[Vol. 17
“Personal Corporations” Under the Income Tax Act –
to Use or not to Use?
Kenneth H. Brown **
The various techniques whereby individuals utilise corporations
as vehicles to take title to their investments are generally well known.
The role which can be played for this purpose by the particular
type of corporation known as the “personal corporation”
(as
defined in s. 68 of the Income Tax Act),’ the limitations which
exist with respect to that role, and the objectives which can and
those which cannot be achieved by the use of this type of corpo-
ration, appear however to be less clearly understood; an examination
of these aspects of the matter may therefore be of some interest.
It should be observed at the outset that, so far as certain of
the objectives are concerned, the individual can with equal ad-
vantage transfer his investments to any type of corporation, i.e.
it need not necessarily be a “personal corporation”.
Thus an investor who owns a substantial and varied portfolio
of securities will realize that these have their legal “situs”
in
various countries, provinces and states, each of which will require
transfer documents on the death of the owner and will probably
also impose its own death duties on the securities which have their
* Editor’s Note: This article was written several months before the intro-
duction of Bill C-259 (the new Income Tax Act), which became effective
on Jan. 1, 1972 and which does not segregate “personal” corporations as a
separately-defined class as does the present Act; nor therefrom the under-
lying securities, through the personal corporation (in whose hands it is not
taxed), to the shareholders, in whose hands it is taxed.
Nevertheless the greater part of the article deals in some depth with topics
which remain relevant for various purposes under the proposed new Act
and of income tax law generally, such as the question whether to use an
investment holding company at all, the meaning of “direct or indirect
control” of corporations, and what constitutes the carrying on of an active
business by a corporation. Moreover, the present law concerning personal
corporations will of course be relevant for many years in litigation arising
out of pre-1972 facts.
For these reasons it has been decided to publish the article as received.
** Q.C., Advocate, of Lafleur & Brown, Montreal.
IR.S.C. 1970, c. 1-5.
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PERSONAL CORPORATIONS
legal “situs” within its jurisdiction, except to the extent that these
duties may be abated by tax conventions with the jurisdiction in
which the owner himself was domiciled.
The investor accordingly sells or transfers his securities to a
corporation and takes in exchange, shares or debt of that corpo-
ration. The corporation becomes the owner of the securities; it
never dies, so that the death of the individual has no effect what-
ever, by way of administration, documentation, or imposition of
death duties, in the various jurisdictions in which the securities
forming the underlying portfolio have their legal situs. In other
words, no change of ownership of the securities having their situs
in those jurisdictions results from the death of the individual, so
nothing has to be done in those jurisdictions.
The investor, when he dies, leaves only his shares in, or the
debt owing to him by, the corporation to which he had transferred
his securities. This corporation will have been so incorporated that
its outstanding shares held by the deceased individual, and its
debt owing to him, have their legal situs in the province in which
he was domiciled, so that their value is dutiable only in that prov-
ince (if it imposes succession duties) and under the Federal
Estate Tax Act, and the only documentation required is that which
relates to the transfer of the shares and/or debt of that one cor-
poration.
The basic point, which must constantly be borne in mind, is
that the above advantages will flow, and can only flow, from the
transfer of ownership of the individual’s securities to a corporation
(which, as I have said, need not necessarily be a “personal cor-
poration”).
This basic point necessitates a note of caution: the common
practice of merely transferring one’s securities into the name of a
corporation (usually a bank or trust company) as nominee for
oneself will not in law achieve the above objectives. The securities
in that case remain owned by the individual, with the various
consequences, upon his death, as to administration and liability
to death duties in jurisdictions other than that of his own domicile
which I have already described. The fact that his ownership
is
“masked” by registration of the securities for example in the
name of a trust company does not change the fact of his ownership
and the resulting liabilities; these may possibly pass unnoticed in
the outside jurisdictions because of the registration in the name
of the corporate nominee, but they continue to exist in law, and
this type of “mask” is readily penetrated under today’s sophisticated
methods of ascertaining where true ownership lies.
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Assuming, therefore, that there has been a genuine transfer of
ownership of the securities from the individual to a corporation,
what is the significance of whether the transferee is a “personal
corporation” or not?
