TaxMatters@EY - September 2013

Unanimous shareholders’ agreement saves CCPC status

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The Queen v PricewaterhouseCoopers Inc., agissant ès qualité de syndic à la faillite de Bioartificial Gel Technologies (Bagtech) Inc., 2013 CAF 164

Jennifer Smith, Ottawa

The Federal Court of Appeal (FCA) has upheld a Tax Court of Canada (TCC) decision that the terms of a unanimous shareholders’ agreement (USA) that restricted the ability of nonresident shareholders to elect directors was effective in preserving Canadian-controlled private corporation (CCPC) status — even though nonresident shareholders collectively held more than 50% of the corporation’s voting shares, determining de jure control.


The lengthy style of cause in this case is due to the fact that the taxpayer, Bioartificial Gel Technologies (Bagtech) Inc., was a bankrupt corporation and PricewaterhouseCoopers Inc. was its trustee in bankruptcy.

At the relevant time, Bagtech operated in the dermo-pharmaceutical industry, developing different types of dressings designed to accelerate skin healing. It conducted scientific research and experimental development (SR&ED) activities and claimed the refundable investment tax credit of 35% of qualified SR&ED expenditures. No single nonresident held a majority of the taxpayer’s shares, but cumulatively nonresidents held 62.52% and 70.42% of its outstanding voting shares in the 2004 and 2005 years, respectively. However, the USA the taxpayer and its shareholders entered into pursuant to the Canada Business Corporations Act (CBCA) gave Canadian residents the right to elect four members of the seven-person board of directors.

The Minister reassessed the taxpayer with respect to its 2004 and 2005 taxation years on the basis that it was not a CCPC and was therefore only entitled to the basic nonrefundable SR&ED investment tax credit of 20%. The Minister claimed that the application of the “hypothetical shareholder” rule in paragraph 125(7)(b) of the Income Tax Act, which aggregates the shareholdings of nonresidents and public corporations for the purposes of determining control, prevented the taxpayer from being a CCPC.

Tax Court of Canada decision

TCC Justice Paul Bédard first reviewed the CCPC definition in subsection 125(7), which reads as follows:

“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 nonresident 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 nonresident 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…

He cited the approach set out in the Sedona Networks case (2007 FCA 169), which carried out a two-step analysis in applying paragraph 125(7)(b). First, determine the nonresident persons and public corporations, and assume that their shareholdings belong to a “particular person.” Once this allocation is made, determine whether the corporation would be controlled by this “person.” If so, the corporation is not a CCPC.

Meaning of “control”

Justice Bédard next considered the meaning of the word “controlled” in paragraph (b) of the CCPC definition. He referred to the leading cases of Buckerfields ([1965] 1 R.C.É. 299) and Duha Printers ([1998] 1 S.C.R. 795) to reconfirm that “control” or “controlled” for the purposes of the Income Tax Act means de jure control — the control that resides in the ownership of shares that carry the voting rights to elect the majority of directors. The de facto control concept only comes into play when the relevant provision of the Income Tax Act uses the phrase “controlled, directly or indirectly in any manner whatever” (see subsection 256(5.1)). Paragraph 125(7)(a) uses this term, but paragraph 125(7)(b) uses only the word “controlled.”

Justice Bédard emphasized that the jurisprudence dealing with de jure control is not restricted to a very formalistic and narrow interpretation of rights attaching to shares. Rather, the courts will look to whether the majority shareholder enjoys “effective control” over the company’s “affairs and fortunes.”

Unanimous shareholders’ agreement

Duha is the leading Canadian case on de jure control. In that case, Supreme Court of Canada held that, in general, external agreements should not be considered in determining de jure control. However, a USA that is a corporate law hybrid, part contractual and part constitutional in nature, is one of the corporation’s constating documents, which also include the articles of incorporation and the corporation’s by-laws. As such, it is relevant in determining whether the majority shareholder(s) exercise effective control over the corporation.

Justice Bédard noted that the mere fact that a corporation’s shareholders have entered into a USA does not automatically mean there will be an impact on de jure control. The court must examine to what extent the terms of the USA would restrict the ability of the majority shareholder to elect members of the board or would impair substantially the power of directors to manage the corporation.

Under most corporate statutes, including the CBCA, a USA is an agreement that restricts, in whole or in part, the directors’ powers to manage the business and the affairs of the corporation. A valid USA binds those who become shareholders after it is signed.

