18 February 2025 External T.I. 2024-1038891E5 - De facto control

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether the holder of a promissory note issued by the purchaser corporation on an intended immediate intergenerational business transfer would have de facto control of the purchaser corporation.

Position: General comments provided.

XXXXXXXXXX									2024-103889

February 18, 2025

Dear XXXXXXXXXX:

Subject: Immediate intergenerational business transfer - de facto control

We are writing in response to your request for our views on whether the holder of a promissory note issued by a corporation in exchange for shares of another corporation would control the issuing corporation “directly or indirectly in any manner whatever” as that phrase is used in paragraph 84.1(2.31)(c) of the Income Tax Act (Act). More specifically, your concern relates to the following hypothetical situation involving an immediate intergenerational business transfer described in subsection 84.1(2.31) of the Act.

A corporation (purchaser corporation) controlled by an adult individual (referred to herein as the “child”) acquires all the shares of another corporation (subject corporation) owned by the child’s parents. External financing is obtained to the extent possible from arm’s length lenders and, in addition, the parents accept a vendor take-back promissory note for the remaining purchase price (a substantial portion). The vendor take-back promissory note requires regular principal payments over 15 years, but does not bear interest unless the repayments are not made as scheduled. The child has de jure control of the purchaser corporation and the subject corporation after the purchase and personally guarantees the debts of the purchaser corporation. The parents do not intend, following the sale of the subject corporation, to have any involvement in the day-to-day operations of the subject corporation, other than providing occasional business advice.

Questions

1) In the case of the vendor take-back promissory note, will the fact that the parents hold such a promissory note, in and of itself, result in the parents having control, directly or indirectly in any manner whatever, of the purchaser corporation?

2) Would the response to Question 1 differ if the vendor take-back promissory note were payable on demand rather than having scheduled repayments?

Our Comments

Please note that it is not our practice to comment on transactions involving specific taxpayers other than in the form of an advance income tax ruling. For information on applying for an advance income tax ruling, see Information Circular IC70-6R12, Advance Income Tax Rulings and Technical Interpretations. Notwithstanding the foregoing, we are prepared to provide general comments regarding the application of paragraph 84.1(2.31)(c) of the Act in the hypothetical circumstances described in your question.

The disposition of the shares of the subject corporation by the parents to the purchaser corporation would qualify as an immediate intergenerational business transfer if the conditions described in paragraphs 84.1(2.31)(a) to (g) of the Act are met and an election, in prescribed form, is filed by the parents and the child pursuant to paragraph 84.1(2.31)(h).

Your question relates to the following condition in paragraph 84.1(2.31)(c) of the Act:

(c) at all times after the disposition time, the taxpayer does not – either alone or together with a spouse or common-law partner of the taxpayer – control, directly or indirectly in any manner whatever,

(i) the subject corporation,

(ii) the purchaser corporation, or

(iii) any other person or partnership (in this subsection referred to as a “relevant group entity”) that carries on, at the disposition time, an active business (referred to in this subsection as a “relevant business”) that is relevant to the determination of whether the subject shares satisfy the condition set out in subparagraph (b)(iii);

Subsection 256(5.1) of the Act provides as follows:

For the purposes of this Act, where the expression "controlled, directly or indirectly in any manner whatever," is used, 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 and the influence is derived from a franchise, licence, lease, distribution, supply or management agreement or other similar agreement or arrangement, the main purpose of which is to govern the relationship between the corporation and the controller regarding the manner in which a business carried on by the corporation is to be conducted, the corporation shall not be considered to be controlled, directly or indirectly in any manner whatever, by the controller by reason only of that agreement or arrangement.

(emphasis added)

Subsection 256(5.11) of the Act further provides:

For the purposes of the Act, the determination of whether a taxpayer has, in respect of a corporation, any direct or indirect influence that, if exercised, would result in control in fact of the corporation, shall

(a) take into consideration all factors that are relevant in the circumstances; and

(b) not be limited to, and the relevant factors need not include, whether the taxpayer has a legally enforceable right or ability to effect a change in the board of directors of the corporation, or its powers, or to exercise influence over the shareholder or shareholders who have that right or ability.

The XXXXXXXXXX describe the impetus for the enactment of subsection 256(5.11) (effective for taxation years that begin after March 21, 2017) as follows:

New subsection 256(5.11) reverses the effect of a 2016 decision of the Federal Court of Appeal (McGillivray Restaurant Ltd. v. The Queen), in which the court held that the factors that may be used to determine if a person has factual (de facto) control are limited to a legally enforceable right and ability to effect a change in the board of directors, or its powers, or to exercise influence over the shareholder or shareholders who have that right and ability.

Paragraph 23 of Interpretation Bulletin IT-64R4, Corporations: Association and Control (Archived) describes general factors that may be used in determining if a person has de facto control of a corporation. That paragraph refers, in part, to the ownership of a large debt of a corporation which may become payable on demand and the influence that a family member, who is a shareholder, creditor, supplier, etc. of a corporation, may have over another family member who is a shareholder of the corporation.

It is important to keep in mind that, in determining whether a person controls a corporation directly or indirectly in any manner whatever, the focus is not on the actual exercise of control but on the existence of direct or indirect influence that, if exercised, would result in control in fact of a corporation. See, in this respect, Corpor-Air Inc. v The Queen, 2006 TCC 75, at paragraph 27:

The only issue is whether, during the relevant period, [the controller] had any direct or indirect influence that, if exercised, would have resulted in control in fact of the Appellant. It should be immediately emphasized that it is not necessary for the evidence to establish that [the controller] held control in fact of the Appellant or that dominant influence was actually exercised. It is enough to find that such influence existed.

Summary

The determination of whether de facto control exists in any particular situation depends on an analysis of all the facts and circumstances. In general, whether the parents, in the circumstances described above, have de facto control of the purchaser corporation will depend on whether the vendor take-back promissory note, considered in the context of all the surrounding circumstances, provides the parents with influence over decisions made by, or in respect of, the purchaser corporation. The relative portion of the financing of the purchaser corporation represented by the promissory note, the terms of repayment, any obligations/guarantees relating to repayment, and the access that the purchaser corporation has to alternative financing in the event a demand for payment is made, would, among other possible factors, be taken into consideration in determining if such influence exists.

With respect to your specific concern as to whether the parents would have de facto control of the purchaser corporation simply by accepting a vendor take-back promissory note, we are of the view that a non-interest-bearing promissory note payable over a commercially reasonable period of time would not, in itself, provide the holder with the type of influence that is indicative of de facto control. Further, we are of the view that a personal guarantee of the amount owing under a vendor take-back promissory note by the controlling shareholder of the purchaser corporation would not, where the purchaser corporation has the capacity to make the scheduled payments under the promissory note (and absent any other factors indicative of de facto control), result in the holder having de facto control of the purchaser corporation.

We trust the foregoing addresses your question.

Yours truly,

Daryl Boychuk
Manager/Reorganizations Section II
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch