Principal Issues: 1) Is there an acquisition of control of a corporation by an unrelated group of persons in a situation where the two 50% shareholders of the corporation would each dispose of one third of their shares in the corporation to an unrelated person. 2) Is there an acquisition of control of a corporation in a situation where the corporation has 4 unrelated shareholders, none of which individually controls the corporation, and redeems the shares held by one of the shareholders such that the corporation now has 3 unrelated shareholders, none of which individually controls the corporation.
Position: 1) Question of fact 2) Question of fact.
Reasons: General comments provided.
TABLE RONDE SUR LA FISCALITÉ FÉDÉRALE DU 10 OCTOBRE 2024
APFF - CONGRÈS 2024
17. Acquisition of control
Situation 1
Mr. A and Ms. B were the sole shareholders of a corporation (“Opco”), each holding 50% of the Class A common shares (voting and participating) of its capital stock. Mr. A and Ms. B wished to include Mr. C in the Opco shareholding. Mr. A, Ms. B and Mr. C are not related persons within the meaning of subsection 251(2).
On January 1, 2024, Mr. A and Ms. B each sold one third of their Class A common shares in the capital stock of Opco to Mr. C, for a consideration equivalent to the FMV.
Following the transaction, Mr. A, Ms. B and Mr. C each hold 33.33% of the capital stock of Opco.
Question to the CRA
Technical Interpretation 2010-0373131C6 (footnote 1) confirmed CRA's general position contained in Interpretation Bulletin IT-419R2 (footnote 2), now contained in Income Tax Folio S1-F5-C1 (footnote 3) (“Folio S1-F5-C1”), which provided a presumption that the shareholders of a private corporation that has two or three unrelated shareholders will act together to exercise control of the corporation.
Also, the CRA had already stated, in the 1984 Federal Taxation Roundtable (footnote 4) (Question 42), that in this situation, Mr. A and Ms. B always form the group of persons who control the corporation.
Is the CRA of the view that the group formed by Mr. A, Ms. B and Mr. C forms a new control group immediately after the transaction, thus resulting in the acquisition of control of Opco at the earliest time on January 1, 2024? Conversely, is the CRA of the view that the group formed by Mr. A and Ms. B still controls the corporation, thereby not resulting in any acquisition of control?
CRA Response
Whether a group of unrelated persons forms a group of persons that controls a corporation is a question of fact that can only be resolved after analyzing all the relevant facts pertaining to a particular situation.
The courts have generally recognized that, in order to conclude that several persons collectively exercise control of a corporation, there must be a sufficient connection between those persons, such as a voting rights agreement, an agreement to act in concert or business or family ties (footnote 5).
In the context of a private corporation with only two or three shareholders, none of whom individually controls the corporation, the CRA's position remains as set out in Folio S1-F5-C1, namely that the shareholders of such a corporation are presumed to act in concert to control the corporation (the “control group presumption”). The CRA also remains of the view that in almost all cases where the voting rights in a corporation are exercised equally by two shareholders, the corporation will be controlled by the group formed by those two shareholders.
Consequently, in the present situation (Situation 1), unless it can be shown that neither Mr. A nor Ms. B controlled Opco prior to the disposition of the shares to Mr. C and that the decision-making process in the corporation was effectively at a standstill, Mr. A and Ms. B would be presumed to form a group of persons that controlled Opco.
Second, whether the acquisition of a minority interest in a corporation, in this case the acquisition by Mr. C of one-third of the Opco shares held by Mr. A and Ms. B, results in an acquisition of control of the corporation by a new group of persons is a question that the CRA generally determines after reviewing all the facts, legal documents and circumstances relating to a particular situation. Paragraph 7 of Interpretation Bulletin IT-302R3 sets out certain aspects that the CRA will consider in making that determination, including the type of corporation, who previously controlled the corporation, the number or percentage of shares purchased, the method of acquisition, common interests and concerted actions.
As stated in the question, the CRA commented on a situation similar to Situation 1 as part of the 1984 Roundtable on Federal Taxation. Essentially, the CRA was asked whether there was an acquisition of control of a loss corporation where, as in Situation 1, the two equal shareholders of the corporation each disposed of one-third of their shares in the corporation to an unrelated person. In its response, CRA noted that the two original shareholders would still be in a position to control the corporation after the disposition of the shares. However, the CRA also stated that to the extent that the two original shareholders would cease to act in concert to control the corporation, the disposition of the shares could result in the acquisition of control of the corporation.
