Date: 20070430
Docket: A-136-06
Citation: 2007 FCA 169
CORAM: NADON
J.A.
SHARLOW
J.A.
MALONE
J.A.
BETWEEN:
SEDONA
NETWORKS CORPORATION
Appellant
and
HER
MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
MALONE J.A.
I. Introduction
[1]
The issue in this appeal is whether Sedona Networks Corporation (Sedona)
was, throughout its 1999 taxation year, a Canadian-controlled private corporation
(CCPC) as defined in subsection 125(7) of the Income Tax Act, R.S.C.
1985, c. 1 (5th Supp) (Act). In a judgment dated
March 2, 2006, a judge of the Tax Court of Canada (2006 TCC 80) dismissed an
income tax appeal by Sedona for 1999 on the basis that Sedona was not a CCPC
throughout that year. Sedona now appeals to this Court.
[2]
A CCPC is
generally defined by subsection 125(7) of the Act as a Canadian
corporation that is not controlled by disqualifying shareholders, such as
non-residents and certain public corporations. Under paragraph (b) of the
statutory definition, shares owned by disqualifying shareholders are
attributed, for the purposes of the definition of CCPC, to a mythical
“particular person”. If the result of that attribution is that the particular
person controls the corporation at any time during the relevant taxation year,
the corporation is not a CCPC for that taxation year. The focus of present
appeal, therefore, is the number of votes exercised by non-resident persons and
public corporations.
[3]
The relevant parts of the definition of CCPC reads as follows:
|
Section 125(7): "Canadian-controlled private corporation"
means a private corporation that is a Canadian corporation other than
…
(b) a corporation that would, if each share of the capital
stock of a corporation that is owned by a non-resident person, by a
public corporation (other than a prescribed venture capital corporation),
or by a corporation described in paragraph (c) were owned by a particular
person, be controlled by the particular person [Emphasis added]
|
Section 125(7): « société
privée sous contrôle canadien » Société privée qui est une
société canadienne, à l'exception des sociétés suivantes:
b) si chaque action du capital-actions d'une
société appartenant à une personne non-résidente, à une société publique
(sauf une société à capital de risque visée par règlement) ou à une société
visée à l'alinéa c) appartenait à une personne donnée, la société qui
serait contrôlée par cette dernière; [Je souligne]
|
II. Factual
Background
[4]
Sedona was
incorporated in 1998 under the Canada Business Corporations Act, R.S.C.
1985, c. C-44 (CBCA), and went into bankruptcy on March 30, 2001. It
was in the business of developing, manufacturing and distributing products that
enable network service providers to deliver bundled voice data services.
During its 1999 taxation year, Sedona incurred $2,929,361 in scientific
research and experimental development expenditures. Sedona claimed a refundable
tax credit of $927,785 in respect of those expenditures pursuant to sections
127(10.1), 127.1(2) and 127.1(2.01) of the Act. Sedona is entitled to
that credit only if it was a CCPC throughout 1999.
[5]
A number
of issues have been raised in determining control of Sedona. “Control” in this
context means de jure control, which is the control manifested in the
ownership of the number of shares required to cast a majority of the votes in
the election of the board of directors. However, an exception arises where the
corporate constitution or a unanimous shareholder agreement deprives the
directors of the authority to manage the business and affairs of the
corporation (see Duha
Printers v. Canada, [1998] 1 S.C.R. 795 [Duha Printers] at paragraph
50; Buckerfield’s Ltd. et al. v. M.N.R., [1965] 1 Ex.C.R. 299).
III. Analysis
(1) Issued and
Outstanding Shares without Options Counted
[6]
The first issue relates to 438,597 class B preferred shares of Sedona
owned by Bank of Montreal Capital Corporation (BMCC), a wholly owned subsidiary
of Bank of Montreal (BMO). BMO is a taxable Canadian corporation and a public
corporation for the purposes of the Act. (A second issue arises in
relation to options granted by Sedona to employees and others to acquire its
treasury shares; that issue is discussed separately in the next section.)
[7]
Excluding the BMCC Shares, the following chart represents the
distribution of all Sedona’s issued voting shares between, in one column,
residents and non-public corporations, and in the other column, non-residents
and public corporations:
|
SHARES
|
RESIDENTS/NON-PUBLIC
|
NON-RESIDENTS/PUBLIC
|
|
Common
and Preferred Shares
|
9
281 789
|
9
419 931
|
|
Percentage
of Control
|
49.6%
|
50.4%
|
[8]
Shares in the ‘non-residents/public’ column are attributed to the
“particular person” under paragraph (b) of the definition of CCPC in subsection
125(7). According to Sedona, the BMCC shares should be included in the
‘residents/non-public’ column. If Sedona is correct, then residents would have
controlled Sedona throughout its 1999 taxation year and it would have been a
CCPC (assuming all options are ignored in the calculation). According to the
Minister, however, these shares are properly to be included in the
‘non-residents/public’ total because BMCC was controlled by a public
corporation (BMO). If the Minister is correct, then the “particular person”
would control Sedona (assuming all options are ignored in the calculation), and
Sedona would not be a CCPC throughout its 1999 taxation year.
[9]
The Minister, relying on Vineland Quarries and Crushed Stone Limited,
[1966] Ex.C.R.
417, argues that, in determining who controls the votes attached to the
BMCC Shares, it is necessary to look though BMCC to its wholly owning parent
corporation, BMO. It argues that, because BMO is a public corporation, the
BMCC Shares must be treated for purpose of paragraph 125(7)(b) as though they
were owned by the ‘particular person’ referred to in that paragraph.
[10]
However, Sedona argues that on the facts of this case, the applicable
principle cannot be found in Vineland Quarries, because the voting
rights attached to the BMCC Shares rest with a Canadian resident private
corporation named Ventures West Management TIP Inc. (Ventures).
[11]
Ventures carries on the business of providing venture capital management
services. Throughout Sedona’s 1999 taxation year, BMCC Shares were the subject
of a Management Agreement between BMCC and Ventures. The Management Agreement permitted
Ventures to organize and operate three venture capital related programs on
behalf of BMO. It gave Ventures the right to exercise, at its sole discretion,
the voting rights with respect to the BMCC Shares, as well as the right to
acquire those shares in the case where BMCC terminated the agreement without
proper cause. A general power of attorney was also executed in order to allow
Ventures to carry out these management services on BMCC’s behalf.
[12]
In my analysis, the correctness of Sedona’s argument turns on the
principles stated in Duha Printers at paragraph 85, where Iacobucci J.
provided a comprehensive list of principles for determining de jure
control:
(1) Section 111(5)
of the Income Tax Act contemplates de jure, not de facto, control.
(2) The general
test for de jure control is that enunciated in Buckerfield's, supra:
whether the majority shareholder enjoys "effective control" over the
"affairs and fortunes" of the corporation, as manifested 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".
(3) To determine whether such
“effective control” exists, one must consider:
(a)
the corporation’s governing statute;
(b) the share register of the corporation;
(c)
any specific or unique limitation on either the majority
shareholder’s power to control the election of the board of the board’s power
to manage the business and affairs of the company, as manifested in either:
i.
the constating documents of the corporation; or
ii.
any unanimous shareholder agreement [Emphasis
added].
(4) Documents other than the share
register, the constating documents, and any unanimous shareholder agreement are
not generally to be considered for this purpose.
[13]
The Judge concluded that the Management Agreement was not to be taken as
determinative of de jure control because it was not a constating
document within the meaning of corporate law, or a unanimous shareholder
agreement. At para. 24 he stated:
The management agreement is an
“ordinary” contractual arrangement between BMCC and Ventures which gives the
latter wide powers in managing the technology portfolio of BMCC. It is just an
external document and, as a general rule, this kind of document is not to be
taken into account as determinative of de jure control. It does not
affect the corporate constitution of BMCC. For instance, it is not a
constating document limiting the powers of the BMCC’s board of directors to
manage its affairs. Nor does it modify the ownership rights of BMCC in the
Sedona shares, although such rights may be exercised by Ventures in the course
of the provision of its management services.
[14]
In my analysis, the Judge was correct to characterize the Management
Agreement as he did. It is well established that the owner of voting shares who
is obliged by contract to exercise them in a certain way does not thereby
divest himself of those rights (see Duha Printers at paragraph 81). I
see no reason why the same principle should not apply where the owner of voting
shares enters into a contract with another person that grants that person a
contractual right to vote the shares but not the other incidents of share
ownership.
[15]
Sedona also argues that the Management Agreement was a unanimous
shareholder agreement, which had the effect of restricting the powers of BMCC
directors to manage its business and affairs. The Judge did not accept that
argument, primarily because BMO was not a party to that agreement. At para. 25
he stated:
The
management agreement cannot be considered to be a USA entered into by BMCC’s shareholder either. BMO is not a party to this
management agreement. Under subsection 146(3) [of the] CBCA, a person who is
the beneficial owner of all the issued shares of a corporation can make a
written declaration that restricts in whole or in part the powers of the
directors to manage the business and affairs of the corporation, and this
declaration is deemed to be a USA. Here, there is no evidence that BMO made
such a written declaration. If BMO had the intention of removing or altering
directors’ powers to manage the business and affairs of BMCC, it would have at
the very least intervened in the management agreement and made its intention
clear.
