Tax Factor 2016-10

October 19, 2016

In this issue, we cover:
Selling your business: five tax considerations for business owners
De facto control—Federal Court of Appeal relies on a narrower approach
Beware of phony correspondence from individuals posing as CRA agents

Selling your business: five tax considerations for business owners

Please see the updated article here.

De facto control—Federal Court of Appeal relies on a narrower approach

Control is a key concept when applying certain corporate income tax rules. This is true for the association rules which must be considered when dealing with corporations. Certain conditions must be met for corporations to be considered 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 (SBD) because associated corporations must share the SBD, rather than each corporation being eligible to claim their own.

There are three types of control to consider when determining whether corporations are associated. These include de jure control (legal control of a corporation), de facto control (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, many cases have considered whether de facto control exists. De facto control focuses on influence, rather than legal power. Based on various court case decisions, different factors of both shareholder and operational influence have been considered when determining whether there is de facto control in a corporate structure.

In a previous Tax Factor article, "De facto control and what it means for your corporation", we provided more details on de facto control and discussed the 2015 Tax Court of Canada (TCC) decision in the McGillivray Restaurant (MR) case. This case considered whether de facto control existed. The Canada Revenue Agency (CRA) had assessed the taxpayer, MR, as being associated with two other corporations, which meant they had to share the SBD. MR was owned by Mrs. H who held a 76% interest, giving her de jure control of the company, and by Mr. H who held a 24% interest. The other two corporations were 100% owned by Mr. H. Based on the ownership structure, MR was not legally owned by the same person or group of persons as the other two corporations with the required cross-ownership for association. Instead, the CRA based their association assessment on the existence of de facto control.

In this case, the TCC considered broader manners of influence, including both shareholder and operational influence, in order to determine who had "effective control of the affairs and fortunes" of the taxpayer, instead of looking only at the ability of a person or persons to effect a change in the board of directors. Based on all of the facts, the TCC held that Mr. H exercised de facto control over MR. Although Mr. H held only a 24% interest in MR, he had significant day-to-day control and greater long-term control over the management and operations of MR, which greatly impacted the decision that de facto control existed. This resulted in the association of MR with the other two corporations owned by Mr. H. (For more case details, refer to the previous article).

The taxpayer appealed the decision to the Federal Court of Appeal (FCA). Interestingly, although the FCA also decided that de facto control existed to associate the corporations in this case, the FCA held that the TCC applied the wrong test in making this determination.

In its decision, the FCA analyzed previous court decisions dealing with de facto control. It concluded that a narrower approach to determining de facto control should be used, rejecting the assertion that the test for this type of control is based on "operational control". The judge stated that "de facto control, like de jure control, is concerned with control over the board of directors and not with control of the day-to-day operations of the corporation or its business". Further to this, it was the judge's view that the consideration of operational control when determining whether de facto control exists would bring a degree of subjectivity into the analysis; this could lead to unpredictability in the interpretative approach mandated by previous case law.

In deciding the case, the FCA therefore considered shareholder influence and whether Mr. H had the ability to affect the composition or the powers of the board of directors. The FCA agreed with the TCC's finding that there was an unwritten agreement between Mrs. H and Mr. H which effectively allowed Mr. H to retain the right to determine the entirety of MR's board of directors. Although this agreement did not give Mr. H de jure control, it did support a finding of de facto control.

Overall, a narrower approach to determining de facto control will likely favour taxpayers in cases where there is no support for shareholder influence. However, only time will tell whether the CRA will continue to argue broader manners of influence depending on the situation.

If you have any questions about de facto control, contact your BDO advisor.

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Beware of phony correspondence from individuals posing as CRA agents

Chances are you have heard of the great lengths that fraudsters will go to retrieve your personal and financial information. As the efforts of these criminals become more brazen, the need to protect your personal information—such as your social insurance number, credit card number, bank account number, or passport information—has become a big priority for many Canadians. In an attempt to obtain your personal information, many telephone scams and other fraudulent communications involve criminals posing as agents from the Canada Revenue Agency (CRA). While these phony communications can be disconcerting to say the least, it is important for you to know how to recognize a scam and distinguish it from a legitimate CRA communication.

Types of fraudulent communications

Whether the type of fraudulent communication employed by those executing this scam is by way of telephone, mail, text message, or email, the language used by the perpetrator is often aggressive and threatening and, most importantly, designed to scare you into paying fictitious amounts. To prevent you from falling victim to this type of fraud, here are some points for you to consider if you receive any sort of communication that purports to be from the "CRA":

Telephone communications – Don't be surprised if fraudsters call your home, business, or cell phone and, in an aggressive manner, tell you that you owe a large amount of unpaid taxes. To coerce you, they may even pretend that they are notifying you that a criminal case has already been filed against your name involving tax fraud and urge you to call back on a fictitious hotline with your personal information to avoid dire consequences.

If you do receive a suspicious phone call that appears to be from the CRA, it is important for you to keep in mind that some scams may involve "Caller ID spoofing", which occurs when a caller deliberately falsifies the information transmitted to your Caller ID display to disguise their identity. Because of this, you should never rely on the displayed caller information to confirm the identity of the caller. As well, remember that if you do receive a phone call or voice message saying that you owe money to the CRA, you can confirm that this information is in fact correct by calling the CRA directly or by checking online using the My Account service. You should not provide any personal or financial information to the caller or leave it on an answering machine.

Mail, text, or email communications – Phony communications by way of mail, text, or email often urge taxpayers to visit a fake "CRA" website where they are asked to verify their identity by entering personal and financial information. Other fraudulent communications may promise bogus tax refunds that can only be claimed after clicking on a link to a fraudulent website. You should take note that the only circumstance in which the CRA will send an email containing links is while they are on the phone with a taxpayer who has called the CRA to request a form or a link to specific information. The CRA will not send an email with a link and request that you divulge personal or financial information, nor will they ask for personal information of any kind by text message or request that you pay your tax liability with prepaid credit cards.

Protect yourself

In an effort to help you properly identify a scam, the CRA has posted samples of the more common scams, as well as transcripts of fraudulent communications, on their website. When it comes to communications from the CRA, exercising caution and ensuring that you never provide personal information through the internet, by email, or over the phone can help protect you from being a victim of fraud. Whether it is the promise of an unknown refund amount or the threat of an unpaid tax liability—if it doesn't seem right to you, it probably isn't, so trust your own judgment.

If you do receive a suspicious phone call or an email purporting to be from the CRA, do not hesitate to contact your BDO advisor to help you determine whether the CRA is in fact trying to get in touch with you.

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