Trust Me, It Was A Mistake: Re Pallen Trust (2015 BCCA 222)

Trusts and estate planning

The highly anticipated BC Court of Appeal decision in Re Pallen Trust was released this week.   The central issue in the case was the validity of a rescission order granted in the face of a challenge by the Canada Revenue Agency (“CRA”).  The Court of Appeal upheld the Chamber Judge’s decision to grant the order.

The facts of the case were not disputed by the parties.  In 2008, Mr. Pallen undertook a reorganization designed to permit a family trust to receive corporate dividends tax free by relying on certain provisions in the Income Tax Act (the “Act”). As part of the reorganization, the Pallen Trust (a discretionary trust) purchased shares in a corporation that was also a beneficiary of the Trust. The corporation then paid two dividends (totalling $1.75 million) to the Trust. It was expected that provisions in the Act would operate to attribute the dividend income paid to the Trust back to the issuing corporation; and then permit the corporation to deduct the income, thus paying no tax.

Specifically, the efficacy of the transaction depended on the operation of section 75(2) of the Act as it was widely understood at the time by both CRA and industry professionals. Without getting into the technicalities, 75(2) essentially provides that where a trust holds property on condition that it may revert to the person who contributed that property, income from the property will be attributed back to that person rather than taxed in the trust. At the time the Pallen Trust transaction took place, section 75(2) was widely accepted to apply regardless of the mode of transfer of the property, i.e. whether the property was gifted or sold to the trust. As such, since the Trust had purchased the shares from a beneficiary corporation, dividend income would be attributed back to the corporation.

The situation changed a few years later, when a decision of the Tax Court of Canada, Canada v. Sommerer (upheld by the Federal Court of Appeal, 2012 FCA 207) changed the accepted interpretation of section 75(2), finding that it does not apply where property is purchased by a trust for fair market value. The result of the change was that the Pallen Trust, having purchased the shares from the corporation, would pay $552,000 in tax on the dividends, which CRA claimed when it reassessed the Trust for the 2008 tax year. The Trust applied for an order rescinding the payment of the dividends to it on the basis of mistake.  The issue was whether this new tax position (which was not contemplated at the time of reorganization) constituted a mistake such that the Court should grant the order sought and allow the dividends to be rescinded, rendering their payment void ab initio.

The Chambers Judge found that the tax implications were basic to the reorganization plan and granted rescission on the basis of mistake, relying on a recent UK Supreme Court decision in Pitt v. Holt (2013 UKSC 26).  CRA took the position that the reorganization had been undertaken with knowledge of the risk that section 75(2) might be interpreted differently in the future. However, the Chambers Judge found as a fact (and the Court of Appeal agreed) that prior to the Sommerer decision, the CRA would not have contested the tax position of the Trust. The Court of Appeal found that in applying Pitt v. Holt a court is not bound to grant rescission where tax consequences are put forward as a mistake, only that it may exercise its discretion to do so. The facts of the case and the intention behind the reorganization would be of central importance.  The Court distinguished between litigants who take an aggressive tax position with full knowledge of the risk and those who (like the Trust) followed the letter of the law and attempted to fall within the existing rules.

In this case, the CRA had, prior to Sommerer, accepted the previous interpretation of section 75(2) and affirmed it in numerous publications.  Its position only changed after the Sommerer decision which occurred four years after the reorganization in question.  The Court of Appeal concluded that the Chambers Judge did not err in finding that this was an appropriate case to grant rescission.  The Trust had relied on a generally accepted interpretation of the Act and had not been aggressive in its tax planning strategy; therefore it should be permitted to have the dividends rescinded and correct the mistake created by the change in the law as it was understood.

As this case demonstrates, the law surrounding trusts is nuanced and ever-changing.  Staying up to date on the latest developments is vitally important.  Those looking for the latest on this case and other trusts issues should attend PBLI’s upcoming program “Trusts: Planning for Success” on June 9th.   

 

To view all upcoming PBLI programs click here.

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Alix Golgoni, Director of Marketing & Communications 

Posted on March 29, 2020  |  Comments (0)


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