Principal Issues: According to the situation described below, whether the corporations are closely related to each other.
Position: No.
Reasons: Application of the E.T.A. and previous position.
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2020
APFF CONFERENCE 2020
14. Qualifying control test for closely related corporations
On March 18, 2019, the CRA issued GST/HST Interpretation - 186839 Personnes morales étroitement liées [Closely related legal persons] in which it concluded that a corporation ("Corporation") and its subsidiaries ("Subsidiaries") were not considered to be closely related under section 128 of the Excise Tax Act ("ETA") where a unanimous shareholder agreement ("Unanimous Agreement") gave all the voting rights attached to the shares of a Subsidiary to the shareholders ("Shareholders") of the Corporation.
According to the facts submitted to the CRA:
- The Shareholders, which are corporations, each own less than 90% of the capital stock of the Corporation. None of those corporations is therefore closely related to each other within the meaning of ETA section 128;
- The Subsidiaries are the sole property of the Corporation;
- A Unanimous Agreement has been entered into between the Shareholders and the Corporation. In the Unanimous Agreement between the Shareholders and the Corporation, all powers to manage the business and affairs of the Corporation and the Subsidiaries are held by the Shareholders, who agree to exercise the voting rights attached to their shares. All the rights, powers, duties and obligations of the directors of the Corporation have been transferred to the Shareholders as if they were the directors of the Corporation or any Subsidiary.
- The Unanimous Agreement also provides that the proportion of votes required for the passing of any resolution in respect of any routine administrative matter will be a majority of the votes of the Shareholders present at the relevant meeting. Each Shareholder present at a meeting will be entitled to as many votes as are attached to the voting shares registered in the Shareholder’s name in the books of the Corporation.
- The board of directors of the Corporation and of each of the Subsidiaries will be composed of representatives of the Shareholders.
The CRA cites ETA subsection 128(4) which provides that, for the purposes of ETA subsection 128(1.1), a particular person is deemed not to own a share at a particular time if the voting rights of the shareholders attached to the particular person are subject to a right under a contract, in equity or otherwise, of control by another person who is not closely related to the particular person.
The CRA argues that the Unanimous Agreement not only limits the powers of the Corporation's board of directors to manage the business and affairs of the Corporation, but also applies to the voting rights of the Corporation attached to the shares of the Subsidiaries owned by the Corporation.
As such, the CRA concludes that the Corporation and the Subsidiaries are not considered to be closely related for Goods and Services Tax/Harmonized Sales Tax (GST/HST) purposes, as the Corporation is deemed not to own the shares of the Subsidiaries whose voting rights attached to its shares are subject to the control of another person who is not closely related to the Corporation, i.e. the Shareholders.
Consider the following alternative scenario: the Unanimous Agreement removes all powers of the directors of the Corporation with respect to the management of the business and affairs of the Corporation in favour of its Shareholders, but does not remove the power of the directors of the Subsidiaries with respect to the management of their business and affairs. In that context, the Shareholders will act as if they were the directors of the Corporation only and the decisions of the Corporation will therefore be approved by a majority of the votes of Shareholders holding voting shares. Those decisions include the exercise of the voting rights attached to the shares held by the Corporation in its Subsidiaries for the purpose of, inter alia, appointing the directors of the Subsidiaries. In that case, the Corporation, as shareholder of the Subsidiaries, has not withdrawn the powers of the directors of its Subsidiaries in favour of the Shareholders and the decisions of the Subsidiaries are not subject to the control or vote of the Shareholders. The Corporation continues to control the Subsidiaries; only the Corporation's decision making is governed by the Unanimous Agreement.
Questions to the CRA
(a) Considering that the powers of the directors of the Subsidiaries are not withdrawn in favour of the Shareholders in the alternative scenario, does the CRA consider that the Corporation and the Subsidiaries are not considered to be closely related for GST/HST purposes for the purposes of ETA subsection 128(1.1)?
(b) If so, considering the distortion that the broad scope of the presumption in ETA subsection 128(4) brings to the current situation where the Subsidiaries are wholly owned by the Corporation and a Unanimous Agreement governs the decision-making of the Corporation, is any relief or amendment to the rule contemplated?
In a parallel regard, ETA subsection 128(4) essentially reproduces the same rules as those set out in ITA paragraph 251(5)(b) and subsection 256(1.4), except that under those provisions, the person is deemed to own the shares, whereas ETA subsection 128(4) provides that the person is deemed not to own the shares. In that regard, following a judicial decision (footnote 1), the ITA was amended to add subsection 256(6.1), which applies to all of the ITA, to specify, for the purpose of clarity, that the determination of control of a corporation controlled by another corporation is made at each level and that the corporation may therefore be controlled both by its parent corporation and by the persons who control its parent corporation. That clarification was added to ensure that the ultimate control of a subsidiary by one of its parent's shareholders would not remove the parent's control over its subsidiary (and thus result in a wholly-owned subsidiary of a parent not being related to or controlled by its parent for the purposes of other provisions of the ITA, but rather being deemed to be controlled by the parent's controlling shareholder, thereby producing a result that does not reflect reality).