First of all, if the transferee is not a “personal corporation”,
the income from the securities will simply form part of the corpo-
ration’s income from all sources and, to the extent that the income
is not exempt from tax under the Act, it will bear tax at the regular
corporate rates. If and when what is left of it is distributed, or
deemed to be distributed, to the shareholders as interest or as
a dividend, it will be taxed in the hands of the shareholders at
their respective individual graduated rates minus (if it is received
as a dividend) the credit (20% of the amount of the dividend) which
is provided under s. 38 of the Income Tax Act.
The first step, therefore, before deciding whether or not to
utilise a “personal corporation”, should be for the individual to
calculate, on the basis set out in the preceding paragraph, what
the total tax impact (in the hands of the corporation and in his
own hands as shareholder) would be, on the total income stream
from the underlying securities to his own pocket, if he did not
use a “personal corporation” but an ordinary corporation, e.g. his
business corporation if he has one.
This brings us to the main consideration: that of the “personal
corporation” itself. Much detail will appear later, but for the moment
it will suffice to say that as regards income tax treatment the main
characteristic of a “personal corporation” (as distinct from an
ordinary corporation) is that it is not taxed on its income, but
all its income is deemed to be distributed to its shareholders as a
dividend on the last day of its fiscal year, and the shareholders
are taxable accordingly, as if the corporation did not exist.
The relevant “definition” provisions are found in ss. 68(1) and
68(2) of the Income Tax Act:
“68. (1) In this Act, a ‘personal corporation’ means a corporation that,
during the whole of the taxation year in respect of which the expression
is being applied,
(a) was controlled, whether through holding a majority of the shares of
the corporation or in any other manner whatsoever, by an individual
resident in Canada, by such an individual and one or more members
of his family who were resident in Canada or by any other person on
his or their behalf;
(b) derived at least one-quarter of its income from
(i) ownership of or trading or dealing in bonds, shares, debentures,
mortgages, hypothecs, bills, notes or other similar property or
an interest therein,
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PERSONAL CORPORATIONS
(ii) lending money with or without securities,
(iii) rents, hire of chattels, charter-party fees or remunerations, an-
nuities, royalties, interest or dividends, or
(iv) estates or trusts; and
(c) did not carry on an active financial, commercial or industrial business.
(2) For the purpose of paragraph (a) of subsection (1), the members
of an individual’s family are his spouses, sons and daughters whether or
not they live together.”
If a corporation falls within the foregoing definition, the follow-
ing provisions of s. 67 automatically apply:
“67.
(1) The income of a personal corporation whether actually distributed
or not shall be deemed to have been distributed to, and received by, the
shareholders as a dividend on the last day of each taxation year of the
corporation.
(2) No tax is payable under this Part on the taxable income of a
corporation for a taxation year during which it was a personal corporation.
(3) The part of the income of a personal corporation that shall be
deemed, under this section, to have been distributed to and received
by a shareholder of the corporation, shall be the proportion thereof that
the value of all property transferred or loaned to the corporation by the
shareholder or any person by whom his share was previously owned is
of the value of the property so acquired by the corporation from al
its
shareholders.”
The provisions of the definition section, s. 68, require exam-
ination under the three headings of “control”, “sources of income”,
and “active business”, the only necessary preliminary observation
being that it
is immaterial whether the corporation was incorpo-
rated in Canada or elsewhere.
I. Control
The first question is whether, throughout its fiscal year in
question, the corporation was “controlled” by or on behalf of the
persons specified in s. 68(1)(a).
The words “controlled, whether through holding a majority
of the shares of the corporation or in any other manner whatsoever”,
which appear in s. 68(1) (a), appear to be very broad, and to be
capable of embracing almost any conceivable type of control. I
suggest, however, that they are not as comprehensive as that,
and that the key to their real meaning and limitations lies in
realizing that the word “whatsoever” qualifies the word “manner”,
and not the word “control”.
There is clear authority for this interpretation in the U.K. case
of Himley Estates Ltd. and Humble Investments Ltd. v. C.I.R.2
2 (1932), 17 T.C. 367, at p. 377.
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In the Court of Appeal Lord Hanworth, M.R., speaking of the words
“where the control is by any other means whatever in the hands
of those persons”, said, referring to the word “whatever”: “It is
true that that word is found, but it is in reference to the ‘any
other means’, and not with regard to the word ‘control’.”
