Bioartificial gel technologies (Bagtech) inc. v. The Queen

Bioartificial gel technologies (Bagtech) inc. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2012-04-12
Neutral citation
2012 TCC 120
File numbers
2009-3734(IT)G
Judges and Taxing Officers
Paul Bédard
Subjects
Income Tax Act
Decision Content
Docket: 2009-3734(IT)G
BETWEEN:
PRICE WATERHOUSE COOPERS INC.
ACTING IN THE CAPACITY OF TRUSTEE IN BANKRUPTCY
OF BIOARTIFICIAL GEL TECHNOLOGIES (BAGTECH) INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeals heard on October 17, 2011, at Montréal, Quebec.
Before: The Honourable Justice Paul Bédard
Appearances:
Counsel for the Appellant:
Isabelle Pillet
Counsel for the Respondent:
Anne-Marie Boutin
Marie-Aimée Cantin
____________________________________________________________________
JUDGMENT
The reassessments made under the Income Tax Act for the 2004 and 2005 taxation years are allowed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 12th day of April 2012.
“Paul Bédard”
Bédard J.
Translation certified true
on this 9th day of January 2013.
François Brunet, Revisor
Citation: 2012 TCC 120
Date: 20120412
Docket: 2009-3734(IT)G
BETWEEN:
PRICE WATERHOUSE COOPERS INC.
ACTING IN THE CAPACITY OF TRUSTEE IN BANKRUPTCY
OF BIOARTIFICIAL GEL TECHNOLOGIES (BAGTECH) INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
REASONS FOR JUDGMENT
Bédard J.
[1] During the taxation years ending on December 31, 2004 and 2005 (the relevant years), Bioartificial Gel Technologies (BAGTECH) Inc. (Bagtech) incurred scientific research and experimental development (SR&ED) expenses and SR&ED capital expenditures. To determine Bagtech’s investment tax credit (ITC) for SR&ED for the relevant years, the Minister of National Revenue (the Minister) concluded that Bagtech was not a “Canadian-controlled private corporation” (CCPC) within the meaning of subsection 125(7) of the Income Tax Act (the ITA). The Minister, therefore, concluded that, during the relevant years, Bagtech was a “non-qualifying corporation” within the meaning of subsection 127(9) of the ITA and was not entitled to the “refundable investment tax credit” provided for in subsection 127.1(1) of the ITA.
[2] The only issue in this case is whether Bagtech was a CCPC under subsection 125(7) of the ITA. That definition reads as follows:
125(7) In this section,
. . .
“Canadian-controlled private corporation” means a private corporation that is a Canadian corporation other than
(a) a corporation controlled, directly or indirectly in any manner whatever, by one or more non-resident persons, by one or more public corporations (other than a prescribed venture capital corporation), by one or more corporations described in paragraph (c), or by any combination of them,
(b) a corporation that would, if each share of the capital stock of a corporation that is owned by a non-resident person, by a public corporation (other than a prescribed venture capital corporation), or by a corporation described in paragraph (c) were owned by a particular person, be controlled by the particular person,
(c) a corporation a class of the shares of the capital stock of which is listed on a designated stock exchange, or
(d) in applying subsection (1), paragraphs 87(2)(vv) and (ww) (including, for greater certainty, in applying those paragraphs as provided under paragraph 88(1)(e.2)), the definitions “excessive eligible dividend designation”, “general rate income pool” and “low rate income pool” in subsection 89(1) and subsections 89(4) to (6), (8) to (10) and 249(3.1), a corporation that has made an election under subsection 89(11) and that has not revoked the election under subsection 89(12);
[3] The appellant essentially contends that a “particular person” does not control Bagtech simply because they hold more than 50% of the voting shares, since the person is bound by the unanimous shareholders’ agreement (the USA), which prevents them from electing a majority of Bagtech’s directors (see Appendix 1). However, the respondent contends that, for the purposes of paragraph (b) of the definition of the expression “Canadian-controlled private corporation” in subsection 125(7) of the ITA, shareholders’ agreements or unanimous shareholders’ agreements may not be taken into consideration. The respondent submits that, in the event that the Court concludes that the existence of a unanimous shareholders’ agreement must be taken into consideration in determining whether the “control” referred to in paragraph (b) of the definition of the expression “Canadian-controlled private corporation” is exercised by the “particular person”, the “particular person” nonetheless had de jure control during the relevant years. The respondent’s submission is that if the clauses in the nature of a unanimous shareholders’ agreement are taken into consideration, legal control was not withdrawn from the non-resident shareholders, who together form the majority shareholders, since:
(a) the clauses in the nature of a unanimous shareholders’ agreement did not operate to withdraw de jure control from the non-resident shareholders, who form the majority; and
(b) a majority of the clauses in the unanimous shareholders’ agreement provide that they will be implemented by ordinary resolution. The non-residents, therefore, control the decision-making in relation to those clauses.
