On May 9, 2024, the Tax Court of Canada released its decision in the case of DAC Investment Holdings Inc. v. His Majesty The King, 2024 TCC 63, the first case decided by the Court where a corporation was continued into a foreign jurisdiction so that it was no longer a Canadian-controlled private corporation (CCPC). By way of background, many taxpayers implemented similar structures that have since been audited and assessed by the Canada Revenue Agency (CRA). This particular structure was troubling enough to the CRA and Minister of Finance that legislation has since been proposed to nullify its benefits. 

Background

The appellant, DAC Investment Holdings Inc. (DAC) was incorporated under the Business Corporations Act (Ontario) in 2001. At all times, DAC had one director, Mr. Civiero, who was a resident of Ontario and directly or indirectly, held at least 50% of its common shares.

In October 2011 and June 2013, Mr. Civiero acquired common shares of Soberlink Inc. (Soberlink Shares). Then in December 2013, Mr. Civiero transferred all of his shares of Soberlink Inc. to Jacal Holdings Ltd. (Jacal). Mr. Civiero was the sole director and shareholder of Jacal. Later in 2014, Soberlink received an indication of interest from a potential buyer. Had no structuring been completed, Jacal could have sold the Soberlink shares, realized a gain and paid tax, which would have included a refundable tax on a CCPC’s investment income. 

Instead, Mr. Civiero undertook some planning whereby DAC acquired the Soberlink Shares from Jacal pursuant to a section 85 rollover and then DAC was continued into the British Virgin Islands and as a result of the continuance, DAC ceased to be a Canadian corporation. However since its central management and control remained in Ontario, Canada, it continued to be a resident of Canada. On May 14, 2015, DAC sold the Soberlink’s Shares to an arm’s length party and realized a capital gain in the amount of CA$2,359,295.

DAC reported a taxable capital gain of CA$1,179,648 on its tax return for its taxation year ending April 30, 2016 (2016 Taxation Year) and filed its tax return for the 2016 Taxation Year on the basis that it was not a CCPC. As a result, DAC was not required to pay the refundable tax on a CCPC’s investment income and effectively achieved a deferral of tax until such time as a taxable dividend was paid by DAC up the chain to Mr. Civiero. 

The Minister of National Revenue (Minister) reassessed DAC’s 2016 Taxation Year pursuant to the GAAR on the basis that it was CCPC and was subject to refundable tax of CA$91,003 under section 123.3 and denied a general reduction of CA$148,216 under section 123.4.

The Court’s decision

The Court’s decision followed the general approach to a GAAR case by first determining if there was a tax benefit, achieved by an avoidance transaction that misused or abused the provisions of the Income Tax Act. 

Tax benefit

In order for the GAAR to apply, there must be a tax benefit. Section 123.3 levies a 10 2/3% refundable tax on a CCPC’s investment income. Since DAC ceased to be a CCPC, this refundable tax did not apply. Another provision that ceased to apply with paragraph (b) of the definition of “full rate taxable income” in subsection 123.4(1). As a result, paragraph (a) of the definition of “full rate taxable income” in subsection 123.4(1) applied and DAC was entitled to a 13% general rate reduction under subsection 123.4(2). DAC conceded and the Court agreed that DAC received a tax benefit from the fact that section 123.3 was not applicable and 123.4 was applicable to its 2016 Taxation Year.

Avoidance transactions

The second requirement for GAAR to apply is that the transactions must be avoidance transactions. An avoidance transaction is a transaction that is not undertaken primarily for a bona fide non-tax purpose. DAC conceded that the rollover of the Soberlink Shares from Jacal to DAC and the continuance of DAC into the British Virgin Islands were avoidance transactions.

Misuse or abuse

The Court noted that there is a two-step process in determining whether there is an abuse of the Act:

1. First, the Court must determine the object, spirit or purpose (OSP) of the provisions of the Income Tax Act that are relied on for the tax benefit, having regard to the scheme of the Act, the relevant provisions and permissible extrinsic aids.
2. Second, the Court examines the factual context of the case to determine whether the avoidance transaction defeated or frustrated the OSP of the provisions in issue.

