Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Is a certain Pennsylvania Business Trust considered a trust for Canadian tax purposes where the trust does not appear to have a settlor, may be a purpose trust, has perpetual existence, status as a legal entity and the trustees might be acting as agents rather than trustees?

Position: Provided the trustees cannot reasonably be considered to be acting as agents for the beneficiary, yes.

Reasons: An examination of the essential characteristics of a trust under Canadian law and an examination of the essential characteristics of this particular arrangement would suggest that this arrangement, which is a valid trust for US purposes, would be treated as a trust for Canadian tax purposes. While the object of the trust is described as a purpose, the trust has a U.S. corporation as a beneficiary and is not a purpose trust.

									October 11, 2007

	Non-resident Trust Section				HEADQUARTERS
	International and Large Business Directorate	Annemarie Humenuk

	Attention: Sheila O'Grady
									2007-023698

Pennsylvania Business Trust

This is in response to your memorandum of May 17, 2007, concerning the classification of a Pennsylvania business trust for Canadian tax purposes.

Background

Under the relevant U.S. legislation, the XXXXXXXXXX (hereafter referred to as "U.S. Investor") is only permitted to invest in investments that generate passive income. As a result, U.S. Investor established XXXXXXXXXX, a corporation established under the laws of Delaware that is resident in the U.S. (hereafter referred to as "Corporation") and XXXXXXXXXX, a trust established under the laws of the State of Pennsylvania as a Pennsylvania business trust (hereafter referred to as "PBT") in order to invest in XXXXXXXXXX, a limited partnership that is carrying on the business of XXXXXXXXXX in Canada, (hereafter referred to as "Partnership"). The trustees of PBT are employees of U.S. Investor and are resident in the U.S. such that PBT is also resident in the U.S. U.S. Investor owns XXXXXXXXXX% of the share capital of Corporation and Corporation owns XXXXXXXXXX% of the beneficial interests in PBT. PBT holds XXXXXXXXXX % of the limited partnership interests in Partnership, with the remainder of the interests held by Canadian investors who are not related to PBT, Corporation or U.S. Investor.

PBT was established in XXXXXXXXXX by a declaration of trust signed by the trustees and the Corporation (as beneficiary) to hold the limited partnership interest in Partnership. Although there is no evidence of any property being contributed to the trust at that time, the terms of PBT clearly define the trust property to include the interest in Partnership and any property acquired with the income derived from its interest in Partnership. The sole property of PBT, the interest in Partnership, was acquired with the proceeds of a loan to PBT from Corporation.

You state that the arrangement is structured such that there is effectively no Canadian tax payable on PBT's share of the revenue from Partnership. This is based on your understanding that the income from Partnership is not subject to tax under Part XIII and that the interest paid by PBT on the loan from Corporation reduces the amount of income from Partnership that is subject to tax under Part I to nil. Since there are no thin capitalization rules similar to subsection 18(4) that are applicable to an investment in a non-resident trust, it is your view that, in the absence of a finding that the trust is invalid or otherwise ignored for Canadian tax purposes, the interest expense would be deductible by PBT such that its income from the business carried on in Canada would be reduced to nil. Please note that the auditor has advised us that subsection 212(13) does apply to the interest paid by PBT to the Corporation. In this regard, subsection 212(13.2) states that a non-resident person whose business is carried on principally in Canada is deemed to be a person resident in Canada for the purpose of determining the amount of withholding tax required in respect to a payment to a non-resident that is deductible in computing that person's taxable income earned in Canada.

Your Views

You are of the view that PBT is neither a corporation nor a trust for Canadian tax purposes. Although the Pennsylvania statute recognizes PBT as a legal entity, you have examined the various attributes of PBT and determined that it is not a corporation for Canadian tax purposes. You are also of the view that PBT is not a trust for Canadian tax purposes on the basis that:

a) subsection 711(3) of 20 Pa.C.S. provides that a trust governed by chapter 95 of 15 Pa.C.S. is not an "inter vivos trust" as that term is defined in 20 Pa.C.S.§ 711(3);

b) you have identified elements of the terms of PBT that you believe support the view that the trustees of PBT can be considered to acting as agent for U.S. Investor, Corporation and PBT; and

c) it appears to you that PBT may be a non-charitable purpose trust.

