7 October 1991 Income Tax Severed Letter - Control of Corporation by Related Group

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.

Dear Sirs:

Re: Request for Technical Interpretation
Paragraph 251(5)(b) of the Income Tax Act (the "Act")

We are writing in response to your letter, dated November 29, 1990, regarding the application of the above provision of the Act to the hypothetical situation described below:

1. A Ltd. is a Canadian corporation with the following share structure:
• • 500,000 common shares owned by three unrelated individuals; and
• • 1,500,000 redeemable, non-voting preferred shares owned by X Ltd.
• 2. X Ltd. is controlled by a public corporation and is not related to any of the individuals noted in paragraph 1. above.
• 3. Attached to the preferred shares of A Ltd. is a right that upon an "event of default" (explained in paragraph 4. below), the preferred shareholders may elect that all of the issued and outstanding preferred shares shall acquire voting rights (1 vote per share). These shareholders are also entitled after an event of default has occurred to have all of the preferred shares converted into common shares.
4. There are several events or circumstances which constitute an event of default, such as:
• • A Ltd. fails to pay to the preferred shareholders two consecutive annual dividends;
• • A Ltd. fails to observe any of its material covenants and obligations; or
• • A Ltd. enters into a sale agreement for a material part of its business.

You ask whether paragraph 251(5)(b) of the Act would apply in this situation to deem X Ltd. to control A Ltd.

It is your opinion that paragraph 251(5)(b) should not apply in this situation, based on the decision in Arctic Geophysical Ltd. v. MNR, [[1967] C.T.C. 571] (68 DTC 5013), because X Ltd. does not yet have a right to control the voting rights of A Ltd., since an event of default has not occurred.

Our comments

We disagree with your opinion that paragraph 251(5)(b) should not apply in this situation. In our view, the facts in Arctic distinguish it from the hypothetical situation described above. In that case, two related shareholders had the ability, in their capacity as directors, to cause the appellant corporation to redeem and cancel certain other voting shares. Furthermore, the comments in the Arctic case about the phrase "in a position to control", to which you referred in your letter, were made by Cattanach, J in the context of the predecessor of paragraph 251(5)(a), and not paragraph 251(5)(b).

It is our view that in the hypothetical situation described above, X Ltd., as shareholder, has a contingent right (in the event of a default) to control the voting rights of shares in a corporation (by virtue of the right of the preferred shareholders to elect that the shares acquire voting rights or be converted into common shares).

The foregoing comments are given in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990.