Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: 1. Whether paragraph 251(5)(b) would apply to the situations described considering the different provisions of a shareholders’ agreement? If yes, how would paragraph 251(5)(b) be applied?
2. Where there is a unanimous shareholders’ agreement in which there is a provision stating that the group of Canadian residents will designate two directors and a non-resident will designate two directors, whether the non-resident may have the control if the non-resident is deemed to own more than 50% of the voting shares of the capital stock of a corporation.
Position: 1. In some situations, the non-resident would have a right described in paragraph 251(5)(b). In the situations described in which paragraph 251(5)(b) would apply, it appears appropriate to consider the rights with respect to the shares held by all the other shareholders of the corporation.
2. Following the decision in the Bagtech case, we would take into account a provision of designation and nomination of the directors that is included in an unanimous shareholders’ agreement to determine the effective control where a non-resident is deemed to own more than 50% but less than 100% of the voting shares of the capital stock of a corporation except in the situations where it is not appropriate. However, when the non-resident is deemed to own 100% of the shares, we would not take such a provision into account because the non-resident would be deemed to be the only shareholder of the corporation.
Reasons: 1. It depends on the facts and the provisions described in the agreement. 2. The Bagtech case.
XXXXXXXXXX 2016-066238
Sylvie Labarre, CPA, CA
March 24, 2017
Dear Sir,
Subject: Canadian-controlled private corporation
This letter is in response to your letter dated August 12, 2016, in which you requested our views as to the qualification of a corporation as a "Canadian-controlled private corporation" within the meaning of subsection 125(7) of the Income Tax Act (hereinafter the "Act") in each of the following hypothetical situations.
Unless otherwise indicated, all legislative references in this letter are references to the provisions of the Act.
Hypothetical Situations
1. The only voting and participating shares of a Canadian corporation ("Opco") belong as to 50% to a "non-resident", as defined in subsection 248(1), and as to 50% in total (irrespective of distribution) by three Canadian residents.
2. There is a "unanimous shareholder agreement," as defined in the corporate statutes, under which the two groups of shareholders, the non-resident and the residents, agree that the board of directors of Opco will consist of four members, with two directors appointed by the non-resident, and two directors jointly appointed by the residents regardless of their number.
3. In the same agreement or in a second agreement that may or may not be a "unanimous shareholder agreement," reciprocal rights to purchase shares are granted by the non-resident and residents in the event of the "compulsory withdrawal" of one of the shareholders, with that expression including fraud, theft and similar events.
4. To the extent that the compulsory withdrawal event occurred for one of the resident shareholders (the "defaulted shareholder"), you would like to know the position of the Canada Revenue Agency (the "CRA") respecting the status of Opco as a "Canadian-controlled private corporation" in the following three hypothetical situations:
(a) Situation 1: the right of purchase granted to the non-resident would be suspended for a period of time, say 10 or 15 days, following the withdrawal event, during which other resident shareholders could acquire the shares of the defaulted shareholder. If the shares of the defaulted shareholder were thereby acquired by the other resident shareholders, the non-resident's rights could not be exercised and the agreement(s), including equal representation on the board, would continue to apply to the three remaining shareholders.
(b) Situation 2: the right of purchase granted to the non-resident would be suspended for a period of time, say 10 or 15 days, from the withdrawal event, during which time the remaining resident shareholders could acquire the shares of the defaulted shareholder. Resident shareholders would not proceed with their priority purchase right and the shares of the defaulted shareholder would instead be acquired by the non-resident. In this case, the agreement(s) would continue to apply to the remaining three shareholders, including the equal appointment of the four directors of Opco by the two groups, i.e., the non-resident who would own more than 50% of the voting and participating shares of Opco, and the two resident shareholders who together would own less than 50% of the voting and participating shares in the capital stock of Opco.
(c) Situation 3: the right of purchase granted to the non-resident would be suspended for a period of time, say 10 or 15 days, from the withdrawal event, during which the other resident shareholders could acquire the shares of the defaulting shareholder. If the defaulted shareholder's shares were not acquired by the other resident shareholders, they would be required to offer their own shares to the non-resident who could purchase them in addition to the shares of the defaulted shareholder.
5. Alternatively, the agreement would not accord any right to purchase shares to the non-resident in the event of a "compulsory withdrawal" of a resident shareholder, as described in paragraph 3, but rather provide for redemption rights/obligations and forced sales rights. You wish to know the CRA's position respecting Opco's "Canadian-controlled private corporation" status in the following four hypothetical situations:
(a) Situation 4: Opco would have the right, exercised by a decision of the Board, to purchase for cancellation the shares of the defaulted shareholder at a determined value ["valeur escomptée"]. If the right of redemption were exercised by Opco, the agreement(s) would continue to apply to the three remaining shareholders, including for the equal appointment of the four Directors of Opco by the two groups, i.e., by the non-resident shareholder who would own more than 50% of the voting and participating shares in the capital stock of Opco, and by the two resident shareholders who together would own less than 50% of the voting shares and participating shares in the capital stock of Opco.
(b) Situation 5: Opco would be obligated to purchase for cancellation the shares of the defaulted shareholder at a determined value. In such case, the agreement(s) would continue to apply to the three remaining shareholders, including for the equal appointment of the four directors of Opco by the two groups, i.e., by the non-resident who would own more than 50% of the voting and participating shares in the capital stock of Opco, and by the two resident shareholders who together would own less than 50% of the voting and participating shares in the capital stock of Opco.
(c) Situation 6: the resident shareholders would be entitled to purchase the shares of the defaulted shareholder. If they did not purchase the shares of the defaulted shareholder within 10 or 15 days of the withdrawal event, the non-resident would have the right to require the defaulted shareholder to sell the shares of the defaulted shareholder at a determined value to a Canadian resident not related to the non-resident and on which the non-resident did not exercise de facto control, and would have the right to require the remaining shareholders to approve this new shareholder. The non-resident would have the option of selecting and imposing this new "partner" on Opco.
(d) Situation 7: the resident shareholders would have the right to purchase the shares of the defaulted shareholder. If they did not purchase the shares of the defaulted shareholder within 10 or 15 days of the withdrawal event, the non-resident would have the right to require the three resident shareholders of Opco to purchase the shares of the non-resident at fair market value plus a premium, e.g., 5%.
Our Comments
This technical interpretation provides general comments on the provisions of the Act and related legislation, where referenced. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
For the purposes of this letter, we have assumed that the shareholders resident in Canada would not be public corporations. We also have assumed that the non-resident would not have de facto control of Opco notwithstanding the clauses described above under "Hypothetical Situations."
In the situations provided, Opco would not be a Canadian-controlled private corporation if it were controlled directly or indirectly, in any way whatever, by the non-resident.
For the purpose of determining control, it is necessary inter alia to take into account any unanimous shareholder agreement. In your hypothetical situations, you indicated that there was a "unanimous shareholder agreement", as defined in the corporate laws. You also stated that under this agreement, the two groups of shareholders, the non-resident and the residents, agreed that the board of directors of Opco would be composed of four members, namely, two directors designated by the non-resident, and two directors jointly appointed by the residents, regardless of their number.
Following the decision of the Federal Court of Appeal in The Queen v. Bioartificial Gel Technologies (Bagtech) Inc., 2013 FCA 164, we accept, where appropriate, taking into account a directors' appointment and appointment clause in the unanimous shareholder agreement in determining whether a person controls a corporation. However, in certain situations, the CRA may consider that there exist avoidance transactions that would directly or indirectly result in an abuse of the provisions of the Act for the purposes of the application of subsection 245(2).
On the other hand, there may be other clauses in a unanimous shareholder agreement modifying the effective control of Opco through the actual or deemed holding of the voting shares in the capital stock of Opco. As we do not have information on such clauses, we will only consider the clause for the designation and appointment of directors for the current purposes.
In addition, for the purposes of the definition of "Canadian-controlled private corporation" under subsection 125(7), all relevant documentation should be reviewed to determine whether a person has a right referred to in subparagraph 251(5)(b)(i) or (ii) under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently. For the current purposes, we will consider more specifically whether paragraph 251(5)(b) applies to the non-resident.
Situations 1 and 2
In our view, the non-resident would have a right referred to in subparagraph 251(5)(b)(i) in respect of the shares in the capital stock of the corporation. It would be deemed to be in the same position in relation to control of the corporation as if it were the holder of the shares at that time. In the circumstances, we consider it appropriate to consider this presumption in light of the rights of the non-resident in respect of the shares of all other holders. Thus, on that basis, the non-resident would have rights to all the shares because the non-resident would have rights to the shares of each of the resident shareholders if each of them became a defaulted shareholder. However, even if the non-resident was deemed to own 100% of the voting shares in the capital stock of the corporation, it would be necessary to determine whether the non-resident had effective control of Opco based on the unanimous shareholder agreement. In a situation where the non-resident would have been deemed to hold more than 50% but less than 100% of the voting shares, the clause for the designation and appointment of directors in the unanimous shareholders' agreement could prevent the non-resident from exercising control of the corporation (subject to the other clauses of the unanimous shareholder agreement and the review of all facts relating to the particular situation). However, given that the non-resident would be deemed to own 100% of the shares, we could conclude that this designation and appointment of directors or even the unanimous shareholder agreement would no longer apply in this situation. Therefore, Opco would not be a Canadian-controlled private corporation in these situations.
Situation 3
In our view, the non-resident would have a right referred to in subparagraph 251(5)(b)(i) in respect of the shares in the capital stock of the corporation. The non-resident would be deemed to be in the same position with respect to control of the corporation as if the non-resident were the owner of the shares at that time. The non-resident would be deemed to own 100% of the voting shares in the capital stock of the corporation. We also understand that the directors' designation and appointment clause in the unanimous shareholder agreement would no longer preclude the non-resident from exercising control of the corporation as it would be deemed to own 100% of the voting shares in the capital stock of Opco in the presented situation. Therefore, Opco would not be a Canadian-controlled private corporation in this situation.
Situation 4
Paragraph 251(5)(b) would not appear to apply to this situation taking into account only the clause referred to in paragraph 5(a) under "Hypothetical Situations." Therefore, the non-resident would not be deemed to control the corporation solely because of this clause, and subject to any other clause or agreement, the corporation would be a Canadian-controlled private corporation. On the other hand, there may be other clauses or agreements that could give the non-resident an additional right when there was an impasse in reaching a decision of the board of directors, so that the non-resident would have a right described in subparagraph 251(5)(b)(ii). If this were the case, our conclusion would be different taking into account that all the other shareholders could be defaulted shareholders.
Situation 5
In such a situation, it would be necessary to determine whether the non-resident had the right to require Opco to acquire or cancel the shares in its capital stock if it did not effect the required purchase for cancellation, or if the non-resident had control over the triggering of an event that would entail an obligation to purchase for cancellation. If so, paragraph 251(5)(b) would apply to Situation 5. The non-resident would be deemed to be in the same position with respect to the control of the corporation as if it were the holder of the shares at that time. The non-resident would be deemed to own 100% of the voting shares in the corporation's capital stock since all of the other shareholders could be defaulted shareholders. We also understand that the directors' designation and appointment clause in the unanimous shareholder agreement would no longer preclude the non-resident from exercising control of the corporation as it would be deemed to own 100% of the voting shares in the capital stock of Opco in the presented situation. Therefore, Opco would not be a Canadian-controlled private corporation in this situation.
Situation 6
Paragraph 251(5)(b) does not appear to apply to the presented situation solely as a result of the existence of the clause referred to in paragraph 5(c) under "Hypothetical Situations" section. Consequently, the non-resident would not be deemed to control the corporation solely as a result of this clause and, subject to any other clause or agreement, the corporation would be a Canadian-controlled private corporation.
Situation 7
Paragraph 251(5)(b) does not appear to apply to the situation presented solely as a result of the existence of the clause referred to in paragraph 5(d) under "Hypothetical Situations." Consequently, the non-resident would not be deemed to control the corporation solely because of this clause and, subject to any other clause or agreement, the corporation would be a Canadian-controlled private corporation.
We hope that our comments will be of assistance.
Urszula Chalupa, LL.B, M. Fisc.
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and
Regulatory Affairs Branch
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