2 April 1990 Income Tax Severed Letter 7-4793 - Employers dealing at arm's length

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.

This is in reply to your memorandum of March 5, 1990 addressed to the Business and General Division.

We are unable to advise you which of the participating employers in the XXX registered pension plan do not deal with each other or with the XXX at arm's length since this is a question of fact. There are various criteria to be considered in determining whether or not persons deal with each other at arm's length.

We can offer you general guidelines to assist you in determining whether or not employers deal at arm's length with each other. The definition of "dealing at arm's length" is set out in subsection 251(1) of the Income Tax Act (the "Act"):

"For the purposes of this Act,

• (a) related persons shall be deemed not to deal with each other at arm's length; and
• (b) it is a question of fact whether persons not related to each other were at a particular time dealing with each other at arm's length."

As can be seen from this definition, there are two branches to the arm's length test - one based on relationship, the other on fact.

Concerning the second branch of the arm's length test, Evelyn P. Moskovitz in an article entitled "Dealing at Arm's Length: A Question of Fact" 1987 Canadian Tax Foundation Conference Report 33:1 at 33:14-15-16 gives a summary of the guiding principles:

• • If one party to a transaction has de facto control over another party to the transaction, the first party, by virtue of that control, becomes the directing mind of both parties, who will thus be viewed as not being at arm's length.
• • The same principle applies if a third person has de facto control over both transacting parties. In such circumstances, the third person is seen as the directing mind of the transaction and the parties will be considered factually not at arm's length with each other and with that third person.
• • If more than one person is required to exert control over the other party to a transaction, the persons exerting that control must be acting in concert before a directing mind can be said to exist. Parties will be considered to be acting in concert if they have the same economic interest in achieving a common objective. If the parties have distinct economic interests, however, they will not be considered to be acting in concert, notwithstanding that they both share a common goal.
• • In determining whether parties have distinct economic interests, one must ascertain whether the parties or any of them are indifferent to the terms of the deal being struck or whether the parties or any of them do not bargain in their own best interests even though they have the power to do so. If the absence of bargaining arises because of unequal bargaining power, however, rather than because of an independent decision to act in concert, it seems unreasonable that the acting-in-concert rules should apply.

In addition to these primary principles, there are a number of ancillary concepts that may serve as useful guidlines.

• • A person may have de facto control by virtue of his general influence over a party or because of some particular advantage that he has over that party.
• • Notwithstanding the fact that a transaction takes place at fair market value, the parties may still be factually not at arm's length. The absence of fairness in a transaction may be evidence of non-arm's length dealing, however.
• • The power of a person to control another, not the exercise of that power, is important in establishing de facto control.
• • If a transaction is, in essence, nothing more that the transferring of property by a person from "one of his.. pockets to another" - that is, from one person or group of persons to the same person or group of persons-the parties are factually not at arm's length.
• • In determining whether a non-arm's length relationship exists at a particular time, the court may look to factors that exist both before and after that time.
• • There is no necessity that the parties be "dealing" in order for them to be found to be not at arm's length, as long as a relationship of subordination exists between them.
• • A public company may not be dealing at arm's length with a person or persons who have effective control of that company. Thus, where a person owns a significant block of shares in a widely held company, that person may be factually not at arm s length with that company.
• • In the case of corporations having interlocking directors and officers, they may be factually not at arm's length, and it is not necessarily a defence that the directors of such corporations are under a fiduciary duty to act in the best interests of each corporation.
• • If parties are related, they will be irrebuttably deemed to be not at arm's length, even though they may be factually at arm's length.
• • A transaction can be in part arm's length and in part non-arm's length.
• • Where a person assumes the position of another in a transaction entered into by that other with a third party with whom that other was factually not at arm's length, the person is not then necessarily in a factual non-arm's length relationship with the third party.

Subsection 251(1) of the Act refers to the first branch of the arm's length test, "related persons", which term is defined in succeeding subsections of the Act. Persons who meet the statutory test of relationship are "deemed not to deal with each other at arm's length". This deeming provision raises an irrefutable presumption of law. Related persons are conclusively deemed not to deal with each other at arm's length regardless of the actual circumstances of their dealings, or indeed whether they have any dealings at all.

Individuals are "related persons "if they are connected by blood relationship, marriage or adoption (paragraph 251(2)(a) of the Act). Each of these "connections" is, in turn, statutorily defined (subsection 251(6) of the Act). For a non-arm's length relationship to exist between a person and a corporation there must be an element of control, either solely or through a related group (subparagraph 251(2)(b)(ii) of the Act).

We refer you to Interpretation Bulletin IT-4l9 where the Department's comments on the "Meaning of Arm's Length" are set out. For instance at paragraph 11, the tests that the courts have applied in determining the existence of a factual non-arm's length transaction are reproduced.

We attach, for your information and as an example, a copy of a court case that deals with the question of whether the shareholders were dealing at arm's length with the corporation for the purposes of the Act. The case is Grant et al v. M.N.R. [[1987] 1 C.T.C. 2055] 87 D.T.C. 16

As to whether the above listed guidelines would apply to a province or a municipality, it is our opinion that the same tests would apply.

As for the question whether it would be sufficient to establish that the employers are Crown agents to consider the various employers not to be dealing with each other at arm's length, we suggest you request a written legal opinion from Legal Services since this matter has already been discussed with Mr. Sandy Davidson of Legal Services.

We trust the above comments will be of assistance to you.