There are a plethora of tax issues that can arise in connection with shareholders agreements.  Only a selected number of issues are discussed in this paper.  The private corporation environment has been assumed and the issues addressed have an inter vivos focus, rather than post mortem planning.  Control issues, paragraph 251(5)(b) of the Income Tax Act[1], and the effect of the preferred share rules are analysed in the context of a shareholders agreement.

 Control Concerns

 (a)           De Jure Control

Any discussion of income tax issues, the concept of control and shareholders’ agreements must inevitably start with the Supreme Court of Canada decision in Duha Printers (Western) Ltd. v. The Queen[2]. The Duha decision has been the subject of much commentary but it is worthwhile to summarize the facts and the decision below both to note what the case decided and what it did not.  

 

(i)                   The Duha Decision

 
Duha was essentially a loss utilization transaction.  The loss company was Outdoor Leisure Land of Manitoba Ltd. (“Outdoor”), a Manitoba corporation which was a wholly-owned subsidiary of Marr’s Leisure Holdings Inc. (“Marr’s”).  Marr’s was controlled by a husband and wife, Mr. and Mrs. Marr.  The profitable corporation was Duha Printers (Western) Ltd. (“Duha”), a corporation controlled by Mr. Duha.  Mr. Duha was not related to either of Mr. or Mrs. Marr. 

Marr’s acquired apparent voting control of Duha by the following steps.

·                 By Articles of Amendment, a special class of preferred shares of Duha was created and designated as Class “C” preferred shares.  The Class “C” preferred shares carried the right to one vote per share provided that the voting right would cease upon the death or transfer of the share.  Each Class “C” preferred share was redeemable by the corporation with the consent of the holder or, in the event that the shares were transferred, redeemable without requiring the consent of the holder.

·               Marr’s subscribed for 2,000 Class “C” preferred shares at the price of $1.00 per share or $2,000.00 in the aggregate.  As a result, Marr’s owned shares of Duha carrying the right to 55.71% of the voting rights attached to all shares in the capital of Duha.

·              On the same day as the above acquisition of shares, all of the shareholders of Duha entered into an agreement described as a “unanimous shareholders’ agreement” which provided that the affairs of the corporation were to be managed by a board of three directors elected by the shareholders and composed of four possible nominees being Mr. Duha, Mrs. Duha, Mr. Marr or Mr. Paul Quinton.  Apparently, Mr. Quinton was a friend of both Mr. Duha and Mr. Marr and had previously served as a director of a predecessor corporation to Duha.  The agreement in question also restricted the transfer of shares without the consent of the majority of directors; prohibited any shareholder from transferring or otherwise encumbering its shares in any manner; and further provided that new shares could only be issued with the unanimous consent of the existing shareholders. 

·                On the day following the above (i.e., after Marr’s acquired shares entitling it to greater than 50% of the voting rights of Duha), Duha purchased all the issued and outstanding shares of Outdoor (the loss company) from Marr’s for a nominal consideration of $1.00.

·                On the following day, Duha and Outdoor amalgamated.  Upon the amalgamation, the shares of Outdoor were cancelled and the shareholders of the amalgamated corporation were the same as the shareholders of Duha (pre-amalgamation) and holding the same number and class of shares as prior to the amalgamation.

·                 Subsequently, the shareholders elected Mr. Duha, Mrs. Duha and Mr. Quinton as the three directors of the amalgamated corporation.

The exit to the loss structure was implemented in the following calendar year.

·           The Class “C’ shares of Duha owned by Marr’s (being the shares which gave Marr’s apparent voting control of Duha) were redeemed for the redemption price of $2,000.00 at the beginning of the following calendar year.

·           The unanimous shareholders’ agreement was terminated shortly thereafter and Mr. Quinton resigned as a director of the corporation. 

For income tax purposes, Duha (the amalgamated corporation) deducted the non-capital losses of Outdoor in computing its taxable income.  The Minister disallowed those losses on the basis that Marr’s did not control Duha prior to its amalgamation with Outdoor. 

