NAVIGATING THE MINEFIELD:
THE IMPLICATIONS OF BEING ASSOCIATED, AFFILIATED,
OR RELATED UNDER THE INCOME TAX ACT (CANADA)
Michael Friedman
McMillan LLP
Toronto
Todd Miller
McMillan LLP
Toronto
2015 Ontario Tax Conference
TABLE OF CONTENTS
OVERVIEW ............................................................................................................................................. 1
DEVELOPMENT OF THE CURRENT LEGISLATIVE FRAMEWORK: THE HISTORY OF LEGISLATIVE
CHANGE ................................................................................................................................................. 4
THE EARLY YEARS OF CANADIAN INCOME TAXATION ................................................................ 4
ABANDONMENT OF CONSOLIDATION AND THE INTRODUCTION OF RELATIONSHIP MEASURES ..... 5
“RELATED PERSONS”: THE FUNDAMENTALS ........................................................................................ 6
WHAT DOES IT MEAN TO BE “RELATED”? .................................................................................... 7
(I) INDIVIDUALS ............................................................................................................... 8
(II) CORPORATIONS AND RELATED PERSONS .................................................................... 16
(III) RELATED CORPORATIONS ........................................................................................ 22
RELATED PERSONS: SUPPLEMENTARY INTERPRETIVE/DEEMING RULES .................................... 23
SPECIAL SITUATIONS ................................................................................................................ 30
COMMON TRAPS AND PITFALLS ................................................................................................ 31
(I) CHANGES IN MARITAL STATUS.................................................................................... 32
(II) BREADTH OF SUBPARAGRAPH 251(5)(B) .................................................................... 32
(III) SCOPE OF FAMILIAL DEFINITIONS ............................................................................ 32
(IV) 256.1(3)(B) DEEMING RULE .................................................................................... 33
AFFILIATED PERSONS: THE FUNDAMENTALS ..................................................................................... 34
CRITICAL INTERPRETIVE RULES AND GENERAL PRINCIPLES ...................................................... 35
WHAT DOES IT MEAN TO BE “AFFILIATED”? ............................................................................. 40
(I) INDIVIDUALS ............................................................................................................. 40
(II) A CORPORATION AND ANY PERSON ........................................................................... 41
(III) A CORPORATION AND ANOTHER CORPORATION. ....................................................... 41
(IV) A CORPORATION AND A PARTNERSHIP. ..................................................................... 42
(V) A PARTNERSHIP AND A “MAJORITY-INTEREST PARTNER” ............................................ 42
(VI) A PARTNERSHIP AND ANOTHER PARTNERSHIP ........................................................... 43
(VII) SUPPLEMENTARY AFFILIATED PERSON RULES FOR TRUSTS ....................................... 44
(VIII) A TRUST AND A PERSON ......................................................................................... 45
(IX) A TRUST AND ANOTHER TRUST ................................................................................. 45
“LOSS RESTRICTION EVENT” RULES ......................................................................................... 49
(I) MODIFICATIONS AND DEPARTURES FROM THE GENERAL AFFILIATION PROVISIONS
IN SECTION 251.1........................................................................................................... 51
“ASSOCIATED PERSONS”: THE FUNDAMENTALS................................................................................. 52
WHAT DOES IT MEAN TO BE “ASSOCIATED”? ............................................................................. 53
(I) DE FACTO CONTROL OF ONE CORPORATION BY ANOTHER CORPORATION.................... 54
LEGAL_24490030.12
(II) DE FACTO CONTROL BY A COMMON PARENT ............................................................. 54
(III) CORPORATIONS ASSOCIATED BY VIRTUE OF CROSS-SHAREHOLDINGS – VARIANT #1.... 54
(IV) CORPORATIONS ASSOCIATED BY VIRTUE OF CROSS-SHAREHOLDINGS – VARIANT #2 .... 58
(V) CORPORATIONS ASSOCIATED BY VIRTUE OF CROSS-SHAREHOLDINGS – VARIANT #3 ..... 58
ASSOCIATED CORPORATIONS: SUPPLEMENTARY INTERPRETIVE/DEEMING RULES .................... 58
ASSOCIATED CORPORATION ANTI-AVOIDANCE RULE ............................................................... 68
ASSOCIATED CORPORATIONS: SAVING PROVISIONS .................................................................. 71
COMMON TRAPS AND PITFALLS ................................................................................................ 73
(I) “SPECIFIED CLASS” OF SHARES................................................................................. 73
(II) SHARE VALUATION CONSIDERATIONS ........................................................................ 74
(III) ASSOCIATED CORPORATIONS AND TRUSTS ................................................................ 74
(IV) OPTIONS AND RIGHTS .............................................................................................. 75
(V) DOCUMENTATION AND ANTI-AVOIDANCE RULES ........................................................ 75
CONCLUSION ........................................................................................................................................ 75
LEGAL_24490030.12
Navigating the Minefield: The Implications of being Associated, Affiliated, or Related
under the Income Tax Act (Canada)
Michael Friedman and Todd A. Miller1
“The hardest thing in the world to understand is the income tax.”
Albert Einstein
Overview
Few documents known to Canadians are as complex and daunting as the modern-day
Income Tax Act (the “Act”).2 From its straightforward origins as a temporary measure to raise
revenue in support of the government’s war-time efforts, Canada’s income tax legislation has
increased dramatically over the years in both length and scope. The simple fiscal goals of the
Act have now been supplemented by the desire to use the statute as a vehicle to satisfy a variety
of social and other policy-related objectives, from motivating charitable giving to providing
incentives for increased levels of retirement and personal savings.
The legislative history of the Act also reflects a series of broader public policy debates
concerning who should be the subject of income tax in Canada, how income tax should be
levied, and the manner in which income should be computed for tax assessment purposes.3 In
this regard, much discussion has focused on what is the appropriate entity or “unit” to bear tax in
Canada. At the one extreme, arguments have been made that every individual, corporation and
other juridical entity should separately be subject to tax on the basis of its own earnings and
expenses. At the other end of the spectrum, equitable and pragmatic considerations have been
proffered in support of consolidated or group taxation, which aggregates the earnings, expenses
and other tax attributes of individuals and entities that share a linked existence (such as the
members of a single family or corporate group).
While the recollections of most Canadian income tax practitioners are grounded in a
system that has been oriented toward taxation on a disaggregated or solitary basis, modes of
consolidated tax reporting have not always been foreign to the Canadian tax system. For two
decades in the mid-20th century, Canadian corporations were permitted to file tax returns on a
consolidated basis. Thereafter, the notion of permitting certain groups to prepare their tax filings
on a consolidated basis has been repeatedly revisited, including, most recently, by the federal
Department of Finance in its 2010 solicitation of views on potential approaches to consolidated
corporate tax reporting. 4
1
Michael Friedman and Todd Miller are tax partners in the Toronto office of McMillan LLP. The authors gratefully
acknowledge the assistance provided by Ehsan Wahidie in the preparation of this paper.
2
RSC 1985, c 1 (5th Supp). Unless otherwise stated, statutory references in this paper are to the Act.
3
See, for example, Report of the Royal Commission on Taxation, vols 2-3 (Ottawa: Queens Printer, 1966).
4
Canada, Department of Finance, The Taxation of Corporate Groups (November 2010) <available at
http://www.fin.gc.ca/activty/consult/tcc-igs-eng.asp.>
LEGAL_24490030.12
-2In opting to maintain an income tax system that computes income, and imposes taxation,
largely on a disaggregated basis, the government has been left to grapple with how to account for
transactions between closely-linked persons or taxpayers guided by common interests (such
persons will be referred to in this paper as “connected persons”) that have been structured
primarily to access tax benefits in a manner not contemplated by Parliament. Similarly, Canada’s
disaggregated system of income taxation can permit connected persons to structure transactions
to artificially shift income and expenses in a manner that many would characterize as
distortionary or improper.
Such structural challenges have given rise to a host of legislative questions. Should there
be limitations on the claiming of specialized credits, or reduced rates of taxation, that may
otherwise simultaneously be claimed by connected persons? What countervailing restrictions
should be imposed to preclude taxpayers from artificially dividing or dispersing income or
expenses among connected persons to achieve a better tax result?
Concerns about these and other issues ultimately compelled Parliament to introduce a
series of statutory limitations on the ability of certain taxpayers to claim tax benefits and
advantages otherwise offered under the Act. In addition, specialized deeming rules were enacted
to recharacterize or adjust the results of transactions entered into between parties guided by
common interests to more closely parallel the results of transactions that would be expected to be
undertaken by completely independent parties. These legislative interventions have spawned the
concepts of “associated” corporations, “affiliated persons”, and “related persons” that now
occupy the attention of most tax professionals and are the subject of this paper.
Whether two or more persons or corporations are affiliated, associated or related now
serves as an important predicate to the application of many deeming and anti-avoidance rules in
the Act. Such rules can recharacterize or requantify the amounts considered to have been paid or
received as part of a transaction, restrict claims for certain preferential credits and deductions,
and limit the ability of a taxpayer to recognize certain losses otherwise arising from a particular
transaction. The tests to be applied to determine whether parties are associated, affiliated, or
related share certain common elements, but are also unique in many respects. Key points of
departure among the three concepts include the scope of their application, their reliance on
different measures of corporate control, the degree to which they apply principles of transitivity
in assessing the relationship among persons, their treatment of legal rights in defining the
relationship among persons, and their incorporation of specialized deeming rules to address
unique circumstances.
Aside from the precision and complexity of the current concepts of “associated
corporations”, “affiliated persons”, and “related persons”, the three statutory concepts have also
proven to be dynamic. As Parliament has increasingly sought to restrict the ability of certain
connected persons to claim particular tax benefits and advantages, or manoeuvre to attain certain
tax results, the introduction and refinement of the three relational concepts has been an ongoing
process. One need only peruse the legislative history of sections 251, 251.1 and 256 to gain an
immediate sense of the dramatic evolution of the statute over time. Moreover, the interpretation
of these sections has proven to be a consistent enterprise, giving rise to a host of administrative
statements and jurisprudence. In the last five years alone, over 70 technical interpretation letters,
advance tax rulings, and other administrative statements have been issued by the Canada
LEGAL_24490030.12
-3Revenue Agency (the “CRA”) in relation to what it means for persons to be affiliated, associated
or related. Similarly, no fewer than 55 decisions have been rendered by the courts during that
same period that have made reference to the statutory concepts of related persons, associated
corporations, and affiliated persons.
For tax practitioners, it has become imperative to remain apprised of the latest
developments with respect to the three relational concepts. The eligibility of clients to claim
certain tax credits or deductions, the required computation of income, and a host of critical, and
often counter-intuitive, deeming rules depend upon the proper application of the latest iteration
of the three relational concepts. The sensitivity and nuances of the concepts have become known
to most tax professionals and many a practitioner can tell a harrowing tale of a client that has
been stung by the misapplication of the relevant provisions or by a failure to identify when they
may, in fact, have been related to, or affiliated or associated with, another taxpayer.
Many fine papers have previously been written that document both the evolution of the
concepts of affiliated, associated, and related, and the unique traps that may ensnare those that
are not sufficiently familiar with their reach.5 The goal of this paper is to provide the reader with
sufficient historical context, and an appreciation of the policy imperatives that have driven the
advancement of the concepts of associated corporations, and affiliated and related persons, to
develop an intuition as to when these concepts may potentially be activated under any particular
set of circumstances. It is our hope that this heightened intuition may serve as an early warning
signal of the need to conduct further investigation in the course of advising a particular taxpayer.
Not unlike other complicated elements of the Canadian tax system, a tax practitioner
should not reasonably be expected to memorize all of the new interpretations and technical
deeming rules that are relevant to the characterization of persons as being associated, affiliated or
related to one another. Ultimately, when characterizing a relationship, recourse must always be
had to the relevant statutory definitions and deeming rules and their administrative and judicial
interpretation.
5
See, for example, Ron Dueck and Stephanie Daniels, "Update and Review of the Related, Affiliated, and Associated
Rules: Overlaps, Differences, and Their Significance," 2014 British Columbia Tax Conference, (Toronto: Canadian Tax
Foundation, 2014) 10; Nancy Diep, ""Associated," "Affiliated," and "Related" Transactions, Part 1: A Technical
Overview," Report of Proceedings of Fifty-Seventh Tax Conference, 2005 Conference Report (Toronto: Canadian Tax
Foundation, 2006) 38; Joseph N. Micallef, ""Associated," "Affiliated," and "Related" Transactions, Part 2: The Practical
Applications of the Terms," Report of Proceedings of Fifty-Seventh Tax Conference, 2005 Conference Report (Toronto:
Canadian Tax Foundation, 2006) 39; Michael Dubensky, CA, "Associated/Affiliated/Related: A Case Study for
Canadian-Controlled Private Corporations," 1998 British Columbia Tax Conference, (Vancouver: Canadian Tax
Foundation, 1998) 9; Marc E. Marion, "Associated Corporations-Selected Tax Issues," 2008 Prairie Provinces Tax
Conference, (Toronto: Canadian Tax Foundation, 2008) 3; Maureen Donnelly and Allister Young, "The Associated
Corporation Rules: Getting Tax Reduction Under "Control"," (1998) 46:3 Canadian Tax Journal 589; Starr Carson and
Kelly Watson, "Affiliated Person Rules: A Review of Recent Technical Amendments and Practical Issues Relating to
Stop-Loss Rules," 2004 British Columbia Tax Conference, (Vancouver: Canadian Tax Foundation, 2004) 13.
LEGAL_24490030.12
-4Development of the Current Legislative Framework: The History of Legislative Change
The Early Years of Canadian Income Taxation
Canada’s initial income tax statute, the Income War Tax Act of 1917, sought to impose
tax on a relatively simple basis. The 1917 statute levied a basic rate of tax of 4% on the income
of individuals, and higher, graduated rates of supplementary tax on income earned by individuals
in excess of $6,000 in any particular taxation year. By contrast, corporations were only subject
to income tax levied at the basic 4% rate. To preclude what the government conceived of as the
unjust deferral of income tax at the corporate level, the Income War Tax Act contained certain
anti-avoidance rules that imposed higher incremental levels of taxation on individual
shareholders of a corporation in respect of their share of the undistributed income and capital
gains of the corporation if the Minister was of the opinion that the retention of such income was
not reasonably required by the corporation for business purposes, or was otherwise accumulated
for the purpose of avoiding tax.6 The statute also contained deeming provisions in respect of
certain inter-company transactions aimed at counteracting transactions that artificially shifted
income or expenses. 7
A new version of the Income War Tax Act was enacted in 1927, which included a number
of statutory refinements, including provisions that subjected individual shareholders of certain
closely-held “personal corporations” and electing “family corporations” to taxation on the
income and gains of such corporations, irrespective of whether amounts were distributed to such
shareholders.
Amendments to the Income War Tax Act, effective from 1932, first permitted members of
certain corporate groups to file their tax returns on a consolidated basis. 8 Under the operative
statutory provisions, a company that owned or controlled all of the capital stock (less certain
directors’ qualifying shares) of a subsidiary corporation that carried on the same general class of
business as the parent corporation, and which had a fiscal period that substantially paralleled that
of its parent corporation, could elect to file a consolidated tax return with its wholly-owned
subsidiary. If the corporate group elected to file tax returns on a consolidated basis, the income
of the consolidated group was subject to an increased rate of taxation.9 While some debate has
focused on the reasons for the increased rate of tax, it has been speculated that the additional tax
was intended to discourage consolidated reporting in marginal circumstances, given the
additional burden imposed on the government in administering the consolidated filing regime. 10
While the early Canadian income tax statutes did not, as a general matter, specifically
define special relationships among taxpayers that served as the predicate to the application of
6
Income War Tax Act, SC 1917, c 28, s 3(4).
7
Income War Tax Act, SC 1917, c 28, s 4(2); RSC 1927, c 97, s 23.
8
SC 1932-33, c 41, s 13.
9
Initially, the applicable tax rate was increased by 1%, with such rate applying to the consolidated income of the
corporations. The applicable tax rate was, in later years, increased by 2%.
10
See, for example, Marshall A Cohen, “Consolidated Tax Returns” (1968) 16:5 Canadian Tax Journal, 370-378.
LEGAL_24490030.12
-5anti-avoidance and other restrictive provisions, the statutes did include various deeming rules
that governed the computation of revenue and expenses arising from transactions between certain
connected persons. In many respects, these provisions served as the precursor to certain of the
related-party transaction rules found in more recent versions of the Act.
Abandonment of Consolidation and the Introduction of Relationship Measures
The Income War Tax Act was repealed in 1948 and the first version of the modern Act
was enacted in its place. The structural mechanics of the new Act differed significantly from the
predecessor legislation. A new system of income tax rates was introduced, and the provisions
that permitted consolidated tax filings were increasingly tightened, 11 with the right to elect to file
consolidated tax returns ultimately being eliminated in respect of tax years ending after 1952.
Amendments to the Act in 1949 introduced a predecessor to the modern small business
deduction.12 The new rules provided that the first $10,000 of income of certain corporate
taxpayers was subject to a reduced rate of taxation. However, as a means of restricting the scope
of the new legislative provisions, the concept of “associated” corporations was also introduced.
With a view to precluding businesses from incorporating multiple companies to each claim the
lower tax rate on the first $10,000 of income, the Act provided that no portion of the income of
associated corporations was eligible to be taxed at the lower corporate rate. The statute was
subsequently amended to allow associated corporations to elect to allocate their first $10,000 of
aggregate income amongst themselves, with such allocated income being subject to tax at the
reduced corporate rate.
“Associated” corporations13 were initially defined as corporations that were under
common control. However, this formulation of the statutory definition of “associated”
corporations was retroactively repealed after only one year on account of calls for a “less rigid
limitation”14. In its place, a revised statutory definition was adopted that required common
ownership of 70% of the shares of two or more corporations for them to be considered
“associated”.
The Act of 1948 also first introduced the concept of parties not dealing with one another
at arm’s length.15 Persons that were characterized as not dealing with one another at arm’s
length were subject to a select number of anti-avoidance rules that were aimed at precluding
taxpayers from avoiding or deferring tax by engaging in transactions that would not normally be
undertaken by independent parties.
11
SC 1948, c 52, s 75.
12
Income Tax Act and Income War Tax Act, SC 1949, c 25, s 18(1).
13
The 1949 version of the statute actually used the term “related” corporations, but the label was subsequently changed to
“associated” in 1954 to accommodate the reference to related persons in the newly introduced definition of persons not
dealing with one another at arm’s length.
14
Canada, Department of Finance, Budget Speech, March 28, 1950 at 1217 <available at
http://www.parl.gc.ca/parlinfo/Documents/Budgets/English/1950-03-28.pdf>; SC 1950, c 40, s 15.
15
SC 1948, c 52, s 127(5).
LEGAL_24490030.12
-6In 1953, the non-arm’s length provisions in the Act were repealed and were re-introduced
in a form that largely parallels their current constitution. 16 In particular, persons were
characterized as not dealing with one another at arm’s length where they were (i) “related”, or
(ii) otherwise not dealing with one another at arm’s length as a factual matter. In contrast to its
usage in the modern Act, the concept of “related” persons was a notion that was employed
strictly for the purpose of defining parties not considered to be dealing with one another at arm’s
length, and was not otherwise independently used in the statute.
In the 1960s and early 1970s, the initial formulation of the “associated” corporation rules
in the Act was repealed and was replaced with provisions that largely mirror current section 256.
In 1988, Parliament sought to expand the scope of the “associated” corporation rules in
view of the growing belief that it had become possible for taxpayers to circumvent the
application of the rules with relative ease, particularly as they related to claims for the small
business deduction and refundable investment tax credits. The 1988 Federal Budget proposed to
amend the “associated” corporation rules by expanding the concept of control embedded in the
applicable definitions to capture corporations controlled, “directly or indirectly in any manner
whatever” (i.e., de facto control). A host of specific deeming rules were also introduced as part
of the 1988 reforms.
Finally, in 1995, the government became concerned with transactions being undertaken
by connected persons to prematurely trigger the recognition of accrued losses. Historically, the
Act contained anti-avoidance rules that restricted the ability to trigger a capital loss where the
relevant property continued to be owned by a member of the relevant corporate group. The
“superficial loss” rules, and anti-avoidance rules contained in section 55, were oriented toward
precluding losses from arising on transactions between spouses and between corporations that
were controlled in fact by the transferor, as well as transactions that may reasonably have been
considered to have been undertaken to artificially or unduly create a loss. Parliament became
concerned with the limited scope of such existing anti-avoidance rules and moved to enact the
“affiliated” person rules to more precisely restrict both the accelerated recognition of capital
losses and the transfer of losses within certain groups of taxpayers. The 1995 amendments
eliminated most opportunities to transfer accrued losses within a corporate group and created a
new operational framework restricting the recognition of losses. The affiliated person rules
initially applied expressly to individuals, corporations, and partnerships. While the affiliated
person rules also applied to trusts to a limited extent, further amendments to the rules were
enacted in 2004 to expand their application to trusts in a more fulsome manner.
“Related Persons”: The Fundamentals
Where a taxpayer is characterized as being “related” to another person for the purposes of
the Act, a number of deeming and other operational rules will apply to such related persons and
the transactions between them.
16
SC 1953-54, c 57, s 31.
LEGAL_24490030.12
-7As previously noted, “related persons” have long been deemed not to deal with one
another at “arm’s length” for the purposes of the Act. However, the employment of the concept
of “related persons” now extends far beyond simply serving as a constituent component of the
definition of “arm’s length”. A wide array of specialized deeming and aggregation rules in the
Act are now activated in respect of taxpayers that are “related” to one another, or in respect of
transactions between “related persons”.
The contexts in which a tax practitioner may encounter the concept of “related persons”
in the Act are broad and varied and include the following:
(a)
Provisions governing inadequate consideration and transactions involving related
persons;17
(b)
Provisions aggregating related persons for the purposes of quantitative or other
operational rules in the Act;18
(c)
The permitted transfer/transaction provisions;19
(d)
The benefit conferral provisions;20
(e)
The surplus stripping rules in section 55;
(f)
The restricted covenant provisions in section 56.4;
(g)
The debt forgiveness and debt parking rules;21 and
(h)
The qualified small business corporation share rules. 22
What does it mean to be “Related”?
For the purposes of the Act, “related persons”, or persons considered to be related to each
other, are defined in subsection 251(2). Subsection 251(2) provides as follows:
…“related persons”, or persons related to each other, are
(a) individuals connected by blood relationship, marriage or
common-law partnership or adoption;
17
See, for example, subsections 15(2) and 80.4(1), section 120.4, and subsection 191(2).
18
See, for example, subsections 6(1) and 66(15) “principal-business corporation”, section 95, subsection 125(7) “personal
services business”, and section 143.2.
19
See, for example, paragraphs 40(2)(e.1) and subsections 66(12.67), (12.671), 83(2.4), and 88(1).
20
See, for example, subsection 51(2), paragraph 85(1)(e.2), and subsection 86(2).
