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A Selection of Income Tax Issues in the Downsizing and Restructuring of an Insolvent Company
by Joan E. Jung,
Tax Partner (First presented at the Ontario Bar Association program, “A Selection of Income Tax Issues in the Downsizing and Restructuring of an Insolvent Company”, June, 2005.) ___________ INTRODUCTION This paper will discuss the application of certain provisions of the Income Tax Act (Canada) (the “ITA”)[1] to the scenario of a corporation facing some financial challenges. The choices and methods of restructuring, both on a legal entity and on an enterprise basis, will have different tax consequences and indeed, may also lead to potential personal liability issues for those involved. It is assumed that the corporation will have been in operation for some period of time or, at least, one taxation year and thus, the corporation may have non-capital loss carryforwards and other assets. In this scenario, the goal is to preserve the tax attributes and tax accounts of the corporation. The business may revive and the tax attributes may effectively provide shelter against future income or there may be some opportunity to monetize same. This paper will discuss in particular: · Debt forgiveness · Loss utilization · Liability considerations This paper will not be a technical treatise on various income tax matters and is intentionally written in a non-technical manner. Some details of the actual provisions of the ITA may be found in the footnotes. A PRIMER OF TERMS Non-capital loss The term “non-capital loss” is a defined term in the ITA.[2] In the context of a corporation carrying on a business, a “non-capital loss” is essentially the corporation’s operating losses from carrying on the business and therefore is sometimes colloquially referred to as an “operating loss” or “business loss”. A “non-capital loss” is to be distinguished from a “net capital loss”[3]. Whereas a non-capital loss can be deducted from all sources of income, i.e., income from business or property or employment or capital gains, a “net-capital loss” can only be applied against a taxable capital gain. A non-capital loss may be carried forward for ten (10) taxation years and carried back for three (3) taxation years[4]. Control Subject to a number of anti-avoidance rules, control for purposes of the ITA generally refers to de jure control as opposed to de facto control. Specifically, control has been interpreted by the courts to mean the ownership of enough shares carrying a majority of votes in the election of the directors of the corporation[5]. As a result of the Supreme Court of Canada decision in Duha Printers (Western) Ltd. v. The Queen[6], it is generally understood that for purposes determining control, one looks not only at the share register but also any constating documents of the corporation including a unanimous shareholders agreement. The concept of control is relevant for the purposes of the ITA because of the tax consequences upon the acquisition of control of a corporation and the effect of same upon the existing non-capital loss and net capital loss balances of the corporation. For this purpose, it should be noted that although the phrases “acquisition of control” and “change of control” are sometimes used interchangeably in common parlance, for income tax purposes, the relevant phrase is an acquisition of control. Debt forgiveness rules The debt forgiveness rules[7] have the effect of reducing or “grinding” tax attributes where a debt is settled or extinguished for less than its principal amount. For this purpose, it should be noted that technically, not all debts may be subject to these rules. Specifically, it is only the forgiveness of a “commercial obligation”[8] that may have adverse tax consequences. A “commercial obligation” means either a “commercial debt obligation” or a distress preferred share. Distress preferred shares shall not be discussed herein as those rules are beyond the scope of this presentation.[9] In general terms, a “commercial debt obligation” is a debt obligation in respect of which interest is deductible in computing income or, where the debt obligation is non-interest bearing, such interest would have been deductible. In the case of a corporation carrying on business, if it is assumed that the debt obligations arise from an operating line of credit or specific project financing facilities, such obligations most likely constitute “commercial debt obligations”. Debt parking Prior to the significant changes to the debt forgiveness rules in 1994, these rules could be avoided by arranging for the debt to be purchased by a related entity at a discount. This was often referred to as “debt parking”. However, this planning technique has largely been made ineffective under the current rules. Debt parking[10] is a subset of the debt forgiveness rules and, if applicable, causes the debt forgiveness rules to apply notwithstanding that there may not have been any formal extinguishment, waiver or settlement of an outstanding commercial debt obligation. Rather, the debt parking rule is predicated upon a change in relationship between the debtor and the debt holder (typically a change to a non-arm’s length relationship) including ownership of shares of the corporate debtor, and requires that the debt holder have acquired the debt at a discount of greater than 20%. Non-arm’s length
For purposes of
the ITA, persons can be non-arm’s length
(sometimes referred to as “not dealing with each
other at arm’s length”) by virtue of deeming
rules[11]
or as a question of fact. For example,
individuals may be deemed to be non-arm’s length
by virtue of a connection by blood relationship,
marriage or adoption. However, a corporation
and a shareholder or any two corporations may be
deemed to be non-arm’s length because of control
circumstances. The relevant rules are beyond
the scope of this discussion but suffice it to
state that a corporation and the person who
controls the corporation are deemed to be
non-arm’s length and any two corporations which
are controlled by the same person are also
deemed to be non-arm’s length. WHAT HAPPENS IF A CORPORATION BECOMES A BANKRUPT? For purposes of the ITA, the term “bankrupt” is as defined in section 2 of the Bankruptcy and Insolvency Act (the “BIA”)[12]: “Bankrupt” means a person who has made an assignment or against whom a receiving order has been made or the legal status of that person.