The word “control”, as applied to corporations, has a well-
established legal meaning, which for the moment I shall summarize
as “controlling voting power”. The manner whereby it is attained,
and in which it may subsist, may vary, but the control itself, in
its legal sense, must always exist, and the word “whatever” refers
only to the means whereby this legal control is exercised. If this
be so, it follows that the wording under consideration does not
mean that the control itself may be of any type whatsoever, but
does mean that there must be control in the legal sense, attained
and maintained in any manner whatever.
The simplest situation, that of majority voting power according
to the share register itself, arose in B. W. Noble Limited v. C.I.R.,3
where Rowlatt, J., held that “controlling interest” referred to “the
man whose shareholding in the company is such that he is the
shareholder who is more powerful than all the other shareholders
put together in general meeting”.
In Buckerfields Ltd. et al. v. M.N.R.,4 the Exchequer Court of
Canada followed the same rule (although for the purposes of s. 39
of the Income Tax Act, not s. 68) when it held that Companies C
and D, 50% of each of whose shares were held by each of Companies
A and B, were “controlled” by Companies A and B because of these
shareholdings and regardless of all other considerations.
The first variant occurs when a registered shareholder is a
mere nominee for someone else who is the real owner of the
shares. This situation is of no consequence in Canada because
s. 68(1)(a) refers to the holding of a majority of shares by an
individual, etc. “or by any other person on his or their behalf”.
This obviously includes reference to pure nomineeships which do
not affect real ownership of the shares, so we are still talking of
the simple case of direct “controlling voting power”.
The second complication arises when a second corporation is
interposed between the individual and the corporation whose status
is in question. For example, I own the majority of the shares of
Company A, which in turns owns the majority of the shares of
3 (1926), 12 T.C. 926.
4 [1964] C.T.C. 504.
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PERSONAL CORPORATIONS
Company B Obviously I control Company A under the Noble5
case, and the question whether I also have a “controlling interest”
in Company B was answered affirmatively by the House of Lords
in the oft-quoted case of British American Tobacco Co. v. C.LR.’
The well-known passages from Lord Simon’s judgment include
specific approval of the finding of Rowlatt, J., in the Noble7 case,
and deal with the interposition of another company as follows:
The word ‘interest’ however… is a word of wide connotation and I
think the conception of ‘controlling interest’ may well cover the relation-
ship of one company towards another, the requisite majority of whose
shares are, as regards their voting power, subject, whether directly or
indirectly, to the will and ordering of the first-mentioned company.
Two points emerge clearly from this most important judgment.
The first is that the words “controlling interest” are always linked
to what I might call a flow of “controlling voting power”, even
through intervening corporations. The second is that no proprietary
factor in the legal sense is necessary. It is clear from the judgment
that if it were, the decision would have gone the other way. The
holding was that in the case I put a moment ago, I have no
legal proprietary interest in Company B, but nevertheless have a
“controlling
through my majority shareholding
control of the intervening Company A.
interest”
in it
The case was followed in Canada in Glaspie v. M.N.R.8
The cases so far discussed deal with “a” controlling interest,
and it has already become clear that there may be more than one
“controlling interest” in a company. The Noble 9 case establishes
that, in the example I gave, Company A has a “controlling interest”
in Company B on the sole basis of the share register of the latter
company. The British American Tobacco 10 case holds that I,
also, have a “controlling interest” in Company B through my direct
shareholding control of its parent Company A.
Now s. 68(1)(a) speaks of only one “control”, namely ultimate
control by or on behalf of certain individuals. This concept, I suggest,
would be paralleled by using the words “the controlling interest”
instead of “a controlling interest” in the cases so far discussed.
The provocative case of Vancouver Towing Company Limited
v. M.N.R.1n presented, but did not have to solve, the problem whether
5 Supra, n. 3.
6 [1943], 1 All E.R. 13, at p. 15.
7 Supra, n. 3.
8 (1963), 33 Tax A.B.C. 274.
9 Supra, n. 3.
10 Supra, n. 6.
11 [1947] C.T.C. 18 (Ex. Ct., Cameron, J.).