21
See, for example, sections 80-80.01.
22
See, for example, section 110.6.
LEGAL_24490030.12
-8(b) a corporation and
(i)
a person who controls the corporation, if it is controlled
by one person,
(ii)
a person who is a member of a related group that controls
the corporation, or
(iii)
any person related to a person described in subparagraph
(i) or (ii); and
(c) any two corporations
(i)
if they are controlled by the same person or group of
persons,
(ii)
if each of the corporations is controlled by one person
and the person who controls one of the corporations is
related to the person who controls the other corporation,
(iii)
if one of the corporations is controlled by one person and
that person is related to any member of a related group
that controls the other corporation,
(iv)
if one of the corporations is controlled by one person and
that person is related to each member of an unrelated
group that controls the other corporation,
(v)
if any member of a related group that controls one of the
corporations is related to each member of an unrelated
group that controls the other corporation, or
(vi)
if each member of an unrelated group that controls one
of the corporations is related to at least one member of
an unrelated group that controls the other corporation.
The statutory definition speaks of both relations among individuals and among persons
and corporations. Additional interpretative rules, and supporting statutory definitions, are also
provided in the Act that further inform the relations that will give rise to related party status.
(i) Individuals
Paragraph 251(2)(a) is focused solely on the circumstances under which individuals will
be considered to be related to one another for the purposes of the Act. While intuition will often
guide one to correctly conclude which individuals might rightly be considered to be connected
by “blood relationship”, marriage or adoption, the applicable provisions are wide spanning in
scope and inattention to the supporting statutory definitions could give rise to a failure to
LEGAL_24490030.12
-9properly capture all of the connections that result in individuals being considered to be related to
one another for the purposes of the Act.
(1)
Connected by “Blood Relationship”
Persons connected by “blood relationship” are considered to be related to one another for
the purposes of the Act. Paragraph 251(6)(a) provides that persons are considered to be
connected by “blood relationship” if one is the “child” or other descendant of the other or one is
the brother or sister of the other.
Subsection 252(1) provides that the “child of a taxpayer” will include:
(a)
a person of whom the taxpayer is the legal parent;
(b)
a person who is wholly dependent on the taxpayer for support and
of whom the taxpayer has, or immediately before the person attained
the age of 19 years had, in law or in fact, the custody and control;
(c)
a child of the taxpayer’s spouse or common-law partner; and
(d)
a spouse or common-law partner of a child of the taxpayer.
The extended statutory definition of a “child of a taxpayer” can capture a variety of
persons who are not biologically related to the taxpayer. For instance, the child of a taxpayer’s
spouse or common-law partner, or the spouse or common-law partner of the taxpayer’s child, fall
within the ambit of the extended statutory definition of a child. However, on the death or
divorce of an individual’s child, the CRA has opined that the child’s former spouse or commonlaw partner will be considered to cease to be the child’s spouse or common-law partner and,
therefore, will no longer be a child of the taxpayer for the purposes of the Act.23
In considering the definition of a child of a taxpayer, it is instructive to note that the
extended statutory definition refers to a person of whom the taxpayer is the legal parent. In this
regard, express reference must be made to the applicable family law as part of the assessment of
whether an individual is a child of a taxpayer for the purposes of the Act.
In contrast to other aspects of the extended definition of a “child”, the statute does not
expressly define what it means for a person to be “wholly dependent on the taxpayer for support”
or the circumstances under which a taxpayer will, in law or in fact, be considered to have “the
custody and control” of another person. Nevertheless, the CRA has had occasion to express its
views as to how these particular concepts should be interpreted. In particular, the CRA has
stated the following:
….because of the extended meaning of the word “child” provided in
[subsection] 252(1) of the Act, a taxpayer can, for income tax
23
Income Tax Folio S1-F5-C1, “Related persons and dealing at arm’s length” (effective 9 June 2015) at para 1.5 [Income
Tax Folio S1-F5-C1].
LEGAL_24490030.12
- 10 purposes, be considered to be a parent of a child that is “wholly
dependent on the taxpayer for support” and of whom the taxpayer
has “in law or in fact, the custody and control.”
In general terms, support involves the provision of the basic
necessities of life such as food, shelter, and clothing. “Wholly
dependent for support” means that the child is financially dependent
on the individual such that the individual provides almost entirely
for the child’s well being.
A child is generally not considered to be “wholly dependent for
support” on an individual who cohabits with the parent of the child,
if the parent or the child has income of some significance or there
are other sources of significant financial support for the parent
and/or the child. Examples of other potential sources of “support”
for a child could include (but are not limited to): financial
contributions from the other biological parent of the child, financial
contributions to the parent from other family members, or student
loans or scholarships provided to a parent to cover living expenses
while attending school.
Generally, “custody and control” involves the right of determining
the residence, protection, care (physical, mental and moral),
education, and religion of a minor child. Custody and control
involves not only the right to make the major decisions, such as
those concerning the residence, health, education, and religion, but
also the routine decisions of effective parental care and guidance
which arise in the daily activities of a minor child, such [sic] school
attendance, meal preparation, and the imposition and enforcement
of house rules (e.g. rules concerning TV watching, Internet surfing,
curfew and so on).
It is a question of fact whether a person is wholly dependent for
support on a taxpayer and whether the taxpayer has, in law or in fact,
the custody and control of that person. However, we are of the view
that, in most cases, when a parent and an individual (who is not a
parent of a child by birth or adoption) move in together, they would
likely not be considered to be common-law until they have been
living together for a year. In most of these cases, we would not
expect that both criteria required for the cohabiting individual to be
considered to be a “parent” of the child – i.e. “wholly dependent for
support” and “custody and control” – would be met.24
24
See CRA document no. 2011-0397251E5, April 11, 2011.
LEGAL_24490030.12
- 11 The CRA has opined that the statutory definition of “child” does not include a foster
child for whom the foster parents receive support payments from an agency responsible for the
child’s care. In support of its view, the CRA has reasoned that if “the foster parents received
support payments from a government agency to be used for the purposes of caring for the foster
children, such an arrangement would mean that the foster children are not wholly dependent on
the foster parents for support”.25
Similarly, the CRA has concluded that where a person receives disability support
payments from a government agency and pays rent to an individual for room and board, they
would generally not be considered to be “wholly dependent” on the individual providing the
room and board for support for the purposes of the extended statutory definition of a “child”.26
Paragraph 251(6)(a) defines a “blood relationship” as capturing a child or other
descendant of a taxpayer. In this regard, the reference to other descendants should be taken to
capture other persons further down the lineage of the taxpayer, including grandchildren and great
grandchildren. Quaere whether the scope of the reference to “other descendants” could be
construed broadly enough to encompass spouses and other dependants by marriage further down
one’s family tree?27
Finally, a blood relationship is further defined to capture the “brother” or “sister” of a
taxpayer. Paragraph 252(2)(b) defines a brother of a taxpayer expansively as including a person
who is (i) the brother of the taxpayer’s spouse or common-law partner, or (ii) the spouse or
common-law partner of the taxpayer’s sister. Similarly, paragraph 252(2)(c) defines a sister of a
taxpayer expansively as including a person who is (i) the sister of the taxpayer’s spouse or
common-law partner, or (ii) the spouse or common-law partner of the taxpayer’s brother. 28
(2)
Connected by Marriage
Persons connected by marriage are considered to be related for the purposes for the Act.
“Marriage” is not expressly defined in the Act. However, paragraph 251(6)(b) provides that
persons will be considered to be connected by marriage “if one is married to the other or to a
person who is so connected by blood relationship to the other”. By virtue of the reference to
those connected to a spouse by blood relationship, a person will be connected by marriage to the
parents or any siblings of their spouse. Where a person’s marriage is dissolved by divorce or the
death of his or her spouse, the CRA considers the person to cease to be connected by marriage to
their former spouse or, solely by virtue of the previous marriage, to the parents and any siblings
of their former spouse.29
25
See CRA document no. 2010-0382341E5, October 7, 2010.
26
See CRA document no. 2009-0352771E5, July 27, 2009.
27
But see Burnaby Lake Greenhouses Ltd. v British Columbia, 2005 BCSC 1682, 2005 CarswellBC 2884.
28
It would be prudent for Parliament to amend the definitions of “brother” and “sister” (or perhaps consider replacing
these defined terms with a gender-neutral term such as “sibling”) to ensure that the spouse or common-law partner of a
sibling that is in a same-sex relationship is referenced in gender appropriate terms.
29
Income Tax Folio S1-F5-C1, supra note 23 at para 1.7.
LEGAL_24490030.12
- 12 Taxpayers have frequently run into difficulty when they have mischaracterized their
relationship with spouses with whom they are separated but have yet to divorce. The Tax Court
of Canada has ruled that Parliament’s decision to define related persons by reference to persons
who are married to one another, and not restrict the scope of such language by including the
types of limiting provisos found in other parts of the Act, such as “living separate and apart
because of the breakdown of their marriage”, indicates that the marriage of two persons will
generally be considered to subsist until the marriage is formally dissolved by divorce or the death
of one of the spouses.30
(3)
Connected by “Common-Law Partnership”
Paragraph 251(2)(a) provides that individuals connected by common-law partnership are
considered to be related to one another for the purposes of the Act. A “common-law
partnership” is defined in subsection 248(1) as the relationship between two persons who are
“common-law partners” of each other. A “common-law partner” with respect to a taxpayer is
also defined in subsection 248(1) as meaning a person who cohabits at that time in a conjugal
relationship with the taxpayer and (a) has so cohabited throughout the twelve-month period that
ends at that time, or (b) would be the parent of a child of whom the taxpayer is a parent if the Act
were read without reference to the elements of the extended statutory definition of a “child” that
reference spouses and common-law partners.31 For the purpose of applying the definition of a
“common-law partner”, where at any time the taxpayer and the relevant person cohabit in a
conjugal relationship, they are, at any particular time thereafter, deemed to be cohabiting in a
conjugal relationship unless they were living separate and apart at the particular time for a period
at least 90 days that includes the particular time because of a breakdown of their conjugal
relationship.
The Act does not provide a definition of what it means to “cohabit in a conjugal
relationship”. However, the Supreme Court of Canada has articulated the characteristics of a
conjugal relationship. Specifically, the Supreme Court has stated:
[The case of] Molodowich v. Penttinen…sets out the generally
accepted characteristics of a conjugal relationship. They include
shared shelter, sexual and personal behaviour, services, social
activities, economic support and children, as well as the societal
perception of the couple. However, it was recognized that these
elements may be present in varying degrees and not all are necessary
for the relationship to be found to be conjugal... In order to come
within the definition, neither opposite-sex couples nor same-sex
couples are required to fit precisely the traditional marital model to
demonstrate the relationship is “conjugal”. 32
30
Mathieu v The Queen, 2014 TCC 207, 2015 DTC 1073.
31
In this regard, the relevant sections of the Act are paragraphs 252(1)(c) and (e), and subparagraph 252(2)(a)(iii).
32
M v H, [1999] 2 SCR 3 at 50-51, (1998) SCJ No 23 (SCC).
LEGAL_24490030.12
- 13 The CRA has confirmed that it considers a number of factors in assessing whether
persons are in a conjugal relationship, many of which were cited in the Molodowich decision
referenced by the Supreme Court in M v H, including the following:
1.
2.
3.
Shelter
(a)
Did the parties live under the same roof?
(b)
What were the sleeping arrangements?
(c)
Did anyone else occupy or share the available accommodation?
Sexual and Personal Behaviour:
(a)
Did the parties have sexual relations? If not, why not?
(b)
Did they maintain an attitude of fidelity to each other?
(c)
What were their feelings towards each other?
(d)
Did they communicate on a personal level?
(e)
Did they eat their meals together?
(f)
What, if anything, did they do to assist each other with problems or during
illness?
(g)
Did they buy gifts for each other on special occasions?
Services:
What was the conduct and habit of the parties in relation to:
4.
(a)
preparation of meals;
(b)
washing and mending clothes;
(c)
shopping;
(d)
household maintenance; and
(e)
any other domestic services?
Social:
(a)
LEGAL_24490030.12
Did they participate together or separately in
neighbourhood and community activities?
- 14 (b)
5.
What was the relationship and conduct of each of them
towards members of their respective families and how did
such families behave towards the parties?
Societal:
What was the attitude and conduct of the community towards each of them and as
a couple?
6.
7.
Support (economic):
(a)
What were the financial arrangements between the parties
regarding the provision of or contribution towards the
necessaries of life (food, clothing, shelter, recreation, etc.)?
(b)
What were the arrangements concerning the acquisition and
ownership of property?
(c)
Was there any special financial arrangement between them
which both agreed would be determinant of their overall
relationship?
Children:
What was the attitude and conduct of the parties concerning children?33
Whether two persons cohabit in the same residence is not necessarily determinative of
whether they are cohabiting in a conjugal relationship.34 The CRA has also opined that a person
may simultaneously have both a spouse by marriage and a common-law partner for tax
purposes.35
In assessing whether a person is a parent of his or her partner’s child for the purposes of
the definition of a “common-law partner”, the expansive statutory definition of a “child” applies.
Where a person is a parent of his or her partner’s child at the time the couple begins to cohabit in
a conjugal relationship, a “common-law partnership” is deemed to commence at that time.
Similarly, if a person becomes a parent of his or her partner’s child while the couple is already
cohabiting in a conjugal relationship, and before the requisite 12-month minimum period has
33
See CRA document no. 2002-0161185, October 29, 2002.
34
See, for example, CRA document no. 2002-0161185, ibid. wherein the CRA states that individuals who maintain
separate residences may nevertheless be found to be a conjugal relationship for the purposes of the Act. By contrast, the
Tax Court has repeatedly found that, under certain circumstances, individuals may live in the same residence, yet have
terminated their conjugal relationship. See, for example, Bellavance v The Queen, [2004] 4 CTC 2179 (TCC); Perron v
The Queen, 2010 TCC 547, 2011 DTC 1027.
35
See, for example, CRA document no. 2009-0330301C6F, October 9, 2009.
LEGAL_24490030.12
- 15 elapsed, the common-law partnership of the couple will nevertheless be deemed to begin at the
time the person becomes a parent of the child.36
The post-amble to the definition of a “common-law partner” contains a deeming rule that
provides that where persons begins to cohabit in a conjugal relationship, they are deemed to
cohabit in such conjugal relationship at any time thereafter unless they were living separate and
apart at the particular time for a period of at least 90 days because of a breakdown of their
conjugal relationship. The CRA has interpreted the reference to a period of 90 days as being
limited to a continuous 90-day period.37 Whether two individuals no longer cohabit with each
other “because of the breakdown of their conjugal relationship” is a question of fact. 38
Similar to the circumstances involving a marriage, paragraph 251(6)(b.1) provides that
persons are connected by common-law partnership if one is in a common-law partnership with
the other or with a person who is connected by blood relationship to the other.
(4)
Connected by Adoption
Individuals that are connected by adoption are considered to be related to one another for
the purposes of the Act. The concept of adoption is not expressly defined in the Act. However,
paragraph 251(6)(c) provides that persons are connected by adoption if one has been adopted,
either legally or in fact, as the child of the other or as the child of a person who is so connected
by blood relationship (otherwise then as a brother or sister) to the other. Accordingly, adoption
includes both a legal adoption and an adoption in fact (also referred to as a “de facto” adoption).
While the CRA has acknowledged that one must consider all of the relevant
circumstances when assessing whether a de facto adoption has occurred at a particular time, the
CRA has indicated that it does not construe the appointment of a guardian of a child to, in and of
itself, constitute a de facto adoption.39 Rather, for a de facto adoption to have occurred, the CRA
has stated that, generally, the adoptive parents must “exercise parental care and guidance on a
continuing basis over the child”.40 The factors identified by the CRA as being relevant to
determining whether a de facto adoption has occurred include:
(a)
Where actual control and custody of the child resides;
(b)
Who exercises parental care and responsibility of the child on a continuing basis;
(c)
Whether there is a relationship of dependency of between the parties; and
36
Income Tax Folio S1-F5-C1, supra note 23 at para 1.11.
37
See, for example, CRA document no. 2004-0069021E5, July 28, 2004.
38
See, for example, supra note 33.
39
See, Income Tax Folio S1-F5-C1, supra note 23 at para 1.16.
40
Ibid.
LEGAL_24490030.12
- 16 (d)
The proximity of the proposed adoptive parent and the child to one another.41
It is relevant to note that the extended definition of “adoption” captures, by express
reference, the expanded definition of a “child” in subsection 252(1).
(ii) Corporations and Related Persons
Paragraph 251(2)(b) provides special rules for determining whether a corporation is
related to certain persons. In particular, the paragraph reads as follows:
…“related persons”, or persons related to each other, are
… (b) a corporation and
(1)
(i)
a person who controls the corporation, if it is
controlled by one person,
(ii)
a person who is a member of a “related group” that
controls the corporation, or
(iii)
any person related to a person described in
subparagraph (i) or (ii).
Related Persons and Control
Central to the application of the rules governing whether a corporation is related to a
particular person is the concept of “control”. “Control” is not expressly defined for the purposes
of the Act and has been the subject of much jurisprudence. While the courts continue to grapple
with the proper means of assessing control in the context of particular fact patterns, it is
generally accepted that “control” for the purposes of the Act refers to de jure control. 42
The seminal judicial decision on the meaning of “control” for Canadian tax purposes is
the judgment of the Exchequer Court of Canada in Buckerfield’s Ltd. v The Minister of National
Revenue43 (“Buckerfield’s”). The issue in dispute in Buckerfield’s revolved around whether
certain corporations were rightly considered to be “associated” with each other for the purposes
of the Act. The relevant sections of the Act at the time provided that one corporation was
associated with another in a taxation year if, at any time in the year, both corporations were
controlled by the same person or group of persons. President Jackett, speaking on behalf of the
Exchequer Court in Buckerfield’s, observed that the word “control” was not defined in the Act
and that many different approaches could conceivably be adopted to define control, including
those that focus on control of management of the corporation or the presence of de facto control
of the affairs of the corporation. The Court ultimately concluded that, in the context of the Act,
41
Ibid.
42
Ibid at para 1.19.
43
[1964] 64 DTC 5301, CTC 504 (Ex CR).
LEGAL_24490030.12
- 17 “the word “controlled” contemplates the right of control that rests 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 of a corporation”.44 In reaching its conclusion, the Court observed that its proposed
approach was consistent with previous jurisprudence that articulated that the “owners of the
majority of the voting power in a company are the persons who are in effective control of its
affairs and fortunes”.45
In subsequent years, the courts have had to examine the appropriate parameters of control
and develop tests for assessing control in particular circumstances. In 1998, the Supreme Court
of Canada resolved many lingering debates as to the sources of control of a corporation and the
appropriate indicia to be considered in making assessments of control. In Duha Printers
(Western) Ltd. v The Queen,46 the Supreme Court canvassed the factors that may properly be
considered in assessing the de jure control of a corporation. In this regard, specific attention was
focused on whether a unanimous shareholder agreement may be considered a constating
document of the corporation for the purposes of the de jure control analysis.
In rendering its judgment, the Supreme Court reiterated and affirmed that the test of
control articulated in Buckerfield’s remains the Canadian standard for assessing control “with the
test for such control generally accepted to be whether the controlling party enjoys, by virtue of
its shareholdings, the ability to elect the majority of the board of directors” of the corporation.47
Nevertheless, the Court went on to expand upon the underpinnings of the test to illustrate the
relevant indicia of control. In particular, the Court stated the following:
However, it must be recognized at the outset that this test is really
an attempt to ascertain who is in effective control of the affairs and
fortunes of the corporation. That is, although the directors generally
have, by operation of the corporate law statute governing the
corporation, the formal right to direct the management of the
corporation, the majority shareholder enjoys the indirect exercise of
this control through his or her ability to elect the board of directors.
Thus, it is in reality the majority shareholder, not the directors per
se, who is in effective control of the corporation. 48
The Supreme Court reasoned that, in certain circumstances, it may be appropriate to look
beyond the share register of a corporation to ascertain who possesses the right to elect the
majority of the directors of the corporation, or to fundamentally exercise “effective control” over
the corporation. While simple agreements among shareholders will not be taken into account as
determinants of de jure control, as they do not go to the very constitution of the operations of the
corporation, the Supreme Court observed that unanimous shareholder agreements are a corporate
44
Ibid at para 10.
45
See British American Tobacco Co. v CIR, [1943] 1 All ER 13, [1943] AC 335 (HL).
46
[1998] 1 SCR 795, [1998] CTC 303 [Duha Printers].
47
Ibid at para 36.
48
Ibid.
LEGAL_24490030.12
- 18 law hybrid, partly contractual and partly constitutional in nature. By operation of statute,
unanimous shareholder agreements can have the effect of severing the ability of a majority
shareholder to exercise effective control over the corporation, as otherwise manifested in its
ability to elect the majority of the directors of the corporation. Nevertheless, the Supreme Court
stated that the simple fact that a unanimous shareholder agreement exists does not necessarily
result in a shift of effective control of the corporation from the majority shareholder to others.
One must ask whether the terms of the unanimous shareholder agreement leave any way for the
majority shareholder to exercise effective control over the affairs and fortunes of the corporation
in a way analogous or equivalent to the power to elect the majority of the board of directors.
In summarizing its views in Duha Printers, the Supreme Court directed that to determine
where “effective control” of a corporation resides, one must consider (a) the corporation’s
governing statute, (b) the share register of the corporation, and (c) any specific or unique
limitation on either the majority shareholder’s power to control the election of the board of
directors or 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.49
More recently, the Tax Court of Canada was called upon to further define the parameters
of what constitutes “effective control” of a corporation. In Kruger Wayagamack Inc. v The
Queen,50 the taxpayer (“KWI”) was a corporation that operated a paper mill in the province of
Québec. The paper mill had encountered difficult times and was facing closure prior to its
acquisition by Kruger Inc. (“Kruger”) and SGF Rexfor Inc., a company owned by the
Government of Québec (“SGF”). At the time of the acquisition, Kruger was (and remains) an
active and major producer of paper, tissue and other wood products.
Upon the acquisition of KWI, Kruger and SGF committed significant resources to
modernize the paper mill. In an effort to capitalize on the industry knowledge and business
network of Kruger, KWI entered into a Management Services Agreement and a Sales Agency
and Marketing Agreement with Kruger. Consistent with such agreements, Kruger was
empowered to appoint a general manager of KWI who was directly involved in the day-to-day
operations of KWI.
Ownership of KWI was divided such that Kruger owned 51% of the shares of KWI and
SGF owned the remaining 49% of the shares of KWI. Under the terms of the constating
documents of KWI, Kruger could elect three of the five directors of the corporation. However,
the shareholders of KWI entered into a unanimous shareholder agreement (the “USA”). The
USA imposed many strategic and managerial restrictions on the operations of KWI. With
respect to the conduct of the board of directors of KWI, the USA provided that a quorum at a
meeting of the company’s board of directors would generally require the presence of at least one
director nominated by SGF. In addition, a wide range of matters that came within the purview of
the board of directors of the corporation could only be acted upon with the unanimous consent of
those members of the board of directors present at a validly constituted meeting (i.e., the SGF
49
Ibid at para. 85.
