2015-0581961C6 2015 STEP – Q8 - Foreign entity classification

Principal Issues: Does CRA keep a list of foreign entities that it generally considers to be trusts.

Position: No.

Reasons: It will be a question of fact whether a trust relationship exists.

Author: Kohnen, Phil
Section: -

STEP CRA Roundtable – June 18, 2015

Question 8.  Foreign Entity Classification

The case of Sommerer highlighted the need for practitioners to carefully consider the issue of foreign entity classification when dealing with foreign legal entities / relationships.  While we are certainly aware of the CRA’s approach to foreign entity classification that is outlined in Technical News No. 38 (now Archived), does the CRA keep a list of foreign entities that it generally (we appreciate that each case is a question of fact) considers to be foreign trusts that it would be willing to share with our members?

CRA Response:

In our response to question 4 at the 2014 STEP National Conference Roundtable, it was noted that:

“CRA's approach to entity classification is a two-step approach.  That is, to determine the status of an entity for Canadian tax purposes, we would:

1) Examine the characteristics of the foreign business association under foreign commercial law and any other relevant documents, such as the partnership agreement or other contracts; and

2) Compare these characteristics with those of recognized categories of business associations under Canadian commercial law in order to classify the foreign business association under one of those categories”.

In our view, the comments in our 2014 response are applicable to foreign legal entities and relationships in general. We continue to believe that the two-step approach is the most appropriate method to be followed.

In the context of considering whether a particular foreign legal entity or relationship constitutes a trust for Canadian tax purposes, Justice Miller, in his decision in Sommerer v The Queen (2011 TCC 212), provided useful commentary. He stated in paragraph 59

“What needs to be analyzed, however, is not what the SPF is, but what relationship exists amongst the SPF (a separate legal person), Mr. Herbert Sommerer, and Mr. Peter Sommerer and the Sommerer family. Is there a trust relationship? Can Mr. Herbert Sommerer be seen as a settlor? Can the SPF be seen as a trustee, perhaps a corporate trustee? Can Mr. Sommerer be seen as a beneficiary? Do the three certainties, certainty of intention, certainty of subject matter, and certainty of objects exist”?

In the next paragraph, he noted

“I agree with the Appellant's suggestion that, in characterizing a foreign arrangement, I rely on the Supreme Court of Canada's comments in Backman v. The Queen to look at the private law in Canada to determine the essential elements of a trust, and then compare the elements of the foreign arrangement to determine if it can be treated as its correlate under Canadian law”.

His comments in paragraph 66 of the decision, when considered with his paragraph 82 conclusions on the classification issue specific to the facts in Sommerer, are worth noting. In paragraph 66 he stated

“In summary, the essential ingredients of a trust under Canadian law that I wish to address are:

      a) segregated property;
      b) owned by a person (trustee) having control of the property;
      c) for the benefit of persons (beneficiaries);
      d) to whom the trustee has a fiduciary duty enforceable by the beneficiaries”.

In paragraph 82, he provided the following clarification as to the scope of his findings on the issue (emphasis added)

“It should be clear that in reaching this conclusion, I am not finding the SPF is a trust: I am finding the relationship between Mr. Herbert Sommerer, the SPF and the beneficiaries constitutes a trust, with the SPF as the trustee. Further, I do not make this finding in any way as a generalization that all relationships involving an Austrian Private Foundation are trust relationships. There may well be a Foundation Declaration that is found to be more akin to a power of appointment, for example, by stripping away any rights of enforceability a beneficiary might have. Here, on balance, there are sufficient indices of the essential features of a trust to find the arrangement can be considered a trust”.

To summarize, it is our view that each case is a question of fact, and as such, CRA does not have a list of foreign entities that it generally considers to be trusts for Canadian tax purposes. We view the Sommerer decision as lending support to that view.

Phil Kohnen
2015-058196

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