Principal Issues: Status of a corporation as a CCPC where:
- a disqualifying shareholder controlled by a non-resident holds less than 41% of the voting shares of that corporation but more than 60% of the participating shares;
- a group of Canadian residents holds XXXXXXXXXX % of the voting shares of that corporation and XXXXXXXXXX % of the participating shares; and
- a trust is formed to hold the balance of the voting shares of that corporation (XXXXXXXXXX %), with the intent of keeping the CCPC status of the corporation.
Position: In the particular case, the corporation is not a CCPC because a non-resident who controls the disqualifying shareholder has de facto control.
Reasons: See the comments below.
NOTE: View original document in Word.
June 14, 2010
XXXXXXXXXX Tax Avoidance Income Tax Rulings Directorate XXXXXXXXXX Tax Services Office Sylvie Labarre 2010-036661
Canadian-controlled private corporation
This is in response to your memorandum of April 29, 2010 requesting our opinion on the status as a Canadian-controlled private corporation ("CCPC") of XXXXXXXX (the "Corporation") for the years ending XXXXXXXXXX and XXXXXXXXXX.
For the purposes of our opinion, we reviewed the following documents that you provided to us:
- copy of a document entitled "XXXXXXXXXX" ("Agreement") dated XXXXXXXXXX;
- copy of XXXXXXXXXX to the Amendment to Articles of Incorporation;
- copy of documents entitled "XXXXXXXXXX" dated XXXXXXXX and XXXXXXXXXX ("Term Sheet");
- copy of the General By-Laws adopted on XXXXXXXXXX;
- copy of the Declaration of Trust of XXXXXXXXXX (the "Trust");
- XXXXXXXXXX;
- XXXXXXXXXX;
- various e-mails exchanged mainly by the professionals involved in the reorganization;
- XXXXXXXXXX;
- XXXXXXXXXX;
- XXXXXXXXXX;
- XXXXXXXXXX; minutes of the shareholders' meetings of XXXXXXXX and XXXXXXXX;
- shareholders' resolution of XXXXXXXXXX.
It should be noted that our analysis was based solely on a review of the above documents. You did not consider it relevant, at this stage of the file, for us to review any other documents related to this response.
In addition, unless otherwise indicated, any statutory reference herein is to a provision of the Income Tax Act.
Facts
The Corporation was governed by Part IA of the Quebec Companies Act. XXXXXXXXXX
The Corporation's business commenced in XXXXXXXXXX. Since its incorporation, the Corporation has been a private company that operates mainly in the XXXXXXXXXX field.
On XXXXXXXXXX, its common shares were held by the following shareholders:
XXXXXXXXXX: XXXXXXXXXX%
XXXXXXXXXX: XXXXXXXXXX%
XXXXXXXXXX ("Funds"): XXXXXXXXXX%
Minority shareholders: XXXXXXXXXX%
Several individuals and corporations, including shareholders, held debentures in the aggregate amount of $XXXXXXXXXX. In addition, most of these individuals as well as new entities held XXXXXXXXXX warrants.
The XXXXXXXXXX, XXXXXXXXXX (the "Trust") was created under the laws of Ontario by the contribution of a nominal amount of money by XXXXXXXXXX, the Settlor. XXXXXXXXXX trustees have been appointed: XXXXXXXXXX. XXXXXXXXXXX was also appointed as protector. The Trust was established in favour of the following beneficiary: XXXXXXXXXX (the "Beneficiary").
XXXXXXXXXX is the sole shareholder, director and officer of the Beneficiary. Set out below are certain additional details regarding the Declaration of Trust.
Corporation’s share capital
On XXXXXXXXXX, the Corporation amended its Articles of Incorporation in order to create new categories of shares and to cancel the old ones. According to XXXXXXXXXX of the Articles of Amendment, the Corporation is authorized to issue an unlimited number of shares of XXXXXXXXXX new classes that have no par value and whose attributes are as follows:
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Clause XXXXXXXXXX attached to the Class "B" shares reads as follows:
XXXXXXXXXX
Pursuant to XXXXXXXXXX of the Articles of Amendment, the expression XXXXXXXXXX means:
XXXXXXXXXX
Following the amendment of the articles, each common share of the capital stock of the Corporation was converted into one Class "D" share of such capital stock. In addition, the debentureholders received Class "D" shares of the capital stock of the Corporation in repayment of their debentures and accrued interest thereon. As a result, on XXXXXXXXXX, XXXXXXXXXX Class "D" shares of the capital stock of the Corporation were issued and outstanding. In contrast, on XXXXXXXXXX, this number did not exceed XXXXXXXXXX.