The taxpayer relied upon paragraph 256(7)(a).  From a technical perspective, if subparagraph 256(7)(a)(i)[3] applied at the time that Duha acquired all of the issued and outstanding shares of Outdoor, then Duha was deemed not to have acquired control of Outdoor and as a result, the loss streaming rules in subsection 111(5) would not have applied.  Subparagraph 256(7)(a)(i) required that Duha be related to Marr’s immediately prior to the acquisition of the shares of Outdoor, and Duha and Marr’s would be related to each other at that time if Marr’s controlled Duha.[4]  Thus, an analysis of the meaning of control became critical to the outcome of the case, including the relevance of the unanimous shareholder agreement entered into by the shareholders of Duha.

Iacobucci, J. held that for purposes of the Act, control referred to de jure control and not de facto control.  He referred to the following oft-cited passage from Buckerfield’s Limited v. M.N.R.[5]:

“I am of the view, however, that in Section 39 of the Income Tax Act [the former section dealing with associated companies], the word “controlled” contemplates the right of control that rests in the 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.”

Iacobucci, J. elaborated and explained that the de jure control test is an exercise in determining the person who has “effective control” of the corporation:[6]

“However, it must be recognized at the outset that this test is really an attempt to ascertain who is in effective control of the affairs and fortunes of the corporation.  That is, although the directors generally have, by operation of the corporate law stature governing the corporation, the formal right to direct the management of the corporation, the majority shareholder enjoys the indirect exercise of this control through his or her ability to elect the board of directors.  Thus, it is in reality the majority shareholder, not the directors per se, who is in effective control of the corporation.”

Further, Iacobucci, J. stated that it was appropriate to look beyond the shareholders’ register to constating documents for purposes of this exercise, but not to consider every legally binding arrangement between shareholders.  The judgment made a distinction between contractually binding agreements which are not constating documents and legally binding provisions within a constating document.  A unanimous shareholder agreement was held to constitute a constating document and therefore was relevant for purposes of determining de jure control of a corporation.

The agreement in Duha was a unanimous shareholder agreement because of the restriction on the ability of the directors to issue additional shares.  New shares could only be issued by the directors with the unanimous consent of all shareholders.  On the facts of the case, Iacobucci, J. held that the provisions of the particular unanimous shareholders’ agreement did not result in the loss of de jure control by Marr’s.  In other words, while the inability to issue new shares from treasury without unanimous shareholders’ approval constituted a restriction on the powers of the directors to manage the business and affairs of the corporation, it was not considered to be so severe that Marr’s lost the ability to exercise effective control over the affairs of the corporation. 

(ii)                 What is a Unanimous Shareholder Agreement?

 
Duha drew a distinction between a unanimous shareholder agreement and something other than a unanimous shareholder agreement.  Unanimous shareholder agreements were introduced into Canadian corporate law approximately 30 years ago with the enactment of the Canada Business Corporations Act[7] following the recommendation of the Dickerson Report[8].  Virtually all of the modern Canadian business corporations statutes contain such a concept and with substantially similar definitions.  The rationale for this recommendation, as explained by the relevant commentary in the Dickerson Report, was to overrule jurisprudence where an agreement among shareholders purporting to bind them in their capacity as directors was held to be an unlawful attempt to fetter the exercise of directors’ discretion.[9]  However, the potential scope of a unanimous shareholder agreement as permitted in the various corporate statutes goes beyond overruling such caselaw.  As one author put it[10]:

“Simply stated, the unanimous shareholder agreement allows the shareholders to strip the directors of their managerial powers without going through the time-consuming procedure of giving notice of and convening a shareholders’ meeting to remove the directors from the board.  The effect is instantaneous.  The unanimous shareholder agreement does not remove the directors from their positions.  It simply removes the powers that go with the position of director, to the extent set out in the agreement.”

The relevant provisions in the Ontario Business Corporations Act[11] are as follows:

                                1(1)         “unanimous shareholder agreement” means an agreement described in  subsection 108(2) or a declaration of a shareholder described in subsection 108(3);

108(2)    A written agreement among all the shareholders of a corporation or among all the shareholders and one or more persons who are not shareholders may restrict in whole or in part the powers of the directors to manage or supervise the management of the business and affairs of the corporation.

