2015-0565741E5 Canadian-controlled private corporation

Principal Issues: Whether a corporation would be a CCPC in a particular situation?

Position: Subject to the review of all the relevant documents, the corporation would not be a CCPC.

Reasons: Paragraph 251(5)(b) would apply and subsection 256(6) would not apply.

Author: Labarre, Sylvie
Section: 89(1); 125(7); 251(5)(b); 256(6)

XXXXXXXXXX
                                                                                                                                                         2015-056574
                                                                                                                                                         Sylvie Labarre, CPA, CA

February 4, 2015

Dear Sir:

Re:  Canadian-controlled private corporation

This is in reply to your letter of January 24, 2014 in which you requested our opinion with respect to the qualification as a Canadian-controlled private corporation (“CCPC”) of a corporation in a particular situation.  Unfortunately, we had no record of receiving your letter and you had to resubmit your technical interpretation request.  In any event, we apologize for the delay in responding to your correspondence.

Unless otherwise specified, each legislative reference is a reference to the Income Tax Act (the “Act”).

1)    Assumed Facts

1.    Pubco is a corporation incorporated and existing under the laws of a province of Canada and is resident in Canada for tax purposes. A class of shares in the capital of Pubco is listed on a designated stock exchange in Canada.

2.    Mr. A is a deceased individual who was resident in Canada for tax purposes throughout his life. Prior to his death, Mr. A owned all the issued and outstanding shares in the capital of Aco.

3.    Aco is a corporation incorporated and existing under the laws of a province of Canada and is resident in Canada for tax purposes.

4.    At all relevant times, Aco’s business activities constitute an “active business carried on by a corporation” as defined in subsection 125(7).  Pursuant to the will of Mr. A, all of the issued and outstanding shares in the capital of Aco, among other assets, were transferred from the estate of Mr. A to a testamentary trust established for the benefit of Mr. A’s children (the “A Trust”). Pubco was appointed to act as trustee of the A Trust.

5.    Each child of Mr. A is a resident of Canada for tax purposes.

6.    Prior to the 21st anniversary of the death of Mr. A, A Trust distributes the shares of Aco equally among the children of Mr. A (the “Distribution”).

7.    Pursuant to a written agreement (the “Indemnification Agreement”) entered into prior to the Distribution, each child of Mr. A agrees to indemnify Pubco, its directors and its employees (collectively, the “Indemnified Parties”) in respect of claims and liabilities arising in connection with Pubco having served as trustee of the A Trust, including claims and liabilities of the A Trust for which any of the Indemnified Parties may be or become liable.

8.    The indemnification obligation of the children of Mr. A is secured by a pledge (the “Pledge”) of the property distributed under the Distribution, including all of the Aco shares. The Pledge will remain in place for a XXXXXXXXXX-year period (the “Pledge Period”) commencing at the time of its Distribution.

9.    During the Pledge Period, the Aco shares would be held by Pubco with endorsements permitting their transfer to Pubco where an Event of Default has occurred and is continuing. An Event of Default includes (i) a failure to satisfy an obligation under the Indemnity Agreement within XXXXXXXXXX business days following notice thereof, and (ii) certain usual insolvency or bankruptcy events in respect of Aco or a child of Mr. A.

10.   At the time of its execution of the Indemnification Agreement, there are no known liabilities or claims for which the Indemnified Parties may have liability.

2)    Question

Your question is whether, during the Pledge Period, Aco would fail to qualify as a CCPC because of the pledge of all of the shares of its capital stock by the children of Mr. A as a security for their obligations under the Indemnification Agreement.

3)    Your submissions

Pubco is a “public corporation” as defined in subsection 89(1) because it is a corporation resident in Canada having a class of shares in its capital stock listed on a designated stock exchange in Canada.

Aco is a “Canadian corporation” as defined in subsection 89(1) because it is resident in Canada and is incorporated under the laws of a province of Canada.

After the Distribution, you are of the view that Aco qualifies as a “private corporation” as defined in subsection 89(1) because it is a corporation resident in Canada, is not a public corporation because its shares are not listed on a designated stock exchange in Canada, and it is not controlled by one or more public corporations, prescribed venture capital corporations or any combination thereof. In this regard, and with specific reference to the Pledge Period, you note that subsection 251(5) is not relevant to the determination of Aco’s private corporation status as that subsection applies only for the purposes of a related person determination under subsection 251(2) and for the purposes of the CCPC definition in subsection 125(7).

It is your view that while Aco is a private corporation and a Canadian corporation and each of its shareholders is an individual resident in Canada, it does not appear to qualify as a CCPC during the Pledge Period because, pursuant to subparagraph 251(5)(b)(i), Aco is regarded as controlled by a public corporation, Pubco, during this Pledge Period.  Specifically, each Indemnified Party, including Pubco, has a contingent right pursuant to the Pledge to acquire all the Aco shares from its shareholders. Such right is contingent on an Event of Default occurring, such as an indemnification obligation arising and not being satisfied within the XXXXXXXXXX business day period.

You also note that where a corporation is either controlled or controlled, directly or indirectly in any manner whatever, by a person or partnership and such control arises because of a security under a debt arrangement, then in qualifying circumstances subsection 256(6) may apply to deem the corporation not to be under such control for purposes of the Act. 

