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Associated Corporations and Investment Tax Credits (ITCs)

Posted By: Bobby B. Solhi on November 2, 2015 at 10:21:05 in All

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Associated Corporations and Investment Tax Credits – Kruger Wayagamack Inc. v. The Queen

The Appellant, Kruger W., incurred costs on Scientific Research and Experimental Development (SRED) in the course of its paper mill business for the 2003 to 2006 tax years.  The Appellant claimed refundable, investment tax credits on account of those costs which the CRA denied on the basis that the Appellant was “associated” to one of its corporate shareholders, Kruger Inc., and would not be in a position to receive an investment tax credit refund.

Acquisition of the Appellant

The Appellant was acquired by Kruger Inc. and SGF Rexfor Inc., a company owned by the Government of Quebec.  Kruger Inc. was a major producer of paper, tissue, and other wood products. The acquisition was undertaken to modernize and turnaround an otherwise faltering business.   Kruger Inc. and SGF Rexfor Inc. were successful in modernizing the Appellant’s facilities and operations but due to an unexpected and significant appreciation in the Canadian dollar, the Appellant incurred losses in each of the relevant years.  As a result, there was no income tax payable in the relevant years to offset against the investment tax credits, and the Appellant claimed refundable ITCs.

The CRA denied the Appellant’s claim for refundable ITCs on the basis that it was associated to Kruger Inc. and that placed it outside of the criteria to receive a refund of ITCs.

The Appellant and the CRA (as represented by the Minister) agreed that the case turned entirely on whether or not the Appellant and Kruger Inc. were associated corporations.  There was no dispute as validity of the SRED claims.

Associated Corporations and Investment Tax Credits

Stated simply, corporations are associated with one another where one corporation controls the other.  The primarily implication of associated corporations is that they must share the small business deduction and, for those involved in SRED, must share the expenditure limit for purposes of SRED entitlement. The expenditure limit becomes nil when taxable income of an associated group is $800,000 or greater.

Control can be held by operation of what is called de facto or de jure control or by operation of deeming rules in section 256.

The Court analyzed whether Kruger Inc. controlled the Appellant.

Kruger Inc. owned 51% of the shares of the Appellant which gave it the majority of shares and could elect 3 of the 5 directors and, prima facie, control of the Appellant but there was a Unanimous Shareholder Agreement (USA) that was central to the issue of control irrespective of the number of shares held by Kruger Inc.

Tax Court Decision 

The Court held that Kruger Inc, did not have de jure or de facto control of the Appellant due to the unanimity required in all key decision making, as provided in the USA.

The Court then considered the deeming provision found in paragraph 256(1.2)(c) of the Act, which read as follows:

 (c) a corporation shall be deemed to be controlled by another corporation, a person or a group of persons at any time where

(i) shares of the capital stock of the corporation having a fair market value of more than 50% of the fair market value of all the issued and outstanding shares of the capital stock of the corporation, or

(ii) common shares of the capital stock of the corporation having a fair market value of more than 50% of the fair market value of all the issued and outstanding common shares of the capital stock of the corporation

are owned at that time by the other corporation, the person or the group of persons, as the case may be…

The Appellant’s counsel argued that the value of the shares fluctuated based on the exercise of certain options of the shares and that based on a discount, it would reduce the value of Kruger Inc.

Jorre, J. concluded that the Appellant’s argument did not hold:

[161]   Accordingly, there is no reason to depart from the starting point that 51% of the shares with the right to 51% of the dividends and of any distribution of the assets of the corporation are worth more than 50% of the fair market value.

[162]   It follows that, pursuant to paragraph 256(1.2)(c) of the ActKruger is deemed to control the appellant.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

*Bobby B. Solhi is a tax lawyer and partner at TaxChambers LLP Tax Lawyers and Advisors a boutique tax law firm in Toronto, Canada.  The views and opinions are those of the author and do not necessarily represent the views and opinions of TaxChambers LLP. The information contained herein is general in nature and based on authorities that are subject to change. Applicability to specific situations is to be determined through consultation with your tax adviser.

 

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