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:
1) Whether a corporation and a partnership are dealing with each other at arm's length.
2) Whether a subsidiary corporation would maintain its CCPC status after its parent amalgamates with a public corporation.
Position:
1) Question of fact. In the circumstances described in the opinion request, a rebuttable presumption exists that the corporation and the partnership are not dealing at arm's length.
2) No.
Reasons:
1) Mr A and Mr. B are the sole shareholders of the corporation and, through their respective holding corporations, equal partners in the partnership. In these circumstances, it is reasonable to assume that Mr. A and Mr. B act in concert to control both entities such that the corporation and the partnership would not be dealing at arm's length.
2) After the amalgamation the subsidiary would be controlled directly by a public corporation.
June 9, 2003
Mr. Mel Machado HEADQUARTERS
Financial Legislative Applications Section Shaun Harkin, CMA
SR&ED Directorate
50 O'Connor, 7th Floor
Attention: L. Agarwal
2003-001113
Meaning of Non-Arm's Length and CCPC Status
This is in reply to your memorandum of March 25, 2003 wherein you requested our views on the following:
1) Xco is a Canadian-controlled private corporation ("CCPC") owned equally by two shareholders: Mr. A and Mr. B. Mr. A and Mr. B are the sole shareholders of Aco and Bco respectively. Aco and Bco are equal partners in a partnership (the "Partnership"). Xco contracts out some scientific research and experimental development ("SR&ED") work to the Partnership.
In particular, you asked us whether Xco and the Partnership would be dealing with each other at arm's length in respect of the SR&ED contract?
2) On XXXXXXXXXX Yco, a CCPC, bought the shares of Subco, another CCPC. As a result of the acquisition of control, Subco had a deemed year-end on XXXXXXXXXX. On XXXXXXXXXX, Yco bought the shares of a public corporation ("Pubco") and amalgamated with Pubco to form "Newco". The former shareholders of Yco controlled Newco after the amalgamation. Newco (a public corporation) controls Subco despite the fact that ultimate control of Subco remained with the Yco shareholders after the amalgamation.
In particular, you asked us whether Subco maintained its CCPC status by virtue of any deeming rules found in subsection 256(7) of the Income Tax Act (the "Act")?
1) Are the Partnership and Xco Dealing at Arm's Length?
Paragraph 251(1)(a) of the Act deems related persons not to deal at arm's length. In addition, paragraph 251(1)(c) of the Act states that it is a question of fact whether persons not related to each other are, at a particular time, dealing with each other at arm's length. In the situation described, the Partnership does not control Xco and, therefore, Xco and the Partnership are not related. Accordingly, it is a question of fact whether Xco and the Partnership are dealing with each other at arm's length with respect to the SR&ED contract.
In our view, Xco and the Partnership would not be dealing at arm's length if there is a common link between Mr. A and Mr. B or Mr. A and Mr. B act in concert to control Xco and the Partnership. Whether a group of persons have a common link or interest or act together is a question of fact that can only be determined by reviewing all of the relevant facts relating to a given situation. Two or more persons act in concert when they act with considerable interdependence in transactions involving a common purpose. However, the mere fact that it is necessary for two or more shareholders to agree before the corporation can implement a certain course of action does not necessarily mean that those shareholders are acting in concert. In paragraph 24 of Interpretation Bulletin IT-419R, we state that, "...acting in concert generally means a predetermined agreement to act in a certain manner." This suggests that it would be necessary to show that there is some arrangement whereby the shareholders have agreed to vote their shares in the same manner or to have their nominees to the Board vote together on most matters.
Generally, a common link or interest between two or more members of a group is sufficient evidence to conclude that control is exercised as a result of jointly decided action, rather than a fortuitous event. Furthermore, this common link or interest between two or more shareholders must involve more than their mere status as shareholders (See Yardley Plastics of Canada Ltd. v. M.N.R., 66 DTC 5183 (Exch. Ct.).)
It is our view, as expressed in Technical News #7 that, although the requirement to act in concert is relevant in determining whether a group of persons controls any corporation, certain presumptions are appropriate in the case of closely-held corporations. Our position is further explained as follows:
. . . in a closely-held situation, the fact that shareholders jointly adopt mutually advantageous measures is an important indicator of acting in concert. Furthermore, it is our view that in almost all cases where the voting power in a corporation is equally divided between two shareholders, the group consisting of the two shareholders will control the corporation. In order to rebut this presumption of control by the group, it would be necessary to show that no one is controlling the corporation and that the decision-making process in the corporation is effectively deadlocked. In our view, this would be very unusual; however, an example might be where the two shareholders cannot agree on how to run the corporation and have consequently applied to a court for an order authorizing the dissolution of the company.
Based on the foregoing, we are of the view that there is a rebuttable presumption that Mr. A and Mr. B together control Xco and the Partnership (through Aco and Bco). Accordingly, in the absence of persuasive evidence to the contrary, we believe that the SR&ED Directorate is justified in applying the Act on the basis that the Partnership and Xco are not dealing at arm's length in respect of the SR&ED contract.
2) CCPC Status
The definition of CCPC in subsection 125(7) of the Act states, in part:
"Canadian-controlled private corporation" means a private corporation that is a Canadian corporation other than
(a) a corporation controlled, directly or indirectly in any manner whatever, by one or more non-resident persons, by one or more public corporations (other than a prescribed venture capital corporation), by one or more corporations described in paragraph (c), or by any combination of them ...
Paragraph 87(2)(ii) of the Act states that where a predecessor corporation to an amalgamation was a public corporation, immediately before the amalgamation, the new corporation is deemed to have been a public corporation at the commencement of its first taxation year. Therefore, in the situation described, Newco would be a public corporation as defined in subsection 89(1) of the Act. Following the amalgamation, Newco would control Subco even if another person or group of persons controlled Newco. In this respect, we refer you to paragraph 256(6.1)(a) of the Act, (effective for taxation years that end after November 1999) which states that, where a subsidiary would be controlled by its parent if the parent were not itself controlled by any other person or group, the subsidiary is considered to be controlled both by the parent and by the person or group that controls the parent.
Subsection 256(7) of the Act describes various circumstances where control of a corporation is considered not to have been acquired for purposes of various provisions of the Act. However, subsection 256(7) does not apply for the purpose of section 125 of the Act, which contains the definition of CCPC. Therefore, assuming that subsection 256(7) applies to the amalgamation of Yco and Pubco, it would not affect the determination of whether Subco is a CCPC. In addition, even if subsection 256(7) were to apply for the purpose of section 125, it is not clear that it would affect the status of Subco since the provision would only apply to deem control of Subco not to have been acquired by Newco solely because of the amalgamation. It would not deem Subco not to be controlled by Newco at any time following the amalgamation.
Accordingly, immediately after the amalgamation, Subco would be directly controlled by Newco and indirectly controlled by the former shareholders of Yco. Since Subco would be directly controlled by a public corporation, Subco would no longer be a CCPC.
We trust the above comments are of assistance.
Daryl Boychuk, LL.B
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
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