Thus, the statutory requirements are simple and without formality[12]: (a) a written agreement; (b) all shareholders[13] must be a party to the agreement provided that persons who are not shareholders may also be a party[14]; and (c) a restriction on the powers of the directors to manage or supervise the business and affairs[15] of the corporation.  It is the last mentioned requirement which is critical to constitute the agreement as a unanimous shareholder agreement as it is more than simply an agreement among all shareholders as to the manner in which they will exercise their voting rights.  The latter (which is also provided for in the OBCA[16]) is not a unanimous shareholder agreement notwithstanding that all shareholders may be a party.[17]  Only if the above three requirements are satisfied will a unanimous shareholder agreement be constituted.  Thus, there may be agreements which were not intended to operate as unanimous shareholder agreements which in fact constitute unanimous shareholder agreements[18] and conversely, a shareholders agreement may contain a declaration or statement of intention therein, i.e., that it is intended to be a unanimous shareholder agreement, yet fail to meet the above requirements and therefore not operate as a unanimous shareholder agreement.

Under the OBCA, directors are charged with managing or supervising the management of the business and affairs of the corporation.[19]  However, the statute does not elaborate what may constitute a restriction of the powers of the directors to manage or supervise the management of the business and affairs of a corporation sufficient to qualify an agreement among shareholders as a unanimous shareholder agreement.  In his discussion of the unanimous shareholder agreement as a constating document, Iacobucci, J. alluded to “major issues facing a corporation: corporate structure, issuance of shares, declaration of dividends, election of directors, appointment of officers, and the like”[20] as the items addressed in such an agreement.  In Duha, the agreement in question restricted the ability of the directors to issue new shares and this was sufficient to support unanimous shareholder agreement characterization.  It has been suggested that the statutory requirement for a restriction on the powers of the directors may be interpreted liberally by the courts to qualify an agreement as a unanimous shareholders agreement and not require a restriction that would, at common law, have been regarded as a fetter of directors’ discretion.[21]  For example, in Sportscope Television Network Ltd. v. Shaw Communications Inc.[22], the court noted the following in determining that the agreement in question constituted a unanimous shareholder agreement:

·                   one of the shareholders was entitled to bring a non-voting participant to a meeting of the board of directors – which the court considered was something which could not be ordinarily done without the approval of the directors.

·                  there were restrictions on the transfer of shares, subject to a 90% shareholder approval requirement.

·                   there was a mandated director’s resignation if a shareholder disposed of its shares.

·                  the representatives of the two major shareholders on the board of directors had to be present to constitute a quorum at directors’ meetings and any directors’ resolution required their approval.

Some may argue that the mere requirement of shareholder consent to a resolution of the board of directors represents a restriction on the powers of the directors and therefore any agreement signed by all shareholders with such a requirement constitutes a unanimous shareholders’ agreement. 

The OBCA specifically provides that a unanimous shareholder agreement may override certain statutory provisions.  Where these provisions deal with actions or decisions falling within the realm of directors’ powers, it may be inferred that an agreement which makes use of the override constitutes a restriction on the power of the directors to manage and supervise the affairs and business of the corporation.  For example, the OBCA provides that the issuance of shares may be subject to a unanimous shareholder agreement[23]:

Subject to the articles, the by-laws, any unanimous shareholder agreement and section 26, shares may be issued at such time and to such persons and for such consideration as the directors may determine.

Since the issuance of shares is a directors’ prerogative, if a written agreement signed by all of the shareholders restricts the issuance of shares by the directors, this should constitute a restriction on the power of the directors to manage the affairs of the corporation and thus qualify the agreement as a unanimous shareholder agreement.  There was such a restriction in the agreement in Duha.  Other examples of OBCA provisions which effectively contemplate that a unanimous shareholder agreement may restrict certain powers otherwise expressly reposed on directors by statute include:

·                   restrict or remove the powers of the directors to declare dividends[24]

·                   restrict or remove the powers of the directors to make by-laws[25]

·                   restrict or remove the powers of the directors to appoint officers[26]

·                   restrict or remove the powers of directors to fix remuneration of directors, officers and employees[27]

·                   restrict or remove the deemed borrowing powers of the directors and their ability to   delegate same[28]

·                    provide for the procedure at meetings for shareholders[29]

It must be recognized however that the mere existence of a unanimous shareholder agreement may not change de jure control or rather, cause a majority shareholder (who might otherwise be considered to enjoy de jure control) to lose same.  This was succinctly stated by Iacobucci, J. in Duha:[30]

…the simple fact that the shareholders of a corporation have entered into a USA does not have the automatic effect of removing de jure control from a shareholder who enjoys a majority of the votes in the election of the board of directors.  Rather, the specific provisions of the USA must alter such control as a matter of law.  But to what extent must these powers be compromised before the majority shareholder can be said to have lost de jure control over the company?