The Crown argued that DAC abused 5 provisions of the Income Tax Act:

• Subsection 250(5.1), which applies when a corporation continues in another jurisdiction;
• The definition of CCPC in subsection 125(7);
• The definition of “Canadian corporation” in subsection 89(1);
• Section 123.3 which levies refundable tax on certain investment income of a CCPC; and
• The portion of the definition of “full rate taxable income” included in subparagraph 123.4(b)(iii) which is used to determine the amount of a corporation’s taxable income that is eligible for the 13% rate reduction in subsection 123.4(2)

Justice D’Arcy commenced his analysis by looking at the definitions of CCPC and a Canadian corporation. He noted that a private corporation cannot be a CCPC unless it is a Canadian corporation. Accordingly, for a private corporation to be a CCPC, it must either be incorporated in Canada or have been resident in Canada continuously since June 18, 1971. He noted that the purpose of the definition of CCPC is to “narrow down the pool of private corporations that qualify as CCPCs to include only those that are Canadian corporations.” He acknowledged that there are “different taxing regimes for public corporations, CCPCs and private corporations that are not CCPC;” “[g]enerally speaking, private corporations are entitled to a number of advantages that are not available to public companies;” and “CCPCs are entitled to a number of tax benefits that are not extended to private companies that are not CCPCs.”

Justice D’Arcy went on to contrast the different tax regimes applicable to CCPCs and private corporations that are not CCPCs.

Justice D’Arcy noted that when DAC was continued in the British Virgin Islands, it ceased to be a Canadian corporation and lost its status as a CCPC. it also ceased to be a taxable Canadian corporation and lost the benefit of certain provisions, including the following:

• Section 85 rollover provisions;
• Section 87, which allows corporations to amalgamate on a tax-deferred basis;
• Section 88, which allows a corporation to be wound-up on a tax-deferred basis; and
• The dividend gross up and tax credit mechanism in subsection 82(1) and section 121

The Crown argued that the OSP of the CCPC definition was to ensure that private corporations controlled directly or indirectly in any manner whatever by Canadian residents are subject to the anti-deferral regime applicable to the investment income of CCPCs. Essentially pointing to the concept of integration between individuals and corporations as the overarching policy here.

DAC argued that the OSP of the definition of CCPCs is to enumerate specific criteria to afford such status. Justice D’Arcy agreed with DAC:

[98] … The Act contains a detailed and specific regime for taxing CCPCs, including specific provisions for taxing their business income, for taxing their investment income and for taxing distributions to their shareholders. Other provisions provide specific benefits to corporations that are defined to be CCPCs. The object, spirit and purpose of the definition of a CCPC is to provide a dividing line between those corporations that are taxed under the specific regime for CCPCs and those corporations that are not taxed under this regime.

Summary of the Court’s analysis for Section 123.3

Justice D’Arcy set out that the Income Tax Act contains two sets of rules: one set to integrate the tax paid by CCPCs and their shareholders through the use of eligible and non-eligible dividends and a second set of rules that attempts to discourage the retention of investment income in a CCPC by initially taxing it at a 38 2/3% tax rate (general rate of 28% plus 10 2/3% under section 123.3). This rate is intended to be roughly equal to the highest rate and reduces or eliminates any advantage that would arise from retaining investment in a corporation and deferring the payment of tax on the distribution of investment income to shareholders of a CCPC. This tax is refunded to the CCPC when dividends are paid out to shareholders through the use of the CCPC’s refundable dividend tax on hand (RDTOH) account. During the relevant years, only CCPCs were entitled to a refund in respect of Part I tax that they paid on aggregate investment income; while private corporations that were not CCPCs were only entitled to claim a dividend refund in respect of Part IV tax. The purpose of this refund was to integrate corporate and shareholder taxes and CCPCs paid Part I tax at a rate of 8% on aggregate investment income after receiving a dividend refund. Justice D’Arcy found that these sets of rules “evidence that section 123.3 is part of the legislative scheme that the government only intended to apply to CCPCs” and it was clear “that the government was aware that the tax deferral opportunity existed for all individuals who held shares in private companies, but that it chose to impose section 123.3 refundable tax on CCPCs.

Summary of the Court’s analysis for Section 123.4

Section 123.4(2) provides a “General Rate Reduction” which reduced the general tax rate of a corporation by 13% for years after 2011. As a result, the tax rate that a corporation pays on its “full rate taxable income” is reduced from the general tax rate of 28% to 15%.