CRA Response to Question 14(a)
ETA Subsection 128(1) provides that, for the purposes of ETA Part IX, a particular corporation and another corporation are closely related to each other for GST/HST purposes at any time if, at that time
(a) qualifying voting control in respect of the other corporation is held by, and not less than 90% of the value and number of the issued and outstanding shares, having full voting rights under all circumstances, of the capital stock of the other corporation are owned by,
(i) the particular corporation,
(ii) a qualifying subsidiary of the particular corporation,
(iii) a corporation of which the particular corporation is a qualifying subsidiary,
(iv) a qualifying subsidiary of a corporation of which the particular corporation is a qualifying subsidiary, or
(v) any combination of the corporations or subsidiaries referred to in subparagraphs (i) to (iv)(b) the other corporation is a prescribed corporation in relation to the particular corporation.
By virtue of ETA subsection 128(1.1), a person or group of persons "holds qualifying voting control" in respect of a corporation at any time if, at that time
(a) the person, or the members of the group collectively, as the case may be, own shares of the corporation to which are attached not less than 90% of the shareholder votes that may be cast in respect of each matter, other than a matter
(i) for which a statute of a country, or of a state, province, or other political subdivision of a country, that applies to the corporation provides, in respect of the vote of the shareholders of the corporation on the matter, that
(A) any shareholder of the corporation has voting rights that are different from the voting rights that the shareholder would otherwise have under the letters patent, instrument of continuance or other constating instrument by which the corporation was incorporated or continued, including any amendment to, or restatement of, the constating instrument, or
(B) holders of a class or series of shares of the corporation are entitled to vote separately as a class or series, or
(ii) that is a prescribed matter or a matter that meets prescribed conditions or arises in prescribed circumstances; or
(b) the person or group, as the case may be, is a prescribed person or group in relation to the corporation.
ETA subsection 128(4) provides that for the purposes of subsection (1.1), a particular person is deemed not to own a share at a particular time if
(a) another person has a right under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently, to control the voting rights attached to the share, unless the right is not exercisable at the particular time because its exercise is contingent on the death, bankruptcy or permanent disability of an individual; and
(b) the other person is not closely related to the particular person at the particular time.
In the situation presented in the Interpretation, the Shareholders and the Corporation are not closely related to each other for the purposes of ETA Part IX. The Shareholders of the Corporation vote the shares of the Subsidiaries held by the Corporation and those voting rights attached to the shares of the Subsidiaries are subject to control by the Shareholders of the Corporation. Consequently, the Corporation and its Subsidiaries are not considered to be closely related for the purposes of ETA Part IX.
For the purposes of this question, it is assumed that the Corporation and the Shareholders of the Corporation are not closely related. Under the facts of the matter, the Shareholders will act as if they were the directors of the Corporation only and the decisions of the Corporation will be approved by a majority of the votes cast by the Shareholders holding voting shares. Those decisions include the exercise of the voting rights attached to the shares of the Subsidiaries held by the Corporation.
Since the voting rights attached to the shares of the Subsidiaries held by the Corporation are subject to the control of the Shareholders of the Corporation, the Shareholders of the Corporation retain control of those voting rights, and it would appear that ETA subsection 128(4) would apply to deem that the Corporation does not hold the shares of the Subsidiaries. Consequently, the Corporation would not have qualifying voting control over the Subsidiaries, as defined in ETA subsection 128(1.1), and the Corporation and its Subsidiaries would not be considered closely related for GST/HST purposes.
CRA response to Question 14(b)
We note that the statutory provisions of the Income Tax Act referred to in the question, namely paragraph 251(5)(b) and subsection 256(1.4), do not address the concept of "closely related to each other" applicable to corporations for GST/HST purposes. Section 251 deals with the concept of "non-arm's length" and sets out the conditions under which persons are "related" to each other for purposes of the Income Tax Act and section 256 sets out the conditions under which a corporation is "associated" with one or more other corporations for purposes of the Income Tax Act. ETA section 128 does not refer to the Income Tax Act. The Income Tax Act and the Excise Tax Act are based on different legislative regimes and tax policy frameworks.
Determining whether two or more corporations are "closely related to each other" by virtue of section 128 E.T.A. is important to:
- determine whether they are eligible to make an election by virtue of sections 150 E.T.A. and 156 E.T.A;
- determine the eligibility of corporations for the offset rule in subsection 228(7) E.T.A;
- applying paragraph (t) of the definition of "financial service" in subsection 123(1) E.T.A.
If APFF members have indications that there is a significant problem with this issue, they could bring it to the attention of the Department of Finance for consideration.
Response prepared by:
Lloyd McMaster
Financial Services Unit and Special Arrangements Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Person in the Income Tax Rulings Directorate responsible:
Yvon Beaudoin
(514) 496-6688
October 7, 2020
2020-085226
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Parthenon Investments Ltd. v. MNR, 97 DTC 5343 (FCA).
UNCLASSIFIED