In my view, it is possible to determine whether de jure control has been lost as a result of a USA by asking 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 (as contemplated by the Buckerfield’s test).

Other writers[31] have commented on the unique position of the unanimous shareholder agreement and its function in the determination of de jure control.  If one examines the restrictions on directors’ powers which the OBCA expressly contemplates may be imposed by a unanimous shareholder agreement (some of which are listed above), it is arguable that including any one restriction in a unanimous shareholder agreement that requires unanimous shareholder approval should not result in loss of “effective control” by the majority voting shareholder.  However, this analysis clearly becomes a matter of degree if more directors’ powers are “shifted” to the shareholder level pursuant to the unanimous shareholder agreement and require shareholder unanimity.  For example, in Donald Applicators Ltd. v. MNR[32], the Exchequer Court suggested that the authority of directors had only been “slightly restricted or modified” by provisions in the corporation’s articles of association which prohibited the issuance of shares without unanimous shareholder consent and provided for mandatory distribution of profits which thereby restricted the directors’ authority to accumulate profits.  Thurlow, J. did not think that these restrictions imposed “any serious effect” on the authority of the directors and as a result did not consider that this affected control by the shareholders.[33]  By analogy, it may be that moving these two powers (i.e., issuance of shares and declaration of dividends) to the shareholders by means of a unanimous shareholder agreement and requiring unanimous consent of shareholders may not cause a majority voting shareholder to lose de jure control.  

At the other end of the spectrum is an example given by the Canada Revenue Agency[34] in Interpretation Bulletin IT-64R4[35].  Where the constating documents of a corporation required unanimous consent by all holders of voting shares of all shareholders resolutions, the holder of the majority of the voting shares was not considered to have de jure control of the corporation. 

Alteco Inc. v. The Queen[36] should also be considered in an analysis of the provisions of a unanimous shareholder agreement and de jure control.  Alteco was referred to in Duha.  In this case, Alteco Inc. held 51% of the issued and outstanding shares of 581387 Saskatchewan Ltd. (“387”) and National Record Distributors Ltd. (“National”) held the remaining 49% of the issued and outstanding shares.  387 operated a record/audio retail store franchise.  National and Alteco entered into an agreement which set out capitalization and lending requirements for 387.  The agreement (which the Court found to be a unanimous shareholder agreement) also provided that shares could not be transferred without the prior consent of the other shareholder and a right of first refusal.  The agreement fixed the number of directors at five, set out the names of the directors and provided that these directors could not be changed with the unanimous consent of shareholders.  Any vacancy in the board of directors would be filled by unanimous resolution of the remaining directors.  Unanimous shareholder consent was also required to change the number of directors and to change the capital of the corporation.  The evidence showed that of the five persons listed in the agreement as directors: two were designated by Alteco and three were designated by National.  The issue in the case was whether Alteco controlled 387 as this was relevant to Alteco’s claim for an allowable business investment loss.  The Court held that Alteco did not control 387.  While the Court recognized that Alteco held 51% of the voting shares of the corporation, the critical finding was that it could not alter the composition of the board of directors and it had agreed to a board where three individuals had been nominated by the minority shareholder.  In Duha, Iacobucci, J. referred to this circumstance as guaranteeing the minority shareholder a majority of the representation on the board of directors.

Both Duha and Alteco looked at a unanimous shareholder agreement from the perspective of whether it caused a majority voting shareholder to lose de jure control.  In Duha, the answer was no.  In Alteco, the answer was yes and it is implicit in the decision that it was therefore the minority (49%) shareholder who had de jure control.  If the agreement in Alteco was not a unanimous shareholder agreement (e.g. because the statutory requirements were not complied with[37]), then based on Duha, such agreement would not be relevant to an analysis of de jure control.  However, as described below, the agreement may evidence de facto control by one shareholder or perhaps that the two shareholders constitute a group which controls (de jure) the corporation.