[4] The parties agreed to an [TRANSLATION] “agreement as to the facts, issue and documents” (Exhibit A-1), of which I reproduce the section on the facts in full here:
[Translation]
AGREEMENT AS TO THE FACTS, ISSUE AND DOCUMENTS
FILED BY CONSENT
1. RELEVANT FACTS ADMITTED BY THE PARTIES
1.1 Bioartificial Gel Technologies (BAGTECH) Inc. (“Bagtech”) was incorporated on March 8, 1996, under the Canada Business Corporations Act (“CBCA”).
1.2 It is a taxable Canadian corporation as defined in subsection 89(1) of the Income Tax Act (Canada) (“ITA”).
1.3 After it acquired patented technologies, Bagtech specialized in cutting-edge medical technologies, including the development of several ranges of moist bandages that assist in speeding the scarring process for various types of wounds.
1.4 Since it began operating, and throughout the 2004 and 2005 taxation years, each ending on December 31 (“2004 and 2005 taxation years”), Bagtech carried on scientific research and experimental development activities (“SR&ED”).
1.5 During the 2004 taxation year, Bagtech incurred SR&ED operating expenses in the amount of $1,017,722 and SR&ED capital expenditures in the amount of $431,517.
1.6 During the 2005 taxation year, Bagtech incurred SR&ED operating expenses in the amount of $1,461,189 and SR&ED capital expenditures in the amount of $69,641.
1.7 Bagtech’s authorized capital stock is composed of Class A, B, C, D and E shares.
1.8 Only Class A shares are voting and participating.
1.9 Class B and C shares bear a non-cumulative dividend at a maximum rate of 8% and are redeemable in the amount of the stated capital.
1.10 Class D and E shares bear a non-cumulative dividend at a maximum rate of 8% and are redeemable at the stated amount plus a premium equivalent to the difference between the stated amount and the fair market value of property received by the company at the time the shares were issued.
1.11 Throughout the 2004 and 2005 taxation years, only one Class D share was issued and outstanding, at the time of incorporation, in the name of Guy Fortier (“Fortier”), a Canadian resident, in consideration for certain technologies.
1.12 All other issued and outstanding shares were Class A shares.
1.13 In the first round of financing, carried out in 1998, the Fonds régional de solidarité de l’île de Montréal (Quebec, Canada) (“FRSIM”) and the Fonds de Solidarité des travailleurs du Québec (F.T.Q.) (Quebec, Canada) (“FSTQ”) participated in the subscription for Class A shares of Bagtech.
1.14 The other investors were a group represented by the founders of Bagtech, and only investors resident in Canada were shareholders of Bagtech.
1.15 In 1999, two European “business angels” subscribed to the capital stock of Bagtech, and in 2000, two other venture capital corporations subscribed to the capital stock: SGF Santé Inc. (Quebec, Canada) (“SGF”) and Finedix B.V. (Amsterdam, Netherlands) (“Finedix”).
1.16 In 2002, the following venture capital corporations subscribed to the capital stock of Bagtech : Medco SA (Geneva, Switzerland) (“Medco”), Schroder & Co. Bank AG (Zurich, Switzerland) (“Schroder”) and Gutrafin Limited (London, England) (“Gutrafin”), with the result that 45.31% of the outstanding Class A shares were then held by non-residents of Canada.
