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Tax Savings Using Alberta Trusts May Be More Difficult to Achieve

21/12/2010


Trusts can provide many benefits including income splitting, protection from creditors, multiple lifetime capital gains exemptions, confidentiality, and minimizing probate taxes and capital gains taxes on death. (See the blog dated June 16, 2010 entitled “Use and Taxation of Discretionary Family Trusts” by Kim Drever for a discussion on setting up and using family trusts).

In addition to these benefits, Alberta trusts can be used to access lower provincial tax rates. For example, the top combined federal and Ontario marginal tax rate of 46.41% is 7.41% higher than the comparable Alberta rate of 39%. Shifting $100,000 of ordinary income or the taxable half of capital gains from Ontario to Alberta would save $7,410. For eligible dividends the tax savings would be $10,690 as the rate differential is 10.69%. The comparable savings for a Nova Scotia resident would be $11,000 on ordinary income or taxable gains and $17,690 on eligible dividends.

How does this work? Trusts, like individuals, are taxed in the jurisdiction where they are resident. Traditionally, Trusts have been considered resident where the majority of the Trustees are resident. This was achieved by simply having an accommodating lawyer or accountant in Alberta act as Trustee. Most people, however, are reluctant to have someone else control their Trust assets, particularly, someone who may be thousands of kilometers away. Often, the assets were not transferred to Alberta. The Trust’s bank and brokerage accounts were often set up wherever the principal beneficiaries or even the settlor was resident. The named Trustee may not have been involved in the day to day management of the Trust or may not even have signing authority on the bank accounts. The appointed Trustee may have been “just a puppet”.

A recent Federal Court of Appeal decision (The Garron Family Trust case), which confirmed an earlier Tax Court decision, has made it more difficult to have a Trust considered resident in Alberta. This decision introduced the “mind and management” test to determine the residence of a Trust. The use of this test has traditionally been limited to determining the residence of a corporation. The Federal Court of Appeal stated that the residence of the appointed Trustee will be considered the residence of the Trust “where the trustee is given and actually exercises the powers and discretions regarding the management and control of the trust property, and does so where he resides”. “Where a question arises as to the residence of a trust for tax purposes, it is appropriate to undertake a fact driven analysis with a view to determining the place where the central management and control of the trust is actually exercised.”

The Trust in the Garron case was formed in Barbados and the court found it to be resident in Canada for tax purposes. However, the court uses an example where the Trustees are resident in one province but the beneficiary or other person who actually controls the Trust is resident in another province. The mind and management test would make the Trust resident where the controlling person is resident.

Despite this new test, it will still be possible to have a Trust resident in Alberta. The appointed Trustee could be a trusted family member or friend in Alberta. A trust company could also be used to act as Trustee. Of course, the Trust agreement would be carefully drafted in sufficient detail to clearly set out the objects of the Trust. The Trustee or Trustees would be required to follow the objects set out in the Trust agreement and to act in the best interest of the beneficiaries. However, they would not necessarily have to take instructions from the beneficiaries or others.

In addition, the Trust should ideally have its bank and brokerage accounts in Alberta. Any securities such as shares certificates of a private company should be held by the Trustee. The Trustee should sign the cheques and control the bank accounts. The books and records and financial statements should be prepared in Alberta. The income tax returns should be filed in Alberta. Note that the Trustee could hire advisors elsewhere to assist him in carrying out his duties. The costs of setting up and maintaining Alberta Trusts will in all likelihood increase as a result of the Garron decision.

The potential tax savings of using an Alberta Trust can be significant. Establishing an Alberta Trust that complies with the new “mind and management” test will require careful planning and drafting. Existing Alberta Trusts should be reviewed in light of the new test and appropriate measures taken to ensure that they are not “offside”.

To determine if an Alberta Trust would be appropriate for you; or to assist you in making sure your existing Alberta (or offshore) Trust is “onside”, please contact me or your local MNP Tax Specialist.