(b)                 De Facto Control

If an agreement among shareholders does not qualify as a unanimous shareholder agreement, then it is not relevant for purposes of determining de jure control of the corporation.[38]  Although not containing any restrictions on the powers of the directors to manage the corporation, an agreement among shareholders (referred to herein for purposes of simplicity as an “ordinary shareholder agreement”) may deal with their rights and arrangements inter se, such as:

·        voting rights amongst the shareholders[39]

·        representation on the board of directors and quorum requirements

·        super-majority or unanimity requirements with respect to changes to the articles of the corporation

·        preemptive rights – right to acquire more shares if the corporation chooses to issue additional shares

·        shareholder obligations to capitalize by debt or equity

·        divorce provisions whether voluntary or involuntary, upon death or inter vivos

·        dispute resolution

An ordinary shareholder agreement may be relevant for other provisions of the Act.  In particular, it has long been the administrative view of the CRA that such an agreement is relevant for purposes of determining de facto control.  It is listed in Interpretation Bulletin IT-64R4[40] as one of the general factors which the CRA considers may be used in determining whether de facto control exists.

The concept of de facto control is set out in subsection 256(5.1) which was an amendment to the legislation as a result of the extensive changes to the associated corporation rules in 1988. Subsection 256(5.1) states as follows:

                (5.1) Control in fact

                For the purposes of this Act, where the expression “controlled, directly or indirectly in any matter whatever,” is used, a corporation shall be considered to be so controlled by another corporation, person or group of persons (in this subsection referred to as the “controller”) at any time where, at that time, the controller has any direct or indirect influence that, if exercised, would result in control in fact of the corporation, except that, where the corporation and the controller are dealing with each other at arm’s length and the influence is derived from a franchise, licence, lease, distribution, supply or management agreement or other similar agreement or arrangement, the  main purpose of which is to govern the relationship between the corporation and the controller regarding the manner in which a business is carried on by the corporation is to be conducted, the corporation shall not be considered to be controlled, directly or indirectly in any manner whatever, by the controller by reason only of that agreement or arrangement.

The expression “controlled, directly or indirectly in any manner whatever” as defined above is notably used in the definition of “Canadian-controlled private corporation” (a “CCPC”) in subsection 125(7); the definition of “excluded corporation” in 127.1(2) in respect of the refundable investment tax credit; the particular definition of the word “control” as that applies for purposes of the affiliated persons rules in section 251.1; the associated corporation rules in section 256 and various other provisions including anti-avoidance provisions.[41]  This expression is not used in subsection 249(4) being the taxation year end triggered by control of a corporation being acquired by a person or group of persons, nor is it used in the loss streaming rule in subsection 111(5).

There have been a number of relatively recent cases dealing with de facto control and they have been summarized elsewhere.[42]  Some of these cases have included an ordinary shareholder agreement and for that reason, are commented on below.  However, it is inevitable that de facto control cases are highly fact based and thus limited guidance may be taken from them.

As a preliminary matter, although no shareholder agreement was involved, it is helpful to note the manner in which the de facto control test was articulated by the Federal Court of Appeal in Silicon Graphics Ltd. v. The Queen[43].  In Silicon Graphics, the taxpayer’s claim in respect of scientific research and experimental development expenditures was disallowed on the basis that the corporation was not a CCPC in the taxation years in question.  At that time, the definition of CCPC in subsection 125(7) read as follows:

“Canadian-controlled private corporation” means a private corporation that is a Canadian corporation other than a corporation controlled, directly or indirectly in any matter whatever, by one or more non-resident persons, by one or more public corporations (other than a prescribed venture capital corporation) or by any combination thereof.”

In Silicon Graphics, the corporation was listed on NASDAQ and accordingly its shares were widely held in its 1992 and 1993 taxation years.  In particular, the corporation had over 8 million issued and outstanding common shares (as of January 31, 1993) and during the relevant period, the number of shareholders ranged from 136 to 305 with a majority of such shareholders being non-resident.  Both de jure control and de facto control issues were litigated.  With respect to the issue of de jure control, the Court held that such control required a “common connection” among the shareholders so that a simple aggregation of non-resident shareholders would not result in such non-residents having de jure control of the corporation.[44]  Accordingly, the issue of de facto control had to be considered.  On the facts, Sexton, J. A. noted that there was no evidence of any agreement or common connection among the shareholders influencing the manner in which shares were to be voted.  With respect to the issue of de facto control, Sexton, J. A. stated as follows:[45]

        The case law suggests that in determining whether de facto control exists it is necessary to examine external agreements; shareholder resolutions; and whether any party can change the board of directors or whether any shareholders’ agreement gives any party the ability to influence the composition of the board of directors.

