CRA finds that a highly contingent secondary call right of a non-resident on shares of minority residents undercuts for CCPC purposes their USA right to appoint half the board

A mooted Canadian-controlled private corporation (Opco) had its voting common shares held 50-50 by a single non-resident, and by three Canadian residents. CRA accepted (following Bagtech) that a clause in the unanimous shareholder agreement that gave the three residents the right to jointly appoint two of the four directors would have avoided de jure control by the non-resident even if their collective shareholding fell below 50%.

However, CRA found that a contingent right of the non-resident to acquire the shares of a “defaulted shareholder” (e.g., on the discovery of fraud or theft) disqualified Opco as a CCPC (even though this (secondary) call right was exercisable only after failure of the other resident shareholders to exercise their first call right following the default). CRA’s reasoning was that this represented a contingent right to acquire each resident shareholder’s shares, so that the non-resident was deemed by s. 251(5)(b)(i) to be a 100% shareholder. As a deemed sole shareholder, it no longer would be subject to the board representation clause, so that it would have an unfettered right (in this remote scenario) to appoint a majority of the board.

S. 251(5)(b)(ii) refers to a right of a shareholder (here, in the context of an alternative scenario, the non-resident) “to cause” the corporation (Opco) to redeem the shares of another shareholder (i.e., the shares of a defaulted shareholder). Does this mean that s. 251(5)(b)(ii) cannot apply if the USA directly imposes an obligation on Opco to redeem the shares upon the occurrence of default with no discretion of the non-resident shareholder to choose to cause the redemption? CRA considered that s. 251(5)(b)(ii) would apply because the non-resident would have the right to require Opco to redeem the shares if Opco did not fulfill its obligation to do so automatically.

Neal Armstrong. Summaries of 24 March 2017 External T.I. 2016-0662381E5 Tr under s. 251(5)(b)(i) and s. 251(5)(b)(ii).