1.17 In 2003, in an additional round of financing, a number of shareholders acquired new Class A shares of Bagtech: the venture capital corporation Auriga Ventures II (Paris, France) (“Auriga”) and two “business angels”, Youri Popowski (Geneva, Switzerland) (“Popowski”) and Investissements Onami inc. (Quebec, Canada) (“Onami”).
1.18 On September 11, 2003, the Bagtech shareholders signed a document entitled [Translation] “unanimous shareholders’ agreement” (“USA”), which included the following clauses:
“RULES OF INTERNAL GOVERNANCE
Article 3.1 Subject to the following provisions, the Shareholders agree, during the term of this Agreement, to take the necessary measures and to use the voting rights associated with the Shares they hold to elect and continue seven Directors on the Board of Directors.
Article 3.2 On the date of this Agreement, the Shareholders agree that the Board of Directors shall be composed of representatives appointed by the Shareholders as hereinafter set out:
Group A 2 Directors (including Marie-Pierre Faure)
Group B 3 Directors (including one appointed jointly by FSTQ and FRSIM, one appointed by SGF and one appointed by Auriga)
Group C 2 Directors (including André Lamotte)”
1.19 Under the definition set out in article 1.21 of the USA, Group A is composed of the following shareholders: Marie-Pierre Faure (“Faure”), Fortier, Richard J. Deckelbaum (“Deckelbaum”), Jean Emmanuel Raphael Guetta (“Guetta”), Amaze through its delegated director, Richard Émile Azera (“Amaze”), Jean-François Brisson (“Brisson”), Marie-Claude Lévesque (“Lévesque”), Marielle Robert (“Robert”), Popowski and Onami.
1.20 Under the definition set out in article 1.22 of the USA, Group B is composed of the following shareholders: SGF, FSTQ, FRSIM, Finedix and Auriga, of which SGF appoints one director and FSTQ and FRSIM jointly appoint a second director.
1.21 Under the definition set out in article 1.22 of the USA, Group C is composed of the following shareholders: Medco, Gutrafin and Schroder, which appoints two directors, including Collin Bier who is to act as chair of the board of directors.
1.22 On December 31, 2004, over 60% of the Class A shares outstanding were held by non-residents of Canada.
1.23 In the period from January 1 to July 21, 2005, the shareholders of Bagtech were the same as the shareholders on December 31, 2004.
1.24 On July 22, 2005, other investors subscribed to the capital stock of Bagtech: HSBC (Switzerland), Auxitec (France), Ayman (Switzerland) and Bagadine (France).
1.25 Following the subscriptions of those investors for shares in the capital stock of Bagtech, clauses 3.1 and 3.2 of the USA were changed by amendment to the USA dated July 22, 2005, to indicate that the number of directors of Bagtech would be increased to eight from seven, and that the number of directors appointed by Group C would increase to three from two, one of whom would be appointed by Bagadine.
1.26 On December 31, 2005, over 70% of the Class A shares outstanding were held by non-residents of Canada.
1.27 When Bagtech’s original return for its 2004 and 2005 taxation years was filed, the corporation was not designated as a “Canadian-controlled private corporation” (“CCPC”).
1.28 On or about June 1, 2007, under subsection 127.1(1) of the ITA, an amended prescribed form was filed for the 2004 and 2005 taxation years, to have Bagtech’s status recorded as a CCPC and an “eligible corporation”, for it to be given the applicable refundable investment tax credits at the 35% rate instead of the 20% initially claimed, and to have a portion of that credit refunded to it.
1.29 On October 21, 2008, Bagtech made an assignment of property and Price Waterhouse Coopers Inc. was appointed as trustee in the bankruptcy of Bagtech.
1.30 On November 3, 2008, CRA issued its decision that Bagtech was not, in its opinion, a Canadian-controlled private corporation during the 2004 and 2005 taxation years.
1.31 On April 9, 2009, CRA issued a “notice of determination of loss” for the 2004 and 2005 taxation years.
Analysis and Conclusion
[5] Under paragraph (b) of the definition of a CCPC in subsection 125(7) of the ITA, a corporation is not a CCPC where, if each share of the corporation that is owned by a non-resident person or a public corporation were owned by a “particular person”, the corporation would be controlled by the particular person.