With respect to the terms and conditions relating to PBT that support a view that the trustees are acting as agent, you note that:

• the trustees are employees of U.S Investor;
• article XXXXXXXXXX of the terms of PBT permits the Corporation to remove the trustees and appoint new trustees;
• article XXXXXXXXXX of the terms of PBT permit the Corporation to vary or wind up PBT with the written concurrence of the trustees; and
• article XXXXXXXXXX of the terms of PBT permit Corporation to freely transfer the property of PBT or its interest therein.

You have asked for our views on the classification of PBT for Canadian tax purposes.

Our Views

To determine the status of an entity for Canadian tax purposes, we must examine the foreign legislation creating the entity and compare the essential elements of that entity with the various legal forms recognized in Canada to determine which legal form most closely matches the form of the foreign entity.

As stated above, PBT is a legal entity that is organized as a trust within the meaning of 15 Pa.C.S.§ 9501(a)(1). The Pennsylvania statutes provide that a Pennsylvania business trust will exist in perpetuity unless otherwise stated in the terms of its trust indenture. The terms of the PBT confirm that it will have perpetual existence unless otherwise agreed to by the trustees and the Corporation.

In the 3rd edition of Waters' Law of Trusts in Canada, the following description and definition of the trust is provided:

[T]he relationship between the trustee, having duties and powers, and the beneficiary or purposes, having rights to compel performance of the trusts (or obligations upon which terms the trustee holds), is the traditional way in which the "trust" has been analysed. And among common lawyers the following definition is generally regarded as being one of the best:

A trust is the relationship which arises whenever a person (called the trustee) is compelled in equity to hold property, whether real or personal, and whether by legal or equitable title, for the benefit of some persons (of whom he may be one, and who are termed beneficiaries) or for some object permitted by law, in such a way that the real benefit of the property accrues, not to the trustee, but to the beneficiaries or the objects of the trust [G.W. Keeton and L.A. Sheridan, The Law of Trusts, 10th ed. (London: Barry Rose Publishers, 1993)].

Another familiar definition that has been cited with judicial approval is:

A trust is an equitable obligation binding a person (called the trustee) to deal with property owned by him (which is called the trust property, being distinguished from his private property) for the benefit of persons (who are called the beneficiaries or, in the old cases, cestui que trust), of whom he may himself be one, and anyone of whom may enforce the obligation. [D.J. Hayton (ed.) Underhill and Hayton: Law Relating to Trust and Trustee, 16th ed. (London: Butterworths)].

The previous edition of the text spoke of "property over which [the trustee] has control".

Notwithstanding the above definitions, it is said that the "trust" cannot be defined but can only be described. The description of a trust by reference to dual ownership or equity in an international context would have the result of ignoring all civil law arrangements that have adopted the trust idea of the administration of assets for the benefit of others. On this issue, in The Concept Called "The Trust", Professor Waters said at p. 120:

On the international scene, however, we are concerned with the "trust" idea in civil law as well as in common law, not only does the reference to equity have no meaning, but the relationship between one who has title to property (the fiduciary) and another who derives the benefit from that property is so generalised an element that it describes a range of legally enforced obligations, only some of which accord with the common law lawyer's instinctive notion of a trust. [D.W.M. Waters, The Concept Called "The Trust" (1999) vol 54, no. 3, Bulletin for International Fiscal Documentation]

In his analysis of the trust concept, Professor Waters provides a suggestion as to the essential elements of a trust designated to bridge the trust institution for both the common law and the civil law traditions. Such elements are obviously present in the Canadian common law trust. Professor Waters suggests that the four elements needed to recognize the trust concept regardless of the name given to the arrangement in issue are:

(1) the trust property must be segregated from the personal assets of the trustee;
(2) the trust property must be employed for the object of the trust (a beneficiary or a purpose);
(3) the trustee holds the title of the trust property and owes duties to the beneficiary as consequences both of the terms of the trust instrument and also of the law; and
(4) the right to recover identifiable property in specie from the trustee in breach, or from a third party aware of the breach.