For example, in the context of Situation 1, we are of the view that such a situation could arise if Mr. A or Ms. B withdrew from control of Opco and, after the disposition of the shares, it would be reasonable to consider that control of Opco is instead exercised by a new group of persons of which Mr. C is a member. This could also be the case if, after the disposition of the shares, it was determined that Mr. A, Ms. B and Mr. C formed a group of persons that controls Opco.
Situation 2
Mr. A, Ms. B, Mr. C and Ms. D were the sole shareholders of a corporation ("Opco"), each holding 25 common shares A (voting and participating) of its share capital. Ms. D wished to withdraw from Opco's shareholding and requested the redemption of all her common A shares. Mr. A, Ms. B, Mr. C and Ms. D are not related persons within the meaning of subsection 251(2).
On January 1, 2024, Opco redeemed the 25 common A shares of its share capital held by Ms. D for a consideration equal to their FMV.
Following the transaction, Mr. A, Ms. B and Mr. C each hold one third (1/3) of the common A shares in the capital stock of Opco.
Question to the CRA
Technical Interpretation 2010-0373131C6 (footnote 7) confirmed the CRA general position in the Interpretation Bulletin IT-419R2 (footnote 8) now contained in Folio S1-F5-C1 (footnote 9) that in a situation where a private corporation has three unrelated shareholders, none of whom individually has control, the CRA presumes that the three shareholders act in concert, thereby forming a group that controls the corporation.
In the CRA's view, the question of whether a group of unrelated persons controls a corporation (where a private corporation has more than three unrelated shareholders, none of whom individually controls the corporation) is a question of fact.
Considering the transaction presented to you in the situation, is the CRA of the view that Mr. A, Ms. B and Mr. C form a new control group immediately following the redemption of Ms. D's shares, resulting in the acquisition of control of Opco at the earliest time on January 1, 2024?
CRA Response
Generally speaking, the comments set out above with respect to Situation 1 also apply to this situation (‘Situation 2’).
In Situation 2, immediately following the redemption of Ms. D's shares, the shares of Opco's capital stock are held equally by three unrelated shareholders. Based on the control group presumption discussed above, the three remaining shareholders, Mr. A, Ms. B and Mr. C, will be presumed to be acting in concert to control Opco.
Consequently, we are of the view that the repurchase of Ms. D's shares would result in the acquisition of control of Opco by the group of persons formed by Mr. A, Ms. B and Mr. C, unless the presumption of a control group can be rebutted in light of all the facts and circumstances surrounding Situation 2, or if it can be demonstrated that control of Opco was exercised by the same group of persons before and after the repurchase. For example, this would be the case if it could be demonstrated that the group composed of Mr. A, Ms. B and Mr. C controlled Opco prior to the repurchase.
The question of whether a group of unrelated persons controls a corporation and, if so, the composition of that group, in situations where a private corporation has more than three unrelated shareholders, none of whom individually controls the corporation, remains a question of fact. Since the statement in this question only briefly describes a hypothetical situation, it is impossible for us to pronounce definitively on this question without first examining all the facts, legal documents and circumstances surrounding a particular situation.
Laurence Gagné
October 10, 2024
2024-102898
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 CANADA REVENUE AGENCY, Technical Interpretation 2010-0373131C6, October 8, 2010.
2 CANADA REVENUE AGENCY, Technical Interpretation IT-419R2 (cancelled), “Meaning of Arm’s Length”, June 8, 2004.
3 CANADA REVENUE AGENCY, Income Tax Folio S1-F5-C1, “Related Persons and Dealing at Arm’s Length”, November 26, 2015.
4 "Revenue Canada Round Table", in 1984 Conference Report, Toronto, Canadian Tax Foundation, 1985, p. 783 (“1984 Federal Taxation Round Table”).
5 As set out in Silicon Graphics Ltd. v. Canada, 2002 FCA 260 ("Silicon Graphics"), at paragraph 36. The approach in Silicon Graphics was confirmed in the context of subsection 111(5) in Deans Knight Income Corp. v. Canada, 2023 SCC 16, at paragraph 81, and was repeated in, among others, Madison Pacific Properties Inc. v. The King, 2023 TCC 180, at paragraph 64.
6 CANADA REVENUE AGENCY, Interpretation Bulletin IT-302R3 (Archived), “Losses of a Corporation - The Effect that Acquisitions of Control, Amalgamations, and Windings-up have on Their Deductibility”, January 1, 1995.
7 Supra, note 44.
8 Supra, note 45.
9 Supra, note 46.
10 “Federal Taxation Round Table”, 2010 Conference, Montreal, Association de planification fiscale et financière, 2010, question 1.