[6] As was held in Sedona Networks Corp. v. The Queen, 2007 FCA 169, the paragraph (b) analysis must be done in two stages. First, it is necessary to determine who the non-resident persons and public corporations are, and assume that their shares are owned by a “particular person”. Second, once that attribution is made, it is necessary to determine whether the corporation is controlled by that “particular person”. In the case, the evidence is that on December 31, 2004, 62.52% of the outstanding Class A shares of Bagtech (Class A shares being the only voting shares of Bagtech during that year) were held by non-residents of Canada. The evidence also is that on December 31, 2005, 70.42% of the outstanding Class A shares of Bagtech (Class A shares being the only voting shares of Bagtech during that year) were held by non-residents of Canada.
[7] The question to be answered now is: while the “particular person” held 62.52% and 70.42% of the outstanding Class A shares of Bagtech on December 31, 2004, and December 31, 2005, respectively, did the “particular person” actually control Bagtech during those years? To answer that question, the meaning of the word “control” for the purposes of the ITA must be determined.
[8] The courts have had to rule on the issue of control a number of times, since there is no definition in the ITA.
[9] The leading case with respect to control is Buckerfield’s Ltd. v. Minister of National Revenue, [1965] 1 Ex. C.R. 299, in which President Jackett wrote:
Many approaches might conceivably be adopted in applying the word “control” in a statute such as the Income Tax Act to a corporation. It might, for example, refer to control by “management”, where management and the board of directors are separate, or it might refer to control by the board of directors. . . . The word “control” might conceivably refer to de facto control by one or more shareholders whether or not they hold a majority of shares. I am of the view, however, that in Section 39 of the Income Tax Act [the former section dealing with associated companies], 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. [Emphasis added.] See British American Tobacco Co. v. I.R.C., [1943] 1 All E.R. 13, where Viscount Simon L. C., at page 15, says:
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.
[10] That excerpt from the decision of the Exchequer Court was subsequently cited and approved on a number of occasions by the Supreme Court of Canada (the SCC), in particular in Minister of National Revenue v. Dworkin Furs (Pembroke) Ltd., [1967] S.C.R. 223, Vina-Rug (Canada) Ltd. v. Minister of National Revenue, [1968] S.C.R. 193, R. v. Imperial General Properties Ltd., [1985] 2 S.C.R. 288, and Duha Printers (Western) Ltd. v. The Queen, [1998] 1 S.C.R. 795.
[11] It is clear from that case law that, for the purposes the ITA, “control” of a corporation means de jure control and not de facto control. In short, Buckerfield’s stands for the proposition that the test consists in deciding whether the majority shareholder enjoys “majority control” over the “affairs and fortunes” of the corporation, as manifested 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”.
[12] One important clarification was subsequently added to the comments made by President Jackett in Buckerfield’s. Indeed, in Imperial General Properties Ltd., supra, at para. 11, the SCC stated that, in determining de jure control, “the court is not limited to a highly technical and narrow interpretation of the legal rights attached to the shares of a corporation”. In fact, the highest court in the land essentially reiterated what had been said by Thurlow J. in Donald Applicators Ltd. v. Minister of National Revenue, [1969] 2 Ex. C.R. 43, affirmed by [1971] S.C.R. v, and held that “[n]either is the court constrained to examine those rights in the context only of their immediate application in a corporate meeting”, and that, on the contrary, “these rights must be assessed in their impact ‘over the long run’” (Imperial General Properties Ltd., supra, at para. 11).
[13] While under the legislation that governs the corporation, directors generally have the express right to manage the corporation’s day-to-day activities, the majority shareholder exercises that control indirectly by virtue of their right to elect the board of directors. Accordingly, it is unquestionably the majority shareholder, and not the directors themselves, who exercise control of the corporation “over the long run”: see British American Tobacco Co. v. I.R.C., [1943] 1 All E.R. 13, at p. 15.
[14] The final important authority regarding the de jure control rule laid down in Buckerfield’s is, of course, Duha Printers, a decision of the SCC.
[15] In that case, the fact that the relevant test was de jure control was not really disputed by the parties. The dispute related, rather, to the factors that may be taken into consideration in the determination of whether there is de jure control.