Justice Bédard recognized the differing views on whether a valid USA may only include clauses restricting the powers of directors to manage. After reviewing the jurisprudence and various articles written on the subject, including Robert Couzin’s 2005 article “Reflections on Corporate Control” (2005 CTJ 2 p.305), he concluded that provisions in a USA such as the restrictions on the shareholders’ rights to elect directors would not invalidate a USA. Further, there is no requirement to sever such clauses from a USA, as had been the approach taken in at least one case.

Justice Bédard agreed with comments made by Mr. Couzin to the effect that the greater the restrictions a USA places on the directors’ power to manage the business, the less relevance should be accorded the ownership of the shares that carry the right to elect them. However, in the Bagtech case, these restrictions were considered to be relatively minor limitations on the directors’ power.

The Crown did not take issue with the principle that a USA is one of a corporation’s constating documents. However, it argued that the USA should not be taken into account in determining whether the hypothetical shareholder established in paragraph 125(7)(b) controls the corporation. The basis of this argument appeared to be that the hypothetical shareholder could not be bound by the USA, since it could not be a signatory. To hold otherwise would defeat the purpose of the paragraph 125(7)(b) deeming rule, which purports to deny CCPC status where the aggregate shareholdings of nonresidents exceed 50%, even if such nonresidents do not act in concert to exercise control.

Justice Bédard rejected the Crown’s argument on the basis that insofar as a legal fiction such as the deeming rule in paragraph 125(7)(b) transforms reality, its scope should be limited to what is clearly expressed, and otherwise it should not change reality (see La Survivance v The Queen, 2006 FCA 129, at para. 55). Therefore, the paragraph 125(7)(b) hypothetical shareholder should be deemed to have the same rights as the nonresident shareholders and would be considered to be bound by the USA.

In the end, Justice Bédard allowed the taxpayer’s appeal on the basis that the USA prevented the nonresidents from controlling Bagtech under paragraph 125(7)(b).

The Minister appealed the decision to the FCA.

Federal Court of Appeal decision

The Crown’s primary argument was that the trial judge interpreted too literally the Supreme Court’s comments in Duha dealing with USAs. In the Crown’s view, the Supreme Court’s goal was to establish general principles applicable to all of Canada, but it is still necessary in applying these principles to consider the applicable provincial or federal corporate statute.

Section 146 of the CBCA provides that a USA must include clauses that restrict in whole or in part the powers of the directors to manage the business and the affairs of the company. It does not contemplate clauses restricting the power of the majority shareholder to appoint the board. Therefore, the Crown reasoned, the agreement should be severed, with only the clauses that restricted the powers of the directors to manage being considered to be part of the USA.

The FCA disagreed with this restrictive interpretation. It was not prepared to add wording to the Supreme Court’s decision in Duha that was not there, in particular, since Duha involved the Manitoba corporate statute, which was similar to the CBCA.

Further, a consideration of the Supreme Court’s reasoning shows that its decision was not based on a finding that the relevant clauses were not properly part of the USA, but rather that the clauses were not effective to deprive the majority shareholder of the right to appoint the board.

The Crown also argued in the alternative that the TCC failed to take into account the impact of amendments to the CBCA since Duha was decided, in particular section 145.1, which confirms the validity of shareholder voting agreements and deals with them separately from USAs, which are dealt with in section 146. In support of this interpretation, the Crown cited a consultation document published by Industry Canada in April 1996 and comments from Industry Canada on the 2001 amendments to the CBCA.

Further, the Crown also argued that it was illogical that a restriction on the right of the majority shareholder to appoint directors will not be relevant to the analysis of de jure control if it is contained in a simple voting agreement, but it will be if it is included in a USA.

The FCA was not persuaded and noted that in The Queen v Craig (2012 SCC 43), the Supreme Court reiterated that it alone has the power to change its decisions.

In any event, the FCA did not find the Crown’s arguments to be persuasive for the following reasons:

  • The Industry Canada documents did not support the Crown’s alternative argument in the manner suggested by the Crown.
  • It is not unusual in tax law that a different result is achieved by adopting one legal form rather than another.
  • The FCA endorsed the SCC decision as pragmatic and flexible. The special character of the USA and the fact that it is included in the minute books of the corporation, held at the company’s headquarters, and can be accessed by any representative of a shareholder or a creditor confirms its status as a public document. This creates certainty and clarity for taxpayers.


The Crown’s appeal was dismissed with costs. Both the FCA decision and the TCC decision provide welcome clarification with respect to the role a USA plays in determining de jure control and are important considerations in planning for CCPC status.

The Crown has 60 days from the date of the judgment (21 June 2013) excluding the month of July to seek leave to appeal to the Supreme Court.