Many trustees do not follow the legalities surrounding family trusts in corporate transactions.
On a share sale transaction, the trustees (often one or both of the patriarch or matriarch of the business) purport to allocate sale proceeds received by the family trust to its beneficiaries (often children, grandchildren or other close relatives). The beneficiaries, usually with available lifetime capital gains exemption room or at a low tax bracket, will treat the amounts allocated to them as income for income tax purposes and pay no or little tax. The allocated amounts, however, eventually end up in the hands of other individuals, such as the parents, grandparents or other close relatives of the beneficiaries, who are also often the trustees.
During a Canada Revenue Agency (“CRA“) audit of a trust, the CRA may examine the flow of funds to determine whether the beneficiary to whom the allocation was made actually received the benefit of the funds. If the CRA finds the funds allocated to beneficiaries for income tax purposes end up in the bank account of someone else (such as a parent, grandparent or other close relative), the CRA may reassess the end recipient of the funds and allocate the distribution of funds to him or her for income tax purposes on the basis that such person really received the benefit of the funds from the family trust.
This happened in Daniel Laplante v. The Queen, 2018 CAF 193 (“Laplante“). The Federal Court of Appeal upheld the decision of the Tax Court of Canada (2017 TCC 118) in its ruling that the distribution and allocation of taxable capital gain among beneficiaries of a family trust (on the sale of qualified small business corporation shares by the trust) and their use of the lifetime capital gains exemption amounted to a sham.
Daniel Laplante, the taxpayer, was the dominant trustee of Fiducie DL, a family trust. In January 2008, Fiducie DL sold the shares of DTI Software Inc., a qualified small business corporation, and realized a capital gain of approximately $5,852,074. By resolution of the trustees of Fiducie DL, $2,593,412.50 of taxable capital gain was distributed and allocated to beneficiaries of Fiducie DL, who were also all family members to Mr. Laplante. Upon receipt by the beneficiaries of their trust distribution cheques, the beneficiaries endorsed the cheques to Mr. Laplante and executed deeds of gift in his favour. Mr. Laplante also paid their alternative minimum tax and allowed the beneficiaries to keep the subsequent recoveries in future years.
On March 10, 2014, the Minister of National Revenue (the “Minister“) reassessed Mr. Laplante and added to his income for the 2008 taxation year the taxable capital gain of $2,593,412.50. Mr. Laplante objected to the Minister’s reassessment.
On October 23, 2018, the Federal Court of Appeal upheld the June 23, 2017 decision of the Tax Court of Canada and ruled that the Minister was correct in reassessing Mr. Laplante outside the normal reassessment period and adding to his 2008 income a taxable capital gain of $2,593,412.50.
In the Tax Court of Canada, Justice Ouimet found that the purported distribution of the taxable capital gain to the beneficiaries of Fiducie DL amounted to a sham (or, to be more precise, a “simulation” under Art. 1451 of the Quebec Civil Code), stating that the beneficiaries:
all accepted a mandate [e.g., an agency] from Mr. Laplante. The essential elements of the mandate involved receiving a $375,000 allocation from Fiducie DL and then returning this amount to Mr. Laplante. To this end, they all had to use their capital gains exemption, which was also essential. As consideration, they were able to keep the alternative minimum tax recovered in subsequent taxation years.
In affirming this decision, Justice Boivin of the Federal Court of Appeal found that Justice Ouimet did not err in finding a simulation in this case; that Mr. Laplante was the true beneficiary of the amounts distributed by Fiducie DL to the seeming beneficiaries.
The decision in Laplante highlights the importance of tax advisors advising their clients that the beneficiaries of a family trust should be entitled to keep the distribution funds. Beneficiaries should not merely act as agents to facilitate a tax benefit for the patriarch or matriarch of the business by claiming/multiplying the lifetime capital gains exemption or paying tax at a lower tax rate.