The following article appeared in the February, 2011, edition of the Hamilton Law Association Law Journal.
The CRA likes to stir things up every now and then with this project or that initiative to ensure compliance among various groups of taxpayers. The latest stirring relates to trusts and their administration, and it serves as a sharp reminder to lawyers that tax compliance is not only the province of accountants.The CRA trust initiative was the result of the Auditor General’s 2005 report, which recommended that the CRA give more attention to the audit of trusts. In response, the CRA created a “regional trust team” in the Golden Horseshoe and began auditing trusts. The audits identified so many issues with trust tax compliance that the program has now been expanded to encompass all of Canada. In September, 2010, the CRA appointed a Trust and Estate Coordinator for the Ontario Region who is responsible for coordinating trusts and estates compliance audits.
What are CRA auditors looking for? Apparently, the issues to be addressed include whether the trust was properly constituted (as per Antle v. R[1]), the location of the trust’s residence (for example, where are Alberta trusts really resident, especially in light of Garron v. R[2]), whether the trust’s income is being reported properly and whether deductions were properly claimed.
The CRA technical positions on trusts that seem to animate the audits are definitely persnickety. For example, trust lawyers will know that a trust, in computing its income for a taxation year, is entitled to deduct amounts that it makes payable in the year to beneficiaries of the trust. The CRA takes the position that “legal documents must be in place prior to the end of the year to meet [this] requirement”.[3] The CRA insists that all trusts must maintain proper books and records to substantiate payments like these, which books and records include financial statements, trust accounting records, bank statements, cancelled cheques, applicable loan documents, trustees’ resolutions and original documents to substantiate all deductions.
The CRA has also stated that “failure to provide evidence of the settled property would void the trust agreement due to the trust failing to meet the Certainty of Subject Matter under common law” [sic].[4] Can you find the gold coin used to settle a trust 18 years ago? Can your client? What property should you use to settle a trust to guarantee that you can prove, years later, that that property was in fact delivered to the trustees in connection with the execution of the trust agreement?
If the CRA’s comments in this regard seem ominous, it is only because the Agency has, apparently, found many cases where trusts cannot find the settlement property or prove that the other niceties were observed. The CRA approach must be understood against the background of the Antle case, where the taxpayer’s aggressive avoidance planning foundered on poor execution among other things. The Federal Court of Appeal’s decision in Antle is particularly encouraging for the CRA in this regard because it stoutly re-affirms the “sham doctrine” (the notion that, if the real legal relationships between parties are other than those they present to the world, then the latter can be ignored). In Antle, the taxpayer purported to settle a trust for his wife where the trustee was offshore. The court, however, found that the taxpayer really did not intend to settle a trust and the trustee did not really intend to act as a trustee. Garron is to similar effect. In Garron, the taxpayers intended to settle offshore trusts, but the court held that the real “central mind and management” was in Canada, and so the trusts were really resident in Canada.
In connection with its trust audits, the CRA has been requiring taxpayers to complete detailed questionnaires. For example, the questionnaire for trustees includes the following questions:
1. Who contacted you to enquire about your services as trustee?
2. What date did you become a trustee of this trust?
3. Why were you selected to become a trustee? Who selected you?
4. Did you consult independent legal counsel before agreeing to become the trustee or signing any of the documents? Provide details and documentation as applicable.
5. What was your role, function and responsibility in regard to each transaction in the trust?
Some of these appear to be trick questions. Imagine the result if the trustee answering the questions never learned about his or her role as a trustee from the lawyer who drew the trust.
The CRA says that its audit efforts have uncovered many instances where the attribution rules have applied in respect of trusts. This short article cannot begin to address the ways in which the numerous attribution rules in the Income Tax Act could apply to a trust. Lawyers, however, need to keep in mind that client education about the nature of trusts, careful attention to detail and clear reporting are key preventative measures for ensuring that these rules do not apply. Clear reporting and a paper trail are crucial because, in the end, the CRA, in the absence of suitable evidence (or any evidence) can make assumptions about the facts and assess accordingly. The onus is then on the taxpayer to prove the CRA wrong. The taxpayer must bring forward the evidence — that is, for the most part, the appropriate documentation — to show that the CRA’s allegations are incorrect.[5]
Traditionally, tax compliance — defined as the preparation and filing of tax returns — has been regarded as the purview of accountants. It is suggested that, at least as far as trusts and estates are concerned, that definition of tax compliance needs to be expanded and lawyers need to take on the role that only they can play. Accountants will likely remain largely responsible for filing tax returns, but if a trust is audited, the paper trail that the lawyer has created will be at least as important as the tax returns. Indeed, if the trust was created for tax planning purposes — to income split or to multiply the capital gain exemption, for example — the work the lawyer has done will be the keystone. It is the lawyer who must educate clients about the role of a settlor, the duties of trustees and the entitlements of beneficiaries. It is the lawyer who must assist with documenting properly the creation of the trust. And it is the lawyer who must assist trustees with the exercise and documentation of their discretionary, fiduciary powers by helping with the maintenance of a trust “minute book” during the lifetime of the trust.
Now if only we can convince our clients that they will need to pay for the work necessary to keep them out of trouble!
[1] 2010 FCA 280 (http://goo.gl/zS47W).
[2] 2010 FCA 309 (http://goo.gl/3QQ54). For a discussion of the Tax Court decisions in Antle and Garron, please see my article in the December, 2009, issue of the HLA Journal. The article can also be found on my blog at http://goo.gl/y8QUh.
[3] Presentation by Wendy Stewart, CRA Ontario Regional Coordinator Trusts and Estates, Kitchener-Waterloo Tax Practitioners Breakfast, November 18, 2010 (the “Stewart Presentation”).
[4] The Stewart Presentation.
[5] For an example of these principles in action, see Rajah v. The Queen, 2005 TCC 637, which I discuss on my blog at http://goo.gl/ff5oB.