On XXXXXXXXXX, the Class "A" shares of the capital stock of the Corporation were issued to the following persons:
XXXXXXXXXX ("Shareholder1"): XXXXXXXXXX
XXXXXXXXXX ("Shareholder2"): XXXXXXXXXX
Trust XXXXXXXXXX
Funds XXXXXXXXXX
Various Canadian investors XXXXXXXXXX
XXXXXXXXXX
On XXXXXXXXXXX, the various Canadian investors held XXXXXXXXXX Class "A" shares of the capital stock of the Corporation.
On XXXXXXXXXXX, the Class "B" Shares of the capital stock of the Corporation were issued to the following persons:
Shareholder1 XXXXXXXXXX
Various Canadian investors XXXXXXXXXX
XXXXXXXXXX
On XXXXXXXXXX, the various Canadian investors held XXXXXXXXXX Class "B" Shares of the capital stock of the Corporation.
Shareholder1 and Shareholder2 are corporations that are controlled by XXXXXXXXXX ("X"). X is a non-resident of Canada. As such, Shareholder1 and Shareholder2 are controlled by a person who is not resident in Canada. As of XXXXXXXXXX, Shareholder1 and Shareholder2 own XXXXXXXXXX% of the voting shares of the capital stock of the Corporation and Shareholder1 owns XXXXXXXXXX% of the participating shares of the capital stock of the Corporation. Shareholder1 paid an amount of $XXXXXXXXXX for its participating shares and $XXXXXXXXXX for its voting shares.
Trust disbursed $XXXXXXXXXX for the XXXXXXXXXX% of the voting shares of the capital stock of Corporation that it holds.
Under to the Term Sheet, the group of corporations controlled by X is required to provide financing of $XXXXXXXXXX, and other investors up to an amount of $XXXXXXXXXX. In consideration for these amounts, Class "XXXXXXXXXX" shares were issued. The financing will be delivered to the Corporation in XXXXXXXXXX tranches at certain stages of the research. Based on what you indicated in respect of the Class "XXXXXXXXXX" shares of the capital stock of the Corporation, there would be XXXXXXXX Class "XXXXXXXXXX" shares issued to Shareholder1 and XXXXXXXXXX Class "XXXXXXXXXX" shares issued to other Canadian investors as of XXXXXXXXXX and an additional number of Class "XXXXXXXXXX" shares would be issued to other Canadian investors. However, at least with respect to Shareholder1, only XXXXXXXXXX of the Class "XXXXXXXXXX" shares were paid. In particular, on XXXXXXXXXX, Shareholder1 paid $XXXXXXXXX for the Class "XXXXXXXXXX" shares of the capital stock of the Corporation and was obligated to pay XXXXXXXXXX other tranches of $XXXXXXXXXX each for the Class "XXXXXXXXXX" shares. On XXXXXXXXXXX, Shareholder1 paid $XXXXXXXXXX, as part of one of these tranches.
On XXXXXXXXXXX, Shareholder1 transferred XXXXXXXXXX% of the shares it held in the capital stock of the Corporation to XXXXXXXXXX ("Shareholder3"), and XXXXXXXXXX% of its obligation to make the other XXXXXXXXXX payments was assumed. Shareholder3 is also a corporation controlled by X.
Under the Term Sheet of XXXXXXXXXX, if the XXXXXXXXXX payments for the Class "XXXXXXXXXX" shares were not made when due and payable, the Corporation was authorized to redeem that number of Class "A", Class "B" and Class "C" shares corresponding to the amount of the payments that had not been made, for an aggregate amount of $XXXXXXXXXX. The XXXXXXXXXX% dividend on the Class "XXXXXXXXXX" shares was paid only on the paid-in amount for such shares.
On XXXXXXXXXX, there were warrants on Class "XXXXXXXXXX" participating shares of the capital stock of the of the Corporation: XXXXXXXXXX for Shareholders2; and XXXXXXXXXX for other Canadian investors. These warrants no longer appeared to exist on XXXXXXXXXX.
