Principal Issues: [TaxInterpretations translation] Can the CRA clarify the basis for the presumption in Interpretation Bulletin IT-419R2 that the shareholders of a private corporation that has three unrelated shareholders will act together to exert control over the corporation?
Position: No.
Reasons: Question of fact. While the CRA does presume that, in such a situation, the shareholders are acting together to control the corporation and therefore form a controlling group of persons, it is possible, however, after a review and analysis of all the facts, legal documents and circumstances surrounding a particular situation, that the CRA will consider that the three shareholders do not form a controlling group of persons if it is shown that there is no common bond or interest between the three shareholders or that they are not acting together to control the corporation.
FEDERAL TAX ROUNDTABLE
APFF CONFERENCE 2010
Question 1
Presumption of concerted action to control a corporation for purposes of determining non-arm's length relationship:
Under Interpretation Bulletin IT-419R2 (footnote 1):
[...] For a group of unrelated persons to constitute a group of persons which controls a corporation, there must be a common link or interest between the persons (which must involve more than their mere status as shareholders) or there must be evidence that those shareholders act together to exert control over the corporation. In the case of a closely-held corporation (i.e. where there are two or three unrelated shareholders, none of which individually controls the corporation) the CRA considers that there is a presumption that the shareholders of such a closely-held corporation will act together to control the corporation. In order to rebut this presumption, it would be necessary to show that no one is controlling the corporation and that the decision-making process in the corporation is effectively deadlocked."(emphasis added)
Previously, at the 1995 annual conference of the Canadian Tax Foundation (footnote 2), the Canada Revenue Agency ("CRA") stated that:
“Furthermore, it is our view that in almost all cases where the voting power in a corporation is equally divided between two shareholders, the corporation will be controlled by the group consisting of the two shareholders. In order to rebut this presumption of control by the group, it would be necessary to show that no one is controlling the corporation and that the decision-making process in the corporation is effectively deadlocked. In our view, this would be very unusual; however, an example might be where the two shareholders cannot agree on how to run the corporation and have consequently applied to a court for an order authorizing the dissolution of the company.” (Emphasis added)
Questions to the CRA
Can the CRA clarify the basis for the presumption that the shareholders of a private corporation that has three unrelated shareholders will act together to control the corporation? How can the CRA claim that they form an unrelated group that controls the corporation given that it is possible to show that no one individually controls the corporation and that the decision-making process in the corporation is not deadlocked?
Would the CRA apply the same presumption where a corporation has four or five unrelated shareholders, none of whom individually controls the corporation?
CRA Response
In Silicon Graphics Limited v. The Queen, 2002 DTC 7112, the Federal Court of Appeal made the following comments in paragraph 36 of the judgment regarding the determination of de jure control by a group of shareholders:
“Based on these cases, I agree with the appellant's submission that simple ownership of a mathematical majority of shares by a random aggregation of shareholders in a widely held corporation with some common identifying feature (e.g. place of residence) but without a common connection does not constitute de jure control as that term has been defined in the case law. I also agree with the appellant's submission that in order for more than one person to be in a position to exercise control it is necessary that there be a sufficient common connection between the individual shareholders. The common connection might include, inter alia, a voting agreement, an agreement to act in concert, or business or family relationships.”
The CRA's general position regarding the existence of a group of persons who control a corporation is set out in paragraph 12 of Interpretation Bulletin IT-419R2, Meaning of Arm's Length:
“[…] For a group of unrelated persons to constitute a group of persons which controls a corporation, there must be a common link or interest between the persons (which must involve more than their mere status as shareholders) or there must be evidence that those shareholders act together to exert control over the corporation. In the case of a closely-held corporation (i.e. where there are two or three unrelated shareholders, none of which individually controls the corporation) the CRA considers that there is a presumption that the shareholders of such a closely-held corporation will act together to control the corporation.”
In a situation where a private corporation has three unrelated shareholders, none of whom individually controls the corporation, the CRA effectively presumes that the three shareholders are acting together to control the corporation and therefore form a controlling group. However, it is possible, after a review and analysis of all the facts, legal documents and circumstances surrounding a particular situation, that the CRA may consider that the three shareholders do not form a group of persons who control the corporation if it is demonstrated that there is no common bond or interest between the three shareholders or that they are not acting together for the purpose of controlling the corporation.
Whether a group of unrelated persons controls a corporation and, if so, the composition of that group, in situations where a private corporation has more than three unrelated shareholders, none of whom individually controls the corporation, is a question that the CRA generally determines after a review and analysis of all the facts, legal documents and circumstances surrounding a particular situation.
Isabelle Landry
(450) 623-0193
October 8, 2010
2010-037313.
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Interpretation Bulletin IT-419R2, "Meaning of Arm's Length", June 8, 2004, para. 12.
2 CANADA REVENUE AGENCY, Income Tax Technical News No. 7, "Control by a Group - 50/50 arrangement", February 21, 1996.