In the recent case of Price Waterhouse Coopers Inc. Agissant Ès Qualité de Syndic à la Faillite
de Bioartificial Gel Technologies (Bagtech) Inc. v. The Queen (2012 CCI 120) (“Bagtech”), the Tax Court of Canada (the
“TCC”) ruled that Bagtech qualified as a Canadian-controlled private
corporation (“CCPC”) even though more than 50% of its voting shares were held
by non?resident shareholders. In reaching its conclusion, the TCC relied on the
existence of a unanimous shareholders’ agreement (“USA”) entered into among
Bagtech’s shareholders which included restrictions on the non-resident
shareholders’ rights to elect a majority of Bagtech’s board of directors.
Tax Act (Canada) (the “Act”) contains a “hypothetical shareholder” two?step
test for purposes of determining whether a particular corporation qualifies as
a CCPC. The first part of this test
requires that all shares owned by non?residents, public corporations and
corporations a class of shares of which is listed on a designated stock
exchange be hypothetically aggregated in the hands of a particular person (the
“hypothetical shareholder”). Under the
second part of the test, if the hypothetical shareholder would have de jure control of the corporation on
that basis, then the corporation is not a CCPC.
De jure control is essentially
the direct or indirect ownership of shares of a corporation which gives a
shareholder sufficient votes to elect a majority of the board of directors
The CCPC status of a corporation is
relevant to determine the availability of various tax benefits under the
Act. For instance, CCPC status is an
essential condition for shares to qualify for the $750,000 exemption in respect
of capital gains realized on the disposition of qualified small business
corporation shares. Furthermore, only a CCPC may claim the enhanced refundable
investment tax credit for scientific research and experimental development
(“SR&ED”) expenditures and is entitled to the small business deduction
which reduces the federal corporate taxation rate from 28% to 11% on the first
$500,000 of active business income.
This case is of significant importance
since the historical position of the Canada Revenue Agency (“CRA”) has been to
ignore a USA in applying the hypothetical shareholder test on the basis that
the hypothetical shareholder is not a party to the USA.
The facts in the Bagtech case are
straightforward. Bagtech conducted
SR&ED activities and claimed the enhanced investment tax credit for
SR&ED expenditures available to CCPCs under the Act for its 2004 and 2005
During those years, 62.52% (2004) and
70.42% (2005) of the voting shares of Bagtech were owned in the aggregate by
non?resident shareholders. In 2003, the
shareholders of Bagtech had entered into a USA dealing, among other things,
with the election of the board of directors.
Under the terms of the USA, the Canadian resident shareholders were
entitled to elect a majority of the board of directors of Bagtech. In 2005, the USA was amended to increase the
number of directors to be appointed by non-resident shareholders to 50%.
The CRA reassessed Bagtech for its 2004 and
2005 taxation years on the basis that it did not qualify as a CCPC during these
years under the hypothetical shareholder test.
Bagtech disputed these reassessments and argued that the hypothetical
shareholder did not control Bagtech because such shareholder did not have power
to elect a majority of Bagtech’s board of directors under the terms of the USA.
Analysis and Decision
The TCC reviewed the relevant case law and
cited the principles set forth by the Federal Court of Appeal in Sedona Networks Corp. v. R. (2007 FCA
169) to the effect that the determination of CCPC status under the hypothetical
shareholder test is a two part process.
First, all the shares owned by non-residents and public corporations
must be allocated to a hypothetical shareholder. Second, once this allocation has been made,
it must be determined whether the corporation is “controlled” by that
hypothetical shareholder. Based on this
test, the question to be answered is whether the hypothetical non-resident
shareholder, who held 62.52% and 70.42% of the voting shares in 2004 and 2005,
respectively, controlled Bagtech during these years.
The TCC summarized the various principles
established by the courts regarding the notion of “control”. The leading decision is Buckersfield’s Ltd. v. Minister of National Revenue (64 DTC 5301)
where it was established that the legal control of a corporation lies in “the
ownership of such number of shares as carries with it the right to a majority
of the votes in the election of the Board of Directors.”
The TCC also focused at length on the
Supreme Court of Canada decision in Duha
Printers (Western) Ltd. v. R. ( 1 SCR 795), the most recent major
decision on de jure control, where
additional guidance was provided. The
Supreme Court stated that it was necessary to consider the following in order
to ascertain de jure control of a
(a) the corporation’s governing statute;
share register of the corporation; and
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:
constating documents of the corporation; or
(ii) any unanimous shareholder agreement.”
The Supreme Court of Canada held in Duha Printers that only a USA within the
meaning of the governing corporate act may be considered in the analysis of de jure control of a corporation as a
USA is “a corporate law hybrid, part contractual and part constitutional in
The TCC was of the view that a hypothetical
shareholder under the two-step CCPC test should be deemed to have the same
rights and obligations as the actual non?resident shareholders of a
corporation. The TCC found that the hypothetical non?resident shareholder of
Bagtech did not have de jure control
because it could not elect a majority of the board of directors pursuant to the
terms of the USA entered into under the Canada
Business Corporations Act. Therefore,
the TCC concluded that Bagtech qualified as a CCPC for purposes of the Act.
The Minister has decided to appeal the
TCC’s decision in Bagtech. Stay tuned.