[16] Iacobucci J. commenced his analysis by reiterating that “to apply formalistically a test like that set out in Buckerfield’s, without paying appropriate heed to the reason for the test, can lead to an unfortunately artificial result” (Duha Printers, supra, at para. 37). On that point, it should be recalled that the central objective of the Buckerfield's test is to determine where effective control of the corporation lies.
[17] The SCC then concluded that, as a general rule, “external agreements are not to be taken into account as determinants of de jure control”: at paras. 51 and 55.
[18] The SCC’s reasoning is justified by the principle that de jure control is the control conferred by the majority vote in a corporation. While the SCC has sometimes been prepared to examine factors other than a corporation’s share register, its review has always been restricted only to the constating documents, not external agreements. The only exception is found in cases like Minister of National Revenue v. Consolidated Holding Co., [1974] S.C.R. 419, where the very capacity to act was limited by external documents, but that exeption has emerged only in cases where the shares were held by trustees: at paras. 48 to 50.
[19] Iacobucci J. also placed some weight on the fact that “taxpayers rely heavily on whatever certainty and predictability can be gleaned from the Income Tax Act”. Accordingly, in the opinion of the SCC, “a simple test such as that which has been followed since Buckerfield’s” is desirable: para. 52. “The de facto concept was rejected because it involves ascertaining control in fact, which can lead to a myriad of indicators which may exist apart from these sources”: para. 58.
[20] Accordingly, Iacobucci J. dismissed the possibility of reviewing external agreements in the de jure control analysis, and stated:
. . . agreements among shareholders, voting agreements, and the like are, as a general matter, arrangements that are not examined by courts to ascertain control. In my view, this is because they give rise to obligations that are contractual and not legal or constitutional in nature. (para. 59)
[21] Iacobucci J. then examined the question of whether a unanimous shareholders’ agreement must be qualified as contractual in nature, or in the nature of a constating document.
[22] The SCC settled the issue by deciding that a unanimous shareholders’ agreement is “a corporate law hybrid, part contractual and part constitutional in nature” (para. 66). That being said, the SCC was careful to go on to say that the constitutional element of the unanimous shareholders’ agreement is even more potent than its contractual features: para. 67.
[23] Accordingly, if an agreement can be considered to be a unanimous shareholders’ agreement (USA) within the meaning of the Canada Business Corporations Act (the CBCA), it must be taken into consideration just like the corporation’s constating documents in order to determine de jure control. The legal reasoning underlying the principle that a unanimous shareholders’ agreement may play a vital role in the de jure control analysis is summarized well by the following comments of Iacobucci J.:
As I have said, the essential purpose of the Buckerfield’s test is to determine the locus of effective control of the corporation. To my mind, it is impossible to say that a shareholder can be seen as enjoying such control simply by virtue of his or her ability to elect a majority of a board of directors, when that board may not even have the actual authority to make a single material decision on behalf of the corporation. The de jure control of a corporation by a shareholder is dependent in a very real way on the control enjoyed by the majority of directors, whose election lies within the control of that shareholder. When a constating document such as a USA provides that the legal authority to manage the corporation lies other than with the board, the reality of de jure control is necessarily altered and the court must acknowledge that alteration. (para. 70)
[24] In other words, the share register should be examined having regard to the relevant legislative provisions governing the corporations (in this instance, the CBCA) and the corporation’s constating documents (to which unanimous shareholders’ agreements must be seen as analogous). However, external agreements play no role in this analysis, since they are relevant only to de facto control.
[25] Lastly, the SCC concludes by cautioning that “the simple fact that the shareholders of a corporation have entered into a USA does not have the automatic effect of removing de jure control from a shareholder who enjoys the majority of the votes in the election of the board of directors”. The extent to which the provisions of a unanimous shareholders’ agreement restrict or abrogate the directors’ powers must be examined (para. 81): “it is possible to determine whether de jure control has been lost as a result of a USA by asking whether the USA leaves 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 (as contemplated by the Buckerfield’s test)” (para. 82).
[26] Paragraph 85 of Duha Printers provides an excellent summary of the current law relating to the concept of “control”. That paragraph reads as follows:
[85] It may be useful at this stage to summarize the principles of corporate and taxation law considered in this appeal, in light of their importance. They are as follows:
(1) Section 111(5) of the Income Tax Act contemplates de jure, not de facto, control.