The consequences of a corporation becoming a bankrupt are set out in section 128 of the ITA which specifies the following[13]:
(a)
The trustee in bankruptcy is deemed to be an
agent of the bankrupt for all purposes of the
ITA.
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|||||||||||
|
Loss |
Carry - forward |
Carry - back |
|
Non-capital loss |
10 taxation years |
3 taxation years |
|
Net capital loss |
Unlimited |
3 taxation years |
· Certain losses may be applied against certain income only. Specifically, a net capital loss may only be applied against taxable capital gains and there are also rules resulting in limited utilization of restricted farm losses and limited partnership losses.
Where there is an acquisition of control
If there is an acquisition of control of the corporation, significant restrictions apply, notably:
· limitation of carryforward of non-capital losses by virtue of “loss streaming”
· no further carry forward of net capital losses
· where the fair market value of capital property is less than its adjusted cost base at the time control of the corporation is acquired, such property is deemed to have been disposed of at fair market value immediately before that time, thereby triggering a capital loss[31]
· where the fair market value of depreciable property is less than its undepreciated capital cost at the time control of the corporation is acquired, such property is deemed to have been disposed of at fair market value immediately before that time, thereby triggering a terminal loss which effectively becomes a non-capital loss subject to “loss streaming” after the change of control
· a year end of the corporation is deemed to have ended immediately before the acquisition of control[32]
These restrictions may be found in subsection 111(4), (5) and (5.1) of the ITA. Consideration of these provisions in OSFC Holdings Ltd. v. The Queen resulted in the Federal Court of Appeal holding that there is a clear and unambiguous policy in the ITA against the trading of losses by corporations, subject to the limited circumstances contemplated in section 111.[33]
For purposes of these restrictions, control means de jure control rather than de facto control. The principles applicable in determining control of a corporation were succinctly summarized by Iacobucci, J. in the Supreme Court of Canada decision in Duha, supra, as follow[34]s:
It may be useful at this stage to summarize the principles of corporate and taxation law considered in this appeal, in light of their importance. They are as follows:
(1) Section 111(5) of the Income Tax Act contemplates de jure, not de facto, control.
(2) The general test for de jure control is that enunciated in Buckerfield's, supra: 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".
(3) To determine whether such "effective control" exists, one must consider:
(a) the corporation's governing statute;
(b) the share register of the corporation; and
(c) any 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:
(i) the constating documents of the corporation; or
(ii) any unanimous shareholder agreement.
(4) Documents other than the share register, the constating documents, and any unanimous shareholder agreement are not generally to be considered for this purpose.
(5) If there exists any such limitation as
contemplated by item 3(c), the majority
shareholder may nonetheless possess de jure
control, unless there remains no other way for
that shareholder to exercise "effective control"
over the affairs and fortunes of the corporation
in a manner analogous or equivalent to the
Buckerfield's test.
The loss utilization restriction rules in subsections 111(4) and (5) apply where “control of a corporation has been acquired by a person or group of persons”. The term “group of persons” is not defined in the ITA but is generally considered to mean more than simply any aggregation of persons who own shares in the same corporation. Rather, there must be a common link or interest among those persons such that they may be considered to act in concert to achieve certain purposes.[35]
There are anti-avoidance provisions in the ITA relevant to the concept of an acquisition of control of a corporation. In particular, the interaction of paragraph 251(5)(b) and subsection 256(8) need to be considered in any circumstance where parties are dealing with the shares of a corporation with non-capital loss carryforwards. Pursuant to subsection 256(8), where a taxpayer acquires a right referred to in paragraph 251(5)(b) and “it can reasonably be concluded that one of the main purposes of the acquisition” is to avoid any limitation on the deductibility of any non-capital loss[36], then for purposes of determining whether control of a corporation has been acquired, any such right is treated as if it had been exercised. The rights referred to in paragraph 251(5)(b) are very broadly worded – being a “right under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently” to acquire shares (for example)[37] and thus in the simplest form, would include an option to purchase shares. For example, if a taxpayer acquired less than 50% of the voting shares of a corporation which has non-capital loss carryforwards but also acquires an option to purchase the balance of the voting shares, the interaction of paragraph 251(5)(b) and subsection 256(8) may treat the taxpayer as having acquired control of the corporation assuming that “it can reasonably be concluded that one of the main purposes” of the taxpayer acquiring the option is to avoid the loss streaming rules.
It should also be noted that there are certain mitigating provisions which deem control of a corporation to not be acquired. In particular, control of a corporation is deemed not to have been acquired by virtue of an acquisition of shares from a related person.[38] This generally facilitates the transfer of shares among a family or corporate group without impairing the ability to utilize non-capital losses. There are also specific deeming rules applicable to amalgamations, reverse takeovers and share exchanges.[39]
The non-capital loss streaming rule in subsection 111(5) may generally be summarized as follows:[40].
· There must be a loss(es) from a business.
· “That business”, i.e., the business in which the losses were realized (sometimes colloquially referred to as the “loss business”) must be carried on for profit or with a reasonable expectation of profit throughout the particular taxation year after the acquisition of control in which the non-capital losses are being deducted.
· the non-capital losses carried forward may only be applied against:
o income from the “loss business”, or
o where properties were sold, leased, rented or developed or services were rendered in carrying on the “loss business”, income from another business “substantially all the income of which derived from the sale, leasing, rental or development of similar properties or the rendering of similar services” – the so-called “same or similar business” requirement.
The following provides more detail with respect to the requirements of subsection 111(5) and the above points.
(a) There must be a loss or losses from a business.
Although losses from property and losses from employment also fall with the definition of “non-capital loss” in subsection 111(8), it is only losses from a business that may be carried forward to taxation years ending after control of the corporation has been acquired, subject to the loss streaming restrictions.
(b) The “loss business” must be carried on for profit or with a reasonable expectation of profit throughout the particular taxation year after the acquisition of control in which the non-capital losses are being deducted.
The “loss business” is the very business which was carried on by the taxpayer and gave rise to the losses in question. Thus, it must the “same business” which is being carried on after the acquisition of control. In other words, the “loss business” must be continued after the acquisition of control. Whether it is the “loss business” which continues to be carried on after the acquisition of control or whether it is a “separate business” is a question of fact. The seminal UK case of Scales (Inspector of Taxes) v. G. Thompson & Co.[41], held that question was the degree of “interconnection, any interlacing, any interdependence, any unity at all embracing”[42] the two businesses. In this case, the issue was whether the operation of a fleet of ships was the same business or a separate business from insuring or underwriting shipping risk. It was held that these were separate businesses.
Factors which may be considered in the above analysis include[43]:
· Whether the operations are carried on from the same premises[44]
· Do the operations involve the manufacture and/or sale of similar goods of services? If the subject matter seems similar, is the similarity tangential as in the Scales case, i.e., shipping business and insuring shipping risk?
· Are the operations integrated such that one operation supplies the materials for the other?[45]
· Do employees and management of the loss company continue?[46]
· What is the degree of integration of the operations? Is there separate accounting, separate branding, separate payroll?[47]
(c) Income from the “same or similar business”
To paraphrase subparagraph 111(5)(a)(ii), the non-capital losses may only be applied against income (in a post-acquisition of control year) from the same business (i.e., the “loss business”) or a business where substantially all[48] of the income was derived from a similar business. The determination of whether there is a similar business largely applies the same criteria as the “same business” analysis.[49]
There is a similar loss streaming rules in the winding-up provisions of the ITA[50]. Thus, it is possible to wind-up a subsidiary[51] and thereby effectively “move” its non-capital losses to the parent corporation.[52] However, where control of the subsidiary has been acquired and the subsidiary is thereafter wound-up, loss streaming rules apply.
