Can the Court “Fix” a Trust Deed?

A popular form of estate planning is the family trust. The trust allows for accumulated wealth to pass from one generation to the next in a tax efficient manner – provided the trust is actually set up to do that. What happens when, perhaps in error, it is not? Will the courts rectify the trust so as to give it the effect intended?

That was the issue for the Ontario Superior Court of Justice in the recent case of Kanji v. Lawton. A family trust was created by indenture made March 26, 1992, with Mr. Kanji as the settlor and Mr. and Mrs. Kanji as the initial trustees. Mr. Kanji transferred $5,000 in cash to the trust. The beneficiaries of the trust were Mr. and Mrs. Kanji and their children. All beneficiaries were eligible to receive income and capital from the trust. Under the terms of the trust, Mr. Kanji could remove any of the trustees and appoint substitute or additional trustees. By 2013 the trust had grown to approximately $62 million. There was a problem with the trust though.

Because Mr. Kanji was the settlor of the trust, one of the two trustees and a capital beneficiary, the combined effect of sections 75(2) and 107(4.1) of the Income Tax Act (Canada) may deny a tax-deferred distribution of assets from the trust to any trust beneficiary other than the settlor – Mr. Kanji. The 21-year rule would deem a distribution and reacquisition by the trust on March 26, 2013, triggering a substantial capital gains liability. For Mr. Kanji to distribute to himself before that date would likewise trigger a significant liability and defeat the tax efficiency benefit of a trust.

Mr. Kanji applied to the Court to “rectify” the trust to avoid this result. The Court dismissed the application.

Rectification is a remedy available to correct a mistake in a document of legal effect. With respect to a trust, the Court found that to benefit from the remedy, an applicant “must show that (i) a common, specific intention existed amongst the creators of the instrument effecting the transaction to accomplish a particular result and (ii) a mistake caused the instrument not to comport with the common intention of the parties”. The Court emphasized the need for the applicant to establish as a fact that the true intention was, at least in part, to establish the trust such that the tax liability at issue would be avoided.

The Court here was not convinced that the true intention of the trust was to avoid the tax consequences at hand. The Court noted the lack of contemporaneous evidence as to intention and in particular the lack of evidence from the lawyers acting on the creation of the trust (there is litigation pending between Mr. Kanji and his lawyers). The Court found that based on the evidence of intention available, Mr. Kanji had not established “that at the time [he] settled the Family Trust he intended to structure the Family Trust in a tax efficient manner which would allow for a tax deferred transfer of the trust’s assets to his children in the future or that a mistake was made which resulted in the trust indenture failing to give effect to that intention”.

I would not presume to comment on the issues that exist between Mr. Kanji and the lawyers acting on the establishment of the trust but it goes without saying that it is crucial that lawyers ask all the right questions in order to determine from clients precisely what they are seeking to accomplish in any estate plan.

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