16 June 2000 Internal T.I. 1999-9914177 - REFUNDABLE INVESTMENT TAX CREDITS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: 1. Is a corporation eligible to earn investment tax credits on SR&ED qualified expenditures in 1998.

2. Is the Corporation eligible to claim Refundable ITCs under section 127.1,

3. If it is eligible, can the corporation claim ITC refunds under paragraph (d) or (f) of the definition of refundable investment tax credit in subsection 127.1(2).

Position: 1. The corporation is eligible for ITCs in 1998 under 127(9) and under 127(10.1) of the Act.

2&3. The corporation is eligible for refundable ITCs in 1998 under section 127.1, under paragraph (d) of the definition of refundable investment tax credit in subsection 127.1(2).

Reasons: The corporation is a CCPC and meets the conditions entitling it to ITCs. During its 1998 taxation year, the Corporation was a qualifying corporation. The corporation was not exempt from tax under 149(1)(d) of the Act because 90% of the shares were not owned by a municipality. The Band Council only owned XXXXXXXXXX % of the shares. De facto control of the corporation was not with a person exempt from tax under section 149. The corporation was an excluded corporation because de jure control of the corporation was with the Council. The Council is a public body performing a function of government in Canada. The Corporation is related to the Council and therefore, is an excluded corporation as defined under subsection 127.1(2).

		June 16, 2000

	XXXXXXXXXX  Tax Service 	HEADQUARTERS
	XXXXXXXXXX 	David Shugar
		957-2134
	Attention: XXXXXXXXXX
		1999-991417

XXXXXXXXXX

This is in reply to your correspondence of May 21, 1999 requesting our comments on whether, in respect of its 1998 tax return, XXXXXXXXXX (the "Corporation") is entitled to investment tax credits (ITCs), to deduct ITCs from Part I tax payable under subsection 127(5) of the Income Tax Act (the "Act"), and to a refund of ITCs under subsection 127.1(1) of the Act. We apologize for the delay in our response.

Facts

XXXXXXXXXX

Our Comments

Under paragraph (a.1) of the definition of 'investment tax credit' in subsection 127(9) of the Act, ITC's are earned by a corporation at the rate of 20% of its SR&ED qualified expenditure pool. Under subsection 127(10.1) of the Act, an additional ITC of 15% of a corporation's SR&ED qualified expenditure pool is available to a corporation that was a Canadian Controlled Private Corporation (CCPC) throughout the taxation year.

Subsection 127(5) of the Act provides for the deduction of a taxpayer's investment tax credit from Part I tax otherwise payable. ITCs are refundable under subsection 127.1(1) of the Act, which provides that a taxpayer, other than a person exempt from tax under section 149 of the Act, is deemed to have paid, on account of the taxpayer's Part I tax for the year, the lesser of the taxpayer's refundable investment tax credit for the year, and the amount designated by the taxpayer. ITC's are refundable at the rate of 100% for qualifying corporations other than excluded corporations, and at the rate of 40% for qualifying corporations that are excluded corporations. The ITCs are refundable under subsection 127.1(1) in the year the qualified expenditure is incurred.

To be eligible to earn ITCs and to determine the rate at which the ITCs are refundable in 1998, it must be determined:

1. whether the Corporation's income was exempt income as stated in paragraph (l) of the definition of investment tax credit in subsection 127(9) of the Act;

2. whether the Corporation was exempt from tax under section 149 of the Act, in its 1998 taxation year;

3. whether the Corporation was a qualified corporation under subsection 127.1(1) of the Act, throughout its 1998 taxation year; and,

4. whether the Corporation was an excluded corporation under subsection 127.1(1) of the Act, at any time in the 1998 taxation year.

Entitlement to ITCs

We were not provided with details about the source of income of the Corporation. Therefore, assuming that none of the Corporation's income was exempt income referred to in paragraph (l) of the definition of investment tax credit in subsection 127(9) of the Act, in our view, the corporation would be eligible for ITCs under paragraphs (a.1) and (e) of the definition of 'investment tax credit' in subsection 127(9) of the Act, in respect of its SR&ED qualified expenditure pool in its 1998 taxation year. The Corporation would also be eligible for an additional 15% ITC, under subsection 127(10.1) of the Act. Under subsection 127(5) of the Act, the Corporation would be able to claim a deduction from tax otherwise payable, provided the corporation otherwise met the conditions of the subsection.