LIABILITY CONSIDERATIONS
There are two key potential liability provisions in the ITA to be considered in dealing with a financially troubled corporation: section 160 and section 159.
Section 160 contemplates a non-arm’s length transfer of property for less than fair market value consideration. Where section 160 applies, the transferee becomes jointly and severally liable to pay any amount which the transferor is liable to pay under the ITA for the taxation year of transfer and preceding years (i.e., therefore including interest on unpaid taxes in addition to tax), to the extent that the fair market value of the transferred property exceeds the consideration therefor. Although a taxpayer can typically only be reassessed by the CRA within 3 years after the date of mailing of the notice of original assessment, this limitation does not apply to section 160.
Section 160 may apply to the declaration of a dividend in a non-arm’s length situation. The case of Algoa Trust v. The Queen[53] held that the payment of a cash dividend constituted a “transfer of property”. The possibility of a section 160 assessment may lead to shareholder liability for the corporation’s unpaid taxes.
Section 159 applies to a “legal representative” (as defined)[54]. A “legal representative” is jointly and severally liable with the taxpayer to pay any unpaid amount under the ITA for which the taxpayer is liable, to the extent that the “legal representative” is in possession or control of property belonging to or held for the benefit of the taxpayer. Further a “legal representative” should obtain a clearance certificate from the CRA prior to distributing property in its possession or control. Otherwise, the “legal representative” may be personally liable for any amount which the taxpayer is or can reasonably be expected to become liable, to the extent of the value of the property distributed.
The term “legal representative” is defined as follows:
legal representative” of a taxpayer means a trustee in bankruptcy, an assignee, a liquidator, a curator, a receiver of any kind, a trustee, an heir, an administrator, an executor, a liquidator of a succession, a committee, or any other like person, administering, winding up, controlling or otherwise dealing in a representative or fiduciary capacity with the property that belongs or belonged to, or that is or was held for the benefit of, the taxpayer or the taxpayer's estate
There is limited jurisprudence relating to section 159. It seems to be accepted that directors, acting in their capacity as such, do not constitute “like persons” so as to fall within the “legal representative” definition and therefore should not be held liable under section 159[55] The issue is whether a person could be considered to be acting in a like fashion to a liquidator and thus be considered a “de facto liquidator” potentially subject to personal liability pursuant to section 159. In one reported case, Malka v. The Queen[56], an individual was held to be a “de facto liquidator”.[57] The title or office of the individual is unclear from the facts of the case although he was a shareholder. The case involved a loss utilization arrangement where two individuals acquired the common shares of a loss company but not voting control as the existing shareholder subscribed for voting preferred shares. The loss company acquired a profitable shoe manufacturing business whose profits were sheltered by the pre-existing non-capital losses. The shoe business was thereafter sold and the profits distributed to the shareholders. In this context, the Court held that one individual was acting as de facto liquidator.
SUMMARY
A restructuring of an insolvent corporation will almost inevitably have debt forgiveness issues. The above should provide an overview of the application of these complex rules. A restructuring which results in the introduction or change of shareholders may require a determination of whether there has been an acquisition of control of the corporation for tax purposes. An acquisition of control results in restrictions in the utilization of losses of the corporation as described above.
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[1] The “forgiven amount” formula recognizes that an obligation may be issued at a discount. Technically, the calculation is based on the difference between the lesser of the principal amount of the obligation and the amount for which the obligation was issued.
[2] If an employee loan is forgiven, such forgiveness results in an employment benefit which is included in income pursuant to subsection 6(15) and paragraph 6(1)(a). Forgiveness of shareholder debt also results in an income inclusion pursuant to subsections 15(1) and (1.2) rather than the application of the debt forgiveness rules.
[3] See definition in subsection 80(1). See also discussion in footnote 26 regarding trade debts.
[4] Subsection 78(1) would apply rather than the debt forgiveness rules. Subsection 78(1) causes an income inclusion where a deductible expense is incurred by a taxpayer which is payable to a non-arm’s length person (e.g., interest, fees, royalties) but which is not paid by the end of the second taxation year following the year in which such expenses were incurred.
[5] Pursuant to paragraph 80(2)(g) which reverses earlier case law to the effect that the amount paid upon issuance of shares in satisfaction of debt was equal to the addition to stated capital at the time.
[6] Pursuant to paragraph 80(2)(h).
[7] Pursuant to subsections 80(3) to (11).
[8] See definition in subsection 248(1). In general terms, a taxpayer is a “specified shareholder” of a corporation where he owns not less that 10% of the shares of any class of shares of capital of the corporation or a related corporation. Certain look through and deeming rules also apply. For example, for purposes of this definition, a taxpayer is deemed to own those shares which are owned by a non-arm’s length person.
[9] For example, the “eligible transferee” may not apply the forgiven amount to reduce the adjusted cost base of shares or debt of related persons.
[10] Defined in subsection 89(1). In general terms, a “taxable Canadian corporation” is a corporation resident in Canada for income tax purposes, was incorporated in Canada and is not exempt from tax under the ITA.
[11] “Eligible transferee” is defined in subsection 80.04(2) and incorporates the concept of a “directed person” which is defined in subsection 80(1). An “eligible transferee” includes a taxable Canadian corporation which controls or is controlled by the debtor, or which is controlled by the debtor and persons related to the debtor, or which is controlled by the same person or group of persons which control the debtor. A partnership, all of whose members are residents of Canada for income tax purposes, may also be an “eligible transferee” using a deeming rule in paragraph 80(2)(j) which analogizes a member’s interest in the partnership to shares of a corporation based on proportionate fair market value.
[12] Pursuant to subsection 80(13). The income inclusion is 100% of the remaining unapplied forgiven amount in the case of a debtor which is a partnership.
[13] Such an “eligible transferee” is a “directed person” as defined in subsection 80(1).
[14] See subsection 80(14.1). The “gross tax attributes” are essentially all of the tax attributes which may be reduced by a forgiven amount other than an interest, share or debt in or of a related person.
[15] Pursuant to the formula in subsection 61.3(1), the fair market value of assets is reduced by certain amounts paid in the preceding 12 months to non-arm’s length persons as a dividend, reduction of paid-up capital in respect of any shares, or redemption or cancellation of shares.
[16] Calculated on an unconsolidated basis.
[17] If a debtor claims a reserve pursuant to either section 61.2 or 61.3 and has not made designations to reduce its tax accounts or tax attributes to the maximum extent possible, the Minister of National Revenue has the discretion to do so pursuant to subsection 80(16). Thus if a debtor plans to offset the income inclusion from a debt forgiveness using the reserve provisions and has not made the maximum discretionary tax account reductions, the ITA gives the Minister discretion to make such designations.
[18] See subsection 80.01(6).
[19] See paragraph 80.01(2)(b). For this purpose, a person is deemed to own those shares which are owned by non-arm’s length persons.
[20] This technically results in a deemed disposition of the debt at Nil and reacquisition at same. A debtor might make such an election to trigger a capital loss in respect of the debt.
[21] See subsection 80.01(7).
[22] Supra, footnote 52, provided that such acquisition of debt occurred after July 12, 1994.
[23] See subsection 80.01(8). If the debt parking rule has applied and the loan is subsequently repaid, some relief is available pursuant to subsection 80.01(10) in the form of a deduction in computing income.
[24] Pursuant to subsection 80.01(10). In general terms, the deduction is equal to 50% of the amount by which the subsequent payment exceeds the forgiven amount, subject to adjustments if reserves were claimed pursuant to section 61.3.
[25] The CRA had an administrative position that the changes in terms of a debt obligation may result in a disposition of the debt itself and gave the following examples in Interpretation Bulletin IT-448, “Dispositions – Changes in Securities”:
7. The following changes in respect of the debt obligation itself (unless carried out pursuant to an authorizing provision in its original terms) are considered to be so fundamental to the holder's economic interest in the property that they almost invariably precipitate a disposition:
(a) a change from interest-bearing to interest-free or vice versa,
(b) a change in repayment schedule or maturity date,
(c) an increase or decrease in the principal amount,
(d) the addition, alteration or elimination of a premium payable upon retirement,
(e) a change in the debtor, and
(f) the conversion of a fixed interest bond to a bond in respect of which interest is payable only to the extent that the debtor has made profit, or vice versa.
The above administrative position was the subject of much criticism. Case law, Quincaillerie Laberge Inc. v. The Queen, 95 DTC 155 (TCC) also suggested that the above position was not correct, at least in terms of the effect of an extension in the maturity date.