Shareholder1 and Shareholder2 each has a right to vet new investors - whose purpose, according to the representatives, was to prevent a potential competitor of the Corporation or Shareholder2 from investing in the Corporation.
By-laws
The by-laws provide that a quorum of shareholders is XXXXXXXXXX
XXXXXXXXXX
Agreement
Paragraph XXXXXXXXXX of the Agreement includes provisions for the appointment of the board of directors. It reads as follows:
XXXXXXXXXX
Under Subparagraph XXXXXXXXXX of the Agreement, the quorum for meetings of the board of directors is at least XXXXXXXX directors.
As set forth in Paragraph XXXXXXXXXX of the Agreement, directors' remuneration is in the discretion of the board of directors but subject to the approval of Shareholder1.
Paragraph XXXXXXXXXX of the Agreement indicates the decisions over which Shareholder1 have a veto right. That paragraph reads as follows:
XXXXXXXXXX
Paragraph XXXXXXXXXX of the Agreement indicates that the holders of Class "B", "D" and "E" shares of the capital stock of the Corporation agree that Shareholder1 may decide in its discretion that the amount of $XXXXXXXX, that payable in priority to the holders of Class "D" shares, is to be increased.
Pursuant to paragraph XXXXXXXXXX of the Agreement, shareholders may not encumber the Corporation's securities or any interest therein unless they have the approval of holders of Class "B" shares representing XXXXXXXXXX% of the Class "B" shares.
Paragraph XXXXXXXXXX of the Agreement sets out the conditions for amending the Agreement. It reads as follows:
XXXXXXXXXX
Board of Directors
XXXXXXXXXX
By resolution dated XXXXXXXXXXX, the Trust appointed XXXXXXXXXXX ("Y") to represent it on the Board of Directors. Y was the Chief Executive Officer of the Corporation until XXXXXXXXXX.
On XXXXXXXXXX, XXXXXXXXXX ("A"), X and Y were appointed members of the board of directors of the Corporation. On XXXXXXXXXX, the shareholders elected the same persons as members of the board of directors.
Trust Deed
Paragraph XXXXXXXXXX of the Declaration of Trust provides that XXXXXXXXXX.
Paragraph XXXXXXXXXX of the Declaration of Trust states that, if the Trustees act as directors of a corporation because the trust has invested funds in that corporation, they must act in the best interests of the beneficiary of the trust.
Paragraph XXXXXXXXXX of the Declaration of Trust reads as follows:
XXXXXXXXXX
Paragraph XXXXXXXXXX of the Declaration of Trust provides that the appointment of the protector will be made by the settlor and that the settlor of the trust will have the right at any time, and from time to time, to revoke the appointment.
Paragraph XXXXXXXXXX of the Declaration of Trust states the following:
XXXXXXXXXX
Pursuant to paragraph XXXXXXXXXX of the Declaration of Trust, the protector may replace a trustee and appoint a new trustee or trustees.
Section XXXXXXXXXX of the Declaration of Trust provides that if there are more than XXXXXXXXXX trustees, XXXXXXXXX.
As stated in paragraph XXXXXXXXXX, any provision of the Declaration of Trust may be amended by the trustees and the protector or, in the absence of such persons, by the settlor.
Miscellaneous
According to the term sheet dated XXXXXXXXXX, there are certain consequences if the Corporation does not meet certain milestones within XXXXXXXXXX of the closing date for the financing. This part of the document reads as follows:
XXXXXXXXXX
Similarly, this document provides the following respecting the warrants if the transaction is successfully completed:
XXXXXXXXXX
Question
You inquired as to whether the Corporation is a CCPC for the years ending XXXXXXXXXX and XXXXXXXXXX.
Our Comments
Based on our understanding of the information you have provided, the Corporation was a private company that was a Canadian corporation throughout the period under review. The question is whether it comes within one of the exceptions listed in the definition of CCPC in subsection 125(7) as to corporations that are not CCPCs.
A corporation that is controlled, directly or indirectly in any manner whatever, by one or more non-resident persons, by one or more public corporations (other than a prescribed venture capital corporation), by one or more corporations described in paragraph (c) of the definition of CCPC, or by any combination of those persons or corporations, is not a CCPC under these exceptions.
Since the phrase "directly or indirectly in any manner whatever" is used, the concepts of de jure and de facto control are relevant in determining whether a corporation is a CCPC within the meaning of subsection 125(7).
