This case is a great example of how, in the tortured world of tax avoidance, one taxpayer's success can wreck another's tax plan.
Mr. Kern set up the Brent Kern Family Trust to take advantage of an anti-avoidance rule. This rule, in ITA s. 75(2) prevents high income taxpayers from splitting income with low-income taxpayers (usually family members). The rule says that, despite the transfer to the trust, any income, loss, capital gain or loss from the property transferred will be attributed to the transferor (so that it's taxed at his higher rate, rather than the lower tax rates that might apply to the trust's beneficiaries.)
The tax plan in this case turned (as do most) on a series of tax rules. As a first step, two family trusts bought shares from two family corporations. Because the family corporations were also beneficiaries of the trusts, the tax plan assumed that, because they sold their shares to the trusts, s. 75(2) would apply to attribute all income of the trusts back to the corporations. It didn't work.
Essentially, one of the family corporations earned income in 2005 and 2006, paid tax on it, and then paid the balance through to the Appellant trust as a dividend. The family corporation was also a beneficiary of the trust, and so the tax plan relied on s. 75(2) to say that, for tax purposes, the family corporation got the dividend income, not the trust. Because corporate dividends pass tax-free between corporations, the plan assumed that no tax was payable on the dividends. So, according to the taxpayers' view of the plan, the trust got the dividend money but did not need to report the income and the corporation reported the income but could claim the tax deduction under ITA s. 112 so that it also had no tax to pay.
Unfortunately for the family, within about 3 weeks of the hearing in their TCC appeal, the FCA decided that s. 75(2) does not apply where property is sold to a trust:
"[I]n Canada v Sommerer, 2012 FCA 207, 2012 DTC 5126 (FCA), the Federal Court of Appeal pronounced that a transfer by genuine sale will not invoke subsection 75(2), unlike in situations where the property is gifted." (Para. 2.)
So, Justice Bocock had no trouble saying that as the family corporation had sold its common shares to the trust, s. 75(2) did not apply. The tax plan was a wreck:
"[29] To encapsulate, the Appellant trust purchased 100 common shares of Holdco (905558 Alberta Ltd.) for valuable consideration from OPCO (Wilf’s Oilfield). OPCO was also an enduring beneficiary under the Appellant trust. As such, subsection 75(2) does not apply to the dividend declared on the Holdco shares which comprised the property. The dividend income is not attributable to OPCO, but instead remains to the benefit and for the account of the Appellant."
See Brent Kern Family Trust v. The Queen, (2013 TCC Boccok); affirmed 2014 FCA 230 (CanLII)
Mr. Kern set up the Brent Kern Family Trust to take advantage of an anti-avoidance rule. This rule, in ITA s. 75(2) prevents high income taxpayers from splitting income with low-income taxpayers (usually family members). The rule says that, despite the transfer to the trust, any income, loss, capital gain or loss from the property transferred will be attributed to the transferor (so that it's taxed at his higher rate, rather than the lower tax rates that might apply to the trust's beneficiaries.)
The tax plan in this case turned (as do most) on a series of tax rules. As a first step, two family trusts bought shares from two family corporations. Because the family corporations were also beneficiaries of the trusts, the tax plan assumed that, because they sold their shares to the trusts, s. 75(2) would apply to attribute all income of the trusts back to the corporations. It didn't work.
Essentially, one of the family corporations earned income in 2005 and 2006, paid tax on it, and then paid the balance through to the Appellant trust as a dividend. The family corporation was also a beneficiary of the trust, and so the tax plan relied on s. 75(2) to say that, for tax purposes, the family corporation got the dividend income, not the trust. Because corporate dividends pass tax-free between corporations, the plan assumed that no tax was payable on the dividends. So, according to the taxpayers' view of the plan, the trust got the dividend money but did not need to report the income and the corporation reported the income but could claim the tax deduction under ITA s. 112 so that it also had no tax to pay.
Unfortunately for the family, within about 3 weeks of the hearing in their TCC appeal, the FCA decided that s. 75(2) does not apply where property is sold to a trust:
"[I]n Canada v Sommerer, 2012 FCA 207, 2012 DTC 5126 (FCA), the Federal Court of Appeal pronounced that a transfer by genuine sale will not invoke subsection 75(2), unlike in situations where the property is gifted." (Para. 2.)
So, Justice Bocock had no trouble saying that as the family corporation had sold its common shares to the trust, s. 75(2) did not apply. The tax plan was a wreck:
"[29] To encapsulate, the Appellant trust purchased 100 common shares of Holdco (905558 Alberta Ltd.) for valuable consideration from OPCO (Wilf’s Oilfield). OPCO was also an enduring beneficiary under the Appellant trust. As such, subsection 75(2) does not apply to the dividend declared on the Holdco shares which comprised the property. The dividend income is not attributable to OPCO, but instead remains to the benefit and for the account of the Appellant."
See Brent Kern Family Trust v. The Queen, (2013 TCC Boccok); affirmed 2014 FCA 230 (CanLII)
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