29 November 2022 CTF Roundtable Q. 10, 2022-0950581C6 - Common Reporting Standard

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: (1) Can the CRA provide examples of “indirect” distributions as referred to in paragraph 9.54 of the CRA’s Guidance on the Common Reporting Standard? (2) Would the CRA consider any contributor to the trust as a “settlor” for purposes of Part XIX of the Act?

Position: (1) The response to OECD CRS-FAQ - SECTION VIII: DEFINITIONS - C. FINANCIAL ACCOUNT Question 11 provides examples of what constitute indirect distributions by a trust. (2) For Canadian law purposes the concept of settlor generally refers to the person who set up the trust by contributing property to the trust. On that basis, the question of whether a specific contributor is the settlor of a particular trust for the purposes of the definition of “controlling persons” in subsection 270(1) is generally a question of law to be determined in light of the relevant facts and circumstances.

Reasons: Subsection 270(2) provides that the provisions of Part XIX of the ITA relate to the implementation of the Common Reporting Standard set out in the Standard for Automatic Exchange of Financial Account Information in Tax Matters approved by the Council of the OECD and, unless the context otherwise requires, these provisions are to be interpreted consistently with the Common Reporting Standard, as amended from time to time.

2022 Canadian Tax Foundation Conference
CRA Roundtable

Question 10 - Common Reporting Standard – Trusts and The Meaning of “Controlling Persons”

Assume that a trust is resident in Canada, is not a “reporting financial institution” (“RFI”), is a “passive non-financial entity” (“Passive NFE”), and has a “financial account” with an RFI (footnote 1) .

In this circumstance, the RFI with which the trust has a financial account will have reporting obligations under Part XIX of the Act if one or more “controlling persons” are “reportable persons”, as both of these terms are defined in subsection 270(1).

Subsection 270(1) defines “controlling persons”, in part, as follows:

“controlling persons, in respect of an entity, means the natural persons who exercise control over the entity (interpreted in a manner consistent with the Financial Action Task Force Recommendations - International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation (footnote 2) , adopted in February 2012 and as amended from time to time) and includes

(a) in the case of a trust,

(i) its settlors,

(ii) its trustees,

(iii) its protectors (if any),

(iv) its beneficiaries (for this purpose, a discretionary beneficiary of a trust will only be considered a beneficiary of the trust in a calendar year if a distribution has been paid or made payable to the discretionary beneficiary in the calendar year), and

(v) any other natural persons exercising ultimate effective control over the trust.” (Emphasis Added).

Question (a)

With respect to whether a discretionary beneficiary is a “controlling person”, the CRA’s Guidance on the Common Reporting Standard (“CRA Guidance”) (footnote 3) states as follows:

“9.54 In the case of a trust, the controlling persons include its settlors, trustees, protectors (if any), beneficiaries or class of beneficiaries, and any other natural persons exercising ultimate effective control over the trust. A person is treated as a beneficiary if they have the right to receive, directly or indirectly, a mandatory distribution; or they receive, directly or indirectly, a discretionary distribution from the trust. In the case of discretionary distributions, the beneficiary may only be treated as a beneficiary in the calendar year in which they receive a distribution.” (Emphasis Added)

Can the CRA provide examples of “indirect” distributions?

Question (b)

The term “settlor” is not defined in the Act and the CRA Guidance is also silent on this point.

Would the CRA consider any contributor to the trust as a “settlor” for purposes of Part XIX of the Act?

CRA Response to Question (a)

Subsection 270(2) provides that the provisions of Part XIX of the ITA relate to the implementation of the Common Reporting Standard (“CRS”) set out in the Standard for Automatic Exchange of Financial Account Information in Tax Matters (“OECD Standard for Automatic Exchange”) (footnote 4) approved by the Council of the Organisation for Economic Co-operation and Development (“OECD”) and, unless the context otherwise requires, these provisions are to be interpreted consistently with the CRS, as amended from time to time.