De jure control
As stated in paragraph 13 of Interpretation Bulletin IT-64R4 (the "Bulletin"), the general test for de jure control was established by the Exchequer Court of Canada in Buckerfield's Limited et al. v. MNR, 64 DTC 5301, [1964] CTC 504. The issue is whether the shareholder enjoys “effective control” over the affairs and fortunes of the corporation, as manifested in the ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the board of directors. The test in Buckerfield's was confirmed by the Supreme Court of Canada in Duha Printers (Western) Ltd. v. The Queen, 98 DTC 6334, [1998] 3 CTC 303.
As stated in paragraph [36] of the Supreme Court of Canada decision in Duha Printers, this test is “an attempt to ascertain who is in effective control of the affairs and fortunes of the corporation. That is, although the directors generally have, by operation of the corporate law statute governing the corporation, the formal right to direct the management of the corporation, the majority shareholder enjoys the indirect exercise of this control through his or her ability to elect the board of directors. Thus, it is in reality the majority shareholder, not the directors per se, who is in effective control of the corporation.”
On the other hand, the Supreme Court of Canada stated at paragraph [65] that “[i]t would be truly artificial to conclude, only on the basis of the share register, the articles of incorporation, and the by-laws, that one shareholder has de jure control over the corporation by virtue of its apparent power to elect the majority of the board of directors, if a USA exists which limits substantially the power of the board itself.”
Thus, in Duha Printers, the Court stated at paragraph [85] that in determining whether there is effective control,
"one must consider:
(a) the corporation’s governing statute;
(b) the share register of the corporation; and
(c) any specific or unique limitation on either the majority shareholder’s power to control the election of the board or the board’s power to manage the business and affairs of the company, as manifested in either:
- the constating documents of the corporation; or
- any unanimous shareholder agreement.”
From XXXXXXXXXX to XXXXXXXXXX, Shareholder1, Shareholder2 and Shareholder3 together held XXXXXXXXXX% of the Class "A" shares of the capital stock of the Corporation. This is the only class of voting shares. Subject to the determination of the residency of the Trust, we understand that all other holders of Class "A" shares are residents of Canada. Furthermore, none of these holders is a public corporation.
We may consider the Beneficiary of the Trust to have an entitlement to the voting shares held by the Trust described in paragraph 251(5)(b). However, this fact would not change our answer with respect to de jure control. Furthermore, based on the information you have provided to us, we believe that a court would conclude that no person other than the Beneficiary of the Trust had the right, whether immediate or future, contingent or otherwise, to acquire or control the voting rights of additional Class "A" shares of the capital stock of the Corporation and that it would, therefore, be difficult to argue that anyone had de jure control by virtue of paragraph 251(5)(b).
Regarding the residence of the Trust, you have not gathered any information that would lead you to conclude that the "central management and control" is not located in Canada. Similarly, we are of the view that you have not gatheredsufficient evidence to conclude that the persons holding such control or management of the Trust are persons other than the trustees, all of whom are resident in Canada. Even if an argument could be made that the protector who can replace the trustees, or the settlor of the trust who can replace the protector, is the person who exercises control and management of the trust, these persons are also resident in Canada.
We are of the view that the information you have collected is insufficient to demonstrate that a principal-agent relationship, under common law, exists between the trustees of the Trust and X. In Kinguk Trawl Inc. and Farocan Incorporated v. The Queen, 2003 DTC 5168, the Federal Court of Appeal analyzed the term "agency" under the common law. The analysis states the following:
“The term agency has been defined as:
"... a fiduciary relationship which exists between two persons, one of whom expressly or impliedly consents that the other should act on his behalf so as to affect his relations with third parties, and the other of whom similarly consents so to act or so acts." (Bowstead & Reynolds on Agency (17th edition, Sweet & Maxwell 2001)).”
In Royal Securities Corp. Ltd. v. Montreal Trust Co. et al. 59 D.L.R. (2d) 666, Chief Justice Gale of the High Court enumerated “the essential requisites for or ingredients of an agency relationship:
1. The consent of both the principal and the agent;
2. Authority given to the agent by the principal, allowing the former to affect the latter's legal position;
3. The principal's control of the agent's actions.
In reality, points 2 and 3 are often ovelapping, as the principal's control over the actions of his agent is manifested in the authority given to the agent.”
