6 May 2014 CALU Roundtable, 2014-0523301C6 - Control - unanimous shareholders agreement

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.

Principal Issues: Bagtech case

Position: General comments

Reasons: See below

2014 CALU Conference

Q.3 - Bioartificial Gel Technologies (Bagtech) Inc. v. R., 2013 F.C.A. 164

Background

The issue in Bioartificial Gel Technologies (Bagtech) Inc. v. R., 2013 FCA 164, was whether Bagtech was a Canadian-controlled private corporation ("CCPC"). Generally, a CCPC cannot be controlled by any combination of non-residents and/or public companies and, as a result of paragraph (b) of the definition of CCPC in subsection 125(7) of the Act, a corporation will not be a CCPC if a hypothetical person owning all of the shares of the corporation that were owned by non-resident persons or public corporations would have control of the corporation.

In Bagtech, the company had a number of classes of shares but only one class of shares that were voting and participating. In the years in question, approximately 70% of the voting shares of the corporation were owned by non-residents. However, pursuant to a unanimous shareholder agreement ("USA"), the shareholders agreed that there would at all times be 7 directors and 4 of the 7 directors would be elected by Canadian residents (that were not public corporations). On this basis, the company claimed that it was a CCPC.

In the Duha Printers decision of the Supreme Court of Canada, which dealt with whether there had been an acquisition of control of a corporation, that Court held that in determining whether a majority shareholder enjoys effective control over the affairs of a corporation, consideration must be given to the corporation's governing statute, its share register, its constating documents or any USA. While ordinary shareholder agreements are to be given no weight in looking at control, a USA, which is defined in corporate law to be an agreement among all of the shareholders that restricts, in some manner, the powers of the directors, must be taken into account.

The CRA's view of the Duha case has been that a USA has no impact on the application of paragraph (b) of the CCPC definition, which requires a purely arithmetical calculation, since the hypothetical particular person posited in paragraph (b) cannot be a party to a USA. Moreover, the only relevant parts of a USA are those parts that restrict the powers of the directors and thus result in the agreement being a USA.

The Tax Court Judge essentially agreed with Bagtech that whether or not all of the non-resident shareholders were aggregated, they could not elect a majority of the board of directors given the provisions of the USA and that this analysis was supported by the Duha case. The Federal Court of Appeal upheld the Tax Court decision in favour of the taxpayer.
This decision has not been appealed by the Crown.

Question

Does the CRA accept the position that the CCPC definition should be read taking into account any restrictions in a USA on the directors' powers and on the ability of the holders of a majority of shares to elect the directors?

Answer

The CRA reassessed the 2004 and 2005 taxation years of Bagtech (the "Taxation Years") on the basis that it was not a CCPC.

That position was consistent with the view expressed by the CRA at the 2009 CTF Conference (reflected in Income Tax Technical News number 44) that unanimous shareholder agreements are not to be considered in applying paragraph (b) of the definition "Canadian-controlled private corporation" in subsection 125(7).

That position was also consistent with the view expressed by the CRA at the 2010 CTF Conference (question 34 of the Round table) that a provision in a shareholders agreement allowing a minority shareholder to designate the majority of the board has no incidence in determining de jure control of the corporation, despite other provisions meeting the requirements of the definition of "unanimous shareholders agreement" in subsection 146(1) of the Canada Business Corporations Act or similar definitions in corresponding statutes. That view had previously been expressed in CRA document 2009-031435 where the CRA partly based its position on paragraph 54 of the Duha Printers (Western) Ltd. v. The Queen, [1998] 1 S.C.R. 795 ("Duha") case where the Supreme Court of Canada indicated that "the [de jure] test neither requires nor permits an inquiry into whether a given director is the nominee of any shareholder, or any relationship or allegiance between the directors and the shareholders".

None of the shareholders of Bagtech owned more than 50% of the shares giving the right to vote for the directors of the corporation during the Taxation Years. If the deemed particular person referred to in paragraph (b) of the definition "Canadian-controlled private corporation" in subsection 125(7) (the "Particular Person") had held all the shares held by the non-resident shareholders of Bagtech, the Particular Person would have been in a position to elect the majority of the directors of Bagtech because the total number of voting shares of Bagtech held by non-residents exceeded 50% of the issued and outstanding voting shares of that corporation.

However, the shareholders of Bagtech had entered into a unanimous shareholders agreement that was in force during the Taxation Years. The agreement included a clause grouping the shareholders of Bagtech into three groups for purposes of determining the composition of the Board of Directors of Bagtech. The group composed of non-resident shareholders could not appoint a number of directors that would have represented the majority of them.

Bagtech filed an appeal in respect of the Taxation Years and the reassessments were reversed by the Tax Court of Canada on the basis of its interpretation of the views expressed by the Supreme Court of Canada in the decision of Duha.

Based on his interpretation of Duha (particularly in light of paragraph 85 of that decision), Justice Bédard concluded that the Particular Person could not have had de jure control of Bagtech, despite his view that "the clauses of the USA that are genuinely in the nature of a unanimous shareholders' agreement (that is, that restrict the power of the directors) […] do not operate to strip the hypothetical shareholder of de jure control".

The Federal Court of Appeal dismissed the Crown's appeal. It was decided that the Minister would not seek leave to appeal to the Supreme Court of Canada.

The interpretation that the CRA had given to the Duha case in the documents referred to above cannot be reconciled with the interpretation of that case by the Courts in Bagtech. In determining if a shareholder has de jure control, the CRA will adopt the views of the Court in Bagtech where appropriate in determining which shareholder or group of shareholders has "effective control" (paragraph 36 of the Duha case) or "long run" control (Donald Applicators Ltd. et al v MNR, 69 DTC 5122) of the corporation in light of the applicable provisions of the Act. The CRA will also consider the existence of avoidance transactions that might result in a misuse or abuse having regard to the provisions of the Act for purposes of applying subsection 245(2).

Yves Moreno
2014-052330
May 6, 2014