The terms of PBT clearly contain the four elements suggested by Professor Waters. The trustees hold the limited partnership interest for the benefit of the beneficiary, Corporation, such property being segregated from their personal assets and the trustees owe the Corporation the duties and obligations expressed in the trust agreement in respect of the trust property. As stated in 15 Pa.C.S.§ 9506, the provisions of Subchapters B relating to fiduciary duty and Subchapter D relating to indemnification of Chapter 17 are applicable to a Pennsylvania business trust. The fact that the PBT is subject to the same rules relating to fiduciary duty and indemnification as are applicable to other trusts governed by the law of Pennsylvania suggests that the fourth element is met as well.

Professor Waters says that the three certainties cannot be described as the necessary elements of a trust. On page 123 of The Concept Called "The Trust", he explains:

[The three certainties] merely underline that there must be sufficient evidence that a trust was intended, and, if it was, what property was to be the subject-matter of that trust and who or what the property was to benefit. Without all of the three the trust must fail to come into existence. In other words, while the three certainties can be used to determined if an arrangement that intended to be a trust is validly constituted, it cannot be used to determine whether a particular arrangement has more characteristics in common with a trust, partnership or corporation. [D.W.M. Waters, The Concept Called "The Trust" (1999) vol 54, no. 3, Bulletin for International Fiscal Documentation]

However, the terms of PBT contain evidence that the three certainties are met once the trustees have acquired the interest in the limited partnership. The trust agreement clearly establishes the intention to create a trust (a Pennsylvania business trust), clearly identifies the object or beneficiary of the trust (the Corporation) and clearly states what property is the subject of the trust (the limited partnership interest is identified as the "Trust Estate").

In this case, it appears that the U.S. Investor arranged for the Corporation to create PBT. Once the terms of the PBT were established by the trust agreement signed by the trustees and the Corporation, the trustees obtained a loan from the Corporation and use the proceeds of that loan to acquire the trust property. This property is acknowledged by the trustees and the Corporation to be the trust property.

With respect to the factors you identified as supporting a finding that PBT is not a trust, we offer the following comments.

a) Section 102 of 20 Pa.C.S. defines a trust to be any trust, whether testamentary or inter vivos, that is subject to the jurisdiction of the orphan's court division of the State of Pennsylvania. Section 711 of 20 Pa.C.S. further clarifies that, for the purpose of determining whether the orphan's court division of the State of Pennsylvania has jurisdiction over a particular trust, an inter vivos trust does not include, among others, a Pennsylvania business trust. Section 9501(a)(1) of 15 Pa.C.S. defines a Pennsylvania business trust to be an association that is organized as a trust, the written terms of which state that it is a trust established under the laws of Pennsylvania, is subject to the provisions of Chapter 95 of the Pennsylvania statutes and is not the type of trust listed in section 9501(a)(2) of that statute. While we have no expertise in interpreting the Pennsylvania statutes, it appears to us that the Pennsylvania statute does recognize a Pennsylvania business trust as a trust and that the purpose of 20 Pa.C.S.§ 711 is simply to ensure that such trusts are not subject to the jurisdiction of the orphan's court division of the State of Pennsylvania.

