A CCPC classification is attractive for
a variety of tax reasons, including the preferential small business deduction
and the heightened SRED investment tax credit (ITC) of 35 percent (rather than
20 percent). The decision in Bioartificial
Gel Technologies Inc. (2012 CCI 120) is of particular significance, because
the TCC in Bagtech concluded that a
unanimous shareholder agreement (USA) resulted in CCPC classification although
on the facts more than 50 percent of the corporation’s shares were held by
non-residents. (The TCC in Ekamant Canada
Inc. (2009 TCC 408) concluded that there was no USA on the facts in that
case.)
Bagtech was incorporated under the CBCA and
in 2004 and 2005 claimed the 35-percent SR&ED ITC rate as a CCPC.
Non-residents held 62.52 and 70.42 percent respectively of its voting shares, but
pursuant to a USA the actual right to elect the majority of the directors was
held by Canadian residents.
The concept of control is central to the
CCPC definition in section 127. The term control itself is not defined in the Act
and thus the courts have been left to wrestle with its meaning. For purposes of
a CCPC, control is subdivided into a de
jure test (control in law) and a de
facto test (control in fact). Whenever the Act refers to a corporation as
being controlled “directly or indirectly in any manner whatever”, the de facto test for control is triggered:
otherwise the only appropriate test of control is the de jure test. Due to the foreign ownership of Bagtech’s shares, the
relevant provision to determine control was
paragraph (b) of the CCPC definition in 125(7), which calls for the de jure test for control.
When determining de jure control under paragraph (b) of the CCPC definition, it is
important to note that that paragraph creates an important legal fiction: all
the shares held by non-resident persons and public corporations are deemed to
be owned by a single fictional person. If that fictional person is found to
hold de jure control over the
corporation, it does not qualify as a CCPC. In reality, the shareholders whose
shares are held by the fictional shareholder may or may not act together to
control the corporation, or even have any relationship with one another
whatsoever. (See “Control Further Dissected”, Canadian Tax Highlights, April
2006.)
Generally, de jure control is “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.” (Buckerfield’s Limited, 64 DTC 5301, [1964] CTC 504). Prior to the SCC
decision in Duha Printers (98 DTC 6334,
[1998] 3 CTC 303), the factors
for determining whether de jure
control existed included the corporation’s governing statute and its share
register, and any limitation laid out in the constating documents on the
majority shareholder’s power to control the election of the board or the
board’s power to manage the business and affairs of the corporation.
A USA allows shareholders, by a
unanimous agreement, to limit or take away all of the managerial powers of the
corporation’s directors and to grant those powers to all or some shareholders
(as was the case in Bagtech). A run-of-the-mill
shareholders agreement, which is solely contractual in nature, is distinct from
a USA, which the SCC in Duha said was
“a corporate law hybrid, part contractual and part constitutional in nature.”
Significantly, a USA has the power to bind current and future shareholders. Duha established that a USA should
be treated as a constating document of a corporation in determining whether de
jure control exists. The SCC said that in order for a majority shareholder
to lose de jure control, the USA must not allow that 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
Bagtech the minister contended that a USA does not apply to paragraph
(b) of the CCPC definition in subsection 125(7) for purposes of determining
whether de jure control is present: the text and the purpose of that
provision would be frustrated if the fiction of control it creates could be
watered down by a USA that allocates the powers of directors to a group of
shareholders that never includes the fictional shareholder. The TCC in Bagtech
disagreed and concluded that that provision’s fictional shareholder is bound by
a USA. The TCC reasoned that the CCPC definition is a general provision and the
court’s role is to give effect to its legislative intent: the legal fiction of
a hypothetical shareholder applies in all situations and thus the fictional
shareholder is bound by a USA in the same way that the actual shareholders are
bound.
Bagtech crystallizes what was decided in Duha:
a USA should be treated as a constating document when determining de jure control
and in order to conclude that a non-resident majority shareholder does not have
de jure control, the USA must remove that shareholder’s ability to
control the corporation in a manner equivalent to the power to elect the
majority of the board of directors. In addition Bagtech specifically concludes
that a USA applies to a fictional shareholder created under paragraph (b) of
the subsection 125(7) CCPC definition. Will the Act be amended in light of Bagtech,
as it was following the decision in Silicon Graphics? The policy
behind the CCPC definition and related provisions is to afford Canadian
residents preferential tax treatment under the Act. Any legislative change,
however, will likely await the result of the appeal to the FCA that was filed
on May 14, 2012.
Sunita Doobay
TaxChambers,
Toronto
Rajeeve Thakur
Miller Canfield Paddock & Stone LLP, Toronto
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