Exemption from tax under section 149 of the Act

One of the conditions of eligibility for the refundable ITCs under section 127.1 of the Act is that the taxpayer claiming the refund cannot be exempt from tax under section 149 of the Act. The provisions in subsection 149(1) of the Act, regarding municipally-owned corporations, were amended in 1998, for taxation years and fiscal periods that begin after 1998. The Corporation is subject to the former legislation for its XXXXXXXXXX, 1998 (and 1999) taxation year. For its taxation years beginning after 1998, the Corporation is subject to the new rules in paragraph 149(1)(d.5) of the Act.

In order for the Corporation to have been exempt from tax in its XXXXXXXXXX, 1998 taxation year under former paragraph 149(1)(d) of the Act, two conditions had to be met - the Corporation must have been owned by a Canadian municipality, and the municipality must have owned at least 90% of the shares of the Corporation, either directly, or indirectly through a wholly-owned subsidiary of the municipality. All the issued shares of the Corporation, both voting and non-voting, have to be considered, in determining whether the 90% ownership requirement was met.

According to the facts provided, during the Corporation's 1998 taxation year, the Council did not own more than XXXXXXXXXX% of the Corporation's shares at any time, and therefore, did not meet one of the requirements under former paragraph 149(1)(d) of the Act. Therefore, it is not necessary to determine whether the Council was a municipality during that year. None of the information provided suggests that the Corporation was exempt under any other provision of section 149 of the Act.

In our view, the Corporation was not exempt from tax under section 149 of the Act in its 1998 taxation year, since less than 90% of the shares of the Corporation were owned by the Council. Our views above also apply to the Corporation's XXXXXXXXXX, 1999 taxation year.

Based on the above shareholdings, the Corporation may be exempt from tax in its XXXXXXXXXX, 2000 taxation year. Under paragraph 149(1)(d.5) and subsection 149(1.3) of the Act, a municipality is required to own at least 90% of the votes that could be cast under all circumstances at an annual meeting of shareholders. Based on the share structure given in the facts above, for the Corporation's XXXXXXXXXX, 2000 taxation year, the Council would meet the 90% ownership requirement. If the Council was a municipality during that taxation year, the Corporation would be exempt from tax.

In the Otineka Development Corporation Ltd. et al. v. The Queen, 94 DTC 1234 (T.C.C.) case, the Tax Court of Canada concluded that, since there is no definition of a "Canadian municipality" in the Act, the term must be given its ordinary meaning and is not to be solely determined by the provincial legislation governing municipalities. In the Court's view, the powers conferred under the Indian Act and their exercise by the band created a form of self-government that is an essential attribute of a municipality. The band had passed by-laws to regulate water and sewers, garbage disposal, weed control, domestic animal control, law and order, the provision of housing and other by-laws. It also provided services to band members in areas such as education, health care, social services, employment and training services, counselling and economic development. In the end, the Court concluded that the band was a municipality for the purposes of [former] paragraph 149(1)(d) of the Act and, therefore, that corporations owned by the band were exempt from taxation as municipally-owned corporations.

Since the decision rendered in the Otineka case hinged upon the particular facts of the case, only corporations that can demonstrate that they are in the same position as those in Otineka will be exempt from taxation. We cannot determine from the information provided, whether, in its XXXXXXXXXX, 2000 taxation year, the Corporation was in the same position as in Otineka.

If you determine that the Corporation became exempt from tax in its XXXXXXXXXX, 2000 taxation year, subsection 149(10) of the Act would apply, deeming a year end to occur immediately before the change in status, and deeming the Corporation to have disposed of all its property at fair market value immediately before the change in status.

Although we are unable to determine whether the Council was a municipality, in our view, based on the information available, the Council was at least a public body performing a function of government in Canada, and therefore, was exempt from tax under paragraph 149(1)(c) of the Income Tax Act.

Eligibility for Refundable Investment Tax Credits under subsection 127.1(2) of the Act

Certain ITCs are refundable to corporations that are qualifying corporations, as defined in subsection 127.1(2) of the Act. A corporation is a qualifying corporation for a particular taxation year if, throughout the particular year, it is a CCPC and the total of its taxable income, for its preceding taxation year, together with the taxable incomes for the preceding year of all corporations with which it was associated in the particular year, does not exceed their business limits for the preceding year ($200,000).

