6 November 2002 External T.I. 2002-0149745 - 2002 CTF: Silicon Graphics (FCA)

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 CCRA.

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

Principal Issues: 2002 CTF: Silicon Graphics (FCA)

Position: Impact of Silicon Graphics decision regarding control by groups and de facto control; also discusses a recent position on paragraph (b) of the CCPC definition

Reasons: N/A

November 6, 2002
2002 Canadian Tax Foundation Panel Question

Silicon Graphics Ltd. v. The Queen, 2002 DTC 7112; [2002] 3 CTC 527 (FCA)

Alias Research Inc., a predecessor of the taxpayer, claimed enhanced SR & ED benefits under subsection 127(10.1) and section 127.1 in its 1992 and 1993 taxation years. During those years, the common shares of Alias were publicly traded on the NASDAQ exchange in the United States. The common shares were widely-held and more than 50% of those shares were owned by non-residents. Alias' principal place of business was in Toronto, and a majority of the board of directors and the entire management team were residents of Canada. The management team annually prepared a slate of people to be elected to the board, which was always accepted by the shareholders.

In December 1991, Silicon Graphics Inc., a U.S. public corporation, agreed to advance up to $5 million to Alias in consideration of a security interest in Alias' assets and the issuance of warrants to acquire common shares of Alias. The loan was outstanding for seven weeks, during which time Silicon Graphics Inc. approved daily cash forecasts and determined which creditors of Alias would be paid. Silicon Graphics Inc. also made financial contributions to Alias for software development and marketing. Certain directors and officers of Alias were formerly associated with Silicon Graphics Inc. and Alias software only operated on hardware of Silicon Graphics Inc.

The issue before the Tax Court of Canada was whether Alias was "controlled, directly or indirectly in any manner whatever, by one or more non-resident persons" within the meaning of the "Canadian-controlled private corporation" (CCPC) definition in subsection 125(7) and the extended meaning of control in subsection 256(5.1). The Tax Court of Canada concluded that the non-resident shareholders had de jure control of Alias because they held the simple majority of voting shares, notwithstanding that there was no common connection between them. Because of this finding, the Tax Court of Canada found it was unnecessary to consider whether non-residents had de facto control of Alias.

Silicon Graphics appealed to the Federal Court of Appeal. On the issue of de jure control, the Federal Court of Appeal equated the phrase "control by one or more persons" in the CCPC definition with the phrase "control by a person or group of persons", and, based on prior case law, agreed with Silicon Graphics that in order for a group of persons to be in a position to exercise de jure control, a common connection must exist between the shareholders. As there was no evidence of a common connection, the Federal Court of Appeal overturned the Tax Court of Canada's decision. In reaching its conclusion, the Federal Court of Appeal referred to the 1998 legislative amendment to the CCPC definition, adding paragraph (b) of the CCPC definition, prior positions taken by the CCRA on control by groups and the policy underlying tax advantages given to CCPCs.

With respect to the second issue, the Federal Court of Appeal stated that in order for there to be finding of de facto control, "...a person or group of persons must have a clear right and ability to effect a significant change in the board of directors or the powers of the board of directors or to influence in a very direct way the shareholders who would otherwise have the ability to elect the board of directors." In the Federal Court of Appeal's view, there was no evidence to show that Silicon Graphics Inc. satisfied those criteria. Instead, the Federal Court of Appeal found that de facto control remained in Canada.

Question 1

In the Revenue Canada Forum at the 1994 Canadian Tax Foundation conference, the CCRA expressed the view that since the CCPC definition in subsection 125(7) did not refer to control by a "group of persons", it was meant to mean ownership of that number of shares that would constitute control.¹ Contrary to this position, in Silicon Graphics, the Federal Court of Appeal took the position that the reference to "one or more" in the CCPC definition essentially meant "group of persons", and therefore, there must be a common connection between the non-resident shareholders in order for them to have de jure control.

Does the CCRA accept the Federal Court of Appeal's findings, and if so, what are the implications?

Response 1

Yes. We accept the findings on this issue and have not sought leave to appeal to the Supreme Court of Canada. In the context of the CCPC definition, the findings are largely of historical interest given that paragraph (b) of the CCPC definition would apply, for years after 1995, to deny CCPC status in widely-held situations, such as that which existed in Silicon Graphics.