The definition of “full rate taxable income” distinguishes between the income of a corporation that is a CCPC, the income of an investment corporation or mutual fund and the income of all other corporations. Paragraph (b) of the definition of “full rate taxable income” only applies to CCPCs and it excludes the CCPC’s aggregate investment income. Justice D’Arcy found that Parliament intended that the General Rate Reduction would not apply to income that was taxed lower than the general tax rate of 25%, such as the investment income of a CCPC. Even though a CCPC’s aggregate investment income is originally taxed at a high rate, it is taxed at a rate lower than the general tax rate after the application of the RDTOH rules.

The Crown argued that the OSP of 123.4 was to prevent Canadian-resident individual shareholders from benefitting from a tax deferral on investment income earned through a private corporation which they control directly or indirectly in any manner whatever.

Justice D’Arcy found that the OSP of section 123.4 was to lower the general corporate tax rate so that the highest non-refundable corporate tax rate levied was 15% (28% general tax rate minus the 13% general rate reduction).

Subsection 250(5.1) analysis

Subsection 250(4) deems “a corporation that was incorporated in Canada after April 26, 1965 to be a resident of Canada.” Under subsection 250(5.1) if a corporation is continued in another jurisdiction, it is deemed to have been incorporated in that other jurisdiction from the time it was continued into the new jurisdiction. Corporations that are deemed to be incorporated outside of Canada under subsection 25(5.1) are no longer subject to the subsection 250(4) deeming rules. After DAC continued into the British Virgin Islands, it was no longer deemed to be a Canadian resident under subsection 250(4). However, since DAC’s central management and control remained in Canada, it was still a resident of Canada and taxed on its worldwide income.

Since DAC was deemed to be incorporated in the British Virgin Islands under subsection 250(5.1), it was no longer a Canadian corporation and ceased to be a CCPC. Justice D’Arcy noted that when a corporation loses its status as a Canadian corporation it can no longer rely on the rollover provisions under section 85, the amalgamation provisions under section 87 or the wind-up provisions under section 88. The application of subsection 250(5.1) also causes the corporation to have a deemed year-end and may require the corporation to add an amount to its low-rate income pool (LRIP) account.

Justice D’Arcy found that the OSP of subsection 250(5.1) was to equate the place of continuance of a corporation with its place of incorporation in order to ensure that various provisions of the act that refer to place of incorporation produce the results intended by Parliament with respect to the taxation of the corporation under the Act.

Justice D’Arcy determined that DAC did not abuse any of the provisions in the Income Tax Act. He noted that Parliament appeared to have deliberately chosen “to have different sets of rules for different corporations” and “Parliament recognized that a corporation may move from the taxing regime for a CCPC to the taxing regime for a non-CCPC.” Justice D’Arcy stated that DAC “chose to move from one tax regime with its pluses and minuses to another tax regime with different pluses and minuses.”

Subsequent Amendments to the Income Tax Act

Following the time that DAC was originally assessed, the government proposed legislation to eliminate any benefits associated with this type of planning. The proposed amendments to the Income Tax Act are contained in Bill C-59, which is currently at second reading before the House of Commons. Under these proposed amendments, for taxation years that begin after April 6, 2022, a “substantive CCPC” includes a corporation that is controlled, directly or indirectly in any matter whatever by a resident of Canada. If Bill C-59 is passed, substantive CCPCs will be subject to the same refundable tax on investment income as CCPCs. As a result taxpayers who implemented such structures may want to consider unwinding them to at least gain the benefits of a CCPC.

Implications

The Crown has appealed the Tax Court of Canada’s decision to the Federal Court of Appeal. Therefore, taxpayers will have to wait until the FCA (and potentially the SCC) renders a decision in this case.

This decision will have a direct impact for taxpayers who undertook similar transactions to change a CCPC to a non-CCPC. More broadly, the Tax Court decision provides comfort to taxpayers that engage in planning to select a particular regime of the Income Tax Act, where the Parliament clearly intended for taxpayers to be able to select which regime applies to them. However, the parties will have to wait to see what the decision is on appeal.

If you have any questions, please do not hesitate to contact a member of the Dentons Tax Team.