In The Queen v. Bioartificial Gel Technologies (Bagtech)Inc.,a decision rendered on June 21, 2013, the Federal Court of Appeal clarified the application of de jure control rules for determining whether a Canadian corporation is a "Canadian-controlled private corporation" (CCPC), affirming a decision of the Tax Court of Canada. The decision – which allowed a company to obtain CCPC status despite the fact that non-residents controlled the majority of its voting shares – may have far-reaching consequences, as CCPCs benefit from advantageous tax treatment in a number of respects.
Background
Bioartificial Gel Technologies Inc. (Bagtech), a privately held corporation specializing in medical technology, claimed certain research costs as "scientific research and experimental development" (SR&ED) expenditures – a claim that, if accepted, would entitle it to an enhanced investment tax credit pursuant to the Income Tax Act. Only CCPCs are entitled to the enhanced credit.
In general, a CCPC is defined as a Canadian private corporation that is neither (i) a corporation controlled by one or more non-resident persons or public corporations, nor (ii) a corporation that would, if each share owned by a non-resident person or a public corporation were owned by a single hypothetical person, be "controlled" by that hypothetical person. This "hypothetical person" test was at issue in this case.
As stated in the Tax Court decision, "control" for this purpose is a function of the ability to elect board members:
The general test for de jure control is that enunciated in [Buckerfield's Ltd. v. Minister of National Revenue, [1965] 1 Ex. C.R. 299]: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".
Previous case law had established that "legal control" is synonymous with "effective control", which is established by examining the relevant corporate statute, the share register of the corporation and any limitations on a shareholder's power to control the board of directors that may be contained in the company's constating documents. Importantly, the constating documents of a company were held in the leading case of Duha Printers (Western) Ltd. v. Canada, toinclude a unanimous shareholder agreement (USA) entered into in accordance with the governing company law statute.
This brings us back to Bagtech. The key fact that you need to know about Bagtech is that the shareholders had entered into an agreement entitled "The Unanimous Shareholders Agreement". So as not to prejudge whether it really was a USA under the Canada Business Corporations Act (CBCA), we'll refer to it simply as "the Agreement". The Agreement provided that the Canadian shareholders were entitled to elect a majority of the board of directors. No one disputed that. Two things weren't so clear, however:
- Whether the Agreement qualified as a USA under the CBCA; and
- Whether, even if the Agreement contained each of the necessary elements of a USA, the voting restrictions that it contained were superfluous to a USA and ought therefore to be considered a separate and severable agreement and not part of the USA at all (notwithstanding that they had been dropped into an agreement that said "USA" at the top and which otherwise may have been a proper USA as defined in the CBCA).
At trial, the Crown argued that because non-resident shareholders held more than 60% of the voting shares during the relevant period, Bagtech wasn't a CCPC as it "failed" the hypothetical person test. Bagtech replied that the Agreement was a USA that gave Canadian resident shareholders the power to appoint the majority of directors of the company. Applying the hypothetical person test, it followed that the hypothetical person would not have control of the company. (This of course requires us to accept that the hypothetical person should be considered a (hypothetical) party to the USA: at trial, the Tax Court agreed with this proposition and its conclusion on that point was not appealed.)
Issues before the court
In order to decide whether Bagtech was a CCPC eligible for the enhanced SR&ED credit, the Federal Court of Appeal therefore had to determine whether the Agreement was a CBCA-compliant USA and, if so, whether the voting restrictions in the Agreement ought to be considered part of that USA or whether they constituted a distinct and severable agreement.
Analysis and decision
On appeal, the Crown made much of the Quebec case of Leblanc c. Fertek, REJB 2000-20884 (Sup. Ct.), citing it for the proposition that, within a purported USA, only those clauses that restrict shareholders' powers can be considered part of the actual USA as contemplated by the CBCA (or other similar statute). In Leblanc, the Quebec court had severed the other clauses. Agreeing with counsel for Bagtech and with the court below, the Federal Court of Appeal held that the Leblanc reasoning does not express a general rule, as, in its view, the Supreme Court's opinion in Duha Printers (not addressed in Leblanc) implies that the contrary is the case. The Federal Court of Appeal noted that the USA in Duha Printers had also contained a clause concerning the election of directors and held, contrary to the argument of the Government, that the Supreme Court of Canada in that case had not found that clause to be extraneous to the USA.
So the voting restrictions did indeed constitute part of the USA, from which it followed that they had to be taken into account when the court considered the key issue of de jure control. For this analysis, the court applied the hypothetical person test which, as noted earlier, is essentially a test of de jure control. De jure control is enjoyed by those who are able to elect the majority of directors and therefore "control" the business and affairs of a company. If the hypothetical person as described in that test controls the company, a non-resident is deemed to exercise de jure control and the company is not a CCPC. In this instance, even though non-resident shareholders held more than 60% of the voting rights (which on its face would disqualify Bagtech from CCPC status), the Agreement included provisions requiring that the majority of directors be appointed by Canadian resident shareholders. From this it obviously followed that the hypothetical person could not be said to hold de jure control over Bagtech. The court accordingly held that control was in fact held by Canadian resident shareholders, validating Bagtech's claim to be eligible for CCPC status.
The USA's special status
The Federal Court of Appeal addressed what some have called the inconsistency in recognizing voting provisions in USAs as affecting control while identical provisions in ordinary voting agreements have no such power, as follows:
In order to avoid creating uncertainty for taxpayers, the SCC concluded [in Duha Printers] that such clauses should not be taken into consideration when simply included in private agreements between shareholders. In seeking to strike a fair balance between these two concerns, it is logical that the special nature of USAs, which are constating documents, and the fact that USAs are easily accessible (for example under ... the CBCA, USAs are entered in the records of a corporation and kept at the corporation's registered office, and may be consulted by any representative of the corporation's shareholders or creditors) make a difference. It is not unusual in tax law to obtain a different result by using one form rather than another.
Be this as it may, the upshot from Bagtech's point of view was that its Canadian resident shareholders, having been given the ability to appoint the majority of the directors, were considered to have de jure control. Accordingly, the company could claim CCPC status and the desired enhanced investment tax credit.
Observations
If a corporation wishes to obtain or maintain CCPC status even though non-residents (together with public corporations) own or may come to own a majority of its voting shares, it may be worthwhile to consider the possibility of using a USA to restrict the ability of the non-resident and/or public corporation shareholders to elect a majority of the board of directors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