In your view, the preamble of subsection 256(6) and paragraph 256(6)(a) appear to be satisfied. By virtue of subparagraph 251(5)(b)(i), Aco is regarded as controlled by Pubco during the Pledge Period. Pursuant to the terms of the Pledge, on the expiration of the XXXXXXXXXX-year period, Aco will cease to be controlled by Pubco and will be controlled by a group of persons, being the children of Mr. A. The children of Mr. A will deal at arm’s length with Pubco as Pubco will no longer be the trustee of the A Trust since the A Trust will no longer exist after the distribution of all its assets under the Distribution and, in any event, Pubco is not acting qua trustee in relation to the Indemnification Agreement and the Pledge because it would be pursuing its own self-interests rather than fulfilling fiduciary obligations owed to the beneficiaries of the A Trust.

However, it is your view that the requirements of paragraph 256(6)(b) are not satisfied. While the Pledge has a purpose of safeguarding Pubco’s rights and interests, there is no indebtedness owing to Pubco having an outstanding principal amount. While the indemnification arrangements constitute liabilities or obligations of the children of Mr. A, there are not, in your view, “indebtedness” as there is no “specified sum owing” by those children to the Indemnified Parties. You submit that the expression “specified sum owing” from one party to another has the usual meaning of indebtedness at common law. The reference in subparagraph 256(6)(b)(i) to the indebtedness having a “principal amount” appears to confirm that the usual meaning of indebtedness is intended to apply. The alternative provided under subparagraph 256(6)(b)(ii) is also not applicable since shares of the capital stock of Aco are not owned by Pubco during the Pledge Period unless there is an Event of Default and it is not contemplated under Indemnification Agreement or Pledge that they will be redeemed by Aco or purchased by the children of Mr. A.

Accordingly, it is your view that subsection 256(6) is unsatisfied with the result that, pursuant to subparagraph 251(5)(b)(i), Pubco is deemed to control Aco for the purposes of subsection 251(2) and the CCPC definition during the Pledge Period and that Aco is not a CCPC during the Pledge Period.

4)    Our comments

This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

Subject to the review of all the relevant documents, we agree with your conclusion that subparagraph 251(5)(b) would apply in the particular situation with respect to the definition of CCPC in subsection 125(7). Therefore, Pubco would be considered to be in the same position in relation to the control of Aco as if Pubco owned the Aco shares at that time.

Except as provided for by subsection 256(6), Aco would be regarded as being controlled by Pubco because Pubco would be considered to own all the shares of the capital stock of Aco. Therefore, we agree with you that we have to consider the application of subsection 256(6) for the purposes of the definition of CCPC. If subsection 256(6) were to apply, the controlled corporation would be deemed not to have been controlled by the controller at the particular time.

According to your submissions, the conditions provided for in paragraph 256(6)(a) seem to be met. Therefore, the only issue appears to be whether paragraph 256(6)(b) applies.

Subject to the review of all the relevant documents, we agree with your conclusion that paragraph 256(6)(b) would not apply in the particular situation. According to the facts and submissions that you provided, the purpose of the Pledge would not be the safeguarding of shares as described in subparagraph 256(6)(b)(ii). As for subparagraph 256(6)(b)(i), the question is whether the purpose of the Pledge would be to safeguard rights and interests of Pubco in respect of any indebtedness owing to Pubco the whole or any part of the principal amount of which was outstanding at the particular time.

The Act does not contain any general definition of the term “indebtedness”. Furthermore, there is no special statutory meaning assigned to that word for the purpose of subsection 256(6).

Black’s Law Dictionary (8th Edition) provides the following definition of the word “indebtedness”:

1.    The condition or state of owing money.
2.    Something owed; a debt.

The word “debt” has a broad meaning. For example, in J. Paul Fingold and David B. Fingold v. M.N.R., 92 DTC 2011 (TCC), the Court stated that “a debt is a sum payable in respect of a liquidated money demand.  It does not include an unliquidated claim for damages.” The Court also indicated that “a debt is a sum of money owed in respect of which a plaintiff has a right to bring and maintain an action.” [Re Kerr and Smith (1894), 24 O.R. 473]

In Tonolli Canada Limited v. M.N.R., 91 DTC 520 (TCC), the Tax Court of Canada  stated the following: “In the absence of a special statutory definition, “debt” means a sum payable in respect of a liquidated money demand, recoverable by action (See Diewold v. Diewold [1941] S.C.R. 35 at 39).”

The meaning assigned to “debt” in the Tonolli decision is the meaning that was assigned to that term in the Estate of Arthur Warwick Beament v. M.N.R., 69 DTC 5016 (Ex. Ct.).

In this context, the Courts have used the term “liquidated” to mean fixed or ascertainable.

In the particular situation you described, there was no known liability or claim for which the Indemnified Parties may have liability under the Indemnification Agreement.  Consequently, subject to the review of all the relevant documents and based on the above definitions, we agree with you that the rights and interests of Pubco under the Indemnity Agreement (as mentioned in the facts of the particular situation) do not seem to represent indebtedness the whole or any part of the principal amount of which was outstanding in the context of subparagraph 256(6)(b)(i).Therefore, and again subject to the review of all the relevant documents, Aco would not be a CCPC as defined in subsection 125(7) in the particular situation during the Pledge Period.

We trust our comments will be of assistance.

Yours truly,

Stéphane Charette, CPA, CMA, MBA
for Division Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2015

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2015