Principal Issues: 1) Whether the expression "controlled, directly or indirectly in any manner whatever" includes "de jure control"?
2) What are the consequences of the application of subsection 256(6)?
Position: 1) Yes.
2) The controlled corporation is deemed not to have been controlled in fact or in law by the controller at the particular time.
Reasons: The Law and previous positions.
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2004-005931
Guy Goulet, CA, M. Fisc.
(613) -957-9768
June 28, 2004
Dear Sir,
Subject: Subsections 256(3) and 256(6) of the Act
This is in response to your letter of January 23, 2004 requesting clarification of our letter of January 8, 2004 (2003-004057) (the Opinion) regarding the application of subsections 256(3) and 256(6) to a Particular Situation.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Particular Situation:
The Particular Situation as you had explained it to us in the Opinion is the following:
1. Opco is a Canadian-controlled private corporation as defined in subsection 125(7).
2. Mr. X holds 100% of the issued and outstanding shares of Opco, namely, 10 Class A shares. The Class A shares of Opco are voting and participating.
3. Opco issued a convertible debenture to Lenderco, a corporation which deals at arm's length with Opco and Mr. X. In the event of insolvency, this debenture is convertible into 1,000 Class A shares of Opco. The terms of the debenture do not specify when the right to convert into shares will expire.
4. The only reason the right to convert into Class A shares is provided for in the debenture is to safeguard the creditor rights of Lenderco.
5. Opco expects to redeem the Debenture in less than five years.
6. Upon full payment of the debenture, a release will be given by Lenderco.
Your Questions:
You asked us the following questions in relation to the Particular Situation and our comments in the Opinion.
1. You would like confirmation that it is not necessary for the text of the debenture to state verbatim that the payment will extinguish the right to convert to shares for paragraphs 256(3)(a) and 256(6)(a) to be satisfied.
2. You would like confirmation that our interpretation of the words “under which” ["stipuler" in the French version] as used in paragraphs 256(3)(a) and 256(6)(a) is to give it the meaning of implicitly or explicitly providing rather than expressly stating.
3. You would like confirmation that whether or not it is reasonable to expect the debenture to be repaid is a question of fact that depends on the financial condition of the debtor, its obligation to repay and the good faith of the parties rather than on specific terms included in the agreement.
4. You would like to know what would be grounds for concluding that the Debenture was an agreement or arrangement that would not be enforceable under its terms for the purposes of paragraphs 256(3)(a) and 256(6)(a).
5. You would like us to comment on the contradiction between the position in IT-64R4 (paragraph 19) that the reference to control of a corporation with the phrase "directly or indirectly in any manner whatever" refers to both de jure and de facto control and the separate reference to the two types of control ("controlled, or controlled, directly or indirectly in any manner whatever") in subsection 256(6). In your view, the reason Parliament distinguishes between "control" (de jure) and "direct or indirect control in any manner whatever" is that one is not the other, and vice versa. Thus, in your view, "controlled, directly or indirectly in any manner whatever" cannot include de jure control.
6. Finally, you would like confirmation that subsection 256(6) only has the effect of deeming a corporation not to be controlled de jure and has no effect on "controlled, directly or indirectly in any manner whatever". Thus, in your view, both subsection 256(6) and subsection 256(3) would not cover de facto control by a creditor for the purposes of the definition of "Canadian-controlled private corporation", for example.
Our Comments
It appears to us that the situation described in the Opinion could be an actual situation involving taxpayers. The Canada Revenue Agency ("CRA") generally does not provide written opinions on proposed transactions otherwise than by way of an advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received the appropriate tax treatment. We can, however, offer the following general comments which may not be fully applicable in a particular situation.
Whether the conditions for the application of subsections 256(3) and 256(6) are satisfied at a particular time in a particular situation is a question that must be resolved after a full review of all relevant facts, circumstances and documents.
With respect to your first four questions, we are of the view that the onus is on the individual taxpayer to demonstrate to the satisfaction of the CRA that the conditions for the application of subsections 256(3) or 256(6) are satisfied in a particular situation, as those provisions are exception measures. In this regard, we believe that the application of subsections 256(3) or 256(6) must be based, inter alia, on clearly worded documents (including, as the case may be: articles of incorporation of a corporation; directors' resolutions; sales agreements; loan agreements; shareholder agreements; etc.) that explicitly demonstrate the intention of the parties, the rights, options or obligations of the parties as well as the means available to enforce an agreement or arrangement. It is our view that the application of these provisions of the Act must also be based on an overall analysis of the facts and circumstances of a particular situation and should not be limited to drawing conclusions solely from a particular clause in a particular agreement or arrangement.
With respect to your fifth question, we do not share your view that the phrase "controlled, directly or indirectly in any manner whatever" cannot include de jure control. Rather, our position is that the phrase includes de jure and de facto control under subsection 256(5.1) of the Act. Our position is supported by the jurisprudence and we refer you in particular to HSC Research Development Corporation v. The Queen, 95 DTC 225 (TCC), where O'Connor J. stated at page 231 of the decision:
The cases reviewed above show that prior to the amendments to the Act made in 1988 which added subsection 256(5.1), the courts consistently construed the words "controlled, directly or indirectly, in any manner whatever" to apply a de jure and not a de facto test for control.
For taxation years commencing after 1988, subsection 256(5.1) of the Act provides that the phrase "controlled, directly or indirectly, in any manner whatever" includes factual or de facto control.
In addition, the Department of Finance Explanatory Notes accompanying the June 1988 legislative proposals for subsection 256(5.1) state:
New subsection 256(5.1) expands the concept of control for certain provisions of the Act to include what is often referred to as de facto control.
The fact that the term "controlled" and the expression "controlled, directly or indirectly in any manner whatever" are used together in subsection 256(6) does not appear to us to be an expression of tax policy consistent with your argument.
Finally, in response to your last question, the CRA's position on the effect of subsection 256(6) is that where it is determined that all of the conditions for the application of that subsection are met, the controlled corporation is deemed not to have been controlled in law or fact by the controller at the particular time.
We hope that our comments are of assistance.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Industrial Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch