The following article was first published by the Canadian Tax Foundation in 2022 vol 22, no 2, Tax for the Owner-Manager (April, 2022)
Suppose that, after an estate freeze, Mr. X owns all of the freeze shares and thin-voting shares of Opco. A family trust that is related to Mr. X owns all of the non-voting common shares of the corporation. One of the beneficiaries of the family trust is Investco. The trust also owns all of the shares of Investco.
Having the trust own the Investco shares offers a number of advantages, one of which is the ability to accumulate excess cash from Opco in a tax-effective manner and then decide later how to divide among family members the value represented by the shares of Opco and Investco. If some of Mr. X’s children work in the Opco business but others do not, Mr. X might achieve equality in the future, or take a step in that direction, by distributing Opco shares to one set of children and Investco shares to the other.
But can the family trust hold all of the Investco shares, given that Investco is also a beneficiary of the trust? Section 28(1) of the Ontario Business Corporations Act (OBCA) prohibits a corporation from holding shares in itself or its holding body corporate. Section 30(1) of the Canada Business Corporations Act is to similar effect. Arguably, the issuance of shares that contravenes these prohibitions is void. If section 28(1) of the OBCA makes void the issuance of Investco shares to the trust, the planning relating to Investco will be vitiated. The Ontario Superior Court’s decision in Ontario Securities Commission v. Kotton, 2017 ONSC 4947, suggests that this is a risk that needs to be considered carefully.
Kotton was decided in the context of the insolvency of a large group of corporations that had carried on a property development business. The court was called on to determine the nature of some claims in the insolvency of certain individuals (“the judgment creditors”). The judgment creditors had purchased preferred shares of MM, an OBCA corporation that was one of the members of the group. MM owned all of the issued shares of 230, another OBCA corporation. MM was required to pay dividends on the preferred shares and redeem them in 2014, but it failed to do so because it was insolvent. The judgment creditors, in response, brought an application against several corporations that belonged to the group, including MM and 230. The parties to the application settled it by minutes of settlement that required the respondents, including 230, to purchase the preferred shares of MM and pay interest and costs as well. One question the court addressed was whether the minutes of settlement were enforceable against 230 insofar as it was required to purchase the MM shares.
The judgment creditors conceded that the minutes were not enforceable against 230, to the extent that they required it to purchase the preferred shares of its parent, MM. Section 28(1) of the OBCA prohibited 230 from doing so. The court, for greater certainty, held that section 28(1) also applied to prohibit 230 from acquiring a beneficial interest in the preferred shares because the provision “applies to the holding of the beneficial interest, as well as the legal interest, in shares of a parent corporation” (at paragraph 50).
Kotton, then, calls into question whether the Investco structure is legally effective if Investco “holds” a beneficial interest in its own shares “through” a trust. It might be argued that Investco, as a beneficiary, does not “hold” its own shares for the purposes of section 28(1). The nature of a beneficiary’s proprietary interest, if any, in the property of a trust is the subject of some debate. If a trust is fully discretionary, then perhaps the beneficiary does not “hold” shares for the purposes of section 28(1): the beneficiary does not have any proprietary right in the trust property. Instead, the beneficiary merely has a right to enforce the terms of the trust as against its trustees. On the other hand, the case law in this area makes it clear that a beneficiary might be treated as the owner of trust property for certain statutory purposes, especially if those purposes would otherwise be frustrated.
The court in Kotton did not provide detailed reasons for its holding. The cautious adviser, in view of this uncertainty, might do well to amend the Investco structure in order to anticipate the issue. For example, it could be argued that section 28(1) should not apply when the trust holds only non-voting shares of Investco and the terms of the trust ensure that Investco cannot enjoy any other benefits associated with the trust’s ownership of its shares. Mr. X could subscribe for thin-voting shares of Investco; the trust could own only non-voting common shares of the corporation; and the trust deed could prohibit the trustees from distributing dividends or capital gains realized in respect of the shares to Investco. The trust deed could also prohibit the trustees from distributing the shares of Investco to Investco. The trust would hold Investco shares, but Investco should not be treated as a beneficial owner of the shares because, in accordance with the terms of the trust, Investco would never enjoy any of the benefits of such ownership.
Another alternative would have Investco remain as a beneficiary of the trust that holds the Opco shares, but a second trust for the benefit of Mr. X’s family would own the shares of Investco. The terms of the second trust would prohibit Investco from becoming one of its beneficiaries. A possible drawback of this structure is that it might be a “notifiable transaction” for the purposes of draft section 237.4 of the Act. (See Backgrounder, under “Transfer of trust value using a dividend.”)
These alternative structures should also anticipate the application of subsection 75(2) of the Act to the trust, if that is of concern. The CRA might argue that subsection 75(2) could apply to amounts of income or capital derived by a trust from shares that it owns in the capital of a corporate beneficiary. While technical interpretations 2007-0243241C6 (October 5, 2007) and 2009-0317641E5 (September 30, 2009) should provide comfort in this regard, the cautious adviser might nonetheless prefer the structures described in the previous two paragraphs. Those structures would prevent a trust from paying amounts in respect of the Investco shares back to Investco, which should address any subsection 75(2) concerns.
