11 October 2019 APFF Roundtable Q. 12, 2019-0812711C6 - Part IV
PRINCIPAL ISSUES: Whether two corporations are dealing non-arm's length with another corporation.
POSITION: Question of fact.
REASONS: Presumption presented in paragraph 1.20 of Folio S1-F5-C1 and comment made in paragraph 1.53 of the same Folio.
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2019
2019 APFF CONFERENCE
Question 12
Application of Part IV tax
Corporation A and Corporation B each hold 50% of the voting and participating shares of Corporation X and Corporation Y. The corporations are Canadian-controlled private corporations. Corporation A is not related to Corporation B.
Corporation X holds non-voting preferred shares of Corporation Y, which are redeemable by the corporation.
In order to simplify the structure, the shareholders of Corporation A and Corporation B decide by mutual agreement that Corporation Y will proceed to redeem the shares held by Corporation X. The redemption triggers a dividend that is deemed to be paid by Corporation Y and received by Corporation X. Corporation Y has nil refundable dividend tax on hand.
Corporation Y is not controlled by Corporation X. However, it is controlled by the same corporate group as Corporation X. In order to consider Corporation Y to be controlled by Corporation X, through the expanded definition of control in subsection 186(2), Corporation Y would need to be controlled by persons with whom Corporation X does not deal at arm's length.
Questions for the CRA
1. Is Corporation Y considered to be connected with Corporation X for Part IV tax purposes?
2. Would Corporation A and Corporation B be deemed not to deal at arm's length with Corporation X for the purposes of subsection 186(2), considering that they took the decision to proceed with the redemption by common accord?
CRA Response
By virtue of paragraph 186(4)(a), a payer corporation, in this case Y Corp., is connected with a particular corporation, X Corp., at a particular time in a taxation year if the payer corporation is controlled, otherwise than by virtue of a right referred to in paragraph 251(5)(b), by the particular corporation at that time.
In determining whether X Corp. controls Y Corp. for the purposes of paragraph 186(4)(a), subsection 186(2) provides that a corporation is controlled by another corporation if more than 50% of its issued share capital (having full voting rights under all circumstances) belongs to the other corporation, to persons with whom the other corporation does not deal at arm’s length, or to the other corporation and persons with whom the other corporation does not deal at arm’s length.
In this situation, X Corp. does not hold any shares of the capital stock of Y Corp. with full voting rights under all circumstances. Consequently, it must be determined whether A Corp. and B Corp., which together hold more than 50% of the issued shares of the capital stock of Y Corp., with full voting rights under all circumstances, are not dealing at arm's length with X Corp.
We understand that A Corp. and B Corp. are unrelated persons and therefore do not form a related group of persons that controls X Corp.. We also understand that neither A Corp. nor B Corp. is related to X Corp. Consequently, paragraph 251(1)(a) would not apply in this situation.
That said, under paragraph 251(1)(c), the question of whether unrelated persons deal at arm's length at a particular time is a question of fact. Unrelated persons may or may not deal at arm's length depending on the facts and circumstances pertaining to a particular situation. Each file must be examined in the light of its own facts and circumstances. Consequently, we can only make the following general comments.
As indicated inter alia in paragraph 1.53 of Folio S1-F5-C1, "Related Persons and Dealing at Arm's Length”, "[a] person who is not related to a corporation is not considered not to deal at arm’s length with the corporation merely because he or she owns shares of the corporation. However, if a sufficient number of minority shareholders act in concert in order to direct the affairs of a corporation, they may be considered not to be dealing at arm's length with the corporation.”
In addition, paragraph 1.20 of Folio S1-F5-C1, Related Persons and Dealing at Arm's Length, states that “[i]n the case of a closely-held corporation (for example, 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.”
On the basis of the limited facts submitted, in a structure such as that described in this question, A Corp. and B Corp. could a priori be considered not to be dealing at arm's length with X Corp.
Consequently, X Corp. would be considered to control Y Corp. since more than 50% of the shares of the capital stock of Y Corp. would belong to persons not dealing at arm's length with X Corp., i.e. A Corp. and B Corp. Consequently, Y Corp. would be considered to be connected to X Corp.
Marc Séguin
(514) 620-8562
October 11, 2019
2019-081271