29 June 1992 Income Tax Severed Letter 9204447 - Control

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

SUBJECT: CONTROL SECTION: 249(4), 256(5.1)]
June 29, 1992

P. Middlestead Corporate
Director-Taxation Reorganizations I
Ottawa District Office D. Yuen
(613) 957-8967

• 7- 920444

XXX

We are writing in response to your request to Denis Lefebvre for our comments regarding the following situation.

Situation

XXX

District Office Questions

In the situation described above:

A. Was there, for the purpose of subsection 249(4), an acquisition of control ofXXX by the Control Group on XXX ?

B. Was XXX "controlled, directly or indirectly in any manner whatever" (within the meaning assigned to that expression by subsection 256(5.1) of the Act) by XXX after XXX ?

(In the remainder of this memorandum, control for the purposes of a provision such as subsection 249(4), where the word "control" alone is used, will be referred to as "legal control", while the expression "controlled, directly or indirectly in any manner whatever" within the meaning of subsection 256(5.1) will be referred to as "256(5.1) effective control".)

Our Comments

A. Although there have been several cases in which the courts have considered, in the context of the association rules, whether a corporation was controlled by a group of persons, we are not aware of any case in which a court has considered whether control of a corporation had been acquired by a group of persons. Paragraph 16 of Interpretation Bulletin IT-64R2 sets out the Department's general position concerning when a corporation may be considered to be controlled by a group of persons for purposes of the association rules; the Department's general position concerning when a group of persons can be considered to have acquired legal control of a corporation, for purposes of provisions such as subsection 249(4), is set out in our response to question 43 at the 1988 Revenue Canada Round Table where we indicated that "de jure control of a corporation would be considered to have been acquired by a group of persons where there is evidence that such persons have a common link or interest or that they act together to control the corporation." This position is based in part on the reasoning of the court in Vina-Rug (Canada) Limited v. Minister of National Revenue [[1968] C.T.C. 1] 68 DTC 5021 (SCC), and is intended to ensure that an acquisition of legal control by a group not be fortuitous or coincidental, but the outcome of an action or an event organized by the group.

• Applying the common interest test to the situation at hand, XXX representative maintains that the members of the Control Group did have a common link or interest by virtue of their previous business association at XXX and by virtue of the fact that they were all directors of XXX on XXX.

The common interest test is one of very difficult practical
application. However, although the question is certainly not free
of doubt, it is our view that it is reasonable to conclude that the
members of the Control Group were sufficiently connected so as to be
in a position to exercise legal control over XXX after the
transactions which occurred on XXX Accordingly, we
would recommend that you accept XXX position that the Control Group
acquired control of XXX on XXX (As you have noted, if
control of XXX was indeed acquired on XXX there will be
several consequences in addition to a deemed year-end for XXX.
Control of XXX would also have been acquired, and the effect of
several provisions of the Act (including, for example,
subsections 15(2), 37(6.1), 111(1), 111(4) to (5.5),
127(9.1) and 127(9.2)) on both XXX and XXX would have to be
considered.)

C. We are not aware of any case in which a court has considered whether a person had 256(5.1) effective control of a corporation. Whether XXX had 256(5.1) effective control of XXX is primarily a question of fact. In our review of the situation, the following factors were noted:

• (1) XXX had a XXX% shareholding in XXX. Although this percentage is not greater than 50%, it would seem to be substantial in view of the fact that the balance of XXXs shares were widely-held.

(2) Question 15 at the 1989 Revenue Canada Round Table asked
whether 256(5.1) effective control pertained to the electing of the
board of directors of a corporation, the day-to-day management and
operation of the company, or both of these factors. In its
response, the Department stated that the ability to elect a majority of
the directors or to control the day-to-day management and operation of
the business may be indications of direct or indirect influence which
may, if exercised, result in control of a corporation. XXX
In view of the requirements
that XXX was obligated to undertake as described in subparagraph
B.(4) below, it would seem that XXX was the directing mind of XXX
and his influence on the day-to-day operations was significant.

(3) There would appear to be a good argument that XXX had 256(5.1)
effective control of XXX in that it would appear that he would have
effective control over the composition of the board of directors after
that time. XXX controlled XXX and it can therefore be presumed that
its board of directors was composed of a majority of XXX' nominees.
The articles and by-laws of XXX in effect until May 19, 1989
appear to be silent with respect to the election, replacement and
nomination of directors; accordingly the provisions of the CBCA would
govern such matters. The relevant provisions of the CBCA in
this regard provide as follows:

• 106(3). A director not elected for an expressly stated term ceases to hold office at the close of the first annual meeting of shareholders following his election.

108(1). A director of a corporation ceases to hold office when

• (a) he dies or resigns; (b) he is removed in accordance with section

109; or

• (c) he becomes disqualified under subsection

105(1).

• 109(1). Subject to paragraph 107(g), the shareholders of a corporation may by ordinary resolution at a special meeting remove any director or directors from office.
• In other words, after XXX nominees on the board continued to represent a majority of the board and could only be replaced by a majority vote of the shareholders. If an incumbent director did not cease to hold office by reason of death, resignation or removal, he would continue to hold office until at least the subsequent annual meeting of shareholders. It would seem highly unlikely that anyone could have, against XXX' wishes, marshalled the votes of more than 50% out of the approximately XXX% of the shares that were not directly or indirectly held by XXX, in order to replace a XXX nominee on the board. This would have been particularly difficult in view of the fact that many of the otherXXX % of the shares were held by persons who were, by XXX representative's own admission, close associates of XXX while the remainder of the shares were widely-held by more than 200 shareholders. It is our view that these circumstances provide further strong support for the view that XXX had 256(5.1) effective control of XXX. (See, by analogy, International Mercantile Factors Ltd. v. The Queen [[1990] 2 C.T.C. 137] 90 DTC 6390 (FCTD). In that case the could held that a 50% shareholder had legal control of a corporation where its nominees formed a majority of the board of directors and no one could effectively change the board. See also Noranda Mines Limited v. Minister of National Revenue [[1987] 2 C.T.C. 2089] 87 DTC 379 (TCC), where the court found that a 45% shareholder of an otherwise widely-held corporation effectively controlled the corporation such that the shareholder and the corporation were not dealing at arm's length.)

XXX

• (4) As you have noted, in its Explanatory Notes to Bill C-139, the Department of Finance indicated that it considered 256(5.1) control to exist "in a situation where a person held 49% of the voting control of a corporation and the balance was widely dispersed among many employees of the corporation or was held by persons who could reasonably be considered to act in respect of the corporation in accordance with his wishes". The situation contemplated by the Department of Finance is strikingly similar to the situation that existed with respect to XXX. It would therefore seem to be beyond question that the present situation is the type of situation that Parliament wished 256(5.1) effective control to address. In our view, a court would be likely to attach considerable weight to the Explanatory Notes in attempting to apply the words of subsection 256(5.1) to the situation in question.
• (5) As described in paragraph 8 above, XXX representatives have cited a court case which they view as support that 256(5.1) effective control does not exist in the present case. The decision in Zinkhofer dealt with the question of whether a person controlled a corporation at a time which preceded the enactment of subsection 256(5.1). Therefore, the case is, in our view, of very little relevance in determining whetherXXX had 256(5.1) effective control.

It is our opinion that the above factors strongly support a finding that XXX had 256(5.1) effective control of XXX such that XXX continued to be associated after that time.

Director
Reorganizations and Foreign Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch