In a recent new case, Sommerer P. v. The Queen,1 the Tax Court of Canada reinterprets the attribution rule in subsection 75(2), significantly narrowing the prior understanding of the rule’s scope. The Minister of National Revenue has appealed this decision. The case also deals with a number of other interesting tax and legal issues, which we will not discuss in the blog.
Until now, it was commonly believed that the attribution rule under subsection 75(2) could apply to any transfer of property to a trust, be it by the original settlor or any other person, upon or after the trust’s creation, for value or not. However, Justice Campbell Miller, writing for the Tax Court, now suggests that the only person to whom subsection 75(2) attribution applies is a settlor, including a subsequent contributor (because such a person could be seen as creating a new trust and could, therefore, be a settlor). Moreover, according to Justice Miller, fair market value (“FMV”) transfers do not trigger the attribution rule, given that a vendor disposing of property for value is not a settlor or contributor by definition.
In Sommerer, the taxpayer was an Austrian national and Canadian resident. In 1996, he established an Austrian private foundation, the “SPF” for the benefit of himself and his family.2 The original settlor was the taxpayer’s father, who contributed 1M Austrian schillings upon the creation of the SPF. The SPF was managed by an “Executive Board” which was comprised of three Austrian residents. In 1996, coincident with the establishment of the SPF, the taxpayer sold a number of shares of Canadian corporations to the SPF at FMV. One of the many issues in the case was whether the SPF was a trust in Canadian law, and whether the taxpayer would suffer the effect of subsection 75(2), given he transferred shares to the trust at FMV. If so, subsection 75(2) would cause any future income, gains or losses of the trust to be attributed to the taxpayer for income tax purposes during his/her lifetime.
The Court finds that the relationship between the SPF, the taxpayer and his family was a trust relationship, though cautions that not all Austrian private foundations are necessarily trusts in Canadian law. In finding there was a trust, the Court notes that the three certainties (certainty of intention, subject matter, and objects) are a necessary but not sufficient condition for a trust to be valid under trust law. The Court suggests a fourth element is required, the existence of an enforceable fiduciary duty owed by the trustees by the beneficiaries. Analyzing the terms of the SPF deed, the Court concludes that the relationship between the settlor, the SPF and the beneficiaries had all the requisite elements of a trust relationship, including a fiduciary duty of the SPF that is enforceable by the beneficiaries.
The Court then analyzes whether subsection 75(2) applies to attribute share income to the taxpayer given his 1996 share sale to the trust. In deciding that the only “person” or attributee to whom subsection 75(2) could apply is a settlor, the Court relies on the provision’s opening words, which read: “where by a trust created…property is held on condition”. Because of this wording, the Court infers that one must look to the time of the trust’s creation in determining whether a trust is one to which subsection 75(2) applies. At the time of the trust’s creation, there can be only one person from whom property is received, the settlor or (subsequent contributors akin to a settlor). The Court writes:
“On the creation of the trust by a settlor, there can only be one person from whom property is received — the settlor. There is no other person. This does not however preclude the possibility of another person settling property in trust with the same trustee and on the same terms, but in such a case, I would suggest there is another trust created. In effect, by the opening words of subsection 75(2) of the Act only a settlor, or a contributor akin to a settlor is contemplated as being the defined person.”3
The Court’s view that subsequent contributors are caught by subsection 75(2), because, at the point, “a new trust is created” is both interesting and problematic. What if, upon a subsequent contribution of property to a trust, there was no intention to create a new trust? Would subsection 75(2) still apply in that case? If a new trust is in fact created every time property is contributed, is there a resettlement of trust property and thus a deemed disposition for tax purposes?
Further in its analysis, the Court examines the difference between the phrases “property substituted therefor” and “property for which it was substituted” in subparagraph 75(2)(a)(i):4 whereas “property substituted therefor” means the subsequently held property, (in this case, shares), “property for which it was substituted” could only mean the original property, (in this case, the schillings). Because of this difference, the only person to whom the attribution rule could apply is the transferor of the original property, i.e. settlor.
This passage is frankly difficult to follow. The Court’s interpretation of “property for which it was substituted” as the original property is surprising. Indeed, subparagraph 75(2)(a)(i) apposes the expressions “property” and “property for which it was substituted” in the same sentence. Would it not be reasonable, then, to assume that the expression “property for which it was substituted” means something different from “property”? Furthermore, if the expression “property for which it was substituted” simply means the original property, what, if anything, does the expression add to the subparagraph?
The Court then addresses the Minister’s argument that the reference to “property” in the first line of subsection 75(2) could refer to the substituted property (in this case, the shares). The Court rejects this possibility. “Property” in the opening words of the provision could only mean the original property contributed by the settlor, otherwise, subsection 75(2) would result in more than one person to whom the attribution rules apply.5 On this point, the Court agreed with the appellant that subsection 75(2) should not result in more than one attributee, given the provision does not make the various possible attributees jointly liable for a single tax, and permitting the Minister to impute the gain amongst them would be contrary to public policy.
Finally, the Court excludes FMV transfers from the ambit of subsection 75(2), basing itself on one tax author;6 who indicates that the usual object of subsection 75(2) is the settlor, though could apply to a subsequent transferor in the sense of a contributor. Because “contributed” signifies a voluntary payment made to increase the capital of the estate or trust,7 the Court reasons that FMV transfers are not caught by subsection 75(2). Thus, the taxpayer’s FMV share sale to the trust does not trigger subsection 75(2) attribution.
This case provides a fresh look at subsection 75(2), discrediting the prior (Canada Revenue Agency dominated) view. It will interesting to see where the jurisprudence will go from here. More analysis of the provision’s text, context and purpose will be welcome. If Sommerer in fact turns out to be good law, planning opportunities that many tax advisors previously thought did not exist may now be available. Stay tuned.
1. 2011 TCC 212
2. The beneficiaries of the SPF were the taxpayer, his wife, and the children of their marriage, but only as of their 18th birthday and provided they are Austrian residents. The “ultimate beneficiaries” under the SPF were the taxpayer and his wife.
3. Paragraph 87 of the decision
4. Subparagraph 75(a)(i) reads : Where by a trust created (…) property is held on condition that it or property substituted therefor
may revert to the person from whom the property or property for which it was substituted was directly or indirectly received.
5. Par 93 of the decision.
6. Maurice Cullity in Taxation and Estate Planning
7. Greenberg Estate v. The Queen, 97 DTC 1380