in a somewhat guarded fashion:

[63]    St. Michael Trust Corp. argues that a test of central management and control cannot be applied to a trust because a trust is a “legal relationship” without a separate legal personality. I do not accept this argument. It is true that as a matter of law a trust is not a person, but it is also true that for income tax purposes, a trust is treated as though it were a person. In my view, it is consistent with that implicit statutory fiction to recognize that the residence of a trust may not always be determined by the residence of its trustee.

[64]    St. Michael Trust Corp. also argues that the residence of the trust must be determined as the residence of the trustee because section 104 of the Income Tax Act embodies the trust, as taxpayer, in the person of the trustee. In my view, that gives section 104 a meaning beyond its words and purpose. Section 104 was enacted to solve the practical problems of tax administration that would necessarily arise when it was determined that trusts were to be taxed despite the absence of legal personality. I do not read section 104 as a signal that Parliament intended that in all cases, the residence of the trust must be the residence of the trustee.

When the Supreme Court of Canada granted leave to appeal, some tax professionals were puzzled.  These tax professionals believed that it was unlikely the decision would be reversed since the Crown had a very strong factual case that the trusts in question were managed in Canada by the trust beneficiaries.  The decision released on April 12 by the Supreme Court (Fundy Settlement v. Canada, 2012 SCC 14) in fact dismissed the appeal in somewhat cursory fashion.

[15]    As with corporations, residence of a trust should be determined by the principle that a trust resides for the purposes of the Act where “its real business is carried on” (De Beers, at p. 458), which is where the central management and control of the trust actually takes place.  As indicated, the Tax Court judge found as a fact that the main beneficiaries exercised the central management and control of the trusts in Canada.  She found that St. Michael had only a limited role ― to provide administrative services ― and little or no responsibility beyond that (paras. 189-90).  Therefore, on this test, the trusts must be found to be resident in Canada.  This is not to say that the residence of a trust can never be the residence of the trustee.  The residence of the trustee will also be the residence of the trust where the trustee carries out the central management and control of the trust, and these duties are performed where the trustee is resident.  These, however, were not the facts in this case.

[16]    We agree with Woods J. that adopting a similar test for trusts and corporations promotes “the important principles of consistency, predictability and fairness in the application of tax law” (para. 160).  As she noted, if there were to be a totally different test for trusts than for corporations, there should be good reasons for it.  No such reasons were offered here.  [Emphasis added]

On a close reading it is arguable that the Supreme Court has gently tempered the new rule set out by Justice Woods and, to some extent, by the Federal Court of Appeal.  Where the trustee does what it is supposed to do, including managing the trust and its properties, the operative test remains the residence of the trustee.  It would seem that only where the trustee carries on those “management and control” activities in a place other than where the trustee is resident, or where the trustee abdicates many of its powers to a third party, that Justice Woods’ new test becomes relevant.

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Further thoughts on the Fundy Settlement decision: Supreme Court offers a nuanced view of trust residence