Based on the shareholder information you provided, and additional information from Industry Canada, the Corporation was not controlled directly, or indirectly, by one or more public corporations or non-residents, or a combination of these. Therefore, in our view, the Corporation was a CCPC during its 1998 taxation year, as defined under subsection 125(7) of the Act. Included with your letter of May 21, 1999, was a chart showing that Corporation XXXXXXXXXX has shareholdings in several companies. It will be necessary, therefore, for you to determine whether Corporation XXXXXXXXXX is associated with any of those other corporations, and whether the combined taxable incomes are within the combined business limit.

An additional ITC refund is available to qualifying corporations that are not excluded corporations. An excluded corporation, under subsection 127.1(2) of the Act, is described in paragraph 66 Interpretation Bulletin IT-151R4, Scientific Research and Experimental Development Expenditures, which states:

A corporation is an excluded corporation if, at any time during the year, it is a corporation that is either controlled (directly or indirectly, in any manner whatever) by, or is related to:

(a) one or more persons exempt from Part I tax under section 149,

(b) Her Majesty in right of a province, a Canadian municipality or any other public authority, or

(c) any combination of the above.

The expression "controlled, directly or indirectly in any manner whatever" is defined under subsection 256(5.1) of the Act and includes any situation where a person, or group of persons, has de facto control of the corporation. The determination of whether a person, or group of persons, has de facto control of a corporation or control over the business carried on by a corporation is a question of fact which can only be determined by reviewing the share ownership, the rights of shareholders as discussed in paragraph 17 of IT-64R3, the factors outlined in paragraph 19 of IT-64R3, and any agreements entered into between the corporation and its shareholders as to how the business of a corporation will be carried on. Because the Council is exempt from tax under section 149 of the Act, de facto control of the Corporation by the Council would cause the Corporation to be an excluded corporation. The determination of who has de facto control of the Corporation, at a given time, such that subsection 256(5.1) of the Act would apply, is a question of fact which can only be determined by reference to all of the relevant facts and circumstances of a particular case determined at that given time.

Subsection 127.1(2) of the Act also states that a corporation will be an excluded corporation if it is related to one or more persons exempt from tax under section 149 of the Act, Her Majesty in right of a province, a Canadian municipality, or any other public authority. Under paragraph 251(2)(b) of the Act, a corporation is related to a person who controls the corporation. Control in subsection 251(2) of the Act contemplates the right of control that rests in ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the board of directors. Such control is commonly referred to as de jure control. De jure control, rather than de facto control is relevant in deciding who has control of the Corporation for purposes of subsection 251(2) of the Act.

The shareholders' agreement, which evenly apportions control over the Board of Directors between the Council and the other shareholders, is not one of the constating documents of the corporation. The Supreme Court, in Duha Printers, concluded that outside of the constating documents of a corporation and its share register, unanimous shareholders agreements were the only relevant documents that should be examined in determining de jure control. Article XXXXXXXXXX of the shareholders' agreement states "XXXXXXXXXX".

In our view, Corporation XXXXXXXXXX, which owns XXXXXXXXXX% of the voting shares of the Corporation, controls the Corporation, and is related to the Corporation, under subparagraph 251(2)(b)(i) of the Act. The Council, which owns, directly or indirectly, XXXXXXXXXX% of the voting shares of Corporation XXXXXXXXXX, controls Corporation XXXXXXXXXX, and is related to Corporation XXXXXXXXXX, under subparagraph 251(2)(b)(i) of the Act. The Council is related to the Corporation under subparagraph 251(2)(b)(iii) of the Act. Therefore, the Corporation is an excluded corporation because it is related to the Council, an exempt entity.

In our view, the Corporation was a qualifying corporation that was an excluded corporation, and in its 1998 taxation year, was entitled to claim an ITC refund equal to 40% of the amount described in paragraph (d) of the definition of refundable investment tax credit in subsection 127.1(2) of the Act.

Tax Avoidance

Our comments have not taken into consideration whether the share structure of the company and the shareholders' agreement are avoidance transactions that would result in a tax benefit, and we have not reviewed the possibility of applying GAAR in this situation.

Roberta Albert, CA
for Director
Business and Publications Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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