(2) The general test for de jure control is that enunciated in Buckerfield’s, supra: whether the majority shareholder enjoys “effective control” over the “affairs and fortunes” of the corporation, as manifested 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”.
(3) To determine whether such “effective control” exists, 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 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.
(4) Documents other than the share register, the constating documents, and any unanimous shareholder agreement are not generally to be considered for this purpose.
(5) If there exists any such limitation as contemplated by item 3(c), the majority shareholder may nonetheless possess de jure control, unless there remains no other way for that shareholder to exercise “effective control” over the affairs and fortunes of the corporation in a manner analogous or equivalent to the Buckerfield’s test.
[27] While Duha Printers clearly stands for the proposition that a unanimous shareholders’ agreement must be taken into consideration in determining de jure control, the Minister submits that an agreement of that nature must have no influence on the second stage of the analysis (that is, the determination of control of a corporation by a “particular person”) for the purposes of paragraph (b) of the definition of a CCPC. Paragraph 21 of technical interpretation 2008–0265902I7 – Canadian‑Controlled Private Corporation provides a fairly good summary of the Minister’s argument on this point. That paragraph reads as follows:
[Translation]
21. In that specific case, indeed as a general proposition, we reiterate our position that a USA has no impact on the second stage of the analysis (i.e. determination of control of a corporation by the hypothetical particular person) for the purposes of paragraph (b) of the definition of CPCC in subsection 125(7). It still seems to us that the determination provided for in the second stage of the analysis is purely arithmetical. The case law in no way rejects that approach; on the contrary, the Federal Court of Appeal unreservedly holds that mere possession of shares by a non-resident majority is sufficient to give the non-residents control for the purposes of paragraph (b) of the definition of CCPC in subsection 125(7). In any event, as stated in the Document, the hypothetical particular person is not a party to any unanimous shareholders’ agreement or deemed to be such for the purposes of paragraph (b) of the definition of CCPC in subsection 125(7).
CRA, Technical Interpretation 2008-0265902I7, “Canadian-Controlled Private Corporation” (May 6, 2008), at para. 21.
[28] At this point, I think it will be useful to summarize the circumstances in which Parliament added paragraph (b) to the definition of a CCPC. It was added by S.C. 1998, c. 19, subsection 145(2), and evidently runs counter to the decision of the Federal Court of Appeal in Silicon Graphics Ltd. v. The Queen, [2003] 1 F.C. 447, in which the Court held that “simple ownership of a 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” (at para. 36). The comments by the Federal Court of Appeal were made in the context of an analysis of the applicable law before new paragraph (b) was added to the definition of a CCPC.
[29] In this regard, the purpose of the provision is, moreover, clearly laid out in the relevant technical notes published by the Minister of Finance:
Currently, a corporation is a CCPC if it is a private corporation and a Canadian corporation (both of which terms are defined in subsection 89(1) of the Act), and it is not controlled, directly or indirectly in any manner whatever by one or any combination of public corporations (other than prescribed venture capital corporations) or non-resident persons. This amendment ensures that two other types of corporation are not CCPCs. The first type are corporations that, if they are not actually controlled by non-residents, avoid that status only because their shares are widely held. The second type are corporations the shares of which are listed on a foreign stock exchange.
A corporation the voting shares of which are distributed among a large number of persons is usually not considered to be controlled by any group of its shareholders, provided the shareholders do not act together to exercise control. As a result, it may be argued that a private Canadian corporation that is owned by a number of non-residents or public corporations is not controlled by non-residents or public corporations, and is thus a CCPC. New paragraph (b) of the CCPC definition clarifies that this is not the case. Paragraph (b) requires non-residents’ and public corporations’ shareholdings – not only of the corporation in question, but of all corporations – to be notionally attributed to one hypothetical person. If that person would control the corporation, then the corporation is not a CCPC.
Department of Finance of Canada, Explanatory Notes Relating to Income Tax (December 8, 1997), s. 125(7), “Canadian-controlled private corporation”.