50
2015 TCC 90, 2015 DTC 1112 [Wayagamack].
LEGAL_24490030.12
- 19 nominees attending each meeting of the board effectively possessed a veto over a number of
central strategic matters). Pursuant to the USA, other decisions regarding the affairs of the
corporation required the unanimous consent of the shareholders.
In respect of the taxation years at issue, KWI claimed refundable investment tax credits
in respect of its scientific research and experimental development activities. The Minister of
National Revenue reassessed KWI on the basis that it was “associated” with Kruger and,
therefore, was not entitled to the refundable tax credits that were claimed. (As will be discussed
in greater detail below, significant elements of the “associated corporation” rules in the Act
hinge upon whether certain persons have control of a corporation.)
In the context of the facts in Wayagamack, the Tax Court was required to apply the
interpretative principles articulated by the Supreme Court in Duha Printers and determine how
much control is needed to constitute “effective control” in a given set of circumstances. In
particular, the Court was required to decide whether routine, operational control of a corporation
amounts to “effective control” when one does not have the ability to guide the strategic decisions
of the corporation.
In rendering its decision, the Tax Court suggested that one will have “effective control”
over a corporation where they have “a dominant influence in the management or direction of the
[corporation] or a dominant influence in the orientation of its future”.51 The Tax Court carefully
considered the limitations on the management of KWI imposed by the USA and concluded that
Kruger was incapable of making or causing to be made strategic decisions that would change the
course of KWI, despite the ability of Kruger to elect three of the five directors of the
corporation.52 The Court observed that Kruger did not have a dominant influence over the
direction of the corporation or the orientation of its future, despite being actively involved in
guiding its day-to-day operations. 53
The Minister attempted to argue that, by virtue of a call option granted to Kruger in the
USA that would permit Kruger to compel SGF to sell its shares of KWI to Kruger on the 7th
anniversary of the USA, such future shareholdings would amount to Kruger controlling the
taxpayer “in the long run” (citing the decision rendered in Donald Applicators Ltd. v MNR
(“Donald Applicators”)54 wherein the Court suggested that attention should be focused on the
person that exercises effective control of a corporation in the long run where control of the
corporation does not otherwise appear to reside with the particular person55). The Tax Court
dismissed this argument by stating that “the principle arising out of Donald Applicators has to be
51
Ibid at para 26.
52
Ibid at para 60.
53
Ibid at para 66.
54
[1969] 2 Ex CR 43, [1969] CTC 98 [Donald Applicators] cited in Wayagamack, supra note 50 at para 67.
55
In Donald Applicators, a particular shareholder lacked the right to elect the directors of a corporation, but could pass
resolutions that would permit it to direct the affairs of the corporation in the long run.
LEGAL_24490030.12
- 20 understood as being a long run power based on what a person could do at some future date with
their presently existing shareholdings.56
On the basis of the foregoing, the Tax Court concluded that Kruger did not have de jure
control of KWI.
(2)
Related Groups
Subparagraph 251(2)(b)(ii) provides that a person who is a member of a “related group”
that controls a corporation will be considered to be related to the corporation. For these
purposes, a “related group” is defined in subsection 251(4) as “a group of persons each member
of which is related to every other member of the group”.
The phrase “group of persons” is not separately defined in the Act and the meaning of the
phrase was historically the subject of much debate in the Canadian tax jurisprudence. Many
initially questioned whether references to a “group of persons” captured any aggregation of two
or more persons, or whether there was a requirement for there to be some form of connection or
co-ordination amongst a collection of persons for them to be considered to be members of a
“group of persons”. The Federal Court of Appeal largely resolved this debate in 2002 in its
judgment in the case of Silicon Graphics Ltd. v The Queen.57 In Silicon Graphics, the Court was
called upon to determine whether the taxpayer was a “Canadian-controlled private corporation”
for the purposes of the Act (a “CCPC”) such that it was entitled to claim certain refundable
investment tax credits. Central to the relevant analysis was whether the corporation was
controlled, directly or indirectly, in any manner whatever, by one or more non-resident persons.
The Court held that the concepts of “one or more persons” and a “group of persons” were
functionally indistinguishable.58 On that basis, the Court canvassed the historical case law that
considered the necessary prerequisites to a “group of persons” existing and held that the
available jurisprudence consistently suggested that a “common connection” or a “community of
interests” must exist before an aggregation of persons can be considered to be a “group of
persons” as that term is used for the purposes of the Act.59
In summarizing the historical jurisprudence, and articulating the test to be applied in
determining whether an assortment of persons comprised a “group of persons”, the Court stated
that the:
… simple ownership of the mathematical majority of shares by a
random aggregation of shareholders in a widely held corporation
with some common identifying feature (e.g. place of residence) but
without a common connection does not constitute de jure control as
that term has been defined in the case law. I also agree with the
56
Wayagamack, supra note 50 at para 69.
57
2002 FCA 260, [2002] CTC 527 [Silicon Graphics].
58
Ibid at para 54.
59
Ibid at paras 33-36.
LEGAL_24490030.12
- 21 appellant’s submission that in order for more than one person to be
in a position to exercise control it is necessary that there be a
sufficient common connection between the individual shareholders.
The common connection might include, inter alia, a voting
agreement, an agreement to act in concert, or business or family
relationships. 60
Accordingly, for a set of persons to be considered to constitute a “related group” that
controls a corporation, there must be some evidence of a common connection or coordination to
act in concert among such persons in exercising rights in respect of the subject corporation. The
CRA subsequently confirmed its acceptance of the interpretative holding in Silicon Graphics.61
Recently, the Tax Court of Canada was asked to consider whether the granting of voting
proxies by shareholders of a corporation to a common representative would result in the
participating shareholders constituting a “group of persons” for the purposes of the Act.62 In the
context of the facts of the case at hand, the Court concluded that the mere granting of proxies
was insufficient to demonstrate a common connection between the relevant shareholders that
would result in them comprising a “group of persons”. In the view of the Court, the contrary
conclusion “would have significant consequences for, and interfere with, common business
practices”.63 In this regard, the Court observed that “[p]roxies have become a common feature of
modern corporate law” and that “[i]t is reasonable to infer that shareholders agree to give such
proxies because it simplifies their life and because the slate conforms to their individual
interests”.64 The Court also drew a parallel to what it referenced as another common feature of
modern corporate law – the plan of arrangement – and suggested that characterizing common
support of a plan of arrangement as resulting in those supporting the plan comprising a “group of
persons” would similarly be over-reaching and without justification.
It is interesting to note that, in discussing the required pre-conditions for an aggregation
of persons to be considered to be a “group of persons” for the purposes of the Act, the CRA’s
published administrative statements only focus on whether persons not related to one another
could constitute a group of persons for the purposes of applying the definition of an “unrelated
group” 65. In this regard, the CRA has suggested that, for an unrelated group to constitute a
group of persons which controls a corporation, there must be:
(a)
a common link or interest between the persons which must involve more than their
mere status as shareholders, or
60
Ibid at para 36.
61
See, for example, CRA Income Tax Technical News no. 25, October 30, 2002.
62
Birchcliff Energy Ltd. v The Queen, 2015 TCC 232.
63
Ibid at para 56.
64
Ibid at para 57.
65
An “unrelated group” is defined in subsection 251(4) as a group of persons that is not a “related group”.
LEGAL_24490030.12
- 22 (e)
evidence that those shareholders act together to exert control over the corporation. 66
In the case of a closely-held corporation, the CRA has suggested that it considers there to
be a presumption that the shareholders of the corporation will act together to control the
corporation. In order to rebut the presumption, the CRA suggests that one must demonstrate that
no one is controlling the corporation and that the decision-making process in respect of the
corporation is effectively deadlocked. 67
Additional interpretative rules have been included in section 251 to further guide the
determination of both the composition of a “related group”, as well as when a “related group”
may be considered to control a corporation. For instance, paragraph 251(5)(a) provides that
“where a related group is in a position to control a corporation, it shall be deemed to be a related
group that controls the corporation whether or not it is part of a larger group by which the
corporation is in fact controlled”.
(iii) Related Corporations
Paragraph 251(2)(c) sets out the conditions under which two corporations are to be
considered to be related to each other. The paragraph provides that two corporations will be
considered to be related to each other if:
(i)
they are controlled by the same person or group of persons,
(ii)
each of the corporations is controlled by one person and the person
who controls one of the corporations is related to the person who
controls the other corporation;
(iii)
one of the corporations is controlled by one person and that person
is related to any member of a related group that controls the other
corporation;
(iv)
one of the corporations is controlled by one person and that person
is related to each member of an unrelated group that controls the
other corporation;
(v)
any member of a related group that controls one of the corporations
is related to each member of an unrelated group that controls the
other corporation; or
(vi)
each member of an unrelated group that controls one of the
corporations is related to at least one member of an unrelated group
that controls the other corporation.
66
Income Tax Folio S1-F5-C1, supra note 23 at para 1.20.
67
Ibid.
LEGAL_24490030.12
- 23 The complexity of the foregoing relational rules reflects Parliament’s desire to attempt to
capture the broadest range of corporations that can be said to have some form of meaningful
connection of control.
Related Persons: Supplementary Interpretive/Deeming Rules
As a supplement to subsection 251(2), a number of additional deeming and interpretive
rules were enacted to clarify the intended application of subsection 251(2), broaden the scope of
the concept of “related persons”, and counteract artificial attempts by taxpayers to avoid being
characterized as related persons.
Subsection 251(5) contains rules that both clarify and broaden the scope of persons that
are to be characterized as “related persons” for the purposes of the Act. Paragraph 251(5)(c), for
example, provides that where a person owns shares in two or more corporations, the person shall
as shareholder of one of the corporations be deemed to be related to himself, herself or itself as
shareholder of each of the other corporations.
Paragraph 251(5)(b) contains a host of expansive rules that deem a person to have an
altered position or standing relative to the control of a corporation for the purposes of assessing
whether they are related to another person. Specifically, paragraph 251(5)(b) provides that:
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 the 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,
(ii)
to cause a corporation to redeem, acquire, or cancel any shares
of its capital stock owned by other shareholders of the
corporation, 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 shares were so
redeemed, acquired, or cancelled by the corporation at that
time,
(iii) to, or to acquire or control, voting rights in respect of shares of
the capital stock of the corporation, the person is, except where
the right is not exercisable at that time because its exercise is
contingent on the death, bankruptcy, or permanent disability
of an individual, deemed to have the same position in relation
LEGAL_24490030.12
- 24 to the control of the corporation as if the person could exercise
the voting rights at that time, or
(iv) to cause the reduction of voting rights in respect of shares,
owned by other shareholders, of the capital stock of a
corporation, the person is, except where the right is not
exercisable at that time because its exercise is contingent on
the death, bankruptcy, or permanent disability of an
individual, deemed to have the same position in relation to the
control of the corporation as if the voting rights were so
reduced at that time.
Subject to limited exceptions (most notably, where the particular right is only exercisable
on the death, bankruptcy or permanent disability of an individual), 68 a person holding a right
described above will be deemed (on a current basis), by virtue of paragraph 251(5)(b), to be in
the same position in relation to the control of the corporation as if the right had been exercised.
Examples of rights generally considered to fall within the purview of paragraph 251(5)(b)
include securities that are convertible into voting shares of the subject corporation, or warrants
containing a right to subscribe for voting shares. The CRA has opined that such rights will also
potentially include the following:
(a)
a right to acquire shares under a purchase and sale agreement;
(b)
an absolute right as capital beneficiary to receive shares of a corporation held by a
trust;
(c)
a right of a partner to receive a portion of the shares of a corporation held by the
partnership at the time of the dissolution of the partnership;69 and
(d)
a right to purchase shares from other shareholders provided in a shareholders'
agreement.70
In response to concerns raised by taxpayers, the CRA has acknowledged that the literal
application of paragraph 251(5)(b) could have overly broad or unwieldy consequences. For
instance, the CRA has stated that indebtedness or non-voting shares of a corporation that may be
convertible into voting shares in accordance with their terms could activate one of the deeming
rules in paragraph 251(5)(b), thereby deeming the owner of the securities to be in the same
position as if it had held such voting shares for the purpose of assessing related party status.
68
The impact of paragraph 251(5)(b) on a control analysis may effectively be negated by subsection 256(6) (as discussed
in further detail below) where the rights in respect of a corporation’s shares arise in the context of an agreement entered
into for the purpose of safeguarding a taxpayer’s rights in respect of certain indebtedness or shares. See, for example,
CRA document no. 2015-0565741E5, February 4, 2015.
69
It appears the CRA’s position is based on such entitlement being expressly provided for under the provisions of the
relevant partnership agreement (although most partnership agreements would provide for some form of property
distribution in the case of dissolution).
70
See CRA document no. 2009-032994C6, October 9, 2009.
LEGAL_24490030.12
- 25 However, the CRA, as an administrative matter, has indicated that where such convertible
securities have been issued to the general public and have wide distribution, such securities may
“usually” be ignored for the purposes of paragraph 251(5)(b) on the basis that it is highly
unlikely that the exercise of the conversion rights will result in any person or group of persons
acquiring control of a corporation. Nevertheless, the CRA has cautioned that if large numbers of
such securities were concentrated in the hands of a small group of people, this relieving
administrative presumption may not apply. 71
Similarly, the CRA has acknowledged that, while the wording of paragraph 251(5)(b) is
broad enough to capture typical “buy-sell” arrangements often found in agreements between
shareholders of a corporation, the paragraph will not “normally” be applied by the CRA solely
because the applicable shareholder agreement contains:
(a)
a right of first refusal, or
(b)
a “shotgun” arrangement whereunder if a shareholder offers to purchase the shares
of another shareholder, the other shareholder must either accept the offer or offer
to purchase the shares owned by the offering party on the proposed terms. 72
The application of paragraph 251(5)(b) in a manner that deems someone to be controlling
a corporation for the purposes of the related party rules does not preclude another person from
simultaneously controlling the same corporation by virtue of their own shareholdings or
otherwise. Therefore, it is possible for two or more persons or groups of persons to be
considered to be controlling a corporation simultaneously for the purposes of the related party
rules. 73
Paragraph 251(5)(b)-related concerns often inadvertently arise in the context of arm’s
length contractual arrangements. For example, in a recent technical interpretation, the CRA
considered the impact of paragraph 251(5)(b) on a taxpayer’s status as a CCPC in circumstances
where a public corporation held a right to acquire all of the issued shares of the taxpayer upon
the occurrence of an event of default under an indemnity agreement between the two companies.
The CRA concluded that this future, contingent right fell within the purview of paragraph
251(5)(b) such that the private corporation’s status as a CCPC would be compromised.74
Similarly, the CRA was recently asked to consider whether rights granted under a letter
of intent may be sufficient to activate the rules in paragraph 251(5)(b) in a manner that would
deem the offeror under the letter of intent to own the referenced shares. The CRA was ultimately
non-committal on the point, but did suggest that the following conditions need to be met in order
for a letter of intent to engage the application of paragraph 251(5)(b):
71
See Income Tax Folio S1-F5-C1, supra note 23 at para 1.27.
72
Ibid at para 1.28.
73
Ibid at para 1.29.
74
See CRA document no. 2015-05657415, February 4, 2015.
LEGAL_24490030.12
- 26 (a)
The letter of intent must contemplate the exercise of one of the rights provided in
paragraph 251(5)(b);
(b)
The right provided in the letter of intent can either be absolute or contingent and
can be exercised either immediately or in the future; and
(c)
The letter of intent must constitute a contract between two or more persons, in
equity or otherwise.75
The CRA refused to opine on whether a letter of intent may constitute a contract for these
purposes. While letters of intent are frequently expressed as being non-binding, the CRA’s
recent views underscore the importance of ensuring that rights are not inadvertently created in
the context of commercial expressions of interest.
The contemplation of rights “in contract, equity or otherwise” in paragraph 251(5)(b) has
led many practitioners to question whether the wording of the paragraph is broad enough to
capture a discretionary interest in a trust holding shares in a corporation. In a 2007 technical
interpretation letter, the CRA summarized its views on the issue as follows:
[Translation]
There is no consensus, however, on the application of 251(5)(b) in
a trust context. Some feel that discretionary beneficiaries of a trust
have no right to trust property as long as the trustees’ discretion is
not exercised in their favour. On the other hand, others consider the
wording of paragraph 251(5)(b) broad enough that it could in fact
apply to a discretionary beneficiary of a trust's capital.
It should be noted that in a technical interpretation (F9730395), we
have already stated that paragraph 251(5)(b) could apply to
beneficiaries of a trust. We did specify, however, that paragraph
251(5)(b) could not apply to beneficiaries of a trust who held shares
in a corporation if, under the terms of the trust agreement, the
beneficiaries could never obtain ownership of the corporation's
shares or control the voting rights attached to these shares. 76
The merit of this CRA position was recently considered in Lyrtech RD Inc. v The Queen
where the primary issue in dispute was whether the taxpayer qualified as a CCPC under
subsection 125(7) for the purposes of ascertaining its eligibility for certain refundable investment
tax credits.77 The shares of the taxpayer were owned by a trust (“FFT”), the conditional income
and capital beneficiaries of which were certain affiliates of Lyrtech Inc., the parent corporation
75
See CRA document no. 2014-0552711E5, July 7, 2015 [emphasis added].
76
See CRA document no. 2007-0246721E5, February 20, 2008 cited in Lyrtech RD Inc. v The Queen, 2013 TCC 12 at 39,
aff’d 2014 FCA 267 [Lyrtech]. On July 9, 2015, the Supreme Court of Canada dismissed the taxpayer’s leave to appeal.
77
Ibid.
LEGAL_24490030.12
- 27 of the taxpayer (the “L-Subs”). The transactions implementing the arrangement and the ongoing
operational and other dealings between the taxpayer and Lyrtech Inc. contained numerous de
facto control indicia (including, among others, the fact that the trustees of FFT were required to
be selected from a pool of the directors of Lyrtech Inc.).
The Court ultimately decided the case against the taxpayer on the basis that it was
controlled, directly or indirectly, by a public company and was, thus, not a CCPC. However, the
Court also considered whether the entitlement of the L-Subs, as conditional beneficiaries of FFT
and having regard to subsection 248(25), could be considered to reflect rights in the taxpayer of
the variety contemplated in subparagraph 251(5)(b)(i). For the purposes of its analysis, the Court
observed that the subject trust deed specifically provided that the persons designated as
beneficiaries therein (i.e., the L-Subs) were only potential beneficiaries of the trust, and that the
language utilized in the trust deed appeared to have been crafted for the specific purpose of
avoiding the application of subsection 248(25).78 Despite the highly contingent nature of the LSubs’ interests, the Court concluded that the L-Subs were “beneficially interested” in the subject
trust, but the Court was not prepared to accept that the trust interests in question fell within the
purview of the “rights” contemplated in paragraph 251(5)(b) on the basis that the beneficial
interests were “too aleatory, uncertain or indirect to be a right to the [taxpayer’s] shares”. 79 In the
words of the Court:
The beneficial interest in question here does not confer any right on
the holder of that interest to acquire shares in the appellant.
I highly doubt that Parliament's intent was for subsection 248(25) to
apply to paragraph 251(5)(b) because the concept of beneficial
interest is far too broad in scope and much too vague for it to apply
to the concept of de jure control for the purposes of the definition of
"Canadian-controlled private corporation".
If Parliament had intended that the beneficiaries of the income and
capital of a discretionary trust be deemed owners of the shares that
are part of the trust property, it would have clearly expressed that
intent, as it did by introducing paragraph 256(1.2)(f) into the Act for
the purposes of the rules concerning associated corporations. 80
78
Ibid at paras 41 and 42. Under the relevant trust deed, the trustees had absolute discretion to eventually distribute all of
the taxpayer’s shares to one or more beneficiaries. The trust deed also specifically provided that the persons designated
therein would have no rights as beneficiaries of the trust “until they have received some part of the revenue or capital of
the trust”.
79
Ibid at para 55. The Court also appeared to be influenced by the authorities it canvassed classifying a right of a
beneficiary under a discretionary trust as being a limited personal right (against the trustee) as opposed to a proprietary
right in the trust property itself.
80
Ibid at paras 55-57.
LEGAL_24490030.12
- 28 It will interesting to see whether the findings in Lyrtech respecting potential limitations
on the breadth of paragraph 251(5)(b) will serve to reign in some of the more aggressive
positions that the CRA has adopted with respect to this provision.
One final noteworthy aspect of the Lyrtech case was the Court’s endorsement of the
finding in Sedona Networks Corp. v The Queen81 with respect to certain important conceptual
principles applicable in the context of a paragraph 251(5)(b) analysis, namely, that the “fiction”
in paragraph 251(5)(b) relates to the concept of ownership of shares and not to the concept of
control of shares. As stated by the Federal Court of Appeal:
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. 82
It follows that an analysis as to the impact of a particular right falling within the ambit of
paragraph 251(5)(b) should begin, as a first step, with adjusting the relative share ownership in
the subject corporation in a manner consistent with the right having been exercised, and then, as
a second step, assessing the control position of the rights holder (and other taxpayers, as
appropriate) following the adjustment.
Subsection 256(6) provides an important exception to what would otherwise be a finding
of control in respect of a corporation (be it de jure or de facto) on the part of a person or
partnership (referred in subsection 256(6) as the “controller”) in circumstances where the
purpose83 of the control is to safeguard the rights or interests of the controller in respect of
certain indebtedness owing to the controller or certain shares held by the controller in the
controlled corporation. Specifically, subsection 256(6) operates to negate a finding of control
(be it de jure or de facto) at a particular time if is established that (i) there was in effect at the
particular time an agreement or arrangement enforceable according to its terms, under which, on
the satisfaction of a condition or the happening of an event that is reasonable to expect will be
satisfied or happen, control of the subject corporation will cease to be held by the controller and
revert to a person or group of persons (the “new controller”) that, at the particular time, deal at
arm’s length with the controller, and (ii) the purpose for the control on the controller’s part is the
safeguarding of the controller’s rights or interests with respect to (A) indebtedness owing to the
controller, or (B) shares of the corporation held by the controller that are, under the agreement or
arrangement, to be redeemed by the corporation or purchased by the new controller. 84 According
to the CRA, subsection 256(6) could have application, for example, in the case where a
81
2007 FCA 169.
82
Ibid at para 53.
83
As opposed to other provisions in the relational rules that employ the phrase “one of the purposes” or “one of the main
purposes”.
84
A similar rule may be found in subsection 256(3) with respect to determinations involving associated corporation status.