[26] This change in administrative position was announced in Income Tax Technical News No. 14 (December 9, 1998):
Interpretation Bulletin IT-448, Disposition — Changes in Terms of Securities, comments on whether or not there has been a disposition of a debt obligation and the creation of a new debt when there are changes in its terms. Paragraph 7 particularly provides examples of changes that are considered to be so fundamental to the holder's economic interest in the property that they almost invariably precipitate a disposition. This position has created some controversy and confusion. The Department has indicated at various tax conferences that the settlement, extinguishment or disposition of a debt obligation was primarily a matter of law and that the Department was reviewing its position expressed in paragraph 7 of Interpretation Bulletin IT-448.
As a result of the review, it is now our position that if a debt obligation is renegotiated otherwise than as provided for in its original terms, the determination of whether a change in its terms is a substitution of a debt obligation for another should be made in accordance with the law of the relevant jurisdiction.
If, in accordance with the relevant contract law in Quebec, the changes in the terms of the original debt obligation have resulted in a novation (where the original debt obligation is discharged and substituted by a new obligation), it is appropriate to view the original obligation as having been disposed of for income tax purposes.
In the other provinces, a rescission of a debt obligation will be implied when the parties have effected such an alteration of its terms as to substitute a new obligation in its place, which is entirely inconsistent with the old, or, if not entirely inconsistent with it, inconsistent with it to an extent that goes to the very root of it. In such a case, it is appropriate to view the original obligation as having been disposed of for income tax purposes.
This position applies for the purposes of the Act and will be reflected in the next revision of IT-448.
[27] The preferred share regime in the ITA is complex. The terms, “taxable preferred share” and “short term preferred share” are defined in subsection 248(1). As a gross over-simplification, a fixed dividend rate is an attribute of a “taxable preferred share”. The limited exceptions referred to require the shareholder to have a “substantial interest” in the corporation which generally requires the shareholder to be “related” to the corporation (as that concept applies for purposes of the ITA) or to hold shares representing greater than 25% of the “votes and value” of the corporation, including 25% of the shares in the capital of the corporation which are not “taxable preferred shares”.
[28] Subject to a clawback (and therefore effective reduction in the dividend allowance) on a dollar for dollar basis to the extent of dividends paid by the corporation and its associated corporations in excess of $1,000,000 on “taxable preferred shares” or “short term preferred shares”. See subsection 191.1(4).
[29] Paragraph 110(1)(k) provides for a deduction in computing taxable income equal to three (3) times the Part VI.1 tax. This deduction approximates the income that would have generated sufficient income tax equal to the Part VI.1 tax and therefore implies a tax rate of 33.3%.
[30] Carryover periods in respect of restricted farm losses; limited partnership losses and allowable business investment losses are not reproduced in the above table.
[31] It is possible for the corporation to make a designation pursuant to paragraph 111(4)(e) in respect of capital property to effectively trigger a capital gain where the fair market value of a particular property exceeds its adjusted cost base. Pre-change of control net capital losses could then be applied against the resultant capital gain.
[32] Pursuant to subsection 249(4).
[33] 2001 DTC 5471 at paragraph 98. OSFC is, thus far, the highest court decision on the General Anti-Avoidance Rule in section 245.
[34] Supra, footnote 6 at p. 6350. Duha was essentially a loss utilization case which focused on subsection 256(7), a related party mitigating provision.
[35] See Interpretation Bulletin IT-302R3, “Losses of a corporation – The effect on their deductibility of changes in control, amalgamation and winding-up”, paragraphs 3-6.
[36] There are other “main purposes” referred to in subsection 256(8). For example, subsection 256(8) may also apply where it can reasonably be concluded that one of the main purposes of the acquisition of the paragraph 251(5)(b) right is “to affect the application of section 80”. Section 80 comprises the debt forgiveness rules.
[37] Paragraph 251(5)(b) contemplates such a right not only to acquire shares but also such a right to control the voting rights of shares; to cause a corporation to redeem shares held by anther person; to acquire voting rights in respect of shares; or to cause the reduction of voting rights in respect of shares held by another person.
[38] See subsection 256(7)(a). The concept of “related persons” is found in section 251.
[39] See paragraphs 256(7)(b) – (e).
