7 October 2016 APFF Roundtable Q. 20, 2016-0655831C6 F - Employee Buycos and the Poulin Case -- translation

Principal Issues: Whether our position with respect to Employee Buycos, as stated at the CRA Panel held at the 2012 CTF Annual Conference, has changed as a result of the Tax Court of Canada decision in Poulin et al.

Position: No.

Reasons: The question as to whether the employee and the Employee Buyco are, upon the sale of the shares of the capital stock of a particular corporation, dealing with each other at arm’s length is a question of fact. Such determination can only be made following the review of all facts and circumstances relating to a particular situation. However, in a particular situation, it could be concluded that the employee and the Employee Buyco are acting in concert without separate interests. For example the particular facts and circumstances could establish that the Employee Buyco assumes no risks associated with the purchase of the shares of the capital stock of the particular corporation, does not benefit from buying such shares, has no interest other than to enable the employee to realize a capital gain and claim the capital gains deduction, has no role independent of the employee or the operating corporation. In other words, the Employee Buyco is only involved in the transaction as an accommodating party for the benefit of the employee.

2016 APFF ROUNDTABLE

Question 20

Sale of shares to a Buyco and recent jurisprudence

At the Canada Revenue Agency ("CRA") Panel held in conjunction with the 2012 Annual Meeting of the Canadian Tax Foundation (footnote 1) (the "Panel"), the CRA discussed matters of interest, including those relating to transactions that allow employees/shareholders of private companies to realize a capital gain in lieu of a deemed dividend when they must dispose of their shares, inter alia, upon retirement.

For illustrative purposes, a hypothetical situation was described at this Panel. In this situation, a corporation ("Opco") incorporates a new corporation ("BuyCo") and injects it with funds. BuyCo uses these funds to purchase the shares in the capital stock of Opco held by the resigning employee/shareholder.

Among other things, the CRA indicated that, in respect of requests for advance rulings submitted to it in 2012, it had refused to confirm that the resigning employees/shareholders would not be deemed under section 84.1 to have received a dividend from BuyCo on the disposition of the shares in the capital stock of Opco.

Recently, the Tax Court of Canada (the "Court"), in the case of Poulin et al. v. The Queen (footnote 2), had to determine whether there was an arm's length relationship between an individual and a corporation for the purposes of section 84.1.

More precisely, Mr. Ghislain Poulin ("Mr. Poulin") and Mr. Herman Turgeon ("Mr. Turgeon") disposed of shares in the capital stock of Les Constructions de l'Amiante Inc. ("L’Amiante") in the course of the reorganization of the corporate structure of L’Amiante leading to Mr. Poulin's phased departure and the integration of Mr. David Hélie (" Mr. Hélie "), a key employee of L’Amiante, into the shareholdings in the latter. On the one hand, Mr. Poulin sold the shares he held in L’Amiante to a newly-formed corporation controlled by Mr. Turgeon ("Turgeon Holdco"). For his part, Mr. Turgeon sold the shares he held in L’Amiante to a newly-incorporated corporation controlled by Mr. Helie ("Hélie Holdco").

Following these dispositions, Mr. Poulin and Mr. Turgeon both reported a taxable capital gain for which they claimed the capital gains deduction under subsection 110.6(2.1) (the "Deduction.")

The CRA denied the Deduction claimed by these taxpayers. According to the CRA, Mr. Poulin and Turgeon Holdco, on the one hand, and Mr. Turgeon and Hélie Holdco, for their part, acted in concert without separate interests and, therefore, did not deal at arm's length. Accordingly, section 84.1 applied to both Mr. Poulin and Mr. Turgeon.

The Court agreed with the CRA in respect of Mr. Turgeon. However, the Court found that Mr. Poulin and Turgeon Holdco were dealing at arm’s length because they had not acted in concert without separate interests.

The Court, on the basis of all the evidence, was of the view that Mr. Poulin wished to leave the L’Amiante and sell all his shares in L’Amiante at the best price and on the best terms possible, one of these being to benefit from the Deduction. As for Turgeon Holdco, it wanted to acquire the Amiante shares held by Mr. Poulin, thereby allowing Mr. Turgeon to acquire control of the L’Amiante. In short, the Court was of the view that the sale of shares reflected ordinary commercial relations between parties acting in their own interests.

Question to the CRA

Given the similarities between the situation of the employee/shareholder who, with a view to departing on retiring, disposes of shares in the capital stock of Opco in favour of BuyCo and that of Mr. Poulin, and taking into account the findings of the Court in respect of the latter, does the CRA intend to modify its position respecting the potential application of section 84.1 on the sale of shares by an employee/shareholder to a BuyCo?

CRA response

It must first be emphasized that the CRA generally agrees with the Court when it recognized that "[t]he fact that Mr. Poulin and Mr. Turgeon had structured the transaction such that Mr. Poulin could benefit from his capital gains deduction does not mean that the parties acted in concert without separate interests.”

However, the Court noted that this eventuality is not untrammelled: "That being said, while it is completely acceptable for an entrepreneur to want to benefit from tax relief available to them, it is, however, necessary to ensure that the method used is permitted.” Thus, the court held that Mr. Turgeon and Hélie Holdco acted in concert without separate interests and, consequently, did not deal at arm's length.

The CRA is and has always been of the view that the question whether, for the purposes of section 84.1 of the Act, unrelated persons deal at arm's length at a given time is a question of fact requiring the analysis of all the facts and circumstances of a particular given situation.

In this regard, the mere fact that (as with Mr. Poulin) an employee/shareholder wishes to dispose of all their shares of capital stock of a corporation to a BuyCo who wishes to acquire them is not in itself sufficient to conclude that these taxpayers are dealing at arm’s length.

In fact, in the context of a particular given situation, it could nevertheless be established that the employee/shareholder and BuyCo acted in concert without separate interests. For example, the facts may demonstrate that, as with Hélie Holdco, BuyCo incurred no economic risk in participating in the transaction, did not derive any benefit from the purchase of shares, had no interest other than to allow the employee/shareholder to realize a capital gain and benefit from the deduction, and had no function independent of the employee /shareholder or the operating corporation - and, in short, it only participated in the transaction as an accommodation for the benefit of the employee/shareholder.

In closing, where taxpayers are planning to undertake transaction where section 84.1 could apply, obtaining an advance income tax ruling prior to such transactions is recommended.

Jean Lafrenière
(613) 670-9013
October 7, 2016
2016-065583

FOOTNOTES

Due to our system requirements, footnotes contained in the original document are reproduced below:

1 See in this respect, Mickey SARAZIN, « The Income Tax Rulings Directorate and Its Interaction with Practitioners », in 2012 Conference Report, Toronto, Canadian Tax Foundation, 2013, p. 5:1-17.
2 2016 CCI 154&d1=&d2=&su=0">2016 TCC 154.
3 Ibid., at para. 81.
4 Ibid., at para. 90.