If you cannot demonstrate that the Trust, through its trustees, acted as X's agent for the acquisition of the voting shares of Corporation and at meetings of shareholders taking into account the essential elements of an agency relationship, you could not use this argument to conclude that X owned the voting shares held by Trust and thus had de jure control of Corporation.
Furthermore, in the review of this file, the Agreement should also be examined to determine whether it constitutes a unanimous shareholder agreement (USA) and whether it should be taken into account in determining the identity of any de jure control holder. If an agreement is a unanimous shareholder agreement, we are of the view that it would be necessary to determine which clauses constitute a unanimous shareholder agreement and which would address any restrictions, specific or exceptional, trenching on the powers of the shareholders with respect to the election of the Board or the power of the Board to manage the business and affairs of the Corporation. We are of the view that a specific or unique limitation clause affecting both of these matters should be considered only if, under the laws governing the Corporation, such powers can be modified by a USA. In this regard, the direction of the Supreme Court of Canada to consider any restriction imposed on the power of shareholders to control the election of the Board, by virtue of a constating instrument or clause of this nature, refers, in our view, only to changes in the number of votes required for the election of such Board by the shareholders. On this point, we refer you to paragraph [67] of the Duha Printers decision.
It does not appear that the QCA and other relevant legislation in this case provide that a USA can alter the power of shareholders to control the election of the board of directors. However, section 123.91 of the QCA states that the shareholders may, if they all consent and enter into a written agreement to that effect, restrict the powers of the directors.
We understand, based on the majority view in Quebec, that the shareholders of a corporation governed by Part IA of the QCA can only restrict the powers of the directors by means of a USA by transferring the powers of the directors to the shareholders outright, so that the shareholders can exercise them themselves. On this point, we refer you inter alia to paragraph 27-51 of Maurice and Paul Martel, Volume 1 entitled "Les Aspects juridiques de la compagnie au Québec" (Éditions Wilson & Lafleur, Martel Ltée, 2007).
Consequently, there is no provision in provincial legislation affecting Part IA corporations under the QCA for the power of shareholders to control the election of the board of directors to be limited or modified by way of a USA.
Furthermore, we understand that Article XXXXXXXXXX of the Agreement gives Shareholder1 a veto right on certain important corporate decisions. Therefore, this clause of the Agreement does not constitute a transfer of power from the directors to Shareholder1. Furthermore, there is no other clause in the Agreement that restricts the powers of the directors by transferring them to Shareholders.
In light of the foregoing, there are arguments for concluding that the Agreement is not a USA for the purposes of the QCA. On this basis, the Agreement would not be taken into account in determining the de jure control of the Corporation.
On the other hand, even if we were to interpret Article XXXXXXXXXX of the Agreement as being a restriction on the powers of the directors within the meaning of section 123.91 of the QCA, we are of the view that there would be arguments for considering that Article XXXXXXXXXX of the Agreement is the only clause of the Agreement that is consistent with a constating instrument and the only clause that must be taken into account for the purposes of determining the de jure control of the Corporation. We would not consider other contractual provisions of the Agreement such as Paragraph XXXXXXXXXX (as contrasted to any provision that could be construed as a constating clause) in determining de jure control of the Corporation.
We are of the view that this is precisely the approach taken by the Supreme Court of Canada in Duha Printers in considering only the clause in the agreement that restricted the powers of the directors to manage the business and affairs of the corporation.
Taking into account only Article XXXXXXXXXX of the Agreement (in the event that this clause should be considered as restricting the powers of the directors within the meaning of section 123.91 of the QCA), we conclude that Shareholder1 did not acquire de jure control of the Corporation through its exclusive veto right with respect to important decisions. At most, it can block the decisions of the Board of Directors with respect to such matters without being able to decide unilaterally.
Furthermore, in the present situation, even if we were to take into account Article XXXXXXXXXX of the Agreement for the purposes of determining de jure control of the Corporation, it should be noted that the number of votes required to elect the directors of the Corporation has not changed even though each group of shareholders has one designate. In this regard, we refer you to paragraph [54] of the Duha Printers' reasons for judgment where Iacobucci J. stated the following:
[54]..." In any event, however, the major concern of the de jure test is to ascertain which shareholder or shareholders have the voting power to elect a majority of the directors. The test neither requires nor permits an inquiry into whether a given director is the nominee of any shareholder, or any relationship or allegiance between the directors and the shareholders.”