b) Article XXXXXXXXXX of the terms of PBT states that the affairs of the PBT will be managed solely and exclusively by the trustees and that the trustees shall have all rights and powers to act on behalf of PBT with respect to the objects and purpose of PBT. The fact that the trustees are employees of U.S. Investor does not preclude a finding that they are acting in their capacity as trustees and not as agents of the beneficiary of PBT with respect to matters of the trust property. In this case, the trustees' responsibilities and powers are not limited by the terms of the trust nor are the trustees are required to obtain direction from the Corporation with respect to the property of the PBT. The fact that the trustees and the Corporation are able to amend the terms of the trust without court approval is not relevant in determining whether the trustees are acting in the capacity as agents rather than trustees, nor is the fact that the Corporation has the power to appoint or replace the trustees. While it is possible that the trustees may be taking direction from the Corporation or from U.S. Investor such that an agency relationship exists, evidence of such control would be required if this issue were to be brought before the courts. It would be very difficult to convince a court based on the information provided with your request that Corporation was the controlling mind of this relationship and directed the decisions of the trustees. To support your position, the CRA would likely be required to provide the court with written documents setting out specific instructions for the investments or distributions of property of PBT and evidence that the trustees complied with these instructions.

With respect to article XXXXXXXXXX of the trust agreement and the Corporation's ability to freely transfer the trust property or its interest in PBT, we note that article XXXXXXXXXX of the trust agreement provides that if any part of the trust agreement is invalid or unenforceable, such invalidity or unenforceability does not affect the other terms of the trust and to that end, such invalid or unenforceable provision shall be severed from the trust agreement. Given that the Corporation does not have ownership or control of the property of PBT, it is difficult to imagine how the Corporation could transfer such property "freely", although the Corporation would presumably be free to transfer its interest in PBT to another person. While you may wish to obtain clarification from the trustees on this issue, it seems likely that the wording of this provision is in error.

c) You note that a non-charitable purpose trust is not valid in Canada. In the past, a non-charitable purpose trust was typically not accepted as a valid trust under common law because a purpose is not a person and therefore no one would be capable of enforcing the trust. However, there has been a softening in the application of this common law principle and some Canadian jurisdictions have enacted legislation to deal with this issue. The type of non-charitable purpose trust that has typically been found invalid in Canada is truly impersonal, existing only to fulfil a purpose and not necessarily to benefit any person or class of persons. Business trusts that are used as investment vehicles may have objects that are phrased as a purpose similar to the objects of a corporation but they are not purpose trusts in the sense of the type of trust not generally recognized in Canada. While appearing to be purpose trusts, such trusts, including PBT, are in reality for the benefit of a particular class of persons, the investors. As a result, it is our view that PBT would not be considered invalid for lack of a beneficiary or uncertainty of objects.

Other factors that we considered in determining whether PBT is a valid trust include the fact that it has a separate legal personality under the laws of Pennsylvania and that it is intended to have perpetual existence, absent a decision by the trustees and Corporation to terminate the trust at some time in the future. Even though a trust established under and governed by the laws of Canada does not have a separate legal personality and cannot have perpetual existence, we do not believe such characteristics are fatal to the determination that the arrangement is a trust.

In discussing the conflict of laws in the context of English law in The Law of Trusts and Equitable Remedies, J. Hayton states that in such circumstances, the English courts would only find a foreign trust invalid if the "foreign trust concept was so repugnant to the core of the trust concept or contrary to the English public policy." [David J. Hayton and Charles Mitchell, Law of Trusts and Equitable Remedies, 12th ed. (London: Sweet & Maxwell, 2005)]. Elsewhere in that text, J. Hayton comments on the perpetuity principle and the reason for it - inalienability and uncertainty as to remoteness. In looking at the attributes of a Pennsylvania business trust, neither of these principles would be violated since neither the legal personality of the PBT nor the fact that would exist forever, absent a decision to wind it up, would be repugnant to the core of the trust concept or contrary to Canadian public policy.

Conclusion

In our view, PBT is a trust for Canadian tax purposes. However, you may wish to consider the application of subsection 247(2) if the interest rate negotiated on the loan between Corporation and PBT in XXXXXXXXXX is not a rate that would be agreed upon between parties dealing at arm's length at the relevant time or subsection 245(2) if the creation of PBT can reasonably be considered to be an avoidance transaction that results in a misuse of a provision of the Act or an abuse of Act.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

T. Murphy
Section Manager
for Division Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch