THE EVOLVING VIEWS ON DE FACTO CONTROL
There are a number of corporate tax rules that are impacted by whether or not corporations are associated with each other. Certain conditions must be met for corporations to be associated, but in general terms association means that there is common control of two or more corporations (for example, control by the same person or group of non-arm’s length persons). For Canadian-controlled private corporations, association is a key concern when it comes to claiming the small business deduction as it means having to share this deduction among associated corporations. Planning may be undertaken to ensure that a corporation is eligible to claim the full small business deduction. However, there are certain rules concerning control that need to be considered when planning within a corporate group.
When determining whether the association rules apply, there are three types of control to consider — de jure control which is legal control of a corporation; de facto control which is factual control; and deemed control which extends the meaning of control to certain situations for purposes of the association rules. The concept of control has been the subject of numerous court cases and, in particular, the views on de facto control appear to be evolving, so it is important to keep current on recent court decisions.
The de facto control test focuses on whether another corporation, person or group of persons has any direct or indirect influence, as opposed to the legal power, that if exercised would result in control in fact of the corporation. Note that de facto control will not apply where the controlling party and the corporation deal at arm’s length and influence is derived from a franchise, lease, distribution, supply or management agreement, and the main purpose of the agreement is to govern the relationship between the parties regarding conduct or business.
The Canada Revenue Agency (CRA) has been actively trying to establish de facto control in taxpayer situations in recent years to eliminate tax benefits such as multiple small business deductions in a corporate group. Court decisions have often focused on one of two types of influence when concluding on the existence of de facto control. Certain case decisions have focused on the influence of control at the shareholder level. Based on this type of influence, de facto control may exist if a person or group of persons has the ability to affect the composition of the board of directors or the powers of the board of directors. The other focus has been on operational influence, where de facto control may exist if a person or group of persons has the ability to affect the operations of the corporation, based on day-to-day management decisions and/or economic dependence.
Recent court cases appear to be considering different factors of both shareholder and operational influence. In the Taber Solids case, a recent Tax Court of Canada decision, a corporation owned equally by a husband and wife operated a specialized equipment rental and servicing business in the oil and gas industry. A reorganization was undertaken, resulting in two corporations (which we’ll call Corporation A and Corporation B). Corporation A, fully owned by the wife, retained the equipment and rented it to Corporation B. The husband owned the majority of Corporation B’s shares and this company rented out the equipment to third party oil and gas companies, as well as provided maintenance and repair services.
In this case, the CRA assessed the corporations as being associated requiring them to share the small business deduction. The two corporations were not legally owned by the same person or group of persons, rather the existence of de facto control was at issue. The court considered several factors and found that de facto control existed. The husband had de facto control of Corporation A because he had significant influence over the major operational decision for Corporation B to be Corporation A’s only customer. He also had significant influence over the board decisions regarding the acquisition and disposition of Corporation A’s equipment. Although the wife made certain board related decisions and took an active role in the business as the sole director of Corporation A, it was enough that the husband had influence over a decision of the board of directors at some point in the year. Further to that, Corporation A had complete economic dependence on Corporation B.
These reasons cover both shareholder influence and operational influence over Corporation A. The Judge noted that prior case decisions suggest that operational control on its own is not sufficient to constitute de facto control, but it is a factor to consider. As well, in this case, de facto control was not a matter of influencing the composition of the board of directors, but rather the influence over the powers of the board together with economic dependence.
As can be seen from this decision, it is important to consider the different factors of influence in a family situation when determining whether de facto control exists.
Next section: TAX COURT SETS NEW RESIDENCY RULES FOR TRUSTS
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