[30] The practical result is, therefore, that paragraph (b) of the definition of a CCPC creates a legal fiction. This kind of alteration of reality was thoroughly canvassed by the SCC in R. v. Verrette, [1978] 2 S.C.R. 838. Writing for the Court, Mr. Justice Beetz characterized this kind of legal fiction as a “deeming provision” and explained its effect as follows:
A deeming provision is a statutory fiction; as a rule it implicitly admits that a thing is not what it is deemed to be but decrees that for some particular purpose it shall be taken as if it were that thing although it is not or there is doubt as to whether it is. (p. 845)
[31] The purpose and application of a deeming provision was then examined in detail by the Federal Court of Appeal in Attorney General of Canada v. Scarola, 2003 FCA 157, [2003] 4 F.C. 645, in which Létourneau J. based his explanation in part on the following French doctrine:
Fiction is a process that, as repeatedly noted, is part of the pragmatics of law. It consists first in misrepresenting the facts, stating them to be other than what they really are and extracting from that very adulteration and that false supposition the legal consequences that would flow from the dissembled truth, if that truth existed beyond the cloak of external appearances. (para. 19)
[32] In Survivance v. Canada, 2006 FCA 129, at para. 55, the Court stated: “Insofar as [a legal fiction] effectively alters reality, its meaning should be limited to what is clearly expressed. A deeming provision cannot otherwise modify the actual situation that obtains.”
[33] Indeed, those comments are consistent with those of the SCC in Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, in which Madam Justice McLachlin, as she then was, stated, in comments that have been repeatedly cited since then:
The Act is a complex statute through which Parliament seeks to balance a myriad of principles. This Court has consistently held that courts must therefore be cautious before finding within the clear provisions of the Act an unexpressed legislative intention: . . . . (par. 43)
[34] Accordingly, I am of the opinion that, in spite of the particular characteristics of paragraph (b) of the definition of a CCPC, it must be read in its entire context and in its ordinary and grammatical sense harmoniously with the scheme of the Act, the object of the Act and the intention of Parliament: see Ludco Enterprises Ltd. v. The Queen, 2001 SCC 62, [2001] 2 S.C.R. 1082, at para. 36.
[35] Consequently, the legal effects of this legal fiction, which are superimposed on the truth that is being pushed aside, mean that the “particular person” to whom we are referring here is deemed to have the same rights and to be subject to the same obligations as the non-resident owners of the shares of the corporation in question.
[36] Subsection 146(3) of the CBCA provides:
A purchaser or transferee of shares subject to a unanimous shareholder agreement is deemed to be a party to the agreement.
[37] Considering everything that has been discussed here, I therefore find it very difficult to defend the position that the “particular person” referred to in paragraph (b) of the definition of a CPCC cannot be deemed, in determining de jure control, having regard to the alteration of the facts imposed by the provision, to be a party to the unanimous shareholders’ agreements then in effect.
[38] The Minister contends that the effect of having regard to a unanimous shareholders’ agreement in effect at the time the test of the hypothetical shareholder is examined could be to skew the analysis of control of the corporation in question, since when the unanimous shareholders’ agreement in question was written, the shareholders of the corporation could certainly not have foreseen that the fictitious shareholder for which the provision provides would join in the future. Accordingly, in order to avoid unusual or undesirable results, the Minister concludes that it is preferable not to deem the hypothetical shareholder to be a party to the unanimous shareholders’ agreements then in effect. The Minister explains:
Where Canadian residents do not own enough shares to elect a majority of the board of directors, the objective and effect of the presumption in paragraph (b) of the CCPC definition is to treat the hypothetical person as having the ability to exercise effective control over the affairs and fortunes of the corporation in a way analogous to the power to elect the majority of directors. That is so because the hypothetical person is not a party to a unanimous shareholder agreement nor is that person deemed to be a party to it. In our view, it would be contrary to both the text and the purpose of the provision to consider that the fiction of control created by the application of paragraph (b) of the CCPC definition could be diluted by an agreement that restricts the powers of the directors of a corporation to allocate them to shareholders that would never include the hypothetical shareholder.
See: Andrew W. Dunn, Ron Durand, Phil Jolie, and Mark Symes, “Canada Revenue Agency Round Table,” Report of the Proceedings of the Sixty‑First Tax Conference, 2009 Conference Report (Toronto; Canada Tax Foundation, 2009), at pages 3:14-3:15.