 

                It is therefore my view that in order for there to be a finding of de facto control, a person or group of persons must have the clear right and ability to effect a significant change in the board of directors or the powers of the board of directors or to influence in a very direct way the shareholders who would otherwise have the ability to elect the board of directors.

Sexton, J. A. held that no evidence had been adduced to illustrate that the non-resident shareholders (who apparently did not act collectively and may not have even known the identity of others) exercised de facto control over the corporation.

In the above excerpt, Sexton, J. A. referred to two cases, International Mercantile Factors Ltd. v. The Queen[46] and Multiview Inc. v. The Queen.[47] They are discussed below together with the recent case of The Queen v. Lenester Sales Ltd.[48]  All these cases involved some form of shareholder agreement with a control issue.

In International Mercantile, the issue was whether the corporate taxpayer was a CCPC in its 1979-82 taxation years so as to be eligible for small business deduction.  In particular, the question was whether it was “controlled, directly or indirectly in any manner whatever” by one or more public corporations.[49]  Although International Mercantile predated subsection 256(5.1), it is noteworthy as it was cited in support of Sexton, J. A.’s de facto control test as reproduced above, presumably because of the shareholder agreements involved. 

International Mercantile had experienced some financial difficulties and Eric Bissell had been retained originally as a consultant.  Subsequently, a contract was entered into between International Mercantile and Bissell & Bissell Enterprises Inc. (“B & B”) being a company controlled by Mr. Bissell, by means of which B & B offered his services to manage the affairs of International Mercantile.  Under this management agreement, business expansion and projects outside of the ordinary course of business were subject to the prior approval of the board of directors of International Mercantile and the corporation had the option to terminate the arrangement without notice upon payment of an effective penalty equal to one-third of the annual fee.  As part of these arrangements, Mr. Bissell, or his corporation was offered shares such that he would hold 50% of the voting rights.  As a result, the shares of International Mercantile were as follows:

·         shares representing 50% of the aggregate voting rights and 75% of the equity were held by two public corporations, Charter Industries Ltd. (“Charter”) and Hamilton Group Ltd. (“Hamilton”)

·         shares representing 50% of the aggregate voting rights and 25% of the equity were held by a private corporation, Rieris Holdings Ltd. (“Rieris”), a corporation controlled by Eric Bissell

Charter, Hamilton and Rieris entered into a shareholder agreement which, among other things, provided that:

·         no shares of International Mercantile could be issued without the unanimous consent of Rieris, Charter and Hamilton (apparently to ensure that Rieris would retain its relative equity and voting position)

·        the shareholder agreement shall be terminated upon the termination of the management agreement (which as described above could be terminated by International Mercantile at its sole option upon payment of an effective penalty)

·         in the event of termination of the shareholder agreement as a result of the termination of the management agreement, Charter and Hamilton were required to purchase Rieris’ shares of International Mercantile in equal proportions.

The shareholder agreement itself contained no provisions dealing with the election of directors of International Mercantile.  The evidence was that there was no agreement as to the representation of each shareholder on the board of directors although apparently the directors were reappointed each year by unanimous vote.  In the taxation years in question, the board of directors comprised five individuals: Mr. Bissell, two individuals who were considered to be nominees of Charter and two individuals who were considered to be nominees of Hamilton.  The Letters Patent of International Mercantile stated that a 60% vote was required to remove a director from office prior to the end of his term.  Also, the by-law of International Mercantile contemplated an annual shareholders meeting at which the board of directors would be elected provided that the existing directors would remain in office until successors were elected.