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“the controlling interest” could consist of anything but controlling
voting power. It was not a “personal corporation” case but the
facts were substantially as stated in my own example of Companies
A and B (one Jones having shareholding control of Company A,
which in turn had shareholding control of Company B), with the
additional feature that under the Articles of Association of Company
B (the lower company) Jones was managing director of that com-
pany for life, with complete control of its board of directors, sole
authority to exercise the powers vested in the board, and power
to appoint, dismiss and replace ordinary directors. In short, Jones
controlled Company B through his extraordinary powers as managing
director under that company’s Articles of Association quite inde-
pendently of his indirect “controlling voting power” through Com-
pany A.
Unfortunately the only question in the case was whether (for
the purposes of s. 15A of the Excess Profits Tax Act), the upper
company, Company A, had “a controlling interest” in the lower
company, Company B, and the Court held that it had –
purely
on the basis of voting control as established in the Noble 12 and
British American Tobacco 13 cases.
But the intriguing passage from the judgment, reads as follows: 14
It should be noted that the words in the section are ‘a controlling in-
terest’, not ‘the controlling interest’ or ‘the control’. Unquestionably Jones
has the ultimate control in the appellant company and has complete con-
trol of its board of directors. He also has an indirect controlling interest
in the company itself…
It seems clear that if the Court had had to go beyond deciding
who had “a controlling interest” (and we have already found that
there can be more than one of these) and decide who had “the
controlling interest” in Company B, the finger would have been
put on the individual who had indirect shareholding control and
also the extraordinary powers as managing director under the
Articles, i.e. Jones, in both capacities. From our point of view it
is a pity that these two forms of control were not in the hands
of different persons, and that the question was not: which of them
had “the controlling interest”.
However, my submission is that even if in that eventuality it
had been the extraordinary powers as managing director which
determined where “the” control lay, these powers were derived
from the same source which confers decisive voting rights in all
12Supra, n. 3.
13 Supra, n. 6.
14 Supra, n. 11, at p. 28.
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PERSONAL CORPORATIONS
the other cases, namely the Articles of Association themselves, and
not from some source outside the corporate structure.
This, I submit, is the entire key to the meaning of “control”
in the legal sense. You must look, and look only, at the relevant
Companies Act and the Articles of Association, and see who “con-
trols” through the mechanisms which are found there and there
only. In practically every case it will be found that the ultimate
control lies in voting power. But the reason why the Courts have
held for this “controlling voting power” is that this control results
from the normal company law and the Articles of Association.
I would agree that if validly enacted Articles stripped any real
control from the voting of shares and vested that control elsewhere,
then the “elsewhere” would “control”, but again only by reason
of the Articles, i.e. only because the “control” was provided for
by the corporate procedures laid down in the governing company
law and the Articles themselves.
It follows that in my opinion no form of pressure or control
which can be brought to bear upon the company or its controlling
shareholders from outside the corporate structure itself will confer
“control” in the legal sense, no matter how powerful it may be.
I may have the power of life and death over the people who hold
the controlling voting power, so that as a practical matter they
dare not act except as I direct, but I have no status, under the
Articles, within the corporate structure itself, and I therefore
cannot “control” the corporation in the legal sense. Similarly, I
may be a large creditor, with power to “break” the corporation
by calling my loan and suing, in which case the corporation will
no doubt as a. practical matter pay heed to what I say. But within
the corporate structure, for example at general meetings (on
which the Courts have always laid the main emphasis) I have no
status whatever, much less “control”.
Relevant to this irrelevancy between “control” by voting power
(or, I subomit, any other form of control which might actually be
found in the Articles of Association) on the one hand, and control
by some form of outside pressure on the other, is the case of
LR.C. v. J. Bibby & Sons Ltd.15 in which the House of Lords had
to decide whether the company was one “the directors whereof have
a controlling interest therein”. The facts established that the answer
would be in the affirmative if shares held by some of the directors
as trustees under certain trusts were counted, but not otherwise.
The House of Lords held in the affirmative following the decision
15 [1945], 1 All E.R. 667.
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[Vol. 17
in the British American Tobacco 16 case to the effect that beneficial
or proprietary interest was not required.
As to the shares held by some of the directors as trustees under
certain trusts, Lord Simonds said: 17
Those who by their votes can control the company do not the less
control it because they may themselves be amenable to some external
control. Theirs is the control, though in the exercise of it they may be
guilty of some breach of obligation whether of conscience or of law.
Similarly in Barclays Bank Ltd. v. I.R.C.,18 the House of Lords
considered the position where a company had issued an outstanding
8,350 ordinary shares of which a deceased shareholder was registered
as holder of 1,100, which he owned beneficially, and was also
registered as one of four trustees of certain trust settlements with
respect to 3,650 additional shares which he had created for the
benefit of his wife and children, himself taking no beneficial interest.
His name appeared in the share register as the first of the four
trustees and, under the Articles of Association of the company,
this entitled him to vote in respect of the 3,650 shares. The House
of Lords again held that it was irrelevant that a shareholder who
had the apparent control was amenable to some sort of outside
control, in this case the trust settlements. They therefore held that
he “controlled” the company with the 1,100 shares which he owned
beneficially and the 3,650 which comprised the trust settlements.
To like effect is the Canadian case of Rubenstein v. M.N.R.10
in which shares held by an individual as trustee where held to be
on the same footing as, and therefore to be added to, those which
he owned personnaly in order to determine whether he had “control”.
It is also clear that potential “control” is insufficient, no matter
how little remains to be done to translate potentiality into actuality.
In the English case of Himley Estates Ltd. and Humble Invest-
ments Ltd. v. C.LR.20 the question was whether a company was
controlled by not more than five persons. An individual held all
the common shares. The other fourteen shareholders, each holding
as many voting preferred shares as the individual held common
shares, were unrelated in any way. The individual and his solicitor
were the sole directors and could at any time have caused the
company to issue additional shares from Treasury and thereby
acquired voting control. It was held that they did not control the
16 Supra, n. 6.
17 Supra, n. 15, at pp. 673.
Is [1960], 2 All E.R. 817.
19 (1965), 39 Tax A.B.C. 7.
20 (1932), 17 T.C. 367.
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PERSONAL CORPORATIONS
company, however much they might reasonably have expected as
a practical matter to have the “willing co-operation de facto” of
the other shareholders in connection with all matters whatsoever
relating to the company, and the power to put themselves into
legal control if the co-operation had not been forthcoming.
Again, coming closer to home, we have the case of Rous & Mann
Press Limited v. M.N.R.21 The owners of an incorporated business
agreed, by written contract, to sell it progressively to five key
employees. The device adopted was to form a new company which
(simplifying its capital structure) would issue a large number of
redeemable voting preferred shares to the former owners and all its
common shares to the five key employees. The new company bought
the fixed assets of the old company at realistic values. At the
moment of this purchase and for some time afterwards, the owners
of the old company, although obligated by contract to take up
preferred shares of the new company which would give them
voting control, had only taken one share each. The question before
the Tax Appeal-Board related to the basis on which the new company
could depreciate the fixed assets, for the Minister had decided that
both companies were controlled by the same owners, who admittedly
controlled the old company and contracted to control the new one
(but did not in fact control it) at the moment of transfer of the
fixed assets.
The Board, in a carefully-written judgment referring to all the
relevant authorities, including the Himley 22 case, decided that even
an obligation to assume control could not help the Minister if
control had not in fact been assumed. The contractual obligation
to take up the majority of voting shares was between the groups
of shareholders and not with the new company itself. The judgment,
however, makes it clear that the same result would have followed
if the controlling shares of the new company had been subscribed
for but not actually allotted and issued.
In the Australian case of Federal Commissioners of Taxation v.
West Australian Tanners & Fellmongers Ltd.,23 there were several
combinations of not more than seven shareholders of a company,
any one of which could have controlled the company. In choosing
between them the Court said: 23a
… only that group which not only has the capacity to control, but also
exercises it, can be regarded as in control.
21 (1953), 9 Tax A.B.C. 56.
22Supra, n. 20.
23 (1945), 8 A.T.D. 25.
23a Ibid., at p. 28.
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It is true that s. 139(5d) (b) of the Income Tax Act provides in
substance that a person who has a right to acquire shares in a
corporation, or to control the voting rights of shares, will (with
certain exceptions) be deemed to have control of the corporation
as if he owned the shares.
It is expressly stated, however, that this provision applies only
to the purposes of s. 139(5a), which in turn relates back to the
definition of “related persons” in s. 139(5) in connection with the
question of “arm’s length” dealing: in other words, s. 139(5d)(b),
referred to in the preceding paragraph, does not affect the word
”control” in the definition of a “personal corporation” as found in
s. 68(1)(a).
My submissions on the subject of “control” within the meaning
of s. 68(1)(a) are therefore these:
1. The control itself can not be of any type whatever but must
be “control” in the legal sense, i.e. through the corporate procedure
provided by the governing statute and the Articles of Association.
2. In practically every case this will mean “controlling voting
power” either directly or through intervening controlled corpo-
rations. The only exception will be if valid Articles of Association
place elsewhere the ultimate control which is normally vested in
the majority of voting shares.
3. A person in a position to bring even the strongest forms of
pressure from outside against the company or its controlling share-
holders does not “control” the company unless his “control” can
also be exercised by the internal procedures provided by the Articles
and the governing statute.
4. Potential control is not sufficient, even if there is a contractual
obligation to assume actual control.
5. It is only the “manner” in which this legal control may be
exercised, which may take any form “whatsoever”.
In what other manner “whatsoever”, then, one may ask, can
control in the legal sense subsist, i.e. otherwise than by the “holding”
of the majority of the shares? Because of course the words “or in
any other manner whatsoever” must be given some meaning rather
than none. Two examples come readily to mind, though there may
well be others.
The first centres on the word “holding” –
a majority of the
shares. Beneficial ownership, or indirect ownership through an
intervening controlled corporation, is not specifically mentioned.
The case of “control” of Company B through Company A (i.e. the
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British American Tobacco 24 case) is therefore one example of what
“in any other manner whatsoever” may mean.
The second obvious example is the case of a company without
share capital. “Control” must lie somewhere, and one must, pre-
sumably, look to the Articles of Association to find where it is.
The speculations inherent in the possibility of, say, a charitable
corporation or a research foundation without share capital being
within the meaning of its Articles “controlled” by persons designated
in s. 68(1)(a), who however cannot under the objects clauses
possibly under any conditions “get at” any of the assets for their
own benefit, are challenging, to say the least.
The question of what happens to the status of a “personal
corporation” upon the death of the controlling shareholder arose
in Settled Estates Ltd. v. M.M.R.2 5
The controlling shareholder left his estate to executors who
were residents of Canada, for beneficiaries who did not themselves
constitute a family group as contemplated in s. 68(1) (a), nor was
there evidence that any of them resided in Canada.
The appellant company nevertheless contended that it was still
a personal corporation because the executors themselves (one of
whom was an individual and the other a trust company) constituted
“an individual resident in Canada”.
This contention was based on the definitions of “individual”
contained in s. 139(1)(u) and of “person” as found in s. 139(1)(ac).
The relevant portions of those two definition sections may be com-
bined to read as follows:
includes …
the executors, administrators or other legal
‘individual’…
representatives of such individual …
In other words, the appellant argued that because the word “indi-
vidual” is in s. 139 defined so as to include that individual’s executors,
the executors can themselves constitute an “individual” within the
meaning of s. 68(1)(a).
The Tax Appeal Board, the Exchequer Court and the Supreme
Court of Canada all held that for the purposes of s. 68(1) (a) the
word “individual” could not bear that expanded meaning but must
mean a natural living person resident in Canada. The reasoning
underlying this conclusion was that although for general purposes
the word “individual” will include the individual’s executors, such
will not be the case where the contrary clearly appears from the
24 Supra, n. 6.
25 [1959] C.T.C. 284; [1960] C.T.C. 173.
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context. The context in s. 68(1) (a) does indicate the contrary, in
that it consists of reference to an “individual” resident in Canada,
or such an “individual” and one or more members of his family.
Therefore, said the Board and the Courts, for the particular
purposes of s. 68(1)(a), the word “individual” must only refer
to a natural living person capable of having a family. The executors
resident in Canada could therefore not be said to be an individual
residing in Canada, despite the definitions set out in ss. 139(1)(u)
and 139(1) (ac). And, it will be remembered, the legatees themselves
were not the spouse, sons and daughters of the deceased. In the
result, the appeal was dismissed.