[39] In my view, the answer is inescapable. The result appears incongruous only if we choose not to have regard to the fiction. It is not incongruous if the fiction is given full effect.
[40] In my humble opinion, we need only imagine a situation where all of the shareholders that are non-residents or that are public corporations decided, for some reason, to sell all their shares in the corporation to the same purchaser. It is undeniable that, in such a case, the purchaser of the shares would be a party to any unanimous shareholders’ agreement then in effect.
[41] I could not agree more with the Federal Court of Appeal, when it stated: “There would be a risk of creating intolerable uncertainty if the courts could override a deeming provision of general application solely because the result it produces in a particular case seemed undesirable to them. Parliament is well aware of the effect of the presumptions it enacts, and it is up to Parliament to set limits on their scope.” (Survivance, supra, at para. 79).
[42] In this case, paragraph (b) of the definition of a CCPC is a provision of general application and it is the role of the courts to give effect to it.
[43] In conclusion, I am of the opinion that the hypothetical shareholder contemplated in paragraph (b) of the definition of “Canadian-controlled private corporation” in subsection 125(7) of the ITA is bound by the Bagtech USA signed in 2003, and subsequently by the amendments made in 2005.
[44] The question that should now be answered is: must the clauses of a USA governing the election of a corporation’s directors be taken into consideration in the determination of de jure control of the corporation?
[45] In my opinion, before answering that question, we need a clear understanding of the nature of a unanimous shareholders’ agreement for the purposes of the CBCA. Subsection 146(1) of the CBCA reads as follows:
An otherwise lawful written agreement among all the shareholders of a corporation, or among all the shareholders and one or more persons who are not shareholders, that restricts, in whole or in part, the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation is valid.
[46] Subsection 146(1) of the CBCA seems to be setting four requirements that an agreement must meet in order to be qualified as a unanimous shareholders’ agreement. First, the agreement obviously must be lawful and meet the general requirements for contractual validity. Second, the agreement must be in writing, and it should be noted that this requirement is indeed a prerequisite for validity and not merely evidentiary. It must also be entered into by all the shareholders of a corporation, whether among themselves or with third parties. And third, it must restrict, in whole or in part, the powers of the directors to manage or supervise the management of the business and affairs of the corporation. An agreement signed by all the shareholders that merely increases the number of votes required for certain actions to be taken by the shareholders, in accordance with subsection 6(3) of the CBCA, may, in exceptional situations, be a unanimous shareholders’ agreement, even if it does not restrict or abrogate any of the directors’ powers. However, that is the only exception, under both Quebec and federal law: see Paul MARTEL, Entreprises et sociétés, Collection de droit 2011‑2012, École du Barreau du Québec, vol. 9, 2011, pp. 41 et seq.
[47] These four requirements that a unanimous shareholders’ agreement must meet in order to be valid were also reiterated by the SCC in the only case that has examined unanimous shareholders’ agreements in detail: Duha Printers, supra.
[47]
[48] The CBCA, the Ontario Business Corporations Act and the Civil Code of Québec, for example, all provide for an express exception to the prohibition on fettering the power of the directors. Thus the various Canadian statutes governing business corporations provide that unanimous shareholders’ agreements will be valid, notwithstanding the common law principle that shareholders, even acting unanimously, may not fetter the board’s power to manage or supervise the management of the business and affairs of the corporation or prevent it from performing its legal duty to do so. (The prohibition on fettering the powers of the directors seems to originate in Automatic Self Cleansing Filter Syndicate Co. Ltd. v. Cuninghame, [1906] 2 Ch. 34 (C.A.). The principle was then reiterated in Motherwell v. Schoof, [1949] 4 D.L.R. 812 (Alta. S.C.) and Atlas Development Co. v. Calof (1963), 41 W.W.R. 575 (Man. Q.R.).)
[49] In fact, before there were unanimous shareholders’ agreements, the ability of shareholders to control the corporation was limited to the power to elect and dismiss directors. When unanimous shareholders’ agreements became part of corporate law, they fundamentally altered the landscape by creating a mechanism whereby s