Words and Phrases - "supply contract"

The taxpayer (“ADC”) was denied refundable SR&ED investment tax credits on the basis that a U.S. resident (Mr. Silva) and a U.S. corporation controlled by him (Seawind Corp.) exercised de facto control of ADC within the meaning of s. 256(5.1). ADC entered into a Development Agreement with Seawind Corp. at a time that Seawind Corp. was its sole shareholder to provide services necessary to complete the prototyping and certification of an amphibious aircraft on a cost-plus basis. All intellectual property rights resulting from the work carried on by the taxpayer became the property of Mr. Silva and Seawind Corp. Four months later (in August 2009), voting common shares were issued to three resident employees or their companies for an aggregate subscription price $1350, which resulted in Seawind Corp. holding only 46% of the outstanding common shares of ADC.

Gleason JA first stated (at para. 49):

McGillivray … determined that operational control is insufficient to constitute de facto control under subsection 256(5.1) …[and] that, instead, there must be some legally-enforceable arrangement or arrangements that give rise to such control.

She then found (also at para. 49) that although “The development agreement undoubtedly does constitute such an arrangement,” the Tax Court had gone beyond this and thus committed two errors (paras 50 and 51):

… [First] the Tax Court went well beyond relying on the terms of the development agreement in considering what circumstances gave rise to de facto control and instead considered such issues as ADC’s financial position, the other shareholders’ dependence on the viability of ADC and representations made by Mr. Silva in newsletters regarding the integration of ADC with his other companies. While these other factors are indicative of operational control, they are not the result of a legally-enforceable arrangement … [and are] factors that McGillivray determined to be irrelevant … .

[Second] the Tax Court [also] erred in looking to the fact that ADC and Seawind Corp. were related before August 2009 to be a relevant factor in assessing whether they were operating at arm’s length after that date within the meaning of subsection 256(5.1) … .

However, Gleason JA found (at para 52):

Despite these two errors, I see no basis for interfering with the Tax Court’s decision as these two errors are immaterial to the result reached. … [T]he development agreement constitutes a legally-enforceable arrangement capable of establishing de facto control under subsection 256(5.1)… . I also agree with ADC that the development agreement is a supply agreement within the meaning of subsection 256(5.1).

However this “supply agreement” was not between persons dealing with each other at arm’s length, so that the exclusion in the latter part of s. 256(5.1) did not apply. She stated (at paras 58 and 59):

…Under paragraph 251(1)(c) of the ITA, the requisite inquiry is entirely factual, and the ability to set the terms of the supply agreement must accordingly be considered in context. … [I]n light of ADC’s near-total economic dependence on Seawind Corp., the fact that the owner of the latter company dictated (and was able to dictate) the terms of the relationship between the two companies is a very relevant factor in determining whether the two were dealing at arm’s length. Even more telling was Mr. Silva’s ability to make the two companies disregard the terms of the development agreement – as he decided to do when he unilaterally decided that the 5% mark-up [under the Development Agreement] would not be paid to ADC.

…[I]t would be difficult to imagine a stronger indicator of a non-arm’s length relationship than the fact that a company is allowed to operate out of another’s facility for free, without a lease. …