It would, however, apparently be different if the beneficiaries
did, themselves, consist of “an individual resident in Canada” or
“such an individual and one or more members of his family” (i.e.
spouse, sons and daughters) “who were resident in Canada”, for
in that case the executors, wherever they themselves might reside
(and this would not matter), would control the company “on behalf”
of an individual or group resident in Canada and qualified in his
or their own right under the requirements of s. 68(1)(a).
In this regard Judson, J., of the Supreme Court of Canada said
(although obiter), in the Settled Estates 27 case:
The last mode of control is by any other person on behalf of an individual
or on behalf of an individual and members of his family. I can think
of situations where executors could exercise control under this third
mode of control, for example, if T dies leaving all his shares in a personal
corporation to executors and trustees in trust for an individual or for
that individual and members of his family. But that is not the present
case.
That situation, however, did arise in Dawson Investments Ltd.
v. M.N.R. 28 The deceased left his controlling shares in a personal
corporation to executors and trustees upon trusts for his spouse,
a son and a daughter. The spouse and son resided in Canada, the
daughter in the U.S. The son and daughter also owned shares in
their own right, but taking all the issued shares into account, the
control lay in or was being exercised for a family group residing
in Canada which consisted of the testator’s spouse and son. The
Tax Appeal Board held, distinguishing the case from the Settled
Estates 29 case on that ground, that the company retained its status
as a personal corporation.
27 [1960] C.T.C. 173, at pp. 176-177.
28 (1963), 33 Tax A.B.C. 433.
29Supra, n. 27.
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It is worth noting parenthecally that in two cases decided
under the Income War Tax Act, where the definition of a “personal
corporation” in s. 2(i) of that Act was for present purposes
substantially as it now, personal corporations were also held not
to lose that status upon the death of the controlling shareholder
when, and because, the executors and trustees administered the
controlling shares on behalf of the widows and children of the
deceased, who themselves constituted groups meeting the require-
ments of the definition: Port Credit Realty v. M.N.R.; 30 Ernest
Gilman, Incorporated v. M.N.R.31
II. Sources of income
Under s. 68(1) (b), a company must, in order to be a personal
corporation, derive at least 25% of its income from:
(i) ownership of or trading or dealing in bonds, shares, deben-
tures, mortgages, hypothecs, bills, notes or other similar property
or an interest therein,
(ii) lending money with or without securities,
(iii) rents, hire of chattels, charterparty fees or remunerations,
annuities, royalties, interest or dividends, or
(iv) estates or trusts.
This requirement has not occasioned much litigation or difficulty
of interpretation.
It has however been pointed out in two cases that the company
must, in order to meet the requirement, have some net income from
the sources mentioned, i.e. it cannot qualify if it has gross income
but a net loss from these sources (No. 84 v. M.N.R.; 32 Manson v.
M.N.R.
33
The latter case presented an additional point of controversy
in that its income from the abovementioned sources consisted of
rental income of $2,837.14 and mortgage interest of $3,502.96, whilst
its expenses of $6,504.28 all related to the rental income. If (as the
Crown contended) all of the expenses of $6,504.28 were applied
against the rental income of $2,837.14 and the mortgage interest
of $3,502.96 were to be considered as a separate item not subject
to any expenses, more than one-quarter of the company’s income
would have been derived from the above-noted sources and the
company would be a personal corporation.
30 [1937] Ex. C.R. 88.
3’ [1937] Ex. C.R. 98.
32 (1953), 8 Tax A.B.C. 107.
33 (1961), 27 Tax A.B.C. 275.
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It was however held that the income from the rent and the
mortgages must be combined and the total of the expenses deducted
therefrom. On this basis the Company had a loss of $164.18 from
the stipulated sources and, as stated above, was held not to be a
personal corporation.
Before leaving the subject of sources of income, it should be
observed that in the cases of the above items (ii), (iii) and (iv),
the receipts to be taken into the calculation will be receipts of an
income, and not of a capital character, while receipts from item (i)
will also include profits from “trading or dealing in” bonds, shares,
debentures, mortgages, etc.