In addition, corporations controlled by X that hold the voting shares cannot appoint a majority of the directors and there is nothing in the documents you sent to us to indicate that the person designated by Trust is a person designated by X.
In light of the foregoing, we are of the view that X (or the corporations it controls) does not have legal control of the Corporation for the taxation years ending on XXXXXXXXXX and XXXXXXXXXX.
De facto control
For the purposes of the Act, a corporation is considered by subsection 256(5.1) to be "controlled, directly or indirectly in any manner whatever," where another corporation or a person or group of persons has a direct or indirect influence, the exercise of which would result in control in fact of the corporation. Certain specific exceptions that do not apply to this situation are also provided for in this subsection of the Act.
Paragraph 21 of the Bulletin states the following:
21. De facto control goes beyond de jure control and includes the ability to control "in fact" by any direct or indirect influence. De facto control may exist even without the ownership of any shares. It can take many forms, e.g., the ability of a person to change the board of directors or reverse its decisions, to make alternative decisions concerning the actions of the corporation in the short, medium or long term, to directly or indirectly terminate the corporation or its business, or to appropriate its profits and property. The existence of any such influence, even if it is not actually exercised, would be sufficient to result in de facto control.
In our view, we should not limit our consideration of de facto control to the narrow concept described in Silicon Graphics Ltd. v. The Queen, 2002 FCA 260. There are several decisions in which the courts have clearly applied the broader concept of control in fact favoured by the CRA (see the criteria in paragraphs 19 to 23 of the Bulletin) including, among others, Mimetix Pharmaceuticals Inc. v. The Queen, 2001 DTC 1026 (T.C.C.), affirmed by 2003 DTC 5194 (F.C.A.). We also refer you to the recent October 19, 2009 decision of the Tax Court of Canada in Taber Solids Control (1998) Ltd. et al. v. The Queen, 2009 TCC 527.
For example, paragraph [48] of the Tax Court of Canada decision in Mimetix Pharmaceuticals Inc. states the following:
[48] Furthermore, even though the appellant was not in as bad a financial situation as existed in Robson, supra (although I note that the appellant suffered a $1,6 million loss in 1996 and a $2,5 million loss in 1997), I would nevertheless conclude that Mimetix, being the only investor in the appellant's business in 1996, was in a position to exert the kind of pressure that enabled it to have its will prevail with respect to that business. This conclusion is reinforced, in my view, by other instances in which the appellant has not dealt with Mimetix on a commercial basis. Indeed, it was seen that even though Mimetix paid US$100,000 to acquire the licence for DIAC, a sub-licence was granted to the appellant for no consideration. As well, when Mimetix loaned $1,1 million to the appellant, there was no interest charged. With respect to the administrative services, the evidence is unclear as to the cost to the appellant of such services but if there were any costs they would have been minimal. All this, in my view, certainly constitutes a form of economic controlling influence exercised by Mimetix over the appellant in 1996, and that is precisely what is covered by the definition of de facto control in subsection 256(5.1) of the Act.
Furthermore, the following paragraphs of the Taber Solids Control (1998) Ltd. decision also show us the application of a broad concept of control in fact:
[22] I interpret these comments to clarify the test from being one of simply who controls the composition of the board, to who has the potential to make board decisions. This may be a fine distinction, but why else would factors such as economic dependence, family relations and operational control play a role? Those factors speak equally to influence on board decisions as much as influence over who sits on the board. This may be something of a distinction without a difference as the effect of controlling the composition of the board is surely to control its decision-making power. Control of the corporation comes through controlling board decisions one way or the other. This then becomes a question of what decisions are left to a board, and what decisions simply go to management (operational control). The case law suggests that operational control alone is not sufficient to constitute de facto control as contemplated by subsection 256(5.1), yet is a factor to consider.
[23] In the recent case of Brownco Inc. v. R., Justice Brent Paris made it clear that it is not simply influence in the determination of the composition of the board, but influence over board decision-making. In Brownco, that influence arose directly in the form of a casting vote at directors' meetings. Justice Paris stated:
In my opinion, for the purpose of determining de facto control of a corporation, it should make no difference whether a shareholder controls the decision making of the board of directors by virtue of being able to elect the majority of the directors or by virtue of the fact that its nominee director is entitled to cast the majority of the votes at a meeting of directors. The point at which the control arises is perhaps different, but the same practical degree of de facto control over the corporation exists in either situation.
