At issue
A corporation is a separate legal entity and a separate taxable entity from its shareholder/owners. To the extent that the corporation’s tax rate is less than that of the shareholders, it may be possible to achieve tax deferral and savings.While this may be modestly beneficial in comparing against general corporate rates, it is particularly emphasized where the small business deduction may be claimed. Current combined federal-provincial small business rates range from 11% to 19%.
Section 125(7) of the Income Tax Act (ITA)
For a corporation to be able to claim the small business deduction, the key criterion is that it is a Canadian-controlled private corporation (CCPC). In brief, generally the corporation cannot be controlled by non-residents, one or more public corporations, or a combination of them.
One part of the definition, subparagraph (b), includes a test that pools the shares of non-residents and public corporations into a hypothetical person to determine whether control may be exercised by them.
Duha Printers (Western) Ltd. v. Canada, [1998] 1 S.C.R. 795
A unanimous shareholder agreement (USA) legally binds shareholders in one way or another.
With respect to the issue of control (normally meaning the ability to elect a majority of the directors, called de jure or “effective control”), the Supreme Court of Canada held that a USA had to be considered in determining control, though in the present case the USA did not affect control.
Subsequent to this case, the Canada Revenue Agency (CRA) interpreted that the existence of a USA did not necessarily extend to subparagraph (b) of the CCPC definition, in part because the hypothetical person could not be a party to a USA.
Bioartificial Gel Technologies (Bagtech) Inc. v. R., 2013 F.C.A. 164
In filing its 2004 and 2005 tax returns, Bagtech asserted CCPC status, entitling it to claim greater investment tax credits for its scientific research and development activity than otherwise would be available. At the time, approximately 70% of Bagtech’s voting shares were owned by non-residents. However, a USA was in place requiring that 4 of the 7 directors had to be elected by Canadian residents.
In assessing Bagtech, and consistent with its past rulings and administrative statements, the CRA did not view the USA as affecting control. Instead, it applied a straight arithmetic calculation (ie., the 70% figure) to subparagraph (b) to find that Bagtech did not meet the CCPC definition.
Bagtech successfully appealed the assessment to the Federal Court. Following Duha Printers, the trial judge held that, pursuant to the USA, the non-resident shareholders could not elect a majority of the directors.
The CRA appealed to the Federal Court of Appeal, but the FCA found in favour of Bagtech, siding with the trial judge’s interpretation of Duha Printers.
2014-0523301C6E – Control - unanimous shareholders agreement
At the 2014 Conference for Advanced Life Underwriting (CALU) roundtable, representatives of the CRA were asked about the agency’s intentions in the wake of the Bagtech ruling, given that the decision was made not to appeal to the Supreme Court.
The Agency acknowledged that its past interpretation of Duha Printers could not be reconciled with the Bagtech ruling. Accordingly, it would adopt the Bagtech approach with respect to the issue of “effective control”, reserving the background potential for a general anti-avoidance rule (GAAR) analysis in appropriate circumstances.
Practice points
- In these days of very mobile individuals and commerce, this should provide some comfort to companies with non-resident connections seeking the benefits of CCPC status.
- Still, CRA’s acknowledgement at the CALU roundtable appears somewhat begrudging, with that GAAR possibility for those the Agency may feel are taking advantage.
- As noted by the SCC in Duha Printers, the mere existence of a USA is not sufficient on its own, so a legal opinion may be prudent before taking a position when filing the corporation’s tax return.