The OECD Model Competent Authority Agreement for the automatic exchange of CRS information (“Model CAA”) (footnote 5) and associated Commentary contained in the OECD Standard for Automatic Exchange are also relevant to the interpretation of the provisions of Part XIX of the ITA, in addition to the CRA Guidance released on March 10, 2017 and updated on March 10, 2022.

The OECD published the CRS Implementation Handbook (footnote 6) , which, although not part of the CRS, provides a practical guide to implementing the CRS. The OECD also maintains and updates a list of CRS-related Frequently Asked Questions (footnote 7) (“OECD CRS-FAQs”) on the application of the CRS. The OECD’S response to Question 11 of the OECD CRS-FAQs provides examples of what constitute indirect distributions by a trust:

“11. Indirect distributions by a trust

How are indirect distributions by a trust treated under the CRS?

[OECD Response] Pursuant to Section VIII(C)(4), a Reportable Person will be treated as a beneficiary of a trust “if such Reportable Person [...] may receive, directly or indirectly, a discretionary distribution from the trust.

Indirect distributions by a trust may arise when the trust makes payments to a third party for the benefit of another person. For example, instances where a trust pays the tuition fees or repays a loan taken up by another person are to be considered indirect distributions by the trust. Indirect distributions also include cases where the trust grants a loan free of interest or at an interest rate lower than the market interest rate or at other non-arm’s length conditions. In addition, the write-off of a loan granted by a trust to its beneficiary constitutes an indirect distribution in the year the loan is written-off.

In all of the above cases the Reportable Person will be person that is the beneficiary of the trust receiving the indirect distribution (i.e. in the above examples, the debtor of the tuition fees or the recipient of the favourable loan conditions).” (footnote 8)

Although not incorporated into paragraph 9.54 of the CRA Guidance which describes a beneficiary (hence a “controlling person”) as a person receiving or having the right to receive an indirect mandatory or discretionary distribution from a trust, Question 11 of the OECD CRS FAQs provides context for what is referred to in the CRA Guidance.

CRA Response to Question (b)

The term “settlor” is not defined in Part XIX of the Act.

Paragraph 2 of section 1 of the Model CAA states that a term that is not defined therein or in the CRS has the meaning that is has under the applicable tax laws of the jurisdiction applying the Model CAA. Section 8 of the Commentary on paragraph 2 of section 1 of the Model CAA states, in part, as follows:

“The second sentence of paragraph 2 provides that, unless the context otherwise requires or the Competent Authorities agree to a common meaning, any term not otherwise defined in this Agreement or in the Common Reporting Standard has the meaning that it has at that time under the law of the jurisdiction applying the Agreement. In this respect any meaning under the applicable tax laws of that jurisdiction will prevail over a meaning given to that term under other laws of that jurisdiction. Further, when looking at the context, the Competent Authorities should consider the Commentary on the Common Reporting Standard and any terms defined therein.” (footnote 9)

Technical terms are generally to be given their technical meaning unless the context suggests otherwise. For Canadian law purposes the concept of settlor generally refers to the person who set up the trust by contributing property to it. On that basis, the question of whether a specific contributor is the settlor of a particular trust is generally a question of law to be determined in light of the relevant facts and circumstances.

The Department of Finance Explanatory Notes to the definition of “controlling persons” in subsection 270(1) echoes paragraph 132 of the OECD Standard for Automatic Exchange and makes reference to the Financial Action Task Force (FATF) Recommendations:

“[The definition of “controlling persons”] is intended to correspond to the term “beneficial owner” as described in “Recommendation 10” and the “Interpretative Note on Recommendation 10” of the [OECD’s] Financial Action Task Force Recommendations (footnote 10) (as adopted in February 2012 and as amended from time to time - International Standards on Combatting Money Laundering and the Financing of Terrorism and Proliferation, the FATF Recommendations, FATF/OECD Paris), and is to be interpreted in a manner consistent with such Recommendations, with the aim of protecting the international financial system from misuse, including with respect to tax crimes.”

