AROUND THE COURTS
Scheme to extract tax-free dividends from trust disallowed
Under the Income Tax act, a “reversionary trust” rule provides that a person who contributes property to a trust must include in income any income from the property, generally if the property may revert or be returned to the person.
Another rule, quite separate from the above rule, provides that a Canadian resident corporation can deduct dividends received from another Canadian corporation in computing its taxable income. In other words, inter-corporate dividends are normally allowed on a tax-free basis.
In the recent Fiducie Financière Satoma case, the corporate taxpayer tried to have the best of both worlds. The corporation contributed shares to a trust to deliberately fall within the reversionary trust rule. Subsequently, over $6 million of dividends were paid on the shares, and the taxpayers took the position that the corporation, rather than the trust, was required to include the dividends in income. In addition, since the dividends were deductible to the corporation in computing its taxable income as noted above, the corporation paid no tax on the $6 million of dividends. In the meantime, the dividends were retained by the trust, rather than being paid to the corporation.
The CRA challenged the transactions under the Income Tax Act's general anti-avoidance rule (“GAAR”). On the corporation's appeal to the Tax Court of Canada, the Court upheld the CRA assessment. The Court found that the transactions were abusive of the relevant tax provisions, and so the GAAR applied and allowed the Court to uphold the CRA's assessment that the dividends were taxable to the trust.