Under subsection 127(10.1) of the Income Tax Act (the Act), a Canadian-controlled private corporation (CCPC) may benefit from an additional 15% investment tax credit with respect to qualifying scientific research and experimental development expenditures.
In Lyrtech RD Inc. v. The Queen, the Tax Court of Canada found that Lyrtech RD Inc. (the Company) had lost its CCPC status and therefore its entitlement to the additional investment tax credit because Lyrtech Inc. (Lyrtech), a publicly listed corporation, exercised de facto control over it, even though de jure control rested with the trustees of a discretionary trust (the Trust).
Lyrtech reorganized its activities in order to spin off its research and development activities to the Company. All of the Company's voting shares were held by the Trust, and executives of Lyrtech were named as trustees. The Trust's beneficiaries were wholly owned subsidiaries of Lyrtech. The trustees, through a shareholders' declaration, removed all powers from the directors of the Company in order to exercise those powers themselves.
The Company claimed investment tax credits on the basis that it was a CCPC. The Canada Revenue Agency (the CRA) reassessed the Company, refusing its claim of additional investment tax credits on the basis that it was not a CCPC. The Tax Court of Canada sided with the CRA in a judgment rendered on January 24, 2013.
Paragraph 125(7)(a) of the Act provides that a corporation "controlled directly or indirectly in any manner whatever" by a publicly listed corporation does not qualify as a CCPC. The expression "controlled directly or indirectly in any manner whatever" is generally defined in subsection 256(5.1) of the Act to include both de jure and de facto control.
The court concluded that Lyrtech exercised a dominant economic influence, and thus had de facto control, over the Company, although the Trust (and its Trustees) owned all of the Company's voting shares and thus exercised de jure control over it. The evidence presented to the court demonstrated that:
(i) for the assessment period the Company did not have a line of credit;
(ii) Lyrtech was its sole customer and its agreement with Lyrtech did not give rise to any payments by Lyrtech in the years of the assessment (payments were based on Lyrtech's sales rather than costs incurred), such that it was entirely financed with advances from Lyrtech;
(iii) there was an unreasonable allocation of operating expenses between Lyrtech and the Company (the Company occupied Lyrtech's premises at a significantly below-market rent);
(iv) the same individuals were executives and directors of both corporations (the deed of trust required that trustees be directors of Lyrtech, the same persons had signing authority over the bank accounts of both Lyrtech and the Company and the trustees of the Trust were also the sole directors of the Company and of the beneficiaries of the Trust); and
(v) the Trust and Company were included in the consolidated financial statements of Lyrtech.
With respect to CRA's subsidiary argument that Lyrtech had de jure control over the Company based on subparagraph 251(5)(b)(i) of the Act – which deems persons who have a conditional right to acquire shares of a corporation or to control the voting rights of such shares to occupy the same position as actual shareholders with respect to control of the corporation – the court concluded that the beneficiaries' rights, being dependent upon the exercise of discretion by the trustees, were too hypothetical, indirect and uncertain to constitute rights to acquire the Company's shares.
Based on CRA's position that control of a corporation held by a trust rests with its trustees, one might consider using a trust with Canadian resident trustees to ensure that a corporation maintains its CCPC status. However, in light of this recent Tax Court of Canada decision, one should be mindful that the financial and practical influence exercised by a public corporation or non-resident may often rise to the level of de facto control, resulting in loss of CCPC status. One might wonder whether the court's decision would have been different if there had been distinct management, adequate capitalization, a proper arm's length allocation of operating expenses and remuneration based on costs incurred.
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