The Interpretive Note to the FATF Recommendations has a General Glossary which defines terms for the purposes of the FATF Recommendations and defines the term “settlors” as follows:

“Settlors are natural or legal persons who transfer ownership of their assets to trustees by means of a trust deed or similar arrangement.” (footnote 11)

The CRS Implementation Handbook also provides guidance on the meaning of the term “settlor”:

“236. In general terms, a trust is a fiduciary relationship, rather than an entity with its own separate legal personality. The trust arrangement commences when a person (the settlor, or also called the grantor) transfers specific property to the trustee, with the intention that it be applied for the benefit of others (the beneficiaries). A settlor may place any kind of transferrable property into a trust.” (Emphasis Added). (footnote 12)

It is noteworthy that, as a result of consultation between the Society of Trust and Estate Practitioners (“STEP”) UK branch and the OECD, the STEP UK branch published further guidance notes on the CRS and trusts (“STEP/OECD Guidance”) which clarify part of the context for the application of the CRS principles to trusts. In particular, paragraph 1.3 - Example 3 of the STEP/OECD Guidance states as follows:

“1.3 Example 3: ‘nominal’ and joint settlors – there may be trusts in existence where an individual (X) acts as the named settlor of the trust and contributes a nominal amount on its creation but where another individual (Y) then makes the substantive contribution of assets to the trust. In circumstances where trustees satisfy themselves that X has only made a nominal contribution to trust assets and that Y has made the substantive contribution, then applying AML/KYC principles, Y should be regarded as the settlor of the trust for CRS purposes rather than X. However, in accordance with CRS and FATF recommendations, HMRC consider that it is also necessary to identify and disclose X as a settlor and that the full value of the trust assets should be reported with respect to both X and Y notwithstanding the fact that X had added only a nominal amount.” (footnote 13)

The STEP/OECD Guidance, in paragraph 1.5 - Example 4, adds that “it is necessary to consider the Controlling Person of the entity at the time it contributes assets to the trust in order to determine who should be regarded as the settlor for CRS purposes.” (footnote 14)

The discussion above provides context for the interpretation of the definition of “controlling persons” in subparagraph 270(1)(a)(i) to determine who are the “settlors” of a trust under Part XIX of the Act in a given set of circumstances.

In addition, when a contributor exercises ultimate effective control over the trust, the contributor is a “controlling person” of the trust.

Angelina Argento/Marie-Claude Routhier
2022-095058
November 29, 2022

Response in collaboration with:

Lata Agarwal
Specialized Audit Support Division
High Net Worth Compliance Directorate
Compliance Programs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 The terms “RFI”, “Passive NFE” and “financial account” are defined in subsection 270(1).

2 https://www.fatf-gafi.org/publications/fatfrecommendations/?hf=10&b=0&s=desc(fatf_releasedate)

3 https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/enhanced-financial-account-information-reporting/reporting-sharing-financial-account-information-other-jurisdictions/gu..., par. 9.54.

4 https://www.oecd-ilibrary.org/taxation/standard-for-automatic-exchange-of-financial-account-information-in-tax-matters-second-edition_9789264267992-en

5 https://www.oecd-ilibrary.org/taxation/standard-for-automatic-exchange-of-financial-account-information-in-tax-matters-second-edition/model-competent-authority-agreement_9789264267992-4-en

6 https://www.oecd.org/ctp/exchange-of-tax-information/implementation-handbook-standard-for-automatic-exchange-of-financial-account-information-in-tax-matters.htm

7 https://www.oecd.org/tax/automatic-exchange/common-reporting-standard/CRS-related-FAQs.pdf

8 Ibid, page 19.

9 Supra, footnote 5, page 70.

10 Supra, footnote 2.

11 Ibid, page 130.

12 Supra footnote 6, par. 236.

13 https://www.step.org/system/files/media/files/2020-03/Guidance_note_CRS_and_trusts.pdf, par. 1.3.

14 Ibid, par. 1.5.