[...][24]...In reviewing the language of the Federal Court of Appeal on Silicon, I find that reference in its penultimate paragraph not just to a right to effect a change in the composition of the board, but also in the powers of the board, leaves the door wide open to look to the decision-making powers of the board, a broader, more sensible approach.
[26] I turn now to what I consider to be more in the nature of board decisions, as opposed to operational or management decisions. It is up to the Board to provide the vision and direction for the company: will it grow, how quickly, etc.?...
A broad concept of control in fact has also been applied by the courts in the following decisions: Rosario Poirier Inc. v. The Queen, 2002 DTC 1770 (C.C.I.); L.D.G. 2000 Inc. v. The Queen, 2003 DTC 82 (C.C.I.); Plomberie J.C. Langlois Inc. v. The Queen, 2004 TCC 734, affirmed by 2006 FCA 113; and Avotus Corporation v. The Queen, 2006 TCC 505.
Furthermore, Bowman J. stated the following in Société Foncière d'Investissement Inc. v. The Queen, (TCC), 95-19996(IT)I):
Since these decisions, other words have been added for the clear purpose of broadening the concept of control, in particular the words "directly or indirectly in any manner whatever". So far as I know, the point has not been decided, but I would have thought that it could reasonably be argued that these words necessarily include the idea of de facto control of a corporation in the case of a person who does not hold more than 50 per cent of the shares but has a controlling influence, whether economic, contractual or moral, over a corporation's affairs. It is hard to imagine words with a broader meaning.
In the present situation, we note the high degree of artificiality in the addition of the Trust to the implemented structure. In fact, the formation of the Trust, whose trustees and protector were related to X, and the fact that the Trust held XXXXXXXXXX% of the voting and non-participating shares seems to have, as its sole justification or business reason, only that of allowing the Corporation to qualify as a CCPC. Consequently, although this degree of artificiality is not a factor of influence per se, it nevertheless suggests that X had a sufficiently great influence on the Trust and Corporation, the exercise of which would result in X's control in fact of the Corporation.
In analyzing the factors of influence that X or any corporation controlled by it could have in the present situation, one of the elements that must be considered is the impact of Paragraph XXXXXXXXXX of the Agreement. As stated above, this clause appears to confer an exclusive veto right to Shareholder1 over important decisions of the Board of Directors. We have already stated the following position where a Shareholder has a veto right:
The determination of de facto control for the purposes of subsection 256(5.1) of the Act is, of course, a question of fact that can only be determined after a review of all the facts surrounding a particular situation. The existence of a veto power is only one of the factors to be considered for the purposes of de facto control.
The holding by a shareholder of a veto right with respect to the amalgamation or dissolution of a corporation, amendments to the articles or by-laws of a corporation, the issue of additional shares or the purchase of shares of a corporation does not in itself automatically result in de facto control of the corporation by the shareholder.
A shareholder who is the only person with a veto over all transactions of a corporation could have de facto control of a corporation. However, this also depends on all other relevant facts. If all the shareholders of a corporation have a veto over the operations of the corporation, the existence of the veto cannot, in and of itself, give de facto control to any one shareholder.
Even if a veto right by itself does not allow a shareholder to have de facto control of a corporation, it could still, in concert with other sources of influence, allow a shareholder to have de facto control of the corporation.
Shareholder1 has a veto right over more decisions of the Board of Directors than stated in the second paragraph of the opinion set out above, but not with respect to all Corporation transactions. However, this veto right is only granted to Shareholder1. In our view, we must therefore consider this exclusive veto right, at least in conjunction with the other sources of influence, including the source of economic influence, in determining whether Shareholder1 or X has de facto control of the Corporation.
When we review the documents you have sent us, we are of the view that there are a number of elements that would support the argument that Shareholder1 or X has de facto control of the Corporation. This de facto control would result primarily from the economic influence that Shareholder1 exercises over the Corporation, its exclusive veto right with respect to several important decisions made by the Board of Directors, the deciding voting right of the director designated by Shareholder1 and the moral influence of X over certain members of the Board of Directors and over the trustees of the Trust.
More specifically, the following elements that you indicated in your memorandum appear to us to demonstrate that Shareholder1 or X had de facto control of the Corporation during the relevant period:
- You could argue that X, in addition to being a member of the board of directors of the Corporation, had significant moral influence over one of the other two directors of the Corporation during the relevant period because that person was a XXXXXXXXXX of the group of corporations controlled by X.