LEGAL_24490030.12
- 29 manufacturer enters into a dealership arrangement with an arm’s length corporation and
maintains control over the corporation until certain obligations under the operative dealership
financing arrangement have been satisfied. 85
Section 251 also contains special interpretative rules that apply where two or more
corporations have been the subject of an amalgamation or merger. Subsection 251(3.1) provides
that where there has been an amalgamation or merger of two or more corporations, and the new
corporation formed as a result of the amalgamation or merger and any predecessor corporation
would have been related immediately before the amalgamation or merger (if the new corporation
were in existence at that time and if the persons who were the shareholders of the new
corporation immediately after the amalgamation or merger were the shareholders of the new
corporation at that time), the new corporation and any predecessor corporation shall be deemed
to have been related persons. This particular deeming rule can have practical application in a
variety of contexts, including the determination of the limitations on capital cost allowance
claims that may be made by the new corporation.86
Similarly, subsection 251(3.2) provides that where there has been an amalgamation or
merger of two or more corporations, each of which was related (otherwise than because of a right
referred in paragraph 251(5)(b)) to each other immediately before the amalgamation or merger,
the new corporation formed as a result of the amalgamation or merger, and each of the
predecessor corporations, are deemed to have been related to each other.
Finally, section 251 also establishes certain principles of transitivity that govern the
application of the related party rules. In particular, subsection 251(3) provides that where two
corporations are related to the same corporation under the related party rules, they shall, for the
purposes of the rules, be deemed to be related to each other. It is, however, important to note
that the application of subsection 251(3) to deem two corporations, which are not otherwise
related, to be related to one another is limited to circumstances under which each of the two
corporations is separately related to a third corporation, as determined without reference to
subsection 251(3). In other words, the principle of transitivity reflected in subsection 251(3)
may not be applied to deem two separate corporations to be related to one another where the
relation to a common third corporation results solely from the application of subsection 251(3). 87
In considering the application of subsection 251(3), the CRA has also opined that where the
subsection applies to deem certain corporations to be related, such corporations may be deemed
to form a “related group” for the broader purposes of the related party rules in the Act.88
Interpretation Bulletin IT-64R4, “Corporations: Association and Control,” October 13, 2004 at para 12 [Interpretation
Bulletin IT-64R4].
85
86
See CRA, Income Tax Folio S4-S7-C1, “Amalgamations of Canadian Corporations” (effective 8 May 2015) at
para 1.31.
87
See, for example, CRA document no. AC58898, March 13, 1990.
88
See CRA document no. 2014-0538071C6, October 10, 2014.
LEGAL_24490030.12
- 30 Special Situations
When one examines the statutory definition of “related persons” in section 251, the
absence of any express reference to partnerships or trusts is conspicuous. With respect to trusts,
the CRA has asserted that (i) subsection 104(2) deems a trust to be an individual in respect of the
property of the trust,89 and (ii) the Act further defines an individual “as a person”.90 On this
basis, the CRA has reasoned that a trust will be considered to be a person for the purposes of the
related party rules in the Act.91 For instance, where a trust owns a majority of the voting shares
of a corporation in such a manner that the trustees of the trust control the corporation, the CRA
has opined that the trust and the corporation will be related persons by virtue of subparagraph
251(2)(b)(i).92
Subsection 104(1) further provides that a reference to a trust is, subject to certain
specified exceptions, to be read to include a reference to the trustee of the trust who has
ownership or control of the trust property and is not acting merely as an agent for all of the
beneficiaries under the trust in respect of the trust property. On this basis, the CRA has
suggested that control of a particular corporation by a trust may also result in the trustee of the
trust being related to the particular corporation on account of the trustee’s ownership of the
shares of, and control of, the corporation. 93
Where there is more than one trustee of a trust, the CRA has suggested that the
determination of which trustee(s) have control of the corporation will depend on the operative
facts.94 In this regard, where a reference to a trust is to be read to include a reference to the
trustee having ownership or control of the relevant trust property, the CRA has suggested that the
trust will be related to each person who is related to the trustee.95
Equally significant interpretative questions arise in applying the related person rules in
contexts involving partnerships. Partnerships are classically defined as relationships between two
or more persons carrying on business in common with a view to a profit. In most jurisdictions,
partnerships do not constitute separate juridical entities. Accordingly, partnerships are generally
not regarded as “persons” for the purposes of the Act, absent a specific deeming rule to the
contrary.
However, for the purposes of computing certain income or loss amounts in respect of a
member of a partnership, subsection 96(1) provides that such income shall be computed as if the
partnership were a separate person resident in Canada. While the CRA has acknowledged that
the related person rules in the Act do not include the word “partnership” in the definition of
89
See Income Tax Folio S1-F5-C1, supra note 23 at para1.45.
90
Subsection 248(1).
91
See Income Tax Folio S1-F5-C1, supra note 23 at para 1.45.
92
Ibid.
93
Ibid at para 1.47.
94
Ibid at para 1.48.
95
Ibid at para 1.49.
LEGAL_24490030.12
- 31 “related persons”, the CRA has asserted that, on the basis of subsection 96(1), it is appropriate to
consider a partnership to be a “person” in respect of situations where the computation of income
at the partnership level is relevant. As a result, the CRA has indicated that a partnership that
controls a corporation could be considered to be related to the corporation by virtue of paragraph
251(2)(b) where related party status is relevant to the computation of the partnership’s income. 96
By contrast, where it is necessary to apply the provisions of the Act in a context not
involving the calculation of the income of the members of a partnership derived from the
partnership, the CRA has indicated that references to the word “persons” in subsection 251(2)
should be read as references to the partners of the partnership. 97
Where a partnership owns shares of a corporation, the CRA has opined that one must
consider the operative terms of the relevant partnership agreement to determine who controls the
corporation.98 The CRA has suggested that, in reviewing a partnership agreement, any equity
interests of the members of the partnership must be examined to determine which member(s) of
the partnership can exercise voting rights in respect of the shares of a corporation held by the
partnership. In the case of a limited partnership, the CRA has observed that it is usually the
general partner that is empowered to exercise such voting rights. On that basis, the CRA has
stated that “two corporations are usually related under subparagraph 251(2)(c)(i) of the Act,
when the shares in the capital stock of the two corporations that make it possible to exercise
effective control over the corporations are owned by a limited partnership and there is only one
general partner”.99 The CRA has further suggested that “two corporations would be considered
related under subparagraph 251(2)(c)(i) of the Act if a member (“majority partner”) of a general
partnership is able to control the activities of the partnership, including the exercise of the voting
rights in respect of the shares of the two corporations owned by the general partnership, thereby
making it possible to effectively control the two corporations”.100 Finally, the CRA has
suggested that, in circumstances where a general partnership owns the shares of a corporation
and there is no “majority partner” of the partnership, two corporations will be considered related
under subparagraph 251(2)(c)(i) if they are both controlled by the same group of people. The
CRA has suggested that two corporations will normally be controlled by the same group of
persons if the majority of the shares of the two corporations are owned by a general
partnership.101
Common Traps and Pitfalls
The technical nuances of the related person rules in the Act have created a number of
traps for the unwary. Tax practitioners should specifically be conscious of the following
96
See CRA document no. November 1990-358. See also CRA document no. 2013-0484031E5, December 12, 2013.
97
Ibid.
98
See CRA document no. 2000-0038055F, October 6, 2000. See also CRA document no. 2013-0484031E5, December 12,
2013.
99
Ibid.
100
Ibid.
101
Ibid.
LEGAL_24490030.12
- 32 peculiarities of the rules governing the determination of whether persons are related for the
purposes of the Act.
(i) Changes in Marital Status
The concept of marriage is often central to whether two individuals may be considered to
be related to one another. The CRA has repeatedly stated that persons will be considered to be
married to one another until their bonds of matrimony are formally dissolved, even if they are
separated by reason of the breakdown of their relationship and they act in materially adverse
ways to one another.
In many cases, because of cost and/or the emotional stress of obtaining a final divorce
decree, married spouses may live separate and apart for extended periods without formally
dissolving their marriage. Marriages occurring in foreign jurisdictions under foreign law also
offer unique challenges to determining whether persons are considered married for the purposes
of the Act. Tax practitioners must carefully probe the marital status of a taxpayer when mapping
out the persons with whom the taxpayer may be related for the purposes of the Act.
(ii) Breadth of Subparagraph 251(5)(b)
Paragraph 251(5)(b) contains a series of very broad and generally worded deeming rules
that can require the assessment of whether persons are to be considered to be related to be made
on the basis of the deemed ownership of shares or control rights, as if certain other shares of a
corporation were deemed to have been acquired or cancelled, or as if certain other voting rights
were reduced. The circumstances that can trigger the application of these deeming rules hinge
on whether a person has a right under a contract, in equity or otherwise, either immediately or in
the future and either absolutely or contingently, to compel certain actions to take place. The
probability of the exercise of such rights may be remote, or subject to material contingencies.
Nevertheless, the deeming rules in paragraph 251(5)(b) do not weigh probabilities in their
application and generally do not distinguish between the agreements in which such rights may be
embedded.
In performing a related person analysis, tax practitioners must be careful to canvass all
agreements that may bear on the share capital or votes in respect of a corporation. It is critical to
recognize that such rights may not necessarily be a part of the constating documents of the
corporation, nor may necessarily be required to be contained in agreements to which the
corporation is a party. For instance, agreements among the members of a partnership that hold
the majority of the issued shares of a corporation, or agreements among indirect shareholders of
a corporation, could activate the deeming rules in paragraph 251(5)(b), unbeknownst to many of
the other shareholders of the corporation.
(iii) Scope of Familial Definitions
The persons that are considered to be connected by blood relationship, marriage, or
common-law partnership for the purposes of the Act comprise a far larger group than those that
would conventionally be placed in such categories under common parlance. Siblings of spouses
or common-law partners, descendants of a spouse from a subsequent marriage, or persons that
are wholly dependent on a taxpayer for support may each fall within the ambit of what are
LEGAL_24490030.12
- 33 considered to be “related persons” for the purposes of the Act. Similarly, the determination of
whether two persons constitute “common-law partners” can be especially tricky, particularly
where they have previously been common-law partners, were separated for an extended period of
time, and then recently reconciled and began to again cohabit in a conjugal relationship.
Tax practitioners that are required to determine whether persons are related must exercise
extreme caution in ensuring that they have a full appreciation of the broader family tree and
personal relations of the relevant taxpayers to ensure that parties are not inadvertently
characterized as unrelated when the facts demand a contrary conclusion.
(iv) 256.1(3)(b) Deeming Rule
In its 2013 Budget, the Federal government announced the introduction of a new specific
anti-avoidance rule to counteract transactions involving a profitable corporation acquiring a
significant majority of the equity of a corporation with accumulated losses (as measured by the
fair market value of the target corporation’s capital stock) in such a manner that control of the
target corporation would not be acquired for the purposes of the loss-streaming rules in the Act.
To address the perceived circumvention of the loss-streaming provisions of the Act,
Parliament enacted new section 256.1, which effectively deems a person or group of persons to
acquire control of a corporation where (i) they acquire shares of the capital stock of the
corporation having a fair market value that exceeds 75% of the fair market value of all of the
shares of the capital stock of the corporation, (ii) the acquisition transactions do not result in
control of the corporation being acquired by the person or group of persons, and (iii) it is
reasonable to conclude that one of main reasons that the person or group of persons does not
control the corporation is to avoid the application of one or more “specified provisions” (with
such “specified provisions” largely related to restrictions imposed on the use of tax attributes
following an acquisition of control of a corporation).
Where the application of the new anti-avoidance rule in section 256.1 is triggered,
paragraph 256.1(3)(b) provides that, during the period that the relevant person or group of
persons holds shares of the capital stock of the corporation with a fair market value that exceeds
75% of the fair market value of all of the shares of the corporation, the corporation and each
corporation controlled by the corporation, along with any corporation incorporated or otherwise
formed subsequent to the relevant acquisition time and controlled by that corporation, is deemed
not to be related to, or affiliated with, any persons to which it was related to, or affiliated with,
immediately prior to the application of the anti-avoidance rule being triggered.
The Department of Finance Technical Notes that accompanied the introduction of section
256.1 indicate that this special deeming rule was introduced to preclude the referenced
corporations from undertaking “loss consolidations within an affiliated, or related, group”.
Certain commentators have suggested that the deeming rule “is intended to “quarantine” a
corporation of which control has been acquired under…paragraph 256.1(3)(a) from its preacquisition of control corporate group, thereby subjecting loss consolidations amongst such
LEGAL_24490030.12
- 34 parties to the loss-streaming rules, including through the application of…section 256.1”.102 In
assessing whether persons are related to one another for the purposes of the Act , particularly
when structuring what may be characterized as inter-affiliate loss utilization transactions, care
must be taken to ensure that limitations have not previously been triggered under new section
256.1, including the new related party deeming rule in paragraph 256.1(3)(b).
“Affiliated Persons”: The Fundamentals
One of the more significant reforms to Canada’s income tax legislation occurred with the
material amendments to the Act in 1972, which, among other things, introduced capital gains
taxation. To ensure the integrity of the new measures, and to guard against their inappropriate
circumvention, several technical and anti-avoidance rules were enacted, including:
(a)
the “superficial loss” rules, contained in subparagraph 40(2)(g)(i) and section 54;
and
(b)
a rule contained in section 55 (renumbered as subsection 55(1) in 1980) designed
to discourage the “creation” of “artificial” capital losses.103
Prior to 1995, the various loss governance measures in the Act differed in certain
respects, including, with respect to the range of taxpayers affected by each particular measure,
the pre-conditions to their application, and the universe of taxpayers that could benefit from a
particular loss. In some cases, the rationale for these differences was not readily apparent from a
policy perspective, although it had generally been accepted over the years that loss transfers
were, broadly speaking (and subject to certain exceptions), acceptable within the confines of a
“related” group of taxpayers.
The “affiliated person” rules were introduced in 1995, along with a compliment of new or
amended stop-loss and loss transfer provisions, and were primarily aimed at tightening the
various loss utilization rules in the Act. Today, “affiliated person” status under section 251.1
serves as the keystone of most of the stop-loss rules in the Act, including those contained in
subsections 13(21.2), 14(12), 18(15), 40(3.4) and 40(3.6), along with the “superficial loss” rule
102
103
See, for example, Soraya M Jamal, “Revisiting affiliated group loss consolidations: Effective strategies & techniques”,
2013 British Columbia Tax Conference, (Toronto Canadian Tax Foundation, 2013), 3:1-34 at 5.
Former section 55 provided as follows:
For the purposes of this subdivision, where the result of one or more sales, exchanges, declarations of trust, or other
transactions of any kind whatever is that a taxpayer has disposed of property under circumstances such that he may
reasonably be considered to have artificially or unduly:
(a)
reduced the amount of his gain from the disposition,
(b)
created a loss from the disposition, or
(c)
increased the amount of his loss from the disposition,
the taxpayer's gain or loss, as the case may be, from the disposition of the property shall be computed as if such reduction,
creation or increase, as the case may be, had not occurred.
Subsection 55(1) was repealed in 1988 with the enactment of the “general anti-avoidance rule” in section 245.
LEGAL_24490030.12
- 35 in subparagraph 40(2)(g)(i) noted above.104 In broad terms, these rules operate to deny the
recognition of losses incurred in connection with transfers of property between affiliated persons
on the theory that a “true” loss will not have been experienced until the subject property ceases
to be held within the affiliated person sphere. The rules also govern which taxpayer in the
affiliated person sphere may claim the loss when the stipulated “triggering” event occurs.
A detailed discussion of the stop-loss provisions is beyond the scope of this paper and
may be found in a number of other helpful articles. 105 The primary objective of this section is to
provide the reader with an overview of the analytical framework that governs the affiliated
person rules, along with an appreciation of certain nuances in the rules that continue to present
challenges and pitfalls to practitioners seeking to apply the rules in practice.
Critical Interpretive Rules and General Principles
When considering the potential application of the affiliated person provisions in section
251.1, it is helpful to keep the following interpretive rules and principles in mind:
(a)
persons are considered to be affiliated with themselves;106
(b)
a “person” includes a partnership;107
(c)
unlike the associated corporation rules in section 256, the affiliated person rules do
not contain a specialized definition of the term “group of persons”; accordingly, the
tests for determining what constitutes a “group of persons” established under the
jurisprudence (as discussed above in the context of the related person rules) will
need to be satisfied when determining whether a group of persons is present in a
given set of circumstances;108
104
The “affiliated person” rules are also relevant for the purposes of certain anti-avoidance rules such as subsection 69(11)
and, more recently, for the purpose of the “loss restriction event” rules for trusts under section 251.2.
105
See, for example, Vincent De Angelis, CA, “The Stop-Loss Rules: Pitfalls and Opportunities,” Report of Proceedings
of Fifty-Fifth Tax Conference, 2003 Conference Report (Toronto: Canadian Tax Foundation, 2004) 50; Lincoln K.
Schreiner, “Corporate Stop-Loss Rules Some Changes,” 1995 British Columbia Tax Conference, (Toronto: Canadian
Tax Foundation, 1995) 3; Jim Samuel, “Stopping The Losses: The Application Of Stop-Loss Rules To Transactions
Involving Foreign Affiliates,” 2010 58:4 Canadian Tax Journal 897.
106
Paragraph 251.1(4)(a).
107
Paragraph 251.1(4)(b). By contrast, the related person rules in section 251 do not expressly refer to partnerships.
108
In its technical notes to the affiliated person amendments introduced in 2004, the Department of Finance indicated that
only persons “acting in concert” will be considered to be members of a group of persons for the purposes of the
affiliated person rules, which is generally consistent with the meaning developed in the jurisprudence (see, for example,
Vina Rug (Canada) Ltd. v MNR, 68 DTC 5021 (SCC)).
LEGAL_24490030.12
- 36 (d)
the rules contain a definition of an “affiliated group of persons”, which means a
group of persons every member of which is affiliated with every other member;109
(e)
it is important to be mindful of the degree of connection required between a
particular person or group on the one hand and another group on the other hand to
satisfy the various statutory tests within the affiliated person provisions (e.g., a
requirement that a particular person be affiliated with every member of the group,
as opposed to being affiliated with only one member);
(f)
certain charging provisions in the Act that rely on the concept of “affiliated
persons” may contract, expand or otherwise alter the general rules and definitions
contained in section 251.1;110
(g)
there will often be more than one means by which particular persons may be
affiliated;111 accordingly, in most cases, a thorough canvassing of each of the
operative affiliated person provisions will be warranted;
(h)
certain aggregation rules apply for the purposes of assessing whether a particular
statutory threshold has been exceeded, most notably in the context of determining
the existence of a “majority-interest partner” or a “majority-interest beneficiary”;
and
(i)
subsection 256(8) provides that where a taxpayer acquires a right referred to in
paragraph 251(5)(b) in respect of a share, and it can reasonably be concluded that
“one of the main purposes”112 of the acquisition is to avoid, among other provisions,
the application of section 251.1, the taxpayer is deemed to be in the same position
in relation to the control of the corporation as if the right were immediate and
absolute and as if the taxpayer had exercised the right at that time. 113
The notion of de facto control also plays a central role in the application of section 251.1, by
virtue of the requirement for the word “controlled” in section 251.1 to be read as “controlled,
directly or indirectly in any manner whatever”.
Subsection 256(5.1) of the Act provides that:
109
Subsection 251.1(3). Given the “aggregation” rules discussed below, which apply with respect to partnership and trust
interests, the “affiliated group of persons” definition is generally only relevant with respect to corporate control
determinations under paragraph 251.1(1)(c).
110
Examples include subsection 69(11) (contraction by way of limiting “control” references to legal control only) and
section 251.2 (which expands the scope of natural persons considered to be affiliated).
111
For example, corporations may be found to be affiliated under paragraph 251.1(1)(b) or paragraph 251.1(1)(c).
112
See Groupe Honco Inc v The Queen, 2013 FCA 128, 2014 DTC 5006 for a discussion of the meaning of a reference to
“one of the main purposes”.
113
See “Related Persons: Supplementary Interpretative/Deeming Rules” for a discussion of the rights contemplated under
paragraph 251(5)(b).
LEGAL_24490030.12
- 37 For the purposes of [the] Act, where the expression “controlled,
directly or indirectly in any manner whatever,” is used, a corporation
shall be considered to be so controlled by another corporation,
person or group of persons (in this subsection referred to as the
“controller”) at any time where, at that time, the controller has any
direct or indirect influence that, if exercised, would result in control
in fact of the corporation, except that, where the corporation and the
controller are dealing with each other at arm’s length and the
influence is derived from a franchise, licence, lease, distribution,
supply or management agreement or other similar agreement or
arrangement, the main purpose of which is to govern the relationship
between the corporation and the controller regarding the manner in
which a business carried on by the corporation is to be conducted,
the corporation shall not be considered to be controlled, directly or
indirectly in any manner whatever, by the controller by reason only
of that agreement or arrangement.
The use of the phrase “controlled, directly or indirectly in any manner whatever” adds, by
operation of subsection 256(5.1), an additional dimension to the relevant corporate control
analysis, namely, the required consideration of whether the corporation in question is controlled
in fact (or de facto controlled) by another person or group of persons as a result of any direct or
indirect influence the person or group may have in the event that influence was exercised. 114
According to the CRA, the concept of de facto control generally encompasses
circumstances where control exists outside the confines of legal or de jure control due to the
existence of an excessive or constant advantage or influence over the subject corporation.115 The
CRA also takes the position (consistent with the relevant jurisprudence) that de facto control of a
corporation may take the form of an ability to (i) change the board of directors or reverse its
decisions, (ii) make alternative decisions concerning the actions of the corporation, or (iii)
terminate the corporation’s existence or business operations or appropriate its profits and
property. 116 Thus, the applicable advantage or influence need not be exercised for purposes of
supporting a finding of de facto control; rather, the mere ability to exercise the advantage or
influence is sufficient.
An exception to the deeming rule in subsection 256(5.1) applies where the relevant
influence over the subject corporation is derived by an arm’s length person or group of persons
from a franchise, license, lease, distribution, supply or management agreement or other similar
agreement or arrangement, if the main purpose of that agreement or arrangement is to govern the
relationship between the parties as to the manner in which a business carried on by the
corporation is to be conducted.
114
Unlike the determination of de jure control, a de facto control analysis is not limited to an examination of the relevant
corporation’s constitutional documents.
115
Income Tax Folio S1-F5-C1, supra note 23 at para 1.40.
116
Interpretation Bulletin IT-64R4, supra note 85 at para 21.
LEGAL_24490030.12
- 38 The following circumstances have repeatedly been noted by the CRA as potential indicia
of de facto control:117
(a)
a large percentage of voting share ownership (when not more than 50 per cent) in
relation to other shareholders;
(b)
ownership of a large debt of a corporation which may become payable on
demand;118
(c)
shareholder agreements (that are not unanimous shareholder agreements under the
relevant corporate statute) or the holding of a casting vote derived from outside the
relevant corporation’s constitutional documents;
(d)
certain commercial or contractual relationships of the corporation (for example,
agreements giving rise to economic dependence where the relevant corporation
only has a single supplier or customer);
(e)
possession of a unique expertise that is required to operate the business;
(f)
the influence that a family member, who is a shareholder, creditor, supplier, etc., of
a corporation, may have over another family member who is a shareholder of the
corporation;119 and
(g)
the composition of the board of directors and the control of day-to-day management
and operations of the business.