The question of the extent to which trading will amount to the
carrying on of an active financial, commercial or industrial business
(which disqualifies the company from personal corporation status
apart from all other considerations) is a separate matter and will
now be discussed under the heading “Active Business”.
III. Active Business
Under s. 68(1)(c) a corporation is excluded from the definition
of a “personal corporation” if at any time during the taxation year
it carried on an active financial, commercial or industrial business.
To remain outside the definition, therefore, the company must carry
on a business and it must be an active business.
The expression “carrying on business” is dealt with in s. 2(2)
and s. 139(7) of the Act, but only from the viewpoint of non-residents,
for the obvious reason that a resident is taxable on all his income
and he does not need to be “carrying on” a business in order to be
taxable on the profit from a business transaction, let alone carrying
on an “active business”.
The approach must therefore be to look at the definition of a
“business” in s. 139(1)(e), then decide whether a business is being
“carried on”, and then further decide whether it is an “active”
business.
“Business” is defined in s. 139 (1) (e) as follows:
‘business’ includes a profession, calling, trade, manufacture or under-
taking of any kind whatsoever and includes an adventure or concern in
the nature of trade but does not include an office or employment;
the use of the singular “an” adventure.., should be noted.
Now while a resident is taxable under s. 3 on “income” from
any of the sources comprised within that definition, it is not
necessary that he “carry on” any one of those activities with any
indeed, consistently with the
degree of continuity or repetition;
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PERSONAL CORPORATIONS
fact that “an” adventure or concern in the nature of trade constitutes
“business” as defined in s. 139(1)(e), the profit from an isolated
transaction has frequently been brought into charge for tax purposes
Chutter v. M.N.R.; 34 M.N.R. v. Taylor; 35 Alexander v. M.N.R.; 36 and
previous leading U.K. cases including C.IR. v. Livingston; 3 7 Rutledge
v. C.LR.38
In such a case, however, it would not necessarily result that
the taxpayer would be held to be “carrying on” a business. Most
of the cases dealing with the expression “carrying on business”
have arisen under the extra-provincial corporate licensing Acts
of the various provinces, and, while care must be taken in evaluating
these cases because of special definitions which sometimes affect
the interpretation, it is true to say that the expression “carrying on
business” is construed as involving a degree of continuity: of
“carrying on”, as distinct from some isolated exercise of a corporate
power. So far as tax cases are concerned, some support for this
view is found in No. 418 v. M.N.R.,3 9 and I have found nothing to
the contrary.
I therefore submit that if a company is to be taken out of the
definition of a personal corporation by reason of s. 68(1)(c), its
business transactions must possess some substantial degree of
continuity and repetition. This concept is, I think, emphasized by
the use of the word “active”, which is defined in the Concise Oxford
Dictionary, 3rd Ed., as “given to outward action; working, effective,
energetic, diligent”.
As may be expected, the numerous decided cases on what con-
stitutes an “active business” rest on their individual facts. It is
nevertheless possible (though admittedly intrepid!) to distil from
these cases certain general principles or “signposts”. Therefore,
rather than simply analyse cases one by one, I propose to enunciate
each of the general principles or “signposts” which I think can be
discerned, and discuss briefly the principal cases which I think
support each of them.
34 [1955] C.T.C. 377.
35 [1956] C.T.C. 189.
30 (1963), 34 Tax A.B.C. 377.
37 (1926), 11 T.C. 538.
38 (1929), 14 T.C. 490.
39 (1957), 17 Tax A.B.C. 132.
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1. A close connection with personal or family-controlled operations
of a basically investment nature will probably defeat any con-
tention that there is an active business.
In No. 74 v. M.N.R., 40 a company called “B Finance” was owned
by a father and two sons. In another company called “B Motors”
the father owned almost all the preferred shares, and the sons
owned a majority of the common. The income of “B Finance” was
derived solely from the financing of lien notes received by “B
Motors” from its customers and from interest on loans which it
made to “B Motors”. There were only six or seven transactions
per year between the companies. They were accomplished by book
entries, i.e. no cheques passed. “B Finance” had no employees of
its own, no office, no sign on a door, and no telephone listing. Its
records were kept in the office of “B Motors”, whose employees
did all the work. It had no other business and did no soliciting and
its capital was nominal.
The Tax Appeal Board held that in view of all these consider