XXXXXXXXXX
- The Trust appears to have played an accommodation role during the relevant period as it had no financial interest since it only held voting shares that do not pay dividends. In our view, this would tend to show that X could have an influence on the Trust or its trustees.
- During the relevant period, after having invested the amount of $XXXXXXXXXX in the Corporation, Shareholder1 or another corporation controlled by X had committed to pay an additional $XXXXXXXXXX if the Corporation reached the research project milestones set out in the Term Sheet. As a result, Shareholder1 or X had economic influence because of their funding undertaking.
- Shareholder1 had an exclusive veto right with respect to borrowings in excess of $100,000 that were not already budgeted or the creation or authorization of "any debt security". It also had an exclusive veto over the creation or issuance of any "security convertible into or exercisable for any equity security", including stock option plans.
- Shareholder1 had an exclusive veto over any dividend payment. It should be noted that investments held by Shareholder1 or another corporation controlled by X in preferred shares had a cumulative dividend rate.
- Shareholder1 decided whether there was to be an increase in the payment priority with respect to the "XXXXXXXXXX" Class Shares, which were held by the group of Canadian investors, which would have allowed them to receive an additional amount ahead of holders of "XXXXXXXXXX" Class Shares including Shareholder1 and Shareholder3.
- Shareholder1 had influence over strategic corporate decisions. Shareholder1 could, by virtue of its exclusive veto power under Paragraph XXXXXXXXXX of the Agreement, prevent, among other things, a winding-up, certain mergers and reorganizations, a material change to the business of the Corporation, the commencement or completion of a new business, an acquisition of a business or assets for a material amount (in excess of $XXXXXXXXXX) or licensing decisions as referred to in Paragraph XXXXXXXXXX of the Agreement. Under Paragraph XXXXXXXXXX, if Shareholder1 and a majority of the Board of Directors approved a XXXXXXXXXX winding-up event, as defined in the Articles of Amendment, all other Shareholders were required to vote in favour of such transaction.
- Our understanding of Paragraph XXXXXXXXXX and the Corporation's By-laws is that the director appointed by corporations controlled by X had a deciding voting right.
- We do not know whether X, or a company controlled by X, was involved in the day-to-day management of operations. However, even if X were not involved, this would not in itself be a factor that would remove X’s de facto control of the Corporation.
On the other hand, Shareholder1 (or X) could argue that it did not have economic influence during the relevant period because it had not invested much more than the Canadian investors. In fact, while Shareholder1 paid $XXXXXXXXXX for "XXXXXXXXXX" preference shares on XXXXXXXXXX and another $XXXXXXXXXX on XXXXXXXXXX, other Canadian investors first invested $XXXXXXXXXX for "XXXXXXXXXX" preference shares on XXXXXXXXXX and an additional $XXXXXXXXXX for "XXXXXXXXXX" preference shares during the relevant period. In addition, other Canadian investors holding "XXXXXXXXXX" Class "XXXXXXXXXX" shares had a priority for payment of $XXXXXXXXXX in respect of those shares that were issued in consideration for the shares and indebtedness that such investors held prior to the entry of Shareholder1.
Similarly, Shareholder 1 (or X) could argue that the holding of more than 60% of the non-voting participating shares of the capital stock of the Corporation by corporations controlled by X did not accord them, during the relevant period, an economic influence on the Corporation because of the nominal amount invested in the participating class of shares, the priority amount to be paid on the participating shares of other Canadian investors, and the low net asset value of the Corporation during the period under review.
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In addition to the factors mentioned above, it would be preferable for you to examine other documents such as, for example, resolutions of the Corporation's directors and/or the minutes of their meetings or reports from the Corporation's internal committees, if such committees existed. This could allow you to add additional elements demonstrating a potential influence of X or one of its corporation which, if exercised, would result in control in fact of the Corporation by those persons.
Conclusion
In our view, there are arguments to conclude that X had de facto control of the Corporation for the taxation years ending on XXXXXXXXXX and XXXXXXXXXX. As a result, the Corporation would not be a CCPC as defined in subsection 125(7) and you should not accord it an investment tax credit at the 35% rate or a refundable tax credit.
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For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Ms. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.
We hope that our comments are of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
Manager
Mergers and Acquisitions Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.