The first case to consider the application of subsection 256(5.1) following its enactment
in 1988 was Societe Fonciere D’Investissement Inc. v The Queen.120 In Societe Fonciere, a
shareholder holding only 0.2 percent of the shares of the corporate taxpayer was nevertheless
determined to have de facto control of the taxpayer by virtue of what the Court determined to be
his complete authority to manage all aspects of the corporation’s commercial and financial
dealings. In discussing the implications of the expanded control analysis under (what was at the
time) new subsection 256(5.1), the Court made the following observations:
...other words have been added [to the Act] for the clear purpose of
broadening the concept of control, in particular the words "directly
or indirectly in any manner whatever". So far as I know, the point
has not been decided, but I would have thought that it could
reasonably be argued that these words necessarily include the idea
of de facto control of a corporation in the case of a person who does
117
118
Ibid at para 23.
Unless exempted by subsection 256(3) or (6) (which may be operative in respect of certain debt obligations held by
arm’s length parties).
119
CRA document no. 2010-0382381E5, November 2, 2010.
120
Societe Fonciere D’Investissement Inc. v The Queen, [1996] 3 CTC 2537 (TCC) [Societe Fonciere].
LEGAL_24490030.12
- 39 not hold more than 50 per cent of the shares but has a controlling
influence, whether economic, contractual or moral, over a
corporation's affairs. It is hard to imagine words with a broader
meaning [emphasis added].121
In Silicon Graphics Ltd. v The Queen,122 the Federal Court of Appeal succinctly
summarized the law relating to de facto control determinations under the Act as follows:
The case law suggests that in determining whether de facto control
exists it is necessary to examine external agreements (Duha
Printers, supra at 825); shareholder resolutions (Caouette v.
Canada (Minister of National Revenue), [1996] T.C.J. No. 1568
(T.C.C.), para. 10); and whether any party can change the board of
directors or whether any shareholders' agreement gives any party the
ability to influence the composition of the board of directors
(International Mercantile Factors Ltd. v. R. (1990), 90 D.T.C.
6390 (Fed. T.D.) at 6399, aff'd (1994), 94 D.T.C. 6365 (Fed. C.A.);
and Multiview Inc. v. R. (1997), 97 D.T.C. 1489 (T.C.C.) at 149293).
One of the more recent cases to consider the application of subsection 256(5.1) is
Wayagamack. In its analysis of whether Kruger, the 51% shareholder of the corporate taxpayer,
enjoyed de facto control of the taxpayer, the Court first considered the significance of Kruger’s
industry knowledge relative to that of the minority shareholder, SGF, and concluded that any
advantages in that regard were substantially counterbalanced by SFG’s size and relatively high
level of investment sophistication. The Court then considered the impact of each of the
operational contracts between Kruger and the corporate taxpayer 123 and concluded that they did
not have a material impact on the control of the corporation, given (i) their focus on day-to-day
operational matters, (ii) their substantially arm’s length terms, and (iii) the controls that existed
in the USA that effectively prevented amendments to the agreements that would be less
favourable to the taxpayer. The Court concluded that Kruger did not enjoy de facto control of
the taxpayer under the circumstances. 124
By contrast, in Lyrtech, the Court canvassed a number of de facto control indicia in
connection with its analysis of the “side-car” R&D structure that was the focal point of the case.
The factors considered by the Court included the following:
121
Ibid at para 9.
122
Silicon Graphics Ltd. v The Queen, 2002 FCA 260 at para 66.
123
Namely, the Management Services Agreement (under which Kruger was to provide a general manager to the taxpayer,
who remained an employee of Kruger, along with other employees on an as-needed basis, with the taxpayer paying its
proportional share of the costs), the Sales Agency and Marketing Agreement, and the Kraft Pulp Selling Agreement.
124
On that basis, it was not necessary for the Court to consider whether the exception in subsection 256(5.1) with respect
to arm’s length agreements or arrangements relative to the operation of the subject business applied in the circumstances.
LEGAL_24490030.12
- 40 (a)
the same people were the directors or executive officers of all of the entities in the
group;
(b)
the unreasonable allocation of expenses between Lyrtech Inc. and the taxpayer;
(c)
the fact that only one person (an employee of Lyrtech Inc.) could transfer funds
among all the entities in the group;
(d)
the transfers of funds among Lyrtech Inc., 4296621 Canada Inc., Fiducie Financière
Lyrtech (“FFL”), FFL's beneficiaries, and the taxpayer;
(e)
the taxpayer had no royalty income and was dependent on Lyrtech Inc. for the
financing of its activities;125
(f)
Lyrtech Inc. stood as surety with respect to the taxpayer’s credit facilities;
(g)
an October 2006 organization chart showed the “complete integration” of the
taxpayer into Lyrtech Inc.;
(h)
the consolidation of financial statements; and
(i)
the taxpayer was paid on the basis of sales and not according to the expenses it
incurred.
Not surprisingly, the Court concluded that the above-noted factors (among others) clearly
demonstrated that control of the taxpayer resided with Lyrtech Inc. (the public company) on the
basis that Lyrtech Inc. exercised a dominant economic influence over the taxpayer, and that the
taxpayer was not an independent profit centre and could not survive or continue its activities
without the financial support of Lyrtech Inc. The decision in Lyrtech serves as an important
reminder to tax practitioners advising on matters where issues of de facto control are potentially
relevant of the importance of structuring and documenting arrangements on a commercially
reasonable basis, and making certain that proper records of the parties’ dealings are prepared and
maintained.
What Does it Mean to be “Affiliated”?
(i) Individuals
Paragraph 251.1(1)(a) provides that two individuals are considered to be affiliated where
they are spouses or common-law partners of one another.
125
The taxpayer's income was $0, $77, and $14 for 2005, 2006 and 2007 respectively, with income in the latter two years
being only interest income.
LEGAL_24490030.12
- 41 (ii) A Corporation and Any Person
Paragraph 251.1(1)(b) provides that a corporation is affiliated with any of the following
three persons:
(a)
a person by whom the corporation is “controlled”;126
(b)
a member of an “affiliated group of persons” by which the corporation is
controlled;127 and
(c)
the spouses or common-law partners of any of the persons described in either (a) or
(b) above.
(iii) A Corporation and Another Corporation.
Paragraph 251.1(1)(c) sets out the following circumstances under which two corporations
will be affiliated:
(a)
where each corporation is controlled by a person, and those persons are affiliated
with one another;
(b)
where one corporation is controlled by a person and the other corporation is
controlled by a group of persons, and each member of that group is affiliated with
the person controlling the first corporation; and
(c)
where each corporation is controlled by a group of persons, and each member of
each group is affiliated with at least one member of the other group.
In addition, subsection 251.1(2) contains a special interpretive rule for the purposes of
determining, in the context of an amalgamation or merger, whether a particular predecessor
corporation and the new corporation are to be considered as having been affiliated with one
another. The test, which is similar in operation to that contained in subsection 251(3.1) insofar as
related persons are concerned, is applied by determining if the new corporation would have been
affiliated with the predecessor on the assumption that the new corporation existed before the
merger or amalgamation, with the same shareholders as it had immediately after the merger or
amalgamation.
By way of illustration, assume that A Ltd., a taxable Canadian corporation that is whollyowned by Mr. A., amalgamates with B. Ltd., a taxable Canadian corporation wholly-owned by
Mr. B (who is unrelated to Mr. A.), to form “Amalco”. As a result of the amalgamation, A
receives 70% of the Amalco shares and alone is considered to control Amalco for the purposes of
126
As noted earlier, a reference to control in this context includes both de facto control, as provided for in subsection
256(5.1) (by virtue of the definition of “controlled” in subsection 251.1(3)), along with legal or de jure control.
127
Thus, for example, a corporation (ABC Ltd.) that is controlled by a group comprised of three unrelated individuals (A,
B and C) will not be affiliated with any of these individuals by virtue of section 251.1(1)(b) because they do not
constitute an affiliated group of persons.
LEGAL_24490030.12
- 42 section 251.1. Under these circumstances, A Ltd. and Amalco would be affiliated by (among
other provisions) the combined operation of the amalgamation deeming rule in subsection
251.1(2) and paragraph 251.1(1)(c), since A Ltd. and Amalco would have a common controller
in Mr. A. On the other hand, B Ltd. and Amalco would not, given Mr. B’s non-controlling
position in Amalco, be considered affiliated in these circumstances.
(iv) A Corporation and a Partnership.
Under paragraph 251.1(1)(d), a corporation will be considered to be affiliated with a
partnership in circumstances where:
(a)
the corporation is controlled by a group of persons;
(b)
there is a “majority-interest group of partners” in respect of the partnership; and
(c)
each member of the corporation’s control group is affiliated with at least one
member of the “majority-interest group of partners” as defined in subsection
251.1(3) (and discussed below), and each member of that majority-interest group
of partners is affiliated with at least one member of the group that controls the
corporation.128
Where a corporation is controlled by a single person, who is also a majority-interest
partner of a partnership, the corporation and partnership would not appear to be affiliated with
each other under paragraph 251.1(1)(d). However, the corporation and the partnership will, as
discussed below, be affiliated with each other under paragraph 251.1(1)(e), based on the
definition of a “majority-interest partner”.129
(v) A Partnership and a “Majority-Interest Partner”
Under paragraph 251.1(1)(e), a partnership is affiliated with its “majority-interest
partner”, if any.
The term “majority interest partner” in respect of a partnership (sometimes referred to
herein as an “MIP”) is defined in subsection 248(1)130 to mean a particular person or
partnership:
(a)
128
129
130
whose share of the income of the partnership from all sources in respect of its
immediately preceding fiscal period (or its current fiscal period, if the partnership
In addition to these particular circumstances, a partnership (as a “person” for purposes of the affiliated person rules)
may also be affiliated with a corporation under other tests, such as that set out in subparagraph 251.1(1)(b)(i) (a
corporation and a person controlling the corporation).
CRA document no. 2013-0515651E5, January 15, 2014.
The definition of “majority-interest partner” was originally contained in subsection 97(3.1), but was moved to
subsection 248(1) upon the introduction of the affiliated person rules.
LEGAL_24490030.12
- 43 does not have a preceding fiscal period), together with the shares of all persons
affiliated with that person or partnership, exceeds 50%; or
(b)
who, combined with all persons affiliated with that person or partnership, would be
entitled to more than half of the amount paid to all members of the partnership in
the event the partnership were wound up at that time.
(the above two components of the majority-interest partner definition being collectively referred
to herein as the “MIP Test”).
For the purposes of the MIP Test, a particular person is considered to hold, in addition to
its own interest in the partnership (if any), all interests in the partnership held by those with
whom the person is affiliated. This aggregation of interest rule effectively means any person
affiliated with a person holding a majority income interest in a partnership will also be an MIP in
respect of the partnership, regardless of whether the tested person is, in fact, a member of the
partnership. It is also noteworthy that, unlike the partnership look-through rule in paragraph
256(1.2)(e), which is applied in the context of the associated corporation rules, the MIP
definition makes no provision for what happens in the event there is no income of the partnership
in respect of the tested fiscal period. 131 Finally, it is not clear how the second component of the
definition would function (if at all) in circumstances where the subject partnership is insolvent or
in a deficit position; indeed, one could easily envision circumstances where equity value in the
subject partnership moves back and forth over the course of the relevant fiscal period between
positive and negative amounts, potentially resulting in a number of practical challenges
associated with the determination of MIP status at any given point in time.
(vi) A Partnership and Another Partnership
Paragraph 251.1(1)(f) sets out certain circumstances under which a partnership will be
considered to be affiliated with another partnership. Under these rules, which generally parallel
the corporation-to-corporation affiliation provisions in paragraph 251.1(1)(c), two partnerships
will be affiliated with each other if any of the following circumstances are present:
(a)
both partnerships have the same MIP;132
(b)
a majority-interest partner of one partnership is affiliated with each member of a
“majority-interest group of partners” of the other; or
131
Paragraph 256(1.2)(e), like a number of other provisions in the Act, bases its partner allocation mechanics on a
particular partner’s share of the partnership’s income or loss in respect of the tested fiscal period, and employs an
assumed partnership income amount (of $1,000,000) for this purpose in the event partnership income and losses are nil.
132
As noted above, by virtue of the aggregation rule for partners and their affiliates in the definition of “majority-interest
partner”, two partnerships (A-LP and B-LP) will be affiliated under paragraph 251.1(1)(f) in circumstances where one
spouse (Mr. A) holds a greater than 50% income interest in A-LP and the other spouse (Ms. B) holds a greater than 50%
income interest in B-LP, since each spouse, by virtue of the aggregation rules, is considered to be an MIP of each
partnership.
LEGAL_24490030.12
- 44 (c)
there is a majority-interest group of partners in each partnership, and each member
of one group of partners is affiliated with at least one member of the other group.
A “majority-interest group of partners” of a partnership (an “MGIP”) is any particular
group of partners133 whose interests in the subject partnership:
(a)
would satisfy the MIP Test if those interests were held by one person; and
(b)
would not satisfy the MIP Test if one of the partners in the purported group was not
a member.134
(the above two components of the majority-interest group of partners definition being
collectively referred to herein as the “MGIP Test”).
By way of brief illustration, assume ten partners each hold a ten percent income interest
in a particular partnership, and the ten partners (or any subset thereof of two or more) are capable
of constituting a group. In this case, the majority interest group of partners would be comprised
of six partners since (i) a group of fewer than six partners would cause the first component of the
test to be failed, and (ii) a group of more than six partners would cause the second component of
the test to be failed.
(vii) Supplementary Affiliated Person Rules for Trusts 135
The scope of the rules in section 251.1 was expanded in 2004 with the addition of a series
of supplementary provisions specifically applicable to trusts. The primary objective of the
amendments, as indicated by the Department of Finance at the time, was to clarify the affiliation
rules as they applied to trusts and to curb certain abuses, including the disallowance of what were
viewed as artificially created losses in connection with certain transactions carried out between
related persons through the use of a trust. (The Department of Finance favored this route over
having to require the CRA to contest such abuses by way of application of the “general antiavoidance rule” in section 245 (the “GAAR”)).
An example of the targeted circumvention was the subject matter of one of the trilogy of
so-called “value shift” GAAR cases, Triad Gestco Ltd. v The Queen.136 In Triad Gestco, the
following planning techniques were employed:
133
Unlike the MIP Test described above, to be a member of an MGIP, the person must hold a partnership interest. It is also
important to note that a particular partnership may have more than one MGIP.
134
In other words, there must be no subset of the particular group of partners whose collective partnership holdings satisfy
the MIP Test.
135
Generally applicable for affiliated person determinations at any time after March 22, 2004. However, it is important to
note that the more general affiliated person rules have had application to trusts (as persons for purposes of the Act) since
their inception. Examples include a trust that is a majority-interest partner in a partnership or a trust that controls a
corporation.
136
2012 FCA 258, [2012] FCJ No 1274 [Triad Gestco].
LEGAL_24490030.12
- 45 (a)
the taxpayer incorporated a wholly-owned subsidiary, Rcongold Systems Inc.
(“Newco”);
(b)
the taxpayer transferred property to Newco in exchange for common shares of
Newco;
(c)
Newco paid a “high-low” stock dividend on the common shares held by the
taxpayer; and
(d)
The taxpayer sold the common shares to a newly-created trust, of which the
taxpayer’s principal shareholder was the beneficiary and which had an arm’s length
person serving as trustee, for fair market value proceeds and realized a significant
loss on the sale (the stock dividend significantly reduced the fair market value of
the common shares, but did not affect the taxpayer’s adjusted cost base in the
common shares).
At the time of the subject transactions, the trust was not considered to be affiliated with
the taxpayer under section 251.1, with the result that the stop-loss rules in the Act did not apply
to deny the capital loss arising from the transfer of the common shares. As discussed in further
detail below, the supplementary affiliated person rules respecting trusts have broadened the
sphere of persons with which a trust will be considered affiliated, such that losses under many
previously employed planning arrangements (including the Triad Gestco transactions noted
above) would now be deemed to be nil under the applicable stop-loss rules.
(viii) A Trust and a Person
Paragraph 251.1(1)(g) provides that a trust is affiliated with a person that is a “majorityinterest beneficiary” of the trust (sometimes referred to herein as an “MIB”) or a person
affiliated with a majority-interest beneficiary of the trust (other than by virtue of paragraph
251.1(1)(g)).
(ix) A Trust and Another Trust
Paragraph 251.1(1)(h) provides that two trusts will be affiliated if a “contributor” to one
of the trusts is affiliated with a contributor to the other trust and:
(a)
an MIB of one of the trusts is affiliated with an MIB of the other trust,
(b)
an MIB of one of the trusts is affiliated with each member of a “majority-interest
group of beneficiaries” (an “MIGB”) of the other trust, or
(c)
each member of an MIGB of one of the trusts is affiliated with at least one member
of an MIGB of the other trust.
Subsection 251.1(3) contains several definitional provisions that are critical for purposes
of applying the affiliated person rules in circumstances involving a trust.
LEGAL_24490030.12
- 46 The term “beneficiary” is defined in subsection 251.1(3) to include any person who is
“beneficially interested” in a particular trust, within the meaning set forth in subsection 248(25).
Subsection 248(25) is worded expansively and provides that the persons or
partnerships137 beneficially interested in a particular trust include a person or partnership that has
any right as a beneficiary under the trust to receive any of the income or capital of the particular
trust, regardless of whether the right is (i) derived directly from the trust or indirectly through
one or more trusts or partnerships, or (ii) immediate or activated in the future, absolute or
contingent, or conditional on, or subject to, the exercise (or non-exercise) of any discretion by
any person or partnership. In addition, a person or partnership will be deemed to be beneficially
interested in a particular trust where, under the terms or conditions of the trust (or any
arrangement in respect of the trust), the person or partnership might, due to the exercise of any
discretion by any person or partnership, become beneficially interested in the trust in
circumstances where the trust has (i) acquired property, directly or indirectly in any manner
whatever, from the particular person or partnership or an expansive array of other stipulated
taxpayers, or (ii) been the recipient of a guarantee or any other form of financial assistance from
a person or partnership described in (i) above.
The CRA has provided the following examples of circumstances under which an
individual will, in its view, be considered to be beneficially interested in a particular trust:
(a)
where trust income is payable to the individual;
(b)
where income of the trust is payable to the individual conditional upon his/her
attainment of a certain age;
(c)
where the individual is one of a class who has a remainder interest under the terms
of the trust; and
(d)
where the individual has contributed property to the trust (e.g., as settlor) and may,
by virtue of the existence of a power of appointment, be added as a beneficiary of
the trust at a later date.138
Subsection 248(25) was considered in Lyrtech where the principal issue was whether the
taxpayer was a CCPC. As noted above, in Lyrtech, the shares in the taxpayer were owned by a
trust, FFT, the conditional income and capital beneficiaries of which were certain subsidiaries of
Lyrtech Inc. (the L-Subs). The Court ultimately decided the case against the taxpayer on the
basis that the taxpayer was controlled, directly or indirectly in any manner whatever, by a public
company and, thus, was not a CCPC.
However, the Court also considered whether the entitlement of the L-Subs, as conditional
beneficiaries of FFT and having regard to subsection 248(25), could be considered to result in
137
138
For this purpose, members of a partnership are deemed to be beneficially interested in a trust if the partnership is
beneficially interested in the trust. See paragraph 248(25)(c).
Income Tax Folio, S1-F5-C1, supra note 23 at para 1.31.
LEGAL_24490030.12
- 47 the L-Subs being beneficially interested in FFT. For the purposes of its analysis, the Court
observed that the subject trust deed specifically provided that the persons designated as
beneficiaries therein (i.e., the L-Subs) were only potential beneficiaries of the trust, and that the
language utilized in the trust deed appeared to have been crafted with the purpose of avoiding the
application of subsection 248(25).139 Nevertheless, the Court concluded that the L-Subs were
“beneficially interested” in FFT, despite the contingent nature of their interests.
A “contributor” in respect of a particular trust is defined in subsection 251.1(3) as a
person who, at any time, has, directly or indirectly, in any manner whatever, contributed property
or loaned funds to, or for the benefit of, the trust. An exclusion applies for transfers or loans
made on market terms by a person dealing at “arm’s length” with the trust, provided the person is
not a “majority-interest beneficiary” of the trust immediately after the relevant transaction. For
purposes of the arm’s length determination, subparagraph 251.1(4)(d)(ii) overrides the general
rules with respect to personal trusts140 in paragraph 251(1)(b) by providing that a beneficiary of a
trust will not be considered to deal on a non-arm's length basis with such a trust for purposes of
the affiliated person rules in section 251.1 solely by virtue of being a beneficiary thereunder. 141
The CRA was recently asked to consider whether the term “contributor”, as defined in
subsection 251.1(3), properly includes a deceased person in connection with a transfer of
property made as a consequence of a such person’s death (having regard to the inclusion of a
clarification to that effect in the definition of “contributor” in subsection 94(1) for purposes of
the non-resident trust rules). The CRA expressed the view that the “clarification” in subsection
94(1) did not necessarily mean that the definition of a “contributor” in subsection 251.1(3)
excludes deceased persons from its purview, regardless of when the transfer of property occurs
(be it on or prior to death). However, the CRA declined to express a definitive view on the issue,
indicating that it was a question of fact and law to be determined after a careful review of all
facts and circumstances.142
139
140
Ibid at paras 41 and 42. Under the relevant trust deed, the trustees had absolute discretion to eventually distribute all of
the appellant’s shares to one of more beneficiaries. The trust deed in this case also specifically provided that the persons
designated therein would have no rights as beneficiaries of the trust “until they have received some part of the revenue
or capital of the trust”.
Subsection 248(1) defines a “personal trust” as follows:
“personal trust” means a trust (other than a trust that is, or was at any time after 1999, a unit trust) that is
(a) a graduated rate estate, or
(b) a trust in which no beneficial interest was acquired for consideration payable directly or indirectly to
(i) the trust, or
(ii) any person or partnership that has made a contribution to the trust by way of transfer, assignment or
other disposition of property.
141
However, as noted above, this override will not apply to a particular transferor or lender who is, immediately after the
relevant transaction, an MIB in respect of the trust.
142
CRA document no. 2014-0534851C6, October 10, 2014. Some commentators have questioned the CRA’s position on
the basis that the definition of a person does not include a “deceased person,” see David Sherman’s note on 251.1(3)
“Contributor” in David Sherman, Practitioner’s Income Tax Act, 48th ed (Toronto: Thomson Reuters Canada Limited,
2015) at 1525. On a related point, it is interesting to note the CRA’s previously expressed view that a deceased person
should not be considered affiliated with his or her estate, on the basis that the deceased person is not entitled to any of
LEGAL_24490030.12
- 48 It is important to note that subparagraph 251.1(4)(d)(iv) materially expands, for the
purposes of determining whether a contributor to one trust is affiliated with a contributor to
another trust, the types of natural persons who are considered to be affiliated with one another to
include those who are connected by blood relationship, marriage, common-law partnership, or
adoption.
The definition of "majority-interest beneficiary" and its companion definition, “majorityinterest group of beneficiaries”, are broadly comparable in concept and technical application to
the definitions of “majority-interest partner” and “majority-interest group of partners”.
However, there are certain interpretative principles unique to the trust context that demand
careful consideration.
A person will be a majority-interest beneficiary or “MIB” in respect of a particular trust if
its interest in either the income or capital of the trust, combined with the interests of any persons
affiliated with the tested person, is greater than 50% of the fair market value at that time of all
such income or capital interests, as the case may be (the “MIB Test”). Similar to the result in
the partnership context, this means, for example, that if Ms. A and the corporation she controls
(A Co) have no interest in either the income or capital of Trust B, while Ms. A’s husband (Mr.
B) has an income interest in Trust B, the fair market value of which is more than half of the fair
market value of all income interests in Trust B, Ms. A and A Co. will nevertheless each be an
MIB in respect of Trust B, due to their affiliation with Mr. B. It should be noted, however, that
this “MIB by affiliation” principle is not fully operative for purposes of determining whether one
trust is an MIB of another trust – in such cases, subparagraph 251.1(4)(d)(iii) provides that a trust
cannot be an MIB of another trust unless it is a beneficiary thereof.
The possibility of multiple MIBs in respect of the same trust also exists by virtue of
certain other interpretive rules in section 251.1. In particular, subparagraph 251.1(4)(d)(i)
contains a special rule that applies in circumstances where the income or capital entitlement of a
particular beneficiary is dependent on the exercise, or non-exercise, of a discretionary power. 143
Where operative, subparagraph 251.1(4)(d)(i) deems the power to have been fully exercised or
not exercised, as the case may be, thus maximizing, for the purposes of determining whether a
person is affiliated with a trust, the amount of income or capital (as the case may be) of the trust
the person is considered to be entitled to. For example, if there are six persons who may each
potentially receive up to 100% of the capital of a trust in the event that an existing discretion
were exercised in their favour, then each of those six persons would be a majority-interest
beneficiary in respect of the trust on account of the fact that each person’s capital interest in the
trust would be deemed to be 100% by virtue of subparagraph 251.1(4)(d)(i), thus satisfying the
MIB test.
Questions have arisen as to the application of the MIB Test in the context of an
unadministered estate in circumstances where the income and capital amounts payable to a
the assets of the estate and, as such, is not a beneficiary thereof (see CRA document no. 2004-0105471E5, March 30,
2006).
143
The rule does not require that the discretionary power in question be derived from the relevant trust deed, although this
will most often be the case.
LEGAL_24490030.12
- 49 particular beneficiary are uncertain due to (among other things) the amount of testamentary debts
of the estate having yet to be fully quantified. The CRA was asked to consider who the MIB
would be in a hypothetical situation where one beneficiary is entitled to a specific bequest of
$100,000 and the other beneficiary is entitled to the residue of the estate. The CRA confirmed in
this instance that since the determination of who is entitled to the majority of the capital of an
estate depends on the amount of capital available to be distributed to the beneficiaries after the
payment of all of the testamentary debts, determining whether a beneficiary is the majorityinterest beneficiary in an unadministered estate is necessarily a question of fact.144
A majority-interest group of beneficiaries or “MGIB” of a trust is defined as any
particular group of beneficiaries145 whose interests in the subject trust would:
(a)
satisfy the MIB Test if the interests were held by one person; and
(b)
would not satisfy the MIB Test if one of the beneficiaries in the purported group
were not a member.146
Thus, in the example above with respect to the six capital beneficiaries of a discretionary
trust, there would be no group of beneficiaries capable of satisfying the second component of the
test – that is, if each of the six capital beneficiaries is considered to own 100% of the trust’s
capital by virtue of the deeming rule in subparagraph 251.1(4)(d)(i), then the removal of one
person from any purported group would still leave the remaining members (or member as the
case may be) with 100% of the capital, thus causing the second portion of the test in all cases to
be failed.
One final interpretive rule requiring careful consideration is paragraph 251.1(4)(c), which
serves to override the general rule in subsection 104(1) by providing that a reference to a trust
does not include a reference to the trustee or other persons who own or control the trust property.
One of the more important implications of this override is that two trusts will not be affiliated
solely by virtue of having the same trustee. It also means that a person will not be considered
affiliated with a particular trust solely by virtue of being affiliated with the trustee of the trust.
“Loss Restriction Event” Rules
For many years, the Act has contained numerous provisions designed to restrict or
prevent loss and other tax attribute transfers between unrelated or arm’s length parties.
144
CRA document no. 2006-0185581C6, September 11, 2006.
145
For this purpose, each member of a group of persons that may potentially comprise a majority-interest group of
beneficiaries must be a “beneficiary” of the trust (which, as previously noted, requires reference to the broad language in
subsection 248(25)).
146
In other words, the group can be no larger than the minimum number of beneficiaries necessary to satisfy the MIB Test
(assuming all of the relevant interests are held by one person).
LEGAL_24490030.12
- 50 Historically, the focus of these restrictions was generally limited to corporate taxpayers (or their
successors) and applied following an “acquisition of control”.147
Recently enacted section 251.2 introduced the concept of a “loss restriction event”.
Broadly speaking, the new concept seeks to impose the loss and other attribute trading
restrictions traditionally focused on corporations on to trusts. The aspects of section 251.2
relating to trusts draw from the affiliated person rules in section 251.1 – in particular, the
concepts of a “majority-interest beneficiary” and “majority-interest group of beneficiaries.”
A “loss restriction event” in respect of a trust is described in paragraph 251.2(2)(b) as
occurring at the time at which a person becomes a majority-interest beneficiary in respect of the
trust or a group of persons becomes a majority-interest group of beneficiaries of the trust.148
The consequences to a trust that is the subject of a loss restriction event can be material
and may include, among other things (i) the expiry of all net capital loss carry forwards, (ii) a
mandatory write-down of all non-depreciable capital property with accrued losses (and
immediate expiry of the resulting capital losses), (iii) a streaming of non-capital loss carry
forwards, SR&ED expenditures, and ITCs, and (iv) a deemed year-end. In addition, recently
enacted paragraph 256(7)(h) will generally operate in circumstances where a trust is the subject
of a loss restriction event at a particular time to deem acquisitions of control to occur in respect
of any corporations controlled by the trust (or corporations controlled by groups of which the
trust is a member) immediately before that time. According to the Department of Finance, the
rule in paragraph 256(7)(h) was intended to ensure that a trust cannot be used as a “blocker”
between a corporation and its ultimate owners (i.e., the persons behind the trust) for purposes of
shielding the subject corporation from an acquisition of control in the event those owners were to
change.149
Subsection 251.2(3) describes circumstances under which a person or group of persons is
deemed not to have become a majority-interest beneficiary or majority-interest group of
beneficiaries of a particular trust for the purposes of the loss restriction event rules, including
certain transactions involving “equity”150 in the trust. For example, a loss restriction event for
purposes of paragraph 251.2(2)(b) will not be considered to have occurred in relation to the
acquisition of equity in a particular trust by a person (the “acquirer”) affiliated with the trust, or
from another person with whom the acquirer was affiliated immediately before the acquisition.
In addition, an acquisition of trust equity by an estate of a deceased individual under applicable
147
Typically, access to the subject attributes (where permitted) was achieved by causing the company with the subject tax
attributes (the target company) to be wound-up into the acquiring company following the acquisition of the target
company, or by amalgamating the target company and the acquiring company.
148
An acquisition of control remains the trigger point for activating the loss and other tax attribute restriction rules
applicable to corporations (see paragraph 251.2(2)(a)).
149
Canada, Department of Finance, “Notice of Ways and Means Motion and Explanatory (Technical) Notes to Implement
Additional Income Tax and GST/HST Provisions of the 2013 Federal Budget and Other Previously Announced
Measures,” October 18, 2013.
150
The definition of “equity” in section 251.2 incorporates the definition of “equity” in subsection 122.1(1), read without
reference to paragraph (e). In the case of a trust, “equity” generally refers to capital or income interests in the trust.
LEGAL_24490030.12
- 51 succession law is generally excluded, as is an acquisition of trust equity by a particular person
from an estate of an individual, where the person was affiliated with the deceased.151
Subsection 251.2(4) deems certain transactions or events to result in a notional person
becoming a majority-interest beneficiary of a trust and, thus, causing the trust to experience a
loss restriction event. For example, paragraph 251.2(4)(a) may apply to deem a notional person
to have become a majority-interest beneficiary of a particular trust in circumstances where a
corporation, partnership or trust that is a majority-interest beneficiary, or a member of a group of
majority-interest beneficiaries, of the trust becomes a “subsidiary”152 of a person that is not
affiliated with the trust immediately before that time. 153
(i) Modifications and departures from the general affiliation provisions in section 251.1
For the purposes of applying the affiliated person rules in the context of a loss restriction
event analysis under section 251.2, it is important to be aware of the definitional modifications
and anti-avoidance rules contained in subsection 251.2(5). These provisions may, among other
things, impact the operation of the MIB Test when considering whether a person has become a
majority-interest beneficiary, or a group of persons has become a majority-interest group of
beneficiaries, of a trust, along with the quantum of a particular person’s equity holdings or the
value thereof under one or more of the relieving provisions contained in subsections 251.2(3) or
(4).
Of particular note, paragraph 251.2(5)(a) expands the types of natural persons considered
to be affiliated with one another under section 251.2 to include any individuals connected by
blood relationship, marriage, common-law partnership or adoption (thus essentially providing a
“related person” standard as far as natural persons are concerned). In addition (and consistent
with the comparable rules applicable to corporations 154), subparagraph 251.2(5)(a)(i) provides
that control for purposes of an affiliated person determination under section 251.1 is, in almost
all instances, limited to legal or de jure control. 155 Finally, the rules in section 251.2 include the
anti-avoidance-based concept of “specified rights”,156 which largely parallels, in the trust context
(with similar expanse and similar exceptions),157 the rights with respect to corporate share
151
Subparagraphs 251.2(3)(a)(iii) and (iv).
152
As defined in subsection 251.2(1).
153
154
155
156
According to the Department of Finance, this measure was intended to ensure that neither a majority-interest
beneficiary nor a member of a majority-interest group of beneficiaries of a trust could serve as a “blocker” for purposes
of avoiding a loss restriction event at the trust level in circumstances where the ultimate owners (i.e., the persons behind
the MIB or MIGB, as the case may be) change.
Paragraphs 251.1(1)(b), (c) and (d).
The only use of a de facto control standard under section 251.2 occurs in the definition of a “subsidiary” contained in
subsection 251.2(1).
Subsection 251.2(1).
157
Such exceptions including rights that are only exercisable on the death, permanent disability or bankruptcy of an
individual.
LEGAL_24490030.12
- 52 ownership and voting entitlements contemplated in paragraph 251(5)(b) (as applied for the
purposes of the related person rules and the definition of a CCPC in subsection 125(7)).
As noted above, there are several anti-avoidance rules in subsection 251.2(5) that may
impact a particular person’s affiliated status at a particular time for purposes of section 251.2, or
a person’s equity holdings in a trust when determining whether the person has become a
majority-interest beneficiary, or a member of a group of persons that has become a majorityinterest group of beneficiaries, of a trust. For example, subparagraph 251.2(5)(a)(iii) serves to
negate, for purposes of certain of the relieving measures requiring affiliated status in subsections
251.2(3) and (4), the effect of any equity acquired by a person to the extent it may reasonably be
concluded that “one of the reasons” for the acquisition (or any agreement or undertaking with
respect to the acquisition) was to cause the affiliated condition in the particular relieving measure
to be satisfied.
Furthermore, there are two additional anti-avoidance rules in paragraph 251.2(5)(b) that
can potentially apply when determining whether a particular person has become a majorityinterest beneficiary, or a particular group of persons has become a majority-interest group of
beneficiaries, of a trust. The first of the rules provides for this purpose, that the fair market value
of each person’s equity in the trust is to be computed without reference to any trust equity (or
other property) acquired, or to a change in the fair market value of all or part of any trust equity,
if it can reasonably be concluded that “one of the reasons” for the acquisition or change (as the
case may be) is to cause paragraph 251.2(2)(b) (or any provision in the Act that applies by
reference to a trust being subject to a loss restriction event) at any time, not to apply.158 In
addition to these adjustments, paragraph 251.2(5)(b) further provides that the foregoing
determination is made on the basis that each “specified right” held by the particular person, or by
a member of the particular group, in respect of the trust has been exercised, if it can reasonably
be concluded that “one of the reasons” for the acquisition of the right is to cause paragraph
251.2(2)(b) (or any provision in the Act that applies by reference to a trust being subject to a loss
restriction event) not to apply. 159
“Associated Persons”: The Fundamentals
Where two corporations are characterized as being “associated” with one another for the
purposes of the Act, the corporations may be subject to a number of limitations that may restrict
their ability to claim certain tax advantages. The contexts in which a tax practitioner may
encounter the concept of “associated” corporations are numerous and include the following:
(a)
Provisions requiring the sharing of the small business deduction “business limit”; 160
158
Subparagraphs 251.2(5)(b)(i) and (ii).
159
Subparagraph 251.2(5)(b)(iii).
160
See subsections 125(2)-(3).
LEGAL_24490030.12
- 53 (b)
Provisions limiting the calculation of scientific research and experimental
development expenditure limits and tax credits; 161
(c)
Provisions governing instalment requirements for certain small CCPCs;162
(d)
Provisions governing the required sharing of the “dividend allowance” for the
purposes of Part VI.1;163
(e)
Provisions restricting the eligibility for an extended “balance-due day” for tax
remittance purposes;164 and
(f)
Provisions relating to (i) the definitions of a “specified investment business” and a
“personal services business”, and (ii) the computation of income from an active
business carried on in Canada.165
What does it mean to be “Associated”?
Subsection 256(1) sets out the circumstances under which a corporation is considered to
be “associated” with another corporation in a taxation year. The subsection provides that if two
corporations satisfy certain enumerated conditions at any time in a particular taxation year, they
will be considered to be associated with one another “in” the taxation year. Accordingly, even a
momentary association between corporations can have implications for both entities for an entire
year.
Subsection 256(1) specifically provides that a corporation will be associated with another
corporation in a taxation year if, at any time in the year,
(a)
one of the corporations controlled, directly or indirectly in any manner whatever,
the other;
(b)
both of the corporations were controlled, directly or indirectly in any manner
whatever, by the same person or group of persons;
(c)
each of the corporations was controlled, directly or indirectly in any manner
whatever, by a person and the person who so controlled one of the corporations was
related to the person who so controlled the other, and either of those persons owned,
in respect of each corporation, not less than 25% of the issued shares of any class,
other than a specified class, of the capital stock thereof;
161
See, for example, subsections 127(10.2) and 127.1(2).
162
See, for example, subsections 157(1.3)-(1.4).
163
See, for example, subsections 191.2(2)-(3).
164
See clause (d)(i)(C) of the definition of “balance-due day” in subsection 248(1).
165
See subsection 125(7) and the specialized computational rules in subsection 129(6).
LEGAL_24490030.12
- 54 (d)
one of the corporations was controlled, directly or indirectly in any manner
whatever, by a person and that person was related to each member of a group of
persons that so controlled the other corporation, and that person owned, in respect
of the other corporation, not less than 25% of the issued shares of any class, other
than a specified class, of the capital stock thereof; or
(e)
each of the corporations was controlled, directly or indirectly in any manner
whatever, by a related group and each of the members of one of the related groups
was related to all of the members of the other related group, and one or more
persons who were members of both related groups, either alone or together, owned,
in respect of each corporation, not less than 25% of the issued shares of any class,
other than a specified class of the capital stock thereof.
(i) De Facto Control of One Corporation by Another Corporation
Paragraph 256(1)(a) provides that two corporations will be associated with one another
where one of the corporations is “controlled, directly or indirectly in any manner whatever” by
the other corporation. As discussed above, the concept of a corporation being “controlled,
directly or indirectly in any manner whatever” is expressly defined in subsection 256(5.1) as
encompassing what has commonly been referred to as de facto control.
(ii) De Facto Control by a Common Parent
Paragraph 256(1)(b) provides that two corporations will be associated with one another if
they are controlled, directly or indirectly in any manner whatever, by the same person or “group
of persons”.
In interpreting paragraph 256(1)(b), it is important to be conscious of the application of
the special interpretive rule in paragraph 256(1.2)(a) that liberalizes the definition of a “group of
persons” for the purposes of the associated corporation rules. In contrast to the concept of a
“group of persons” that has developed under the common law, where a common connection or
“community of interests” must be present for two or more persons to be found to comprise a
group of persons, paragraph 256(1.2)(a) provides that “a group of persons in respect of a
corporation means any two or more persons each of whom owns shares of the capital stock of the
corporation”. The CRA has stated that this interpretive rule results in any two or more
shareholders of a corporation automatically comprising a “group of persons” for the purposes of
assessing control under subsection 256(1). As stated by the CRA, this interpretive methodology
applies “whether the members of the group are related or not or whether the members of the
group act in concert or not”.166
(iii) Corporations Associated by Virtue of Cross-Shareholdings – Variant #1
Paragraph 256(1)(c) provides that two corporations will be considered to be associated
with one another where, at any time in the year, (i) each of the corporations is controlled, directly
166
CRA document no. December 1990-236. See also CRA document no. 2005-0126891I7, May 18, 2005.
LEGAL_24490030.12
- 55 or indirectly in any manner whatever, by a person, (ii) the person who controlled one of the
corporations was related to the person who controlled the other corporation, and (iii) either of the
controlling persons owned, in respect of each corporation, not less than 25% of the issued shares
of any class of the capital stock of the corporation, other than a “specified class”.
(1)
A “specified class”
For the purposes of subsection 256(1), a “specified class” is defined is subsection
256(1.1) as:
...a class of shares of the capital stock of a corporation where, under
the terms or conditions of the shares or any agreement in respect
thereof,
(a) the shares are not convertible or exchangeable;
(b) the shares are non-voting;
(c) the amount of each dividend payable on the shares is calculated
as a fixed amount or by reference to a fixed percentage of an
amount equal to the fair market value of the consideration for
which the shares were issued;
(d) the annual rate of the dividend on the shares, expressed as a
percentage of an amount equal to the fair market value of the
consideration for which the shares were issued, cannot in any
event exceed,
(i)
where the shares were issued before 1984, the rate of
interest prescribed for the purposes of subsection 161(1)
at the time the shares were issued, and
(ii)
where the shares were issued after 1983, the prescribed
rate of interest at the time the shares were issued; and
(e) the amount that any holder of the shares is entitled to receive on
the redemption, cancellation or acquisition of the shares by the
corporation or by any person with whom the corporation does
not deal at arm's length cannot exceed the total of an amount
equal to the fair market value of the consideration for which the
shares were issued and the amount of any unpaid dividends
thereon.
The notion of excluding shares of a “specified class” from the ambit of the associated
corporation analysis was introduced to permit certain types of cross-financing and capital
LEGAL_24490030.12
- 56 reorganization transactions, including estate freezes, without causing the subject corporation to
be associated with an unduly broad range of equity holders.167
The Department of Finance Technical Notes that were issued with the introduction of
subsection 256(1.1) provided that the relieving provision was introduced to “permit a person to
invest funds in a corporation controlled by a related person – such as a spouse or child – without
subjecting his own corporation to a reduced small business deduction, provided that the
investment takes the form of fixed-rate, non-voting, preferred shares”.
Five separate conditions must be satisfied for a class of shares to be considered to be a
“specified class” for the purposes of section 256.
First, the shares of the class must not be convertible or exchangeable into other securities.
The CRA has opined that any future right to convert shares of a particular class, whether such
right is contingent on a future event or not, will preclude such shares from being considered to be
shares of a “specified class”.168 However, where none of the terms or conditions of a class of
shares, nor any agreement in respect of the shares, specifically provides for a share conversion or
exchange right, the fact that such documents do not specifically preclude a shareholder from
converting or exchanging its shares with the concurrence of the corporation for shares of another
class in the future will not preclude the class of shares from constituting a “specified class”. 169
Second, the shares must be non-voting. The CRA has stated that a shareholders
agreement restricting the ability of shareholders to exercise existing voting entitlements in
respect of certain shares would not permit that class of shares to be characterized as a “specified
class” on the basis that such shares remain voting shares, and the ability to exercise the voting
rights inherent in the shares has simply been limited by contract. 170 Quaere whether this
interpretation is accurate in light of the words in the preamble to the definition of a “specified
class” that expressly reference conditions arising “under…any agreement in respect” of the
shares?
Third, the amount of each dividend payable on the shares of the class must be calculated
as a fixed amount or by reference to a fixed percentage of an amount equal to the fair market
value of the consideration for which the shares were issued. The CRA has stated that it is
possible for shares of a class of the capital stock of a corporation to have a nil dividend
entitlement and still qualify as shares of a “specified class”. 171 Nevertheless, an amount, nil or
otherwise, must be expressly specified in the terms or conditions of the shares or any agreement
in respect thereof. The CRA has opined that this requirement will not be satisfied where the
terms or conditions of the shares provide that the holders are entitled to dividends at rates to be
167
See, for example, Claudette Allard, “Estate Freezing: An Update,” in Report of the Proceedings of the 40th Tax
Conference, 1988 Conference Report (Toronto: Canadian Tax Foundation, 1989), 33:1-30 at 2.
168
See, for example, CRA document no. September 1991-227. See also CRA document no. September 1991-55.
169
See, for example, CRA document no. 2005-0114971E5, March 14, 2006.
170
See, for example, CRA document no. 2003-0028075, September 15, 2003.
171
See, for example, CRA document no. September 1991-227.
