Loss Consolidation – Unanimous Shareholder Agreements
In the past, the CRA has repeatedly stated that loss consolidation transactions that are legally effective and otherwise comply with the technical provisions of the Act would not ordinarily fall within the scope of section 245, provided that the transfer of income or deductions is within an affiliated group of corporations.
The CRA is of the view that there is a scheme to the Act, evidenced by certain provisions, including subsections 69(11) and 111(4) to 111(5.2), that restrict the claims by corporations for losses, deductions or credits incurred by non-affiliated corporations. However, these limitations do not apply to transactions between affiliated corporations.
In many loss consolidation transactions, the “affiliated status” of the relevant corporations is not a concern because these corporations are all directly or indirectly wholly-owned by the same person. However, some loss consolidation transactions may involve corporations that are not wholly-owned. In such cases, the determination of which corporations are affiliated with each other becomes important.
In Duha Printers (Western) Ltd. v. The Queen [Footnote 6] the Supreme Court of Canada stated that the test for de jurecontrol is whether the majority shareholder enjoys “effective control” over the “affairs and fortunes” of the corporation. The Supreme Court also stated that in order to determine whether such “effective control” exists, one must consider the corporation’s governing statute, its share register, and any 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 the constating documents of the corporation or any unanimous shareholder agreement (“USA”).
Question 1
Do we have to consider the potential impact of a USA in the context of loss consolidation transactions?
Response 1
Yes. As mentioned above, loss consolidation transactions within an affiliated group of corporations are generally acceptable. In order to determine whether the relevant corporations are affiliated with each other, one has to establish by whom such corporations are controlled. The Supreme Court of Canada has stated in Duha Printers that in order to determine who has the effective control of a corporation, one must consider not only the share register but, among other things, any USA.
Question 2
Can you give us an example of the impact that a USA could have in the context of loss consolidation within a corporate group?
Response 2
Of course. Let’s assume that a parent corporation (“Parentco”) owns a wholly-owned subsidiary (“Lossco”) and 55% of the shares of the capital stock of another corporation (“Profitco”). The remaining shares of Profitco are owned by an arm’s length person. Parentco and the arm’s length person have entered into a USA with respect to Profitco. This USA provides, among other things, that the following matters shall require the approval of both shareholders of Profitco: any capital expenditure in excess of a certain threshold, any borrowings, any lease arrangements over a certain threshold, any contract or agreement (other than in respect of capital expenditures) under which Profitco’s total obligation aggregates a certain threshold, the approval of any annual budget, any change in the nature of the business being conducted by Profitco, the appointment of senior corporate officers, the issuance, redemption or purchase for cancellation of shares of Profitco, the declaration of any dividends on any share of the capital stock of Profitco, the winding-up and dissolution of the corporation, and the acquisition of an interest in any other corporation.
In this example, Parentco would not be able to implement the loss utilization transaction involving Profitco and Lossco since, in our view, the USA would have the effect of removing legal control from Parentco. Based on the said USA, Profitco would appear to be effectively controlled by Parentco and the arm’s length person jointly. Consequently, Profitco and Lossco (which is controlled by Parentco) would not be affiliated with each other.
As indicated in Duha Printers, the determination of whether de jure control has been lost as a result of a USA in a particular situation requires the determination of 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. In order to answer this question, one has to analyze the specific provisions of the relevant USA and determine whether such provisions of the USA alter the control as a matter of law, taking into consideration the facts and circumstances surrounding the particular situation.
Question 3
Can a taxpayer get certainty on the effects of a USA when contemplating a loss consolidation transaction?
Response 3
As discussed in Information Circular 70-6R5, Advance Income Tax Rulings, the CRA provides an advance income tax rulings service to promote voluntary compliance, uniformity and self-assessment by providing certainty with respect to the income tax implications of proposed transactions. In fact, the CRA has issued rulings in the past involving USA’s and their effects on in-house loss consolidation transactions. Therefore, provided all the facts are presented in the ruling request in accordance with the procedures outlined in the circular, the CRA will consider a request for an advance income tax ruling on proposed transactions involving USA’s and their effect on in-house loss consolidation.