[16]
Pursuant to subsection 146(1) of the Canada Business Corporations Act
a unanimous shareholder agreement is defined in the following way:
|
146(1)
An otherwise lawful written agreement among all the
shareholders of a corporation, or among all the shareholders and one or more
persons who are not shareholders, that restricts, in whole or in part,
the powers of the directors to manage, or supervise the management of,
the business and affairs of the corporation is valid [Emphasis added].
|
146. (1) Est
valide, si elle est par ailleurs licite, la convention écrite conclue
par tous les actionnaires d’une société soit entre eux, soit avec des tiers, qui
restreint, en tout ou en partie, les pouvoirs des administrateurs de
gérer les activités commerciales et les affaires internes de la société
ou d’en surveiller la gestion [Je souligne].
|
[17]
Sedona relies on Duha Printers at para. 64 for the proposition
that a unanimous shareholder agreement may be brought into existence without
specific formality and that all that is required is some written expression of
shareholder will. It argues that the Management Agreement meets the
description of a unanimous shareholder agreement in relation to BMCC for the
following reasons:
§
Subsection 1.1(t) provides that a representative be chosen, who is a BMO
senior executive, to be the primary point of contact between the Manager and
BMO;
§
Section 2.5 requires the transfer of BMO assets to be managed by
Ventures;
§
Ventures is also required to provide services to BMO-TIP (the BMO
program of investments) that Ventures, via the Management Agreement, will
manage;
§
Section 4.2 provides for the secondment of BMO employees to Ventures;
and
§
Various provisions contained in the Management Agreement provide
contractual obligations of Ventures, BMCC and/or BMO.
[18]
In essence, Sedona argues that it is through the agency of BMCC, both
express and implied, that BMO is made a party to the Management Agreement. As
such, the Management Agreement can be construed as a unanimous shareholder agreement
between the shareholder of BMCC, BMCC itself and Ventures, which restricts the
powers of the directors of BMCC to manage the business and affairs.
[19]
In my view, the Judge was correct to find that BMO is not a party to the
Management Agreement. The items listed in paragraph 19 are simply provisions
that enhanced Ventures’ ability to perform its management function.
[20]
Even if BMO were a party to the Management Agreement, there is no basis
for concluding that the Management Agreement restricted the powers of BMCC’s
board of directors to manage its business and affairs. Without this
restriction, the statutory requirements for a unanimous shareholder agreement
are not met.
[21]
In summary, Sedona cannot point to any constating document or unanimous
shareholder agreement that would have the effect of attributing the BMCC Shares
to Ventures, a private corporation. It follows that the BMCC shares fall into
the ‘non-resident/public’ column and must be attributed to the mythical
“particular person” under paragraph (b) of the definition of CCPC in subsection
125(7). The result would be that Sedona was not a CCPC during its 1999 taxation
year:
|
SHARES
|
RESIDENTS/NON-PUBLIC
|
NON-RESIDENTS/PUBLIC
|
|
Common
and Preferred Shares
|
9
281 789
|
9
419 931
|
|
BMCC
shares
|
|
438
597
|
|
Total
|
9
281 789
|
9
858 528
|
|
Percentage
of Control
(ignoring
options)
|
48.5%
|
51.5%
|
(2) Taking the
options into account
[22]
In June of 1999, Sedona adopted a share option plan under which certain
of its employees and consultants could be granted options to subscribe for
common shares of Sedona. During Sedona’s 1999 taxation year, options to acquire
733,500 shares were granted to employees or consultants who were resident in
Canada, and options to acquire 342,000 shares were granted to employees and
consultants who were not resident in Canada.
[23]
On July 22, 1999, Manouch Khezri, a non-resident, was hired by Sedona to
begin employment on August 2, 1999. On that date, Sedona’s board of directors
authorized the grant to Mr. Khezri, on October 15, 1999, of options to acquire
458,000 common shares. The date of the granting of that option was deliberately
chosen to fall outside of Sedona’s 1999 taxation year, which ended on September
30, 1999, in the hope that the status of Sedona as a CCPC in that taxation year
would not be jeopardized.