LEGAL_24490030.12
- 57 determined by the board of directors of the corporation at the times the dividends are declared
(even if the directors are restricted from declaring a dividend that exceeds the prescribed rate at
the time the shares were issued).172 The CRA has, however, confirmed that dividend entitlements
in respect of a class of shares may be cumulative or preferential without compromising the
ability of the relevant class to comprise a “specified class” of shares. 173 With respect to the fixed
rate requirement in paragraph 256(1.1)(c), the CRA has suggested that it is its understanding that
“the fixed rate requirement was included in paragraph 256(1.1) [sic] as the types of shares to be
included were intended to be those which were substantially the same as debt. Since most
indebtedness bears a fixed rate of interest, the requirement that the shares be entitled to a fixed
dividend was included”. 174
Fourth, the annual rate of the dividend on the shares, expressed as a percentage of an
amount equal to the fair market value of the consideration for which the shares were issued,
cannot, in any event, exceed the applicable prescribed rate of interest at the time the shares were
issued. Where shares of a class of capital stock bear an adjusting or floating dividend rate, those
shares will not be considered to be shares of a “specified class”. 175 The CRA has repeatedly
stated that the failure to ensure that the annual rate of dividend payable on a class of shares does
not exceed the applicable prescribed rate cannot be rectified by a subsequent amendment of the
share terms or agreements in respect of the shares.176
Finally, the amount that any holder of the shares is entitled to receive on the redemption,
cancellation or acquisition of the shares by the corporation or by any person with which the
corporation does not deal at arm’s length cannot exceed the total of an amount equal to the fair
market value of the consideration for which the shares were issued and the amount of any unpaid
dividends thereon. The CRA has suggested that it interprets the term “unpaid dividends” in this
regard as referring to the amount of the dividend which would have to be paid by the corporation
upon the redemption, cancellation or acquisition of the particular class of shares pursuant to the
terms or conditions of the shares or any agreement in respect thereof. 177 The CRA has also
indicated that it considers unpaid dividends as potentially including accumulated, undeclared or
unpaid dividends.178 The CRA has stated that preferred shares with a positive redemption value
that are issued as a stock dividend will not qualify as shares of a “specified class”, as such shares
will be considered to be issued for no consideration, yet, by their terms, will be redeemable for
an amount in excess of nil.179
172
See, for example, CRA document no. 9309595, July 8, 1993.
173
Ibid.
174
Ibid.
175
See, for example, CRA document no. 5-6979, February 21, 1989.
176
See, for example, CRA document no. 2009-0340591E5, January 11, 2010.
177
See, for example, CRA document no. October 1991-1.
178
Ibid.
179
See, for example, CRA document no. 9605065, February 20, 1996.
LEGAL_24490030.12
- 58 The CRA has indicated that where shares of a particular class are issued in series and, in
respect of each such series, a distinct dividend rate is set equal to the applicable prescribed rate at
the time the shares of the particular series are issued, the class of shares may still potentially
qualify as a “specified class” on the basis that the Act provides that where shares are issued in
series, statutory references to a “class” are to be read as references to a “series of the class”
pursuant to subsection 248(6).180 The CRA has also suggested that the right of a shareholder to
request the retraction of its shares will not, in and of itself, necessarily result in such shares being
precluded from being part of a “specified class”. 181
The CRA has cautioned that even if a particular person holds shares of a “specified class”
of the capital stock of a corporation, such shares may nevertheless grant the shareholder
sufficient rights and influence over the corporation to cause the shareholder to enjoy de facto
control of the corporation. Under such circumstances, the shareholder and the corporation may
be associated by virtue of another element of the statutory definition in subsection 256(1). 182
(iv) Corporations Associated by Virtue of Cross-Shareholdings – Variant #2
Paragraph 256(1)(d) provides that two corporations will be considered to be associated
with one another where at any time in the year (i) one corporation is controlled directly or
indirectly in any manner whatever by a person (the “control person”), (ii) the other corporation is
controlled directly or indirectly in any manner whatever by a group of persons, (iii) the control
person is related to each member of the group of persons controlling the other corporation, and
(iv) the control person owns at least 25% of the issued shares of any class of the capital stock of
the other corporation (other than a “specified class”).
(v) Corporations Associated by Virtue of Cross-Shareholdings – Variant #3
Paragraph 256(1)(e) provides that two corporations will be associated with one another in
a taxation year if, at any time in the year, (i) each corporation is controlled directly or indirectly
in any manner whatever by a separate “related group of persons”, (ii) each member of one of the
related groups is related to all the members of the other related group, and (iii) one or more
persons who are members of both related groups, either alone or together, owned, in respect of
each corporation, at least 25% of the issued shares of any class of the other corporation (other
than a “specified class”).
Associated Corporations: Supplementary Interpretive/Deeming Rules
As a supplement to subsection 256(1), a number of additional deeming and interpretive
rules were enacted to clarify the intended application of subsection 256(1), broaden the scope of
180
See, for example, CRA document no. November 1990-259.
181
See, for example, CRA document no. 5-8676, September 22, 1989.
182
See, for example, CRA document no. 2001-0104745, October 23, 2001 and CRA document no. 5-8676, September 22,
1989.
LEGAL_24490030.12
- 59 the concept of “associated” corporations, and counteract artificial attempts by corporate
taxpayers to avoid being characterized as associated with one another.
Paragraph 256(1.1)(b) was enacted to establish, for greater certainty, that (i) a corporation
that is controlled by one or more members of a particular group of persons is to be considered to
be controlled by that group of persons, and (ii) a corporation may be controlled by a person or a
particular group of persons notwithstanding the fact that the corporation is also controlled or
deemed to be controlled by another person or group of persons.
Paragraph 256(1.2)(c) was introduced to deem control of a corporation to rest with
particular shareholders that hold a sufficient percentage of the share capital of a corporation
based on the relative fair market value of their shareholdings. Specifically, paragraph
256(1.2)(c) deems a corporation to be controlled by a person or group of persons where that
person or group owns:
(a)
shares of the capital stock of the corporation having a fair market value that is
greater than 50% of the fair market value of all of the issued and outstanding shares
of the corporation; or
(b)
“common shares” of the corporation having a fair market value that is greater than
50% of the fair market value of all the issued and outstanding common shares of
the corporation.
“Common shares” are defined in subsection 248(1) as shares “the holder of which is not
precluded on the reduction or redemption of the capital stock from participating in the assets of
the corporation beyond the amount paid up on the shares plus a fixed premium and a defined rate
of dividend”. It is important for tax practitioners to recognize that shares labelled “preferred
shares” for commercial purposes may, in fact, be “common shares” for the purposes of the Act.
In this regard, the CRA has indicated that the determination of whether particular shares are
“common shares” for income tax purposes is a matter of construction of the applicable share
terms. 183
As discussed in greater detail below, in applying the foregoing tests, shares described in
paragraph (e) of the definition of a “term preferred share” in subsection 248(1) (i.e., so-called
“distress preferred shares”) and shares of a “specified class”184 are to be disregarded185, and any
shares included in the calculation are deemed to be non-voting for valuation purposes.186
The appropriate methodology and valuation factors to be considered when applying
paragraph 256(1.2)(c) were recently considered in Wayagamack. As previously noted, in
Wayagamack, a shareholder of the taxpayer, Kruger, held 51% of the taxpayer’s common shares
183
See, for example, CRA document no. 2004-0088521E5, September 16, 2004.
184
As defined in subsection 256(1.1).
185
See subsection 256(1.6).
186
See paragraph 256(1.2)(g) and the further discussion, infra; see also Interpretation Bulletin IT-64R4, supra note 85 at
para 28.
LEGAL_24490030.12
- 60 (the only class of outstanding shares) with the remaining 49% of the common shares held by
SGF.
After concluding that Kruger did not have de jure or de facto control of the taxpayer,
KWI, under general principles, the Court went on to consider whether Kruger was deemed to
have control of KWI by reason of paragraph 256(1.2)(c). In framing its analysis, the Court
observed that the deeming rule in paragraph 256(1.2)(g) required that a valuation be conducted
in a “hypothetical world where shareholders cannot vote” which, among other things, meant that
the shares “must be valued from a financial perspective without regard to control”187,
notwithstanding that it may seem “counterintuitive to accept the logical consequences of [this]
legal fiction”. 188 The Court went on to note as follows:
…in determining the value per share, one must first look to the share
rights to dividends and to assets if the corporation were wound up.
Second, one must consider what other factors may affect the value
per share, but only factors unrelated to voting rights and, therefore,
unrelated to control may be considered.189
…
In a case where all shareholders have the same class of shares, as
here, in the absence of other factors each share has the same value
since each share is entitled to receive the same dividend and the
same distribution on the wind up of the company. Thus, the starting
point is that normally 51% of the shares would be worth more than
49%.190
The valuation report prepared by KWI’s expert witness contemplated discounts in share
value for both lack of control and lack of marketability, and had concluded that Kruger’s 51% of
the shares of KWI were worth between 41% and 43% of KWI’s outstanding share capital as a
whole.191 After reiterating its findings with respect to the essence of paragraph 256(1.2)(g)
(namely, that control premiums or discounts are not to be considered in the analysis), the Court
stated the following with respect to the relevance of marketability considerations to the required
analysis, and the necessity of assigning the same value to each outstanding share:
Based on Mr. Lafontaine's report, there appears to be some overlap
between the lack of marketability and the issues relating to control
given that he indicates that the discount for the lack of marketability
is greater for a minority interest, about 40%, than for a controlling
187
Wayagamack, supra note 50 at para 95.
188
Ibid at para 116.
189
Ibid at para 95.
190
Ibid at para 97.
191
Ibid at para 102.
LEGAL_24490030.12
- 61 interest where it is about 25%. However, given that we must assume
shares to be non-voting, any such marketability difference resulting
from control must be also ignored.
The factors leading to a lack of marketability and liquidity also apply
equally to the shares as a whole and the shares held by Kruger —
there are relatively few buyers and even more so given the financial
difficulties. As a result, any such discount should be applied to the
entire share value and can not be applied only in assessing the value
of Kruger's shares. 192
Finally, the Court considered whether certain provisions of the USA to which KWI,
Kruger and SGF were parties – in particular, the put right enjoyed by SGF to be able to require
Kruger, under certain circumstances, to acquire its 49% shareholding interest – caused SGF’s
49% of the shares of KWI to be worth more than Kruger’s 51% of the shares of KWI.
Ultimately, the Court declined to ascribe any value to the put right on the basis that it was only
available to SGF, and not to any subsequent holder of the shares, which, the Court determined,
was a necessary pre-condition for purposes of the hypothetical buyer that is to be utilized in the
context of a “fair market value” determination.193
In addition to the insights offered with respect to the valuation exercise under paragraph
256(1.2)(c), the Wayagamack decision also serves as an important reminder of how the myriad
deeming provisions in the associated corporation rules may result in a finding of control (and
thus association), notwithstanding the careful planning efforts that may have been undertaken (in
Wayagamack, by way of a carefully crafted unanimous shareholder agreement) to avoid control
under general principles.
Finally, in the trust context, the CRA has expressed the view that co-trustees of two
different trusts will be considered to be the same person for the purposes of applying paragraph
256(1.2)(c). Thus, where one of the trusts owns shares representing more than 50% of the fair
market value of all of the issued and outstanding shares of one corporation and the other trust
owns shares representing more than 50% of the fair market value of all of the issued and
outstanding shares of the second corporation, the CRA asserts that the two corporations will be
associated by operation of 256(1.2)(c), unless subsection 256(4) is satisfied.194
Paragraph 256(1.2)(d) establishes a “corporate look-through rule” to be applied when
assessing who holds the shares of a corporation. The paragraph provides that where shares of the
capital stock of a corporation are owned or deemed by subsection 256(1.2) to be owned at any
time by another corporation (the “holding corporation”), those shares are deemed to be owned at
that time by any shareholder of the holding corporation in a proportion equal to (i) the fair
192
193
194
Ibid at paras 113-4.
It appears that the Court’s willingness to at least consider SGF’s put entitlement for purposes of this required valuation
analysis was based on its inclusion in a constitutional document (i.e., the USA), although this was not expressly noted.
CRA document no. 9510645, June 29, 1995.
LEGAL_24490030.12
- 62 market value of the shares of the capital stock of the holding corporation owned (or deemed for
the purposes of subsection 256(1.2) to be owned) 195 at that time by the shareholder, divided by
(ii) the fair market value of all of the issued shares of the capital stock of the holding corporation
outstanding at that time. It is instructive to note that the apportionment of indirect shareholdings
is premised on the relative fair market value of the shares held by a particular shareholder in the
holding corporation.196
Paragraph 256(1.2)(e) similarly provides a “partnership look-through rule”. The
paragraph provides that where, at any time, shares of the capital stock of a corporation are
property of a partnership, or are deemed by subsection 256(1.2) to be owned by the partnership,
those shares are deemed to be owned at that time by each member of the partnership in a
proportion equal to the (i) the member’s share of the income or loss of the partnership for its
fiscal period that includes that time, divided by (ii) the income or loss of the partnership for its
fiscal period that includes that time. (It is interesting to note that the paragraph refers to
“property of a partnership”, rather than stock owned by the partnership. Quaere whether this is
motivated by a concern that a partnership is not a separate juridical entity and, therefore, is not
capable of maintaining distinct ownership of property in its own name?)
In contrast to paragraph 256(1.2)(d), which apportioned indirect shareholdings through a
holding corporation on the basis of the fair market value of the shares held by the holding
corporation, paragraph 256(1.2)(e) instead apportions indirect shareholdings on the basis of the
relative entitlement of a member of the partnership to the income or loss of the partnership for
the relevant fiscal period. Quaere whether this is an appropriate apportionment mechanism where
the value of the capital of the partnership is significant, and material income or losses of the
partnership are only expected to be triggered in the terminal year of the partnership? Moreover,
many partnerships allocate income on the basis of multi-tiered “waterfall” provisions. In the
context of applying such “waterfalls”, it may be difficult to determine a particular member’s
share of the income or loss of the partnership in respect of a particular fiscal period in advance of
the end of the fiscal period, as such entitlements could change dramatically from year to year.
Where the income or loss of a partnership for a fiscal period is nil, for the purpose of
applying paragraph 256(1.2)(e), the deemed ownership of shares of an underlying corporation is
to be computed as if the partnership had income for the relevant fiscal period of $1,000,000.197
Paragraph 256(1.2)(f) effectively provides a “trust look-through rule” that deems certain
beneficiaries of a trust to hold shares owned by the trust. In particular, where shares of a
corporation are owned, or are deemed by subsection 256(1.2) to be owned, at any time by a trust,
the following rules apply:
195
Although the failure of Parliament to expressly reference deemed ownership in this regard may raise certain interpretive
questions.
196
Quaere whether this is the appropriate result where a particular shareholder holds “tracking” preferred shares in a
holding corporation, the entitlements of which expressly track the performance and asset value of an underlying
subsidiary corporation?
197
See the post-amble to paragraph 256(1.2)(e).
LEGAL_24490030.12
- 63 (i)
where the trust is a testamentary trust under which one or more
“beneficiaries” are entitled to receive all of the income of the trust that
arose before the date of death of one of the last surviving of such
beneficiaries (the “distribution date”), and no other person could, before
the distribution date, receive or otherwise obtain the use of any of the
income or capital of the trust,
(A)
where any such beneficiary’s share of the income or capital from the
trust depends on the exercise by any person of, or the failure by any
person to exercise, any discretionary power, the shares are deemed
to be owned at any time before the distribution date by the
beneficiary, and
(B)
where clause (A) above does not apply, the shares are deemed to be
owned at any time before the distribution date by any such
beneficiary in a proportion equal to the fair market value of the
beneficial interest of the beneficiary in the trust, divided by the fair
market value of the beneficial interest in the trust of all of the subject
beneficiaries. 198
(ii)
Subsequent to January 1, 2016, subparagraph 256(1.2)(f)(ii) will provide
that where a beneficiary’s share of the accumulating income or capital
from a trust depends on the exercise by any person of, or the failure by any
person to exercise, any discretionary power, the relevant shares owned by
the trust are deemed to be owned at that time by the beneficiary.
(iii)
Where subparagraph (ii) does not apply, subparagraph 256(1.2)(f)(iii) will
provide that a beneficiary of a trust is deemed at that time to own the
proportion of those shares owned by the trust equal to the fair market
value of the beneficial interest of the beneficiary in the trust, divided by
the fair market value of all beneficial interests in the trust; and
(iv)
In the case of a trust referred to in subsection 75(2), the person referred to
in subsection 75(2) from whom property of the trust, or property for which
it was substituted, was directly or indirectly received is deemed to own the
shares owned by the trust at that time.
The references to “discretionary power” in paragraph 256(1.2)(f) raise the prospect of
overlapping deemed ownership of shares in circumstances where there are multiple beneficiaries
of a trust and the exercise of the discretionary power of the trustee or other relevant person could
vest entitlement to the income or capital of the trust in more than one beneficiary. The Technical
Notes released by the Department of Finance at the time of the introduction of paragraph
198
This particular deeming rule will soon only be of historical interest, as Bill C-43, which provides for the repeal of
subparagraph 256(1.2)(f)(i), received Royal Assent on December 16, 2014.
LEGAL_24490030.12
- 64 256(1.2)(f) confirmed that the “results of the application of these provisions may be that more
than one person can be deemed to own the same shares at the same time”.199
Central to the operation of the look-through rules in subsection 256(1.2)(f) is the concept
of whether one is a “beneficiary” of a particular trust. While the term “beneficiary” is defined in
subsection 108(1), the statutory definition is expressed only to apply in respect of Subdivision k
of Part I of Division B (i.e., in respect of sections 104 through 108). Subsection 248(25) further
sets out the circumstances under which a person or partnership may be considered to be
“beneficially interested” in a particular trust. Historically, the CRA suggested that neither the
definition of a “beneficiary” in subsection 108(1), nor the concept of “beneficially interested”
described in subsection 248(25), would apply in interpreting paragraph 256(1.2)(f) on the basis
that the definition of a “beneficiary” only applied in respect of a limited number of other sections
of the Act and the term “beneficially interested” is not used in paragraph 256(1.2)(f). 200
However, the judgment rendered by the Federal Court of Appeal in Propep,201 casts the
correctness of this interpretation into some doubt. In Propep, all of the taxpayer’s voting shares
were owned by another corporation, 9059-3179 Quebec Inc. (“9059”), which, in turn, was owned
by a trust formed under the laws of Québec (the “Trust”). The Trust deed designated 9059 as
the “first-ranking beneficiary” of the Trust, and a son of a trustee (who was under the age of
eighteen) as the “second-ranking beneficiary” of the Trust.202 The Trust deed also required the
trustees to hold the trust capital until such time as 9059 was wound-up, although the trustees
were given discretion to pay to the beneficiaries, or to any one of them, all or part of the net
annual income of the trust.203
The parties agreed that if the second-ranking beneficiary was found to be a beneficiary of
the Trust, then the taxpayer would be associated with the other two corporations in question (by
operation of subparagraph 256(1.2)(f)(ii) and subsection 256(1.3)).
The Federal Court of Appeal found that the trustees of the Trust could, in their discretion
(and at a time of their choosing), cause a wind-up of 9059, which, under the terms of the Trust,
would have the effect of making the second-ranking beneficiary the sole beneficiary of the Trust.
Since the trustees could benefit the second-ranking beneficiary, the Court ruled that the shares of
9059 were deemed to be owned by the second ranking beneficiary under subparagraph
256(1.2)(f)(ii) and, therefore, were deemed to be owned by the father of the second ranking
beneficiary under subsection 256(1.3).
In its consideration of the question of whether the second-ranking beneficiary constituted
a “beneficiary” for purposes of the trust-related provisions in subsection 256(1.2), the Tax Court
199
Canada, Department of Finance, Securing Economic Renewal, February 10, 1988 at 59 <available at
http://www.budget.gc.ca/pdfarch/1988-pap-eng.pdf > [Technical Notes 1988].
200
See, for example, CRA document no. 2004-0086891C6, October 8, 2004 and CRA document no. 2006-0195971C6,
October 6, 2006.
201
Propep Inc. v The Queen, 2009 FCA 274, 2010 DTC 5088 rev’g 2008 TCC 532 [Propep].
202
Ibid at para 7.
203
Ibid at para 8.
LEGAL_24490030.12
- 65 of Canada held that the definition of “beneficially interested” in subsection 248(25) was not
relevant to the analysis, since the expression “beneficially interested” is not used in paragraph
256(1)(c), or subsections 256(1.2) or 256(1.3).204 The Federal Court Appeal, however, disagreed
with this conclusion, stating that:
With respect, the expression “beneficially interested” does not have
to be reproduced in each provision where it is likely to be applied.
This concept applies each time the question arises whether a person
is “beneficially interested” in a particular trust. A person who has a
contingent right to the capital or income of a trust is “beneficially
interested” for the purposes of the Act.205
Accordingly, one must exercise caution in determining who may constitute a “beneficiary” of a
trust for the purposes of applying paragraph 256(1.2)(f).
The CRA has issued technical interpretations that suggest that the CRA is inclined to
attempt to interpret the concept of a “beneficiary” as broadly as permitted by the law. For
instance, the CRA has suggested that an individual may be considered to be a beneficiary of a
discretionary trust even if the trustee of the trust may only allocate income or capital of the trust
to the particular individual upon his or her attaining the age of maturity. According to the CRA,
the fact that the beneficiary’s right to receive income or capital from a trust is subject to a future
condition would not affect the person’s status as a beneficiary of the trust. In the CRA’s view, “a
beneficiary of a trust is a person (other than a protector) who has a right to compel the trustee to
properly enforce the terms of the trust, regardless of whether that person’s right to any of the
income or capital is immediate, future, contingent, absolute or conditional on the exercise of
discretion by any person”. 206
Finally, paragraph 256(1.2)(g) provides that, when determining the fair market value of a
share of the capital stock of a corporation for the purposes of assessing whether particular
corporations are associated, all issued and outstanding shares of the capital stock of the
corporation are to be deemed to be non-voting. The Technical Notes issued by the Department
of Finance at the time paragraph 256(1.2)(g) was first introduced state that:
New paragraph (1.2)(g) provides that the various fair market
valuations that may be required to be made under the new “lookthrough” or attribution rules are to be made without regard to the
voting attributes of all shares of the capital stock of a corporation.
Particularly in the case of closely held private corporations,
204
Ibid at para 22.
205
Ibid at para 24.
206
See, for example, CRA document no. 2005-0112511E5, May 2, 2006.
LEGAL_24490030.12
- 66 assigning a value to such voting rights could be very difficult and
result in inappropriate consequences.207
In effect, paragraph 256(1.2)(g) is intended to preclude majority premiums, minority
discounts, or other valuation adjustments attributable to differing voting percentages from being
factored into the relevant valuation analysis.
As noted above, the Tax Court recently had occasion to consider the application of
paragraph 256(1.2)(g) in Wayagamack and reasoned that the effect of the paragraph is to require
assessments of fair market value to be undertaken on the basis of expected financial returns in
respect of the relevant shares and without regard to any influence that a shareholder may have
over control of the corporation.208 The Tax Court expressly stated that “the effect of paragraph
256(1.2)(g) of the Act is to do away with any consideration of control...the valuation can not
[sic] take account of any premium or discount for control or the absence of control”. 209
For the purpose of applying the interpretive rules contained in subsection 256(1.2) (and
notwithstanding the further interpretive rules described in subsection 256(1.4) below), subsection
256(1.6) provides that any share that is a “distress preferred share”, or a share of a “specified
class” (as defined in subsection 256(1.1)), is deemed not to have been issued and outstanding and
not to be owned by any shareholder, and an amount equal to the greater of the paid-up capital of
the share and the amount, if any, that any holder of the share is entitled to receive on the
redemption, cancellation or acquisition of the share by the corporation is deemed to be a liability
of the corporation. The Technical Notes issued by the Department of Finance at the time of the
introduction of subsection 256(1.6) indicate that these deeming rules were aimed at altering the
fair market valuations required under subsection 256(1.2).210
Subsection 256(1.3) provides a further deeming rule that has the effect of deeming
parents to own the shares owned by certain minor children for the purposes of assessing whether
two corporations are associated. Specifically, subsection 256(1.3) provides that:
Where at any time shares of the capital stock of a corporation are
owned by a child who is under 18 years of age, for the purpose of
determining whether the corporation is associated at that time with
any other corporation that is controlled, directly or indirectly in any
manner whatever, by a parent 211 of the child or by a group of persons
of which the parent is a member, the shares shall be deemed to be
owned at that time by the parent unless, having regard to all the
circumstances, it can reasonably be considered that the child
207
Technical Notes 1988, supra note 199.
