Principal Issues: Whether in both situations the application of paragraph 251(5)(b) would result in Mr. X being considered not dealing at arm's length with Acquéreurco for purposes of section 84.1.
Position: Yes.
Reasons: First situation - application of paragraph 251(5)(b). Second situation - application of paragraph 251(5)(b) on a "holder by holder method" basis. General comments on arm's length determination where a person is only involved in the transaction as an accommodating party for the benefit of another person (see paragraph 1.41 of Folio S1-F5-C1).
APFF FEDERAL TAX ROUNDTABLE 6 OCTOBER 2017
APFF CONFERENCE 2017
QUESTION 17
Application of paragraph 251(5)(b) and section 84.1 when introducing a minority shareholder
The Acquireco shareholders' agreement provided that the son could purchase the shares in the capital stock of Acquireco held by the unrelated person in the event of death, permanent disability and bankruptcy, but also upon the occurrence of other events, such as voluntarily ceasing employment.
In the absence of an agreement between shareholders, and of the issue of the son’s rights to acquire the shares, Mr. X would deal at arm's length with Acquireco.
Questions to the CRA
- Would the application of paragraph 251(5)(b) in such a situation result in a non-arm's length relationship between Acquireco and Mr. X and, therefore, the application of section 84.1?
- If the shareholders of Acquireco instead were the son (as to 30%) and 10 other key employees (each with 7%), and with the same clause in the shareholders’ agreement except that, on any such voluntary departure, the remaining shareholders have a proportionate right to acquire the departing employee’s shares, how would the CRA apply paragraph 251(5)(b) to such a situation? Would the application of this paragraph lead to the application of section 84.1 based on a non-arm's length relationship between Acquireco and Mr. X?
CRA Response
General comments
Subparagraph 251(5)(b)(i) provides inter alia that for the purposes of subsection 251(2), where at any time a person has a right under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently, to, or to acquire, shares of the capital stock of a corporation or to control the voting rights of such shares, the person will be deemed to have the same position in relation to the control of the corporation as if the person owned the shares at that time. However, the provisions of paragraph 251(5)(b) will not apply where the right is exercisable only by reason of the death, bankruptcy or permanent disability of an individual. In addition, the provisions of paragraph 251(5)(b) will not apply merely because an agreement between shareholders contains a clause providing for a right of first refusal or a shotgun arrangement (a “shotgun clause”).
According to the question, the buy-sell clause provided for in the agreement between the shareholders of Acquireco would not come within the exceptions described above.
CRA preliminary response to Q.17(a)
Pursuant to subparagraph 251(5)(b)(i) and by virtue of the rights provided for under the Acquireco shareholders' agreement, Mr. X's son would be deemed, for the purposes of subsection 251(2), to hold the same position in respect of Acquirco's control as if he were the holder of shares of the capital stock of Acquireco held by the unrelated person. Mr. X's son would therefore be related to Acquireco pursuant to subparagraph 251(2)(b)(i) as he would be deemed to hold 100% of the shares of the capital stock of Acquireco. By the same token, Mr. X would be related to Acquireco under subparagraph 251(2)(b)(iii). Mr. X would therefore not deal at arm's length with Acquireco pursuant to paragraph 251(1)(a). Consequently, the provisions of section 84.1 could apply in the event that all the other conditions of application provided for in that section were satisfied.
CRA preliminary response to Q.17(b)
Subparagraph 251(5)(b)(i) creates a presumption for determining the control of a corporation in relation to a particular person. Thus, in the situation presented, under subparagraph 251(5)(b)(i) and by virtue of the rights provided for in the Acquireco shareholders' agreement, Mr. X's son would be deemed, for the purposes of subsection 251(2), to be in the same position in relation to Acquireco's control as if he were the holder of shares of the capital stock of Acquireco held by the other shareholders. As a general rule, the CRA will apply this presumption by taking into account the rights of Mr. X's son in respect of all other shareholders ("holder-by-holder" method). Accordingly, Mr. X's son would have rights to all of the shares because he would have rights to the shares of each of the shareholders if each of them became a shareholder affected by an event provided for in the agreement. Therefore, as with the previous question, Mr. X's son would be related to Acquireco under subparagraph 251(2)(b)(i). By the same token, Mr. X would be related to Acquireco under subparagraph 251(2)(b)(iii). Mr. X would therefore not deal at arm's length with Acquireco pursuant to paragraph 251(1)(a). Consequently, the provisions of section 84.1 could apply in the event that all the other conditions of application provided for in that section were satisfied.
Although the wording of the question states that, had it not been for the shareholders' agreement providing for the rights to acquire the shares and the application of paragraph 251(5)(b), Mr. X would be dealing at arm’s length with Acquireco, the CRA considers it appropriate to recall that paragraph 251(1)(c) makes the issue of whether or not unrelated persons are dealing with each other at arm's length a question of fact. As a result, unrelated persons may not deal at arm's length, depending on the facts and circumstances of a particular situation. Each file must be examined in light of its own facts.
The general position of the CRA on this matter is set out in paragraphs 1.38 to 1.41 of Folio S1-F5-C1, Related Persons and Dealing at Arm's Length. Paragraph 1.41 states, inter alia, that a situation where one party to a transaction is merely accommodating the other party in an attempt to obtain a certain tax result may be a situation where the parties are not dealing at arm's length because they do not have separate economic interests which reflect ordinary commercial dealings between parties acting in their own separate interests. In the scenario set out in this question, Acquireco may not have a separate economic interest in acquiring the shares held by Mr. X, other than to accommodate Mr. X, especially since Mr. X maintains a significant economic interest in the operating corporation. However, since this determination is a question of fact, we cannot comment on this without first analyzing the facts and circumstances of the particular situation.
Marc Séguin
(514) 620-8562
October 6, 2017
2017-070917