Question 2

Will the CCRA interpret control by "one or more persons", as used in other sections of the Act, to mean "group of persons" in accordance with Silicon Graphics? For instance, this wording appears in paragraphs 83(2.2)(c) and (d) and paragraphs 83(2.4)(c) and (d), relating to capital dividends, and in the following definitions: "capital dividend account" and "private corporation" in subsection 89(1), "financial institution" in subsection 142.2(1), "restricted financial institution" and "term preferred share" in subsection 248(1) and "eligible corporation" in subsection 5100(1) of the Income Tax Regulations.

Response 2

Yes. There is no basis for limiting the findings in Silicon Graphics on this issue to the CCPC definition.

Question 3

Have there been any other developments regarding the interpretation of the CCPC definition in subsection 125(7)?

Response 3

Yes. There is one new development regarding the application of paragraph (b) of the CCPC definition to multi-tiered corporate structures similar to that which existed in Parthenon Investments Ltd. v. The Queen.² Recall that in Parthenon, the Federal Court of Appeal held that control meant ultimate control, with the result that CCPC status was not denied to the corporation at the bottom of the corporate chain by reason of the interposition of a non-resident corporation in the middle of the corporate chain, when ultimate control lay with a Canadian resident at the top of the corporate chain. For taxation years that begin after November 1999, subsections 256(6.1) and (6.2) apply to override the position taken by the Federal Court of Appeal in Parthenon.

The Parthenon case only dealt with the application of what is now paragraph (a) of the CCPC definition. The CCRA is of the view, however, that paragraph (b) of the CCPC definition would apply to deny CCPC status in factual situations similar to that which existed in Parthenon for years after 1995. Paragraph (b) requires shares, not only of the corporation in question, but those of all corporations, owned by a non-resident person, a public corporation (other than a prescribed venture capital corporation), or a corporation described in paragraph (c) of the CCPC definition, to be attributed to a hypothetical person. If the hypothetical person would directly or indirectly control the corporation in question, the latter would not be a CCPC.

For illustrative purposes, consider the following scenario: Canco1 is a Canadian corporation that is controlled by a Canadian resident. Canco1 owns more than 50% of the voting shares of Pubco, a Canadian public corporation, which in turn owns more than 50% of the voting shares of Canco2, a Canadian corporation. In determining Canco2's status as a CCPC, in the CCRA's view, paragraph (b) would apply to attribute the shares of Canco2 held by Pubco to a hypothetical person. Because this hypothetical person would then directly control Canco2, CCPC status would be denied notwithstanding the fact that ultimate control of Canco2 lay with a Canadian resident. As noted above, paragraph (b) will also apply if control by the hypothetical person is indirect. This would arise if, instead of owning the shares of Canco2 directly, Pubco owned 100% of the voting shares of Holdco, a Canadian corporation, which in turn owned more than 50% of the voting shares of Canco2. In this case, Canco2 would not be a CCPC because paragraph (b) would apply to attribute the shares of Holdco to the hypothetical person, who would then have indirect control of Canco2.

Question 4

The Federal Court of Appeal set out circumstances in which a person or group of persons would be considered to have de facto control. These circumstances are narrower in scope than those set out by the CCRA in ¶ 21 of Interpretation Bulletin IT-64R4, Corporations: Association and Control, dated August 14, 2001. How does this decision affect these views?

Response 4

The CCRA is not presently considering any change to the criteria contained in ¶ 21 of Interpretation Bulletin IT-64R4 as a result of the Silicon Graphics decision. There are two cases involving the application of subsection 256(5.1) that have been appealed to the Federal Court of Appeal: Mimetix Pharmaceuticals Inc. v. The Queen and Rosario Poirier Inc. v. The Queen.³ The CCRA is of the view that the Tax Court of Canada decision in Mimetix⁴ seems to suggest that the circumstances in which de facto control may arise may not be as narrow as those set out in Silicon Graphics. For instance, it is noted that the Tax Court of Canada in Mimetix found that a non-resident shareholder had de facto control of the appellant in part because the non-resident shareholder exercised the powers of the appellant's board of directors, which is not a situation cited by the Federal Court of Appeal in Silicon Graphics. Given the uncertainty surrounding the scope of de facto control, the CCRA intends to wait for the Federal Court of Appeal's decisions in Mimetix and Rosario Poirier prior to considering whether any change is necessary to our position on de facto control in Interpretation Bulletin IT-64R4.

ENDNOTES

¹ See also Issue No. 3 of the Income Tax Technical News, dated January 30, 1995.

² 97 DTC 5343; [1997] 3 CTC 152 (FCA).

³ Court file No. A-63-02 and Court file No. A-378-02, respectively.

⁴ 2001 DTC 1026; [2002] 1 CTC 2188 (TCC).