USA Saves CCPC Status
Federal Court of Appeal Confirms Importance of Shareholder Agreements for CCPC Status
In an important decision for tech companies in Canada, Bagtech successfully argued that it was a CCPC even though most of its voting shares were held by non-residents of Canada. Bagtech’s unanimous shareholder agreement made all the difference.
In a unanimous decision rendered June 21, 2013 (French only, so far), the Federal Court of Appeal upheld last year’s tax court decision in Canada v. Bioartificial Gel Technologies (Bagtech) Inc. (Bagtech). The issue was whether Bagtech was entitled to the refundable tax credits it had claimed for its scientific research and experimental development (SR&ED) activities at a time when the majority of its voting shares were held by non-Canadian shareholders. Refundable SR&ED tax credits are only available to Canadian-controlled private corporations (CCPCs), and as the name implies, a CCPC cannot be “controlled” by non-Canadian and/or public shareholders.
In keeping with administrative positions taken by the Canada Revenue Agency (CRA) in the past, the Crown argued that the fact that over 50% of Bagtech’s voting shares were held by non-residents of Canada was fatal to the company’s refundable tax claims. When determining CCPC status, the legislation deems all shares held by public and non-Canadian shareholders to be held by a single “hypothetical” shareholder. In turn, the hypothetical shareholder’s voting power determines how much say that shareholder has in the appointment of the board of directors of the company. It is that ability to appoint directors that really dictates whether a shareholder “controls” the company or not. A hypothetical shareholder that holds more than 50% of the votes can generally appoint the majority of the board of directors and therefore controls the company, so the company is not a CCPC.
Bagtech, for its part, argued that the hypothetical shareholder couldn’t actually control the company because Bagtech’s unanimous shareholder agreement (USA) spelled out which shareholders appointed which members of the board. According to the USA, the shares held by the non-resident shareholders appointed no more than half of the directors of Bagtech at all times during the tax years under appeal.
The court agreed that the hypothetical shareholder should be considered to be bound by the USA and specifically the provisions in the USA that govern the appointment of Bagtech’s directors. In the end, despite majority non-Canadian ownership, Bagtech was successful in arguing that it was a CCPC for the years under appeal.
This case is clearly an important one for the high-tech community in Canada. Start-up and mid-stage companies continue to rely heavily on outside investors and frequently those investors are not based in Canada (or, in the case of Canadian investors, are affiliated with public Canadian companies). Bagtech provides some comfort that governance structures in a properly implemented USA can go some way to counterbalancing the non-Canadian and public votes at the shareholder level.
Taxpayers should continue to exercise caution – not every jurisdiction in Canada recognizes USAs (and “regular” shareholder agreements don’t carry the same weight when it comes to CCPC matters), and CCPC status can be lost even where board composition has been weighted in favour of Canadian shareholders. The bottom line remains the same for companies that depend on their CCPC status and the access to refundable tax credits that it brings: with every round of financing and every change of share ownership, the company should undergo a health check of its CCPC status with its tax advisors to minimize the risk of unpleasant audit surprises.