208
Wayagamack, supra note 50 at para 118.
209
Ibid at para 110.
210
Technical Notes 1988, supra note 199 at 60.
211
For the purposes of this section, a “parent” is defined in paragraph 252(2)(a).
LEGAL_24490030.12
- 67 manages the business and affairs of the corporation and does so
without a significant degree of influence by the parent.
It is interesting to note that it is possible that, where a child under the age of 18 is a
beneficiary of a discretionary trust, the combined operation of paragraph 256(1.2)(f) and
subsection 256(1.3) may be to deem a parent to hold shares that are held by a trust even if the
parent has no beneficial entitlement to such shares. Certain taxpayers have complained that this
is an unintended consequence of the combined operation of the two provisions. However, while
the CRA has confirmed that the sections operate in the manner described, the Agency has
indicated that the result appears to reflect the intentions of Parliament.212 With respect to the
exclusionary language at the end of subsection 256(1.3), the CRA and the courts have yet to
consider an express fact pattern involving a child managing the business and affairs of a
corporation without a significant degree of influence by the parent such that the exclusionary
language would apply.
Subsection 256(1.4) provides further deeming rules that apply when determining whether
a corporation is associated with another corporation with which it would not otherwise be
associated. Specifically, where a person or any partnership in which the person has an interest
has a right at any time under a contract, in equity or otherwise, either immediately or in the
future and either absolutely or contingently,
(a)
to, or to acquire, shares of the capital stock of a corporation, or to control the voting
rights of shares of the capital stock of a corporation, the person or partnership will,
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 own the shares at that time, and the shares will be deemed to be issued
and outstanding at that time, or
(b)
to cause a corporation to redeem, acquire or cancel any shares of its capital stock
owned by other shareholders of a corporation, the person or partnership will, 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 at that time to have the same position in relation to control of the
corporation and ownership of shares of its capital stock as if the shares were
redeemed, acquired or cancelled by the corporation.
It is interesting to observe the similarities and differences between subsection 256(1.4)
and subparagraphs 251(5)(b)(i) and (ii). While certain of the variances in wording between the
two sets of provisions may simply be attributable to the structure of the broader sections and the
reference to partnerships in subsection 256(1.4), quaere whether more meaningful interpretive
distinctions were intended? (However, the Technical Notes issued by the Department of Finance
that accompanied the introduction of subsection 256(1.4) did indicate that the subsection was
212
See, for example, CRA document no. 9219885, August 21, 1992. See also CRA document no. 9410075, April 25,
1994.
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- 68 intended to incorporate the “special rules in paragraph 251(5)(b), as amended, dealing with rights
to acquire shares”.)
Subsection 256(1.5) imposes a “self relation rule” that provides that, for the purposes of
the associated corporation provisions, where a person owns shares in two or more corporations,
the person will, as shareholder of one of the corporations, be deemed to be related to himself,
herself or itself as shareholder of each of the other corporations. In this regard, the wording of
subsection 256(1.5) and paragraph 251(5)(c) is functionally identical.
Subsection 256(2) provides a transitivity deeming rule that stipulates that where (i) two
corporations would otherwise not be associated with each other at any time, and (ii) such
corporations are associated, or are deemed by subsection 256(2) to be associated, with the same
corporation at that time, they will, for the purposes of the Act be deemed, with one exception, to
be associated with each other at that time. In contrast to the transitivity rule in subsection
251(3), the express wording of subsection 256(2) provides that the transitivity rule will apply
where two corporations are deemed by the transitivity rule itself to be associated with the same
corporation.
The one exception to the application of subsection 256(2) is that, for the purposes of
section 125 and the computation of the small business deduction, where the common third
corporation is not a CCPC at the relevant time, or it elects, in prescribed form, for its taxation
year that includes that time, not to be associated with either of the two other corporations, the
third corporation will be deemed not to be associated with either of the other two corporations in
that taxation year and its “business limit” for that taxation year will be deemed to be nil. The
practical effect of this exclusionary language is that both of the two other corporations may
continue to claim the small business deduction, provided that the common third corporation
foregoes access to the small business deduction. The CRA has observed that the election to opt
out of the application of the transitivity rule in subsection 256(2) only applies for the purposes of
section 125, and not for the purposes of subsection 129(6).213 The CRA has also indicated that
multiple elections may be made under subsection 256(2) where there are more than three
corporations in a single corporate group.214
Associated Corporation Anti-Avoidance Rule
Subsection 256(2.1) contains a broadly worded anti-avoidance rule that provides that
where it may reasonably be considered that one of the main reasons for the separate existence of
two or more corporations in a taxation year is to reduce the amount of taxes that would otherwise
be payable under the Act, or to increase the amount of refundable investment tax credits that may
be claimed under section 127.1, the corporations will be deemed to be associated with each other
in the year. Subsection 256(2.1) replaced a substantially similar anti-avoidance rule that was
previously contained in former subsection 247(2).
213
See, for example, CRA document no. 2010-0387591E5, December 22, 2010.
214
See, for example, CRA document no. 2003-0038235, October 8, 2003.
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- 69 The Department of Finance Technical Notes that accompanied the introduction of new
subsection 256(2.1) provided some insight into the purpose of the anti-avoidance rule. The
Technical Notes stated that the rule is “intended to apply where two or more corporations are not
otherwise associated but one of the main reasons for their separate existences may reasonably be
considered to be to duplicate the small business deduction or increase their refundable
investment tax credits”. By way of example, the Department of Finance indicated that the antiavoidance rule would apply:
where two parts of what could reasonably be considered to be one
business, such as the manufacturing and sales activities of a single
business, were carried on by two corporations each of which was
controlled by different persons. In such a case, where it is
reasonable to conclude that the separate existence of the
corporations was mainly tax motivated, the corporations will be
treated as associated with each other. As a result, only one small
business deduction will be allowed in respect of the income
generated by the business. 215
Subsection 256(2.1) (and its predecessor in subsection 247(2)) have been the subject of
much jurisprudence. Both the courts and the CRA have repeatedly stated that the application of
subsection 256(2.1) is a question of fact. 216 By its very words, subsection 256(2.1) is focused on
what may reasonably be considered to have motivated the separate existence of the corporations
that the Minister asserts should be deemed to be associated. The use of the phrase “reasonably
be considered” denotes that an objective standard of review must be applied to assess whether
one of the main reasons for the separate existence of the corporations in question was to reduce
the amount of taxes that would otherwise be payable under the Act or to increase the amount of
refundable available investment tax credits under section 127.1.
It is instructive to note that the analysis focuses on the reasons for the separate existence
of the corporations in the taxation year. This is to be contrasted with the reasons for the initial
formation of the separate corporations, although such reasons may have endured from the date of
incorporation of the companies through the relevant taxation year. 217
The courts have held that the relevant analysis requires the determination of whether one
of the main reasons for the separate existence of the subject corporations was to reduce tax or
increase refundable investment tax credit entitlements. In Lenco Fibre Canada Corp. v The
215
Technical Notes 1988, supra note 199 at 61.
216
See CRA document no. 2011-0394471I7, June 17, 2011; CRA document no. 2000-0038625, July 26, 2000; CRA
document no. 9927305, October 19, 1999; Hughes Homes Inc. v The Queen, 98 DTC 1082, 1997 CarswellNat 1513,
[1998] 1 CTC 2367 (TCC).
217
See, for example, Maintenance Euréka Ltée v The Queen, 2011 TCC 307, 2011 DTC 1319 at para 24 [Maintenance
Euréka].
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- 70 Queen,218 the court expanded on the meaning of a “main reason” in this context. In particular,
the court stated that:
…the word “main” must be given its significance. In the French
language version of the statute, the corresponding word is
“principaux”. Not every reason will meet this standard. Thus, even
where the reduction of taxes payable is a reason, a judgment must
still be made as to whether it was a main or principal reason. 219
Similarly, the courts have also suggested that the use of the phrase “main reasons” is
intended to capture “the principal or paramount reasons” for the separate existence of the
relevant corporations. 220 In operational terms, the courts have suggested that the test to be
applied in assessing whether one of the main reasons for the separate existence of multiple
corporations was to achieve one of the enumerated tax advantages may rightly be expressed as
whether “if there had been no tax advantage, would the plan have been adopted in any event?” 221
A taxpayer must take a number of steps to successfully contest a reassessment predicated
on the application of subsection 256(2.1). The courts have provided that the Minister may infer
from the facts disclosed during the course of an audit that one of the main reasons for the
separate existence of two corporations is to reduce tax or increase an entitlement to refundable
investment tax credits.222 The courts have then suggested that it is up to the taxpayer to refute
the factual assumptions relied on by the Minister in support of the assessment, or show that those
assumptions do not support the Minister’s conclusions. It is also open to taxpayers to prove
other facts that contradict the Minister’s conclusions with respect to the main reasons for the
separate existence of the subject corporations. 223
The courts have repeatedly cited the following enunciation of the relevant principles by
Justice Marceau in The Queen v Covertite Ltd.:224
The Minister has inferred from a certain number of facts that the
saving of taxes, which was actually realized, was not a mere side
effect but rather one of the main goals contemplated by the
individuals acting behind the corporations. In verifying the
conclusion, the Court cannot but adopt an approach similar to that
followed by the Minister, the mere denial of the taxpayer, whether
or not accompanied by a simple indication of the other causes that
could have prevailed, can be given no weight. Being a mere
218
[1979] 3 ACWS 318, 79 DTC 5292 (FCTD).
219
Ibid at para 4.
220
McAllister Drilling Ltd. v The Queen, 95 DTC 5001 (FCTD) at para 11 [McAllister].
221
See, for example, MNR v Furnasman Ltd., 73 DTC 5599 (FCTD) at para 31.
222
McAllister, supra note 220.
223
Ibid.
224
81 DTC 5353 (FCTD).
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- 71 assertion of a negative fact, and a fact which has to do with the state
of mind of the witness, it can have no convincing probative force; it
cannot constitute the proof required to annihilate the conclusion of
the Minister. To succeed, the taxpayer must: (a) disprove the facts
assumed by the Minister in reaching his conclusion; or (b) convince
the Court that the inferences drawn by the Minister from the facts
assumed were unreasonable and unwarranted; or (c) add further
facts capable of changing the whole picture and leading to different
inferences pointing to the conclusion that the other reasons alleged
have actually been prevalent.225
A review of past jurisprudence suggests that taxpayers have succeeded in contesting an
assessment made on the basis of subsection 256(2.1) where they have been able to provide
sufficient evidence that the main reasons for the existence of two or more corporations are asset
protection, activity diversification, decentralization for greater profit, a spouse’s intent to operate
his or her own business, or estate planning, among other bases. 226 Ultimately, however, a proper
determination of whether an assessment under subsection 256(2.1) is justified is dependent on
the relevant facts and the credibility of the evidence offered by the taxpayers.
Associated Corporations: Saving Provisions
The Act contains select provisions that deem corporations that would otherwise be
considered to be associated for the purposes of the Act not to be associated with each other in a
particular taxation year.
Subsection 256(3) can deem two corporations not to be associated where the relationship
of control giving rise to the association is in place simply to secure certain indebtedness or share
repurchase obligations. Specifically, subsection 256(3) provides that where one corporation (the
“controlled corporation”) would, but for the subsection, be associated with another corporation in
a taxation year by reason of being controlled, directly or indirectly in any manner whatever, by
the other corporation or by reason of both corporations being controlled, directly or indirectly in
any manner whatever, by the same person at a particular time in the year (such controlling
person or corporation being the “controller”) and it is established to the satisfaction of the
Minister that:
(a)
225
226
there was in effect at the particular time an agreement or arrangement enforceable
according to its terms, under which, on the satisfaction of a condition or the
happening of an event that it is reasonable to expect will be satisfied or happen, the
controlled corporation will:
Ibid at para 4. The Federal Court - Trial Division subsequently suggested that, where the credibility of witnesses is
conceded and the taxpayer’s evidence is accepted by the court as credible, the taxpayer will not be required to cite
external facts to corroborate his/her expressed views. See, for example, McAllister, supra note 220 at para 8.
Maintenance Euréka, supra note 217 at para 25.
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- 72 -
(b)
(i)
cease to be controlled, directly or indirectly in any manner whatever, by
the controller, and
(ii)
be or become controlled, directly or indirectly in any manner whatever, by
a person or group of persons with whom or with each of the members of
which, as the case may be, the controller was at the particular time dealing
at arm’s length, and
the purpose for which the controlled corporation was at the particular time so
controlled with the safeguarding of rights or interests of the controller in respect of
(i)
any indebtedness owing to the controller the whole or any part of the
principal amount of which was outstanding at the particular time, or
(ii)
any shares of the capital stock of the controlled corporation that were
owned by the controller at the particular time and that were, under the
agreement or arrangement, to be redeemed by the controlled corporation
or purchased by the person or group of persons referred to in subparagraph
(a)(ii) above,
the controlled corporation and the other corporation will be deemed not to be associated with
each other in the relevant taxation year.
A number of preconditions must be satisfied for the relief provided in subsection 256(3)
to apply. First, there must be an express agreement or arrangement, enforceable according to its
terms, that provides that, upon the satisfaction or happening of an identifiable condition or event,
the controlled corporation will cease to be controlled by the controller and will commence to be
controlled in fact by a person or group of persons with whom the controller deals at arm’s length.
Second, the condition or event that will result in a change in the factual control of the controlled
corporation must be “reasonable to expect will be satisfied or happen”. Third, the purpose for
which factual control over the controlled corporation was vested with the controller must have
been to “safeguard” the rights or interests of the controller with respect to outstanding
indebtedness owed to the controller or any shares of the capital stock of the controlled
corporation that were owned by the controller and were, under the relevant agreement or
arrangement, to be redeemed by the controlled corporation or purchased by the person or group
of persons that will subsequently obtain factual control of the controlled corporation. The onus
rests with the taxpayer to demonstrate that each of the foregoing conditions have been satisfied
for the deeming relief provided under subsection 256(3) to apply in respect of any given pair of
corporations.
Subsection 256(4) provides an additional saving provision that relates to circumstances
involving corporations controlled by common executors, liquidators of a succession or trustees.
The subsection provides that where two corporations would, but for the subsection, be associated
with one another in a taxation year by reason of both corporations being controlled by the same
executor, liquidator of a succession or trustee, and it is established to the satisfaction of the
Minister (a) that the executor, liquidator or trustee did not acquire control of the corporations as a
result of one or more estates or trusts created by the same individual or two or more individuals
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- 73 not dealing with each other at arm’s length, and (b) that the estate or trust under which the
executor, liquidator, or trustee acquired control of each of the corporations arose only on the
death of the individual creating the estate or trust, the two corporations will be deemed not to be
associated with each other in the relevant taxation year.
Once again, for the relief provided in subsection 256(4) to apply, the relevant taxpayers
are required to demonstrate the existence of a number of facts. First, the executor, liquidator or
trustee must not have acquired control of the corporations as a result of one or more estates or
trusts created by the same individual or two or more individuals not dealing with each other at
arm’s length. Second, the estate or trust under which the executor, liquidator or trustee acquired
control of the corporations must have arisen only on the death of the individual creating the
estate or trust and not at some subsequent point of time.
With respect to the application of both subsections 256(4) and (5), it is important to note
that taxpayers are required to establish the requisite facts “to the satisfaction of the Minister”. As
a consequence, a certain degree of discretion rests with the Minister to determine whether
sufficient evidence has been provided by the taxpayer to support its assertion that the factual
preconditions to the relieving provisions have been satisfied. While the discretion of the
Minister is tempered by principles of procedural fairness and other canons of prevailing
administrative law, the Act does not precisely set out limits on what the Minister can require
prior to accepting that the relief provided by the deeming rules under subsections 256(3) or (4)
should apply.
Finally, subsection 256(5) contains a saving provision that applies in the context of
corporations controlled by commercial trustees. The subsection provides that where a particular
corporation would, but for the subsection, be associated with another corporation in a taxation
year solely by reason of the other corporation being the trustee of a trust that controls the
particular corporation, the two corporations will be deemed not to be associated with each other
in the year unless, at any time in the year, a settlor of the trust controls or is a member of a
related group that controls the corporation that is the trustee under the trust.
Common Traps and Pitfalls
Over the years, the application of the associated corporation rules has given rise to a
number of unintended consequences. The sheer breadth of the rules, coupled with the ingenuity
of taxpayers attempting to circumvent the rules, has led to the introduction of a number of
special deeming rules, as well as several saving provisions, designed to address perceived
shortcomings in the existing statutory regime.
Tax practitioners should specifically be conscious of the following complexities and
pitfalls that arise in determining whether two or more corporations are associated.
(i) “Specified Class” of Shares
As previously noted, where a particular person owns shares of a “specified class” of the
capital stock of a corporation, such shares are frequently ignored when assessing share
ownership for the purposes of subsection 256(1). Many taxpayers have run into difficulty by not
paying sufficient heed to the restrictions on the dividends that may be payable on such shares and
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- 74 the manner in which such dividend entitlements are expressed when establishing the terms of the
class of shares that they wish to qualify as a “specified class”. Floating dividend entitlements, or
any other form of dividend entitlement that is not fixed and based on the applicable prescribed
rate, can result in a class of shares that might otherwise be “a specified class” not satisfying the
operative requirements. Similarly, contingent voting obligations or conversion rights, which
may be embedded deep within the constating documents of a corporation, can inadvertently
result in a class of shares not qualifying as a “specified class”. Finally, agreements in respect of
shares must carefully be considered to ensure that their terms do not result in a class of shares
that would be a “specified class”, based on the constating documents of the corporation alone,
not qualifying as a “specified class”.
(ii) Share Valuation Considerations
Subsection 256(1.2) contains special rules that deem a corporation to be controlled by a
person or group of persons where shares of the corporation having a fair market value of more
than 50% of the fair market value of all of the issued and outstanding capital stock of the
corporation, or common shares of the corporation having a fair market value of more than 50%
of the fair market value of all of the issued and outstanding common shares of the corporation,
are owned by that person or group of persons. Similarly, the “look-through” rules contained in
paragraphs 256(1.2)(d) and (f) apportion indirect shareholdings based on the fair market value of
the relevant equity interests in the applicable holding entity.
The valuation of shares, particularly in the context of privately-held corporations, can be
a difficult task. Moreover, additional deeming rules that require all stock to be assumed to be
non-voting shares eliminate many of the valuation principles that frequently are employed in
valuing private corporation shares. In assessing whether two corporations are associated with
one another, a full appreciation of the value of such shares must be obtained and, in
circumstances where a particular shareholding would appear to approach the operative 50%
threshold, additional supporting documentation or valuation assistance should potentially be
obtained.
(iii) Associated Corporations and Trusts
The “look-through” and other deeming rules in section 256 relating to the relationship
between trusts and corporations are quite complicated and require a keen appreciation of both the
terms of a particular trust agreement (e.g., whether rights under the operative trust indenture are
dependent on the exercise of discretion by a person) and the differing entitlements to income and
capital of beneficiaries under the particular trust. Furthermore, lingering debate about the
universe of persons that may be considered to be a “beneficiary” under a particular trust for the
purposes of section 256 adds further interpretative ambiguity to an already complex statutory
framework. Finally, given that a trustee may control the shares that comprise the property of a
trust, it is possible for both a trustee and one or multiple beneficiaries of a trust to simultaneously
control or be deemed to control a particular corporation. Great care must be taken in assessing
whether particular corporations are considered to be associated with one another for the purposes
of the Act where shares or rights are owned directly or indirectly by a trust.
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- 75 (iv) Options and Rights
Subsection 256(1.4) contains a broadly worded pair of deeming rules, comparable in
many respects to the deeming rules contained in paragraph 251(5)(b), that deem particular
persons that possess certain acquisition or compulsion rights to own shares, or to be in the same
ownership or control position as if certain redemption, acquisition or cancellations of shares had
occurred. Such rights can arise under constating documents of the corporation or private
agreements and may be contingent on remote events. Certain rights that could give rise to
deemed ownership or control positions under subsection 256(1.4) may also not be top of mind to
many taxpayers, including rights arising from conventional powers of attorney or shareholder
agreements. When performing an associated corporations analysis, tax practitioners must take
all reasonable efforts to catalogue the universe of outstanding rights with respect to the shares of
a corporation, wherever situated, to ensure that all possible bases for association are identified.
(v) Documentation and Anti-Avoidance Rules
Subsection 256(2.1) contains an expansive anti-avoidance rule that permits the Minister
to assert that two corporations are associated with one another where one of the main reasons for
their separate existence is to reduce tax payable or increase entitlement to refundable investment
tax credits. The courts have clearly stated that the onus rests with the taxpayer to demolish the
assumptions of the Minister with respect to the main reasons for the separate existence of two or
more corporations. The courts have further ascribed little weight to the statements made by
taxpayers in support of the historical reasons for maintaining separate corporations. As a
consequence, when the separate existence of corporations is being maintained for legitimate,
non-tax reasons, it is important for appropriate contemporaneous documentation and evidence to
be assembled, substantiating the thinking that prevailed during the relevant year, in order to place
the taxpayer in a position to meaningfully contest any potential assertions by the Minister that
subsection 256(2.1) should apply to deem the corporations to be associated.
Conclusion
The sheer density of the Act frequently makes it challenging to identify “associated
corporations”, “affiliated” persons, and “related” persons, even in the most straightforward of
circumstances. Tax practitioners must carefully review the latest versions of each of sections
251, 251.1 and 256, along with the supporting interpretive provisions of the Act, to ensure that
they have properly characterized the relationships of their clients with all potentially connected
persons. While an ever-growing body of CRA administrative statements and jurisprudence has
clarified certain aspects of the relational rules, such statements have also raised other areas of
interpretive ambiguity or questioned past prevailing modes of historical thought.
Nevertheless, despite the inherent complexity of the relational rules in the Act, certain
common themes pervade each of the three concepts. An understanding of the basic architecture
of how the relevant provisions operate should provide most tax practitioners with a solid basis
for beginning any analysis of the relationship between a taxpayer and persons potentially
connected with it. Ultimately, however, as this paper demonstrates, there is no substitute for
carefully considering the actual text of the relevant statutory provisions in the context of any
particular case.
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