On a de jure control analysis and with reference to the decisions in Oakfield Developments (Toronto) Limited v. MNR[50] and The Queen v. Imperial General Properties Limited,[51] the Court determined that the corporation was not a CCPC on the basis that it was controlled directly or indirectly by one or more public corporations, i.e., Charter and Hamilton.  The Court noted that Rieris could take no step to cause any change in the composition of the board of directors given that the shareholder agreement was silent on this point, the removal of directors required a 60% vote and the by-law of the corporation stated that if a new board was not elected (which could only be done by majority vote), then the existing board would remain.  As a result, the Court held that Charter and Hamilton had “legal and effective control” of the corporation.  In effect, although the shareholders agreement preserved the deadlock in voting rights, there was no deadlock at the directors’ level.

In Multiview, the issue was whether the corporation was a CCPC so as to qualify for the refundable investment tax credit.  In the taxation year in issue, 43.6% of the issued and outstanding shares of Multiview were held by 990855 Ontario Inc. and the shares of that numbered company in turn were held equally by John Leslie (a non-resident) and Duncan Campbell (a resident).  In addition, John Leslie (the non-resident) also directly owned 37.5% of the shares of Multiview and Duncan Campbell (the resident) directly owned 13.1% of the shares of Multiview.  There were other Canadian resident shareholders (as to 1.2% and other non-resident shareholders (as to 4.6%).  John Leslie (the non-resident) and Duncan Campbell entered into a letter agreement.  None of the other shareholders of Multiview were apparently parties to this letter agreement.  Few details were available.  The letter agreement provided that both individuals would have equal representation on the board of directors and that both individuals had to be present to constitute a quorum for any directors meeting.  The taxpayer’s submission to the CRA (as reproduced in the judgment) refers to the two individuals having “a clear oral agreement with each other to the effect that all decisions regarding Multiview or the numbered company would be made on an equal basis by them” which oral agreement was presumably intended to be reflected in the letter agreement. 

The Tax Court of Canada held that Multiview was not controlled directly or indirectly in any manner whatever by John Leslie.  In particular, the Court noted the lack of a casting vote and stated:[52]

“For no time did any shareholder agreement provide that Leslie possessed a casting vote in 990855 Ontario Inc. nor did Leslie possess any other mechanism that would result in him controlling the voting shares of 990855 Ontario Inc.”

In this case, although the agreement apparently provided for equal representation on the board of directors by both individuals such that the non-resident had a negative veto over directors’ decisions (as indeed did the resident individual), this was not considered sufficient influence to result in control in fact of the corporation. 

The de facto control test as articulated in Silicon Graphics was applied in Lenester Sales which involved an associated corporations reassessment.  The CRA reassessed on the basis that a franchisee was controlled directly or indirectly in any manner whatever by the franchisor and therefore associated with another franchisee.  Although the tail-end of subsection 256(5.1) contains exclusionary language for what is sometimes referred to as the “franchise exemption”, the Federal Court of Appeal declined to express an opinion on whether this exemption applied but otherwise affirmed the Tax Court of Canada decision on the basis that the franchisor did not have control in fact of the franchisee. 

In Lenester Sales, the franchisor was Giant Tiger Store Limited (“GTS”).  It was the person which the Minister considered had control in fact of the taxpayer.  The relationship between the taxpayer and GTS included a franchising license agreement, a shareholders agreement and a lease.  In this case, the taxpayer operated a retail store under a franchising license from GTS.  The taxpayer also leased space from GTS.  In the taxpayer’s 1997 taxation year, its shares were held as to 501 shares by Russell Kerr (the operator of the particular retail outlet) and as to 499 shares by GTS.  The shareholders agreement provided for the following:

·                     Mr. Kerr was hired by the taxpayer as an employee and was required to devote his full time and attention to such position with remuneration to be determined from time to time by the board of directors.

·                      the board of directors was comprised of two individuals: one as a nominee of GTS and one as a nominee of Mr. Kerr.  The shareholders agreed to vote their shares to effect this result.  There was no provision for a casting vote. 

·                      There was a shotgun buy-sell arrangement.

In the Tax Court of Canada judgment, Bowman, A. C. J. T. C. noted that there was “nothing unusual” about the franchise agreement or the lease.  Bowman, A. C. J. T. C.  quoted the test of de facto control from Silicon Graphics as reproduced above and held that on the facts, GTS did not have the rights contemplated by that test.  In other words, he considered that GTS did not have the right to effect a significant change in the board of directors of Lenester Sales or their powers, or to influence in a direct way Mr. Kerr, being the 51% shareholder who would otherwise have the ability to elect the board of directors.  In addition, Bowman, A. C. J. T. C. also stated that if the broader interpretation of de facto control (i.e., economic dependence; day-to-day operation control) as set out by other caselaw applied, he nonetheless considered that GTS had no such direct or indirect influence so as to result in control in fact.  Further, Bowman, A. C. J. T. C. considered that the franchise exemption in subsection 256(5.1) would have applied.

