Aeronautic Development v. R. – FCA: Federal Court of Appeal upholds finding of de facto control, denying CCPC status for SRED tax credits

Aeronautic Development v. R. – FCA:  Federal Court of Appeal upholds finding of de facto control, denying CCPC status for SRED tax credits

Aeronautic Development Corporation v. Canada (April 4, 2018 – 2018 FCA 67, Nadon, Boivon, Gleason (author) JJ.A.).

Précis:  The appellant, ADC, was originally wholly owned by an American corporation, Seawind Corp., which was in turn owned by Mr. Silva, an American resident.  A few months later the shareholdings of ADC were restructured such that Seawind Corp. had only 46% of the shares and employess of ADC, directly or indirectly, owned the balance.  ADC operated rent free out of a premises in Canada owned by Seawind Corp., which was also the sole client of ADC.  ADC claimed SRED credits after the date of change of de jure control (August 2009) which CRA rejected on the basis that ADC was not a Canadian-controlled private corporation.  ADC appealed unsuccessfully to the Tax Court which held that ADC was under the de facto control of Seawind Corp.  ADC then appealed to the Federal Court of Appeal which dismissed the appeal, with costs, also on the basis of de facto control but without fully endorsing the reasoning of the Tax Court. 

Decision:   The Court of Appeal found that the Tax Court made two errors in reaching its finding of de facto control:

[48]  Turning, first, to the legal errors alleged, I agree with ADC that the Tax Court erred in its interpretation of subsection 256(5.1) of the ITA in the two ways ADC asserts.

[49]  As already noted, in McGillivray, which is the most recent authority on the point, this Court determined that operational control is insufficient to constitute de facto control under subsection 256(5.1) of the ITA and held that, instead, there must be some legally-enforceable arrangement or arrangements that give rise to such control. The development agreement undoubtedly does constitute such an arrangement.

[50]  However, in the instant case, the Tax Court went well beyond relying on the terms of the development agreement in considering what circumstances gave rise to de facto control and instead considered such issues as ADC’s financial position, the other shareholders’ dependence on the viability of ADC and representations made by Mr. Silva in newsletters regarding the integration of ADC with his other companies. While these other factors are indicative of operational control, they are not the result of a legally-enforceable arrangement. I thus conclude that the Tax Court erred in premising its de facto control decision in part on factors that McGillivray determined to be irrelevant under subsection 256(5.1) of the ITA.

[51]  I also agree with ADC that the Tax Court erred in looking to the fact that ADC and Seawind Corp. were related before August 2009 to be a relevant factor in assessing whether they were operating at arm’s length after that date within the meaning of subsection 256(5.1) of the ITA. That provision makes it clear that the time for assessing whether there is an arm’s length relationship for the purposes of the subsection is during the period of time de facto control is alleged to exist. The relevant portion of subsection 256(5.1) states in this regard that:

[…] a corporation shall be considered to be so controlled by another corporation, person or group of persons (in this subsection referred to as the “controller”) at any time where, at that time, the controller has any direct or indirect influence that, if exercised, would result in control in fact of the corporation, except that, where the corporation and the controller are dealing with each other at arm’s length […]. [emphasis added]

[…] une société est considérée comme ainsi contrôlée par une autre société, une personne ou un groupe de personnes — appelé « entité dominante » au présent paragraphe — à un moment donné si, à ce moment, l’entité dominante a une influence directe ou indirecte dont l’exercice entraînerait le contrôle de fait de la société. Toutefois, si cette influence découle d’un contrat de concession […] la société et l’entité dominante n’ayant entre elles aucun lien de dépendance […]. [mon emphase]

The Tax Court therefore erred in considering the fact that the two companies were related and not dealing with each other at arm’s length before the relevant period during which de facto control was alleged to have existed.

Notwithstanding those errors the Court of Appeal found that they did not reach the threshold of reversible error:

[58]  Contrary to what ADC asserts, I do not think there is a hard and fast rule that one cannot have regard to the role of a putative controller in setting the terms of a supply agreement in assessing the non-arm’s length nature of a relationship. Under paragraph 251(1)(c) of the ITA, the requisite inquiry is entirely factual, and the ability to set the terms of the supply agreement must accordingly be considered in context. In the context of the instant case and in light of ADC’s near-total economic dependence on Seawind Corp., the fact that the owner of the latter company dictated (and was able to dictate) the terms of the relationship between the two companies is a very relevant factor in determining whether the three were dealing at arm’s length. Even more telling was Mr. Silva’s ability to make the two companies disregard the terms of the development agreement – as he decided to do when he unilaterally decided that the 5% mark-up would not be paid to ADC.

[59]  As for the other facts relied on by the Tax Court, it would be difficult to imagine a stronger indicator of a non-arm’s length relationship than the fact that a company is allowed to operate out of another’s facility for free, without a lease. Contrary to what ADC asserts, the comments made by the Tax Court in paragraphs 68 and 69 of its reasons are not pure speculation but, rather, merely an elucidation of the implications of such a rent-free arrangement.

[60]  Thus, while I do not agree with all of the Tax Court’s reasoning, I believe that it did not err in concluding that ADC was not a CCPC during the relevant taxation years. Accordingly, there is no basis to interfere with its decision and I would therefore dismiss this appeal, with costs.