On July 13, 2012, the Federal Court of Appeal released its decision in The Queen v. Peter Sommerer 2012 FCA 207 ("Sommerer") in favour of the taxpayer. The decision was eagerly anticipated as it dealt primarily with the scope of subsection 75(2) of the Income Tax Act (Canada) (the "Act"). Broadly speaking, subsection 75(2) of the Act applies where a person transfers property to a trust and the property or substituted property may revert back to the person, pass to persons to be determined by that person after the creation of the trust, or be disposed of only with that person's consent. Where it applies, subsection 75(2) attributes any income or loss and any capital gains or capital losses associated with the transferred property back to the transferor. Unlike other attribution rules in the Act, subsection 75(2) does not contain an exception for fair market value transfers. The Canada Revenue Agency ("CRA") had historically taken the position that subsection 75(2) could apply even if property was transferred at fair market value.
In Sommerer, Peter Sommerer was a beneficiary of an Austrian private foundation ("APF") set up by his father. Peter Sommerer sold certain shares at fair market value to the APF, and the APF later sold these shares, earning substantial capital gains. The Minister of National Revenue (the "Minister") reassessed Peter Sommerer on the basis that subsection 75(2) applied and the capital gains realized by the APF were taxable in his hands. The Minister took the position that subsection 75(2) applied because it was possible when Peter Sommerer sold the shares to the APF that the shares or property substituted for the shares may one day be distributed to him as a beneficiary of the APF. The Tax Court of Canada disagreed with the Minister's position and held that 75(2) should not apply in these circumstances.
The Federal Court of Appeal held that subsection 75(2) did not apply to attribute the gain realised by the APF to Peter Sommerer. The court confirmed that the only person that subsection 75(2) could apply to is the settlor of a trust or a subsequent contributor to a trust who could be seen as a settlor. Subsection 75(2) could not apply to a person that transfers property to a trust in a genuine sale even if that person may one day be entitled to that property by way of a distribution by the trust. The Federal Court of Appeal found that this was consistent with the purpose of subsection 75(2) which was to ensure that a taxpayer does not avoid the income tax consequences of the use or disposition of property by transferring it to a trust while retaining the right of reversion.
Subsection 75(2) had always been a concern to trust advisors due to its potentially broad scope. Moreover, the CRA's position that fair market value transfers could be caught by subsection 75(2) only increased the uncertainty. The Federal Court of Appeal's decision in Sommerer clarifies that subsection 75(2) applies to "endowments" of trusts and not to fair market value purchases. Accordingly, potential beneficiaries of a trust can now engage in transactions involving bona fide sales to the trust with greater certainty.
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