The International Mercantile, Multiview, and Lenester Sales cases may be summarized in the following manner (overlaying a de facto control test to the facts in International Mercantile):

·        a shareholder agreement which recognizes deadlocked voting rights but which effectively “permits” greater representation on the board of directors by one group (i.e., the public corporations) than the other may result in a finding that the public corporations control, directly or indirectly in any manner whatever, the taxpayer corporation in International Mercantile.

·               a shareholder agreement which recognized deadlocked voting rights between a resident and non-resident and which provided for equal representation on the board of directors by each of them led to a finding that a non-resident did not control directly or indirectly in any manner whatever the taxpayer corporation in Multiview.

·              a shareholder agreement where there was a 51%:49% split in voting rights but which provided that each shareholder would have equal representation on the board of directors did not lead to a finding that a minority shareholder controlled, directly or indirectly in any manner whatever, the taxpayer corporation in Lenester Sales.

In a two shareholder situation, where there is equal representation on a board of directors, each of the two persons can exercise influence by virtue of a negative veto as all directors’ resolutions therefore require the consent of both directors.  In Multiview, the non-resident therefore had a negative veto at the director’s level.  Similarly, in Lenester Sales, GTS (the franchisor) had a negative veto at the director’s level although it was only a 49% shareholder.  Based on these cases, it appears that a veto right at the director’s level may not constitute de facto control, i.e., negative control may not be de facto control.  It should be noted that in neither Mutiview nor Lenester Sales was any person given a casting vote.

The foregoing appears to accord with the CRA’s administrative position.  In a response to a question regarding veto rights in a shareholder agreement[53], the CRA replied as follows:

The fact that a shareholder has veto rights over the merging or dissolution of a corporation, changes to its articles of incorporation or by-laws, the issuing of additional shares, or the purchase of shares in a corporation does not automatically mean in itself that the shareholder has control in fact of the corporation.

A shareholder who is the only person with veto rights over all the operations of a corporation could have control in fact of the corporation.  However, this depends as well on all the other relevant facts.  If all the shareholders in a corporation have veto rights over its operations, the veto rights of one of the shareholders could not in themselves give that shareholder control in fact.

It should be noted however (as was noted by Bowman, A. C. J. T. C. in the Tax Court of Canada decision in Lenester Sales) that a broader test of de facto control has appeared in other caselaw (notably in Mimetix Pharmaceuticals Inc. v. The Queen[54] and Transport M.L. Coutoure Inc. and 9044-2807 Quebec Inc. v. The Queen[55]) whereby operational control and economic dependency were considered rather than the narrower test in Silicon Graphics.  Accordingly, notwithstanding that deadlock by virtue of mutual veto may not result, in and of itself, in de facto control, other factors as considered pursuant to the broader principles referred to above it may lead to a different result.[56]

(c)                 Group of Persons

The CRA has stated a number of times that the existence of a shareholder agreement would not always be prima facie evidence that the shareholders that are party to the agreement constitute a group of persons.[57]  This is not relevant for purposes of the associated corporation rules given the special rule in paragraph 256(1.2)(a) which deems any two or more persons owning shares in the capital stock of a corporation to constitute a group.  However, it is relevant for other purposes,  notably the deemed year end upon acquisition of control of a corporation by a person or group of persons pursuant to subsection 249(4) and the loss streaming rules in subsection 111(5).

The prerequisites to constitute a group were outlined most recently by the Federal Court of Appeal in Silicon Graphics.  Sexton, J.A. stated the requirement that there be a “sufficient common connection” between the individual shareholders which might include a voting agreement, an agreement to act in concert or family or business relationships.  On the facts of the case, Sexton, J.A. indicated that there was no evidence that the non-resident shareholders would “vote as a block in the election of directors” or in other important matters related to the control of the company.  Recall however that this was a case involving hundreds of shareholders who may not have known the identity of other shareholders.