Under the Income Tax Act (Canada) (the “Act”),1 the acquisition of control of a corporation can cause a number of unwanted consequences, including a deemed year-end and the restriction or elimination of loss carry forwards. Practitioners need to be aware that, according to the CRA, any replacement of a trustee of a trust or an estate can trigger an acquisition of control unless one of a number of somewhat narrow exceptions applies.
A “group” of persons can be considered to control a corporation, and if the composition of the group changes, a new group will be considered to control the corporation. As a result, the new group, in general, will acquire control of the corporation.
What constitutes a group is not always clear. A group is said to exist where “a sufficient common connection exists” among its members, which includes a common link or interest or a pattern of acting together to control a corporation. In Silicon Graphics Limited v R, 2002 FCA 260, the court stated that the “common connection” might include “a voting agreement, an agreement to act in concert, or business or family relations.”2 The foregoing list is not exhaustive, of course, and so, as the CRA’s loves to say, it will be a question of fact whether a group exists in any particular case.
The CRA, however, believes that the trustees of a trust will almost always constitute a “group”. This matters because it is the trustees of a trust who are treated as the shareholders of a corporation for the purposes of determining the identity of the corporation’s controlling shareholders for tax purposes. As a result, the trustees of a trust will be treated as having voting control of a corporation where the trust’s property includes shares of the corporation that have the right to elect more than 50% of its directors.
If a trustee of a controlling trust is replaced by another person, then, in general, the trust will be treated as having acquired control of the corporation. The same rule applies where the controlling trust has two trustees and one trustee is replaced. The new set of trustees will be considered to constitute a “new” group.
Suppose there are three trustees and the trust agreement provides for majority rule. One would think that the replacement of one trustee would not trigger an acquisition of control. The new trustee could always be outvoted by the other two so that the replacement should not fundamentally affect how the trust would act to control the corporation.
The CRA, however, has stated that, absent evidence to the contrary (including especially in the trust agreement), three or more trustees of a trust will be considered to form a group. According to the CRA, the trustees of a trust must all act in the best interests of the beneficiaries of the trust, and this fiduciary duty is a sufficient “common connection” to constitute any set of trustees a group.3 Accordingly, even where the trustees can act by majority rule, they will be treated as a group so that any change in the composition of the group will result in an acquisition of control of a corporation controlled by the trust. This position has been criticized by a number of commentators,4 but the CRA’s position is long-standing.
Subsection 256(7) contains a number of exceptions that will deem control not to be acquired in certain circumstances. Clauses 256(7)(a)(i)(A) and (B), for example, provide that control of a corporation “shall be deemed not to have been acquired solely because of the acquisition at any time of shares of any corporation” by a person who acquired shares from a related person or by a person who was related to the corporation immediately before the time. This suggests that, if father, mother and son are trustees of a trust that controls a corporation, and a daughter replaces father as a trustee after he resigns, there will be no acquisition of control of the corporation. On the other hand, if an accountant who is unrelated to the family replaces father, there will be an acquisition of control.
Paragraph 256(7)(i) provides that control of a corporation is deemed not to be acquired solely because of a change of trustee or legal representative, but only if there is no change in beneficial ownership of the trust property and
no amount of income or capital of the trust to be distributed, at any time at or after the change, in respect of any interest in the trust depends upon the exercise by any person or partnership, or the failure of any person or partnership, to exercise any discretionary power.
The difficulty is that the agreements governing most inter vivos trusts provide rather broad discretion to the trustees to distribute income or capital. In fact, the grant of that kind of discretion is often part of the point of setting up a trust. Likewise, most spousal trusts will provide for a power to encroach on the capital of the trust. The CRA has said that such a power (such a discretion) in the terms of a spousal trust means that paragraph 256(7)(i) can never apply to prevent an acquisition of control of a corporation controlled by the trust.
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