A non-resident commercial trust (the “Trust”) governed by the laws of a non-resident common law jurisdiction was settled with cash and real estate by “Corp.” and “Ltd.” Each was a capital and income beneficiary. Corp. directly or indirectly held a majority of the ordinary shares of the trustee. Corp. funded the cash portion of the Ltd. contribution with a loan secured on the Ltd. shares and Ltd.’s beneficial interest in the Trust. Ltd. defaulted under the loan.
Pursuant to a Rights Agreement, Corp. sold to an unrelated Canadian-resident third-party purchaser (“Inc.”) its interest as beneficiary in the Trust and (subject to judgment being issued in Corp.’s favour in an action against Ltd., which in fact occurred) the minority beneficiary interest of Ltd in the Trust – as well as the shares of the trustee. Immediately thereafter, the real estate was sold out of the Trust. A short taxation year for the Trust occurred as a result of the Trust becoming resident in Canada on the transfer of the shares of the trustee, so that the sale occurred in the subsequent taxation year of the Trust. The gain on sale was reduced by non-capital and net capital losses of the Trust.
The Directorate found that at common law there was a resettlement of the Trust when the above sale occurred, so that the losses could not be carried forward. It stated:
[T]he two original beneficiaries were not specifically prohibited from disposing of their capital and income interests in the Trust by selling it to someone else. However, in doing so the intention of the two original settlors is completely set aside. The intention of the settlors, as clearly spelled out in the Trust Deed, was to have the trustee hold and invest the capital of the trust for the benefit of two specific beneficiaries, the two original settlors themselves, and this is no longer the case.
Additionally, only Corp sold its capital and income interests through the Rights Agreement. Ltd was not a party to the Rights Agreement. The disposition by Corp of its capital and income interests was not authorized by the Trust Deed. …
[T]he transaction changed the whole substratum or “raison d’etre” of the Trust.