[40] Paragraph (a) of subsection 111(5) is reproduced below with emphasis added to certain words illustrating the points summarized above:
Where, at any time, control of a corporation has been acquired by a person or group of persons, no amount in respect of its non-capital loss or farm loss for a taxation year ending before that time is deductible by the corporation for a taxation year ending after that time and no amount in respect of its non-capital loss or farm loss for a taxation year ending after that time is deductible by the corporation for a taxation year ending before that time except that
(a) such portion of the corporation's non-capital loss or farm loss, as the case may be, for a taxation year ending before that time as may reasonably be regarded as its loss from carrying on a business and, where a business was carried on by the corporation in that year, such portion of the non-capital loss as may reasonably be regarded as being in respect of an amount deductible under paragraph 110(1)(k) in computing its taxable income for the year is deductible by the corporation for a particular taxation year ending after that time
(i) only if that business was carried on by the corporation for profit or with a reasonable expectation of profit throughout the particular year, and
(ii) only to the extent of the total of the corporation's income for the particular year from that business and, where properties were sold, leased, rented or developed or services rendered in the course of carrying on that business before that time, from any other business substantially all the income of which was derived from the sale, leasing, rental or development, as the case may be, of similar properties or the rendering of similar services;
Paragraph (a) of subsection 111(5) applies to the carryforward of non-capital losses to taxation years following the acquisition of control. Paragraph (b) of subsection 111(5) applies to the carryback of non-capital losses to taxation years prior to the acquisition of control.
[41] [1927] 13 TC 83
[42] Supra, at p.89.
[43] See also Interpretation Bulletin IT-206R, “Separate Businesses” for the CRA’s administrative view.
[44] See Canadian Dredge and Dock Company Limited v. M.N.R., 81 DTC 154 (TRB) where there was a scale down of operations in the Maritimes and apparent relocation to Ontario.
[45] See Manac Corp. v. The Queen, 98 DTC 6605 (FCA) where a loss corporation carried on a panel manufacturing business and was acquired by a truck trailer manufacturing corporation. The panels became part of the truck trailers.
[46] The hiring of one employee, albeit the key individual was held insufficient to show that the loss business continued to be carried on in Garage Montplaisir Ltee v. M.N.R., 2001 DTC 5366 (FCA).
[47] For example, in Gaz Metropolitan v. M.N.R., [1999] 2 CTC 2116 (TCC), the acquired business had been merged so extensively with the parent’s enterprise that the operations could not be easily distinguished. See also DuPont Canada Inc. v. the Queen, 2001 DTC 5269 (FCA) where the Court held that explosives manufacturing was not a “separate business” from the business of manufacturing chemicals and plastics and reviewed numerous examples of integration of the operations.
[48] Although it has long been accepted that the CRA administratively considers “substantially all” to mean greater than 90%, recent cases have suggested that a lower threshold may suffice. In Manac, supra, at paragraph 13, the Court noted that 50% “is quite clearly not a percentage corresponding to ‘substantially all’. Watts v. The Queen, 2004 DTC 3111 (TCC) was an informal procedure case and therefore of limited precedent value. This was not a case relating to the loss streaming rules but rather the eligibility of a non-resident to claim certain tax credits. However, the Tax Court of Canada reviewed a growing body of case law (including GST cases, US and UK) as to the meaning of “substantially” and “substantially all” and concluded on the facts in the case that greater than 80% met the “substantially all” requirement
[49] See IT-302R3, supra, paragraph 14 where the CRA states: “The word ‘similar’ in the context of subsection 111(5) is generally interpreted as “of the same general nature or character”.
[50] See subsection 88(1.1).
[51] The rules in subsections 88(1) and (1.1) require that at least 90% of the shares of each class of the subsidiary were owned by the parent corporation immediately before the winding-up.
[52] Timing considerations apply. Although a winding-up does not trigger a year end of the subsidiary for tax purposes, the non-capital losses of the subsidiary may only be applied to taxation years of the parent commencing after the winding-up.
[53] 93 DTC 405 (TCC)
[54] See definition in subsection 248(1).
[55] M.N.R. v. Parsons, 83 DTC 5329 (FCTD).
[56] 78 DTC 6144 (FCTD).
[57] The CRA seems to acknowledge this possibility. In Information Circular IC 82-6R, “Clearance Certificate”, paragraph 3, the following statement is made:
The reference to any other like person includes any person acting as a liquidator, whether or not the person was formally appointed. For instance, in a voluntary dissolution, there may be no formally appointed liquidator and the responsibility may be assumed by an auditor, director, officer, or other person. The facts of each particular case will determine whether a person is a legal representative.