[24]
Options to acquire shares are relevant to determination of the status of
Sedona as a CCPC because of paragraph 251(5)(b), the relevant portion of which
reads as follows:
|
Section
251(5): For the
purposes of subsection 251(2) and the definition "Canadian-controlled
private corporation" in subsection 125(7),
…
(b)
where at any time a person has a right under a contract, in
equity or otherwise, either immediately or in the future and either
absolutely or contingently,
(i) to, or to acquire, shares of the capital stock of a
corporation or to control the voting rights of such shares, the person
shall, except where the right is not exercisable at that time because the
exercise thereof is contingent on the death, bankruptcy or permanent
disability of an individual, be deemed to have the same position in
relation to the control of the corporation as if the person owned the shares
at that time [Emphasis added].
|
(5)
Pour l'application du paragraphe (2) et de la définition de "société
privée sous contrôle canadien" au paragraphe 125(7):
…
b)
la personne qui, à un moment donné, en vertu d'un contrat, en equity
ou autrement, a un droit, immédiat ou futur, conditionnel ou
non:
(i) à des actions du capital-actions d'une
société ou de les acquérir ou d'en contrôler les droits de vote, est
réputée occuper la même position relativement au contrôle de la société que
si elle était propriétaire des actions à ce moment, sauf si le droit ne
peut être exercé à ce moment du fait que son exercice est conditionnel au
décès, à la faillite ou à l'invalidité permanente d'un particulier, [Je
souligne]
|
[25]
In
essence, subparagraph 251(5)(b)(i) deems a person who has a contractual right
to acquire shares at some future date to have the same position in relation to
the control of the corporation as if the person already owned the shares. An
option to acquire a share is a right that fits within the scope of paragraph
251(5)(b). It is not clear whether whatever right Mr. Khezri was granted on
July 22, 1999 fell within paragraph 251(5)(b) at any time during Sedona’s 1999
taxation year. Because of that uncertainty, it is convenient to conduct the
analysis first without taking the Khezri options into account.
[26]
The Judge
made two key findings in relation to the options issue. First, he held that
the option rights contemplated by paragraph 251(5)(b) could never be attributed
to the particular person under paragraph (b) of the definition of CCPC
in subsection 125(7). His reasoning was that paragraph 251(5)(b) does
not deem anyone to own shares; it only creates a legal fiction of control of a
corporation (see Reasons at para. 13). Secondly, the Judge chose not to decide
whether Mr. Khezri’s rights should be included in determining whether Sedona
was a CCPC in its 1999 taxation year because he found that consideration to be
irrelevant in light of his other conclusions.
[27]
In my analysis, the legal fiction created by the paragraph 251(5)(b)
is directed at the concept of ownership, not control. Once it is determined
that a person has an option to acquire treasury shares that falls within the
scope of paragraph 251(5)(b), it is necessary to assume that the option is
exercised and the related shares are actually acquired by the holder of the option.
Then, it is necessary to determine how many votes are attached to the shares
actually issued and the shares that would be issued if the options were
exercised. Finally, answering the question asked by paragraph (b) of the
definition of CCPC in subsection 125(7), it is necessary to determine how many
votes should be attributed to the mythical “particular person”. As this was not
the approach adopted by the Judge, I am compelled to conclude that the Judge
made a legal error in his interpretation of subparagraph 251(5)(b)(i). In my
view, the correct interpretation of these provisions requires them to be
applied as follows. If it is assumed that all of the non-Khezri options were
exercised in 1999, the control calculation would be as follows:
|
SHARES
|
RESIDENTS/NON-PUBLIC
|
NON-RESIDENTS/PUBLIC
|
|
Common
and Preferred Shares (including BMCC Shares)
|
9
281 789
|
9
858 528
|
|
Options
|
733
500
|
342
000
|
|
Total
|
10
015 289
|
10
200 528
|
|
Percentage
of Control
|
49.55%
|
50.45%
|
[28]
If all of the votes attached to the shares in the ‘non-resident/public’
column are attributed to the “particular person” referred to in paragraph (b)
of the definition of CCPC in subsection 125(7), the particular person would
control Sedona in its 1999 taxation year. It follows that Sedona did not
qualify as a CCPC in that year. This conclusion makes it unnecessary to
determine whether or not the right granted to Mr. Khezri fall within paragraph
251(5)(b) during Sedona’s 1999 taxation year.
IV. Conclusion
[29]
As the Judge correctly determined that Sedona was not a CCPC during its
1999 taxation year, there is no basis for reversing his decision. I would
dismiss this appeal with costs.
"B. Malone"
"I agree
M. Nadon J.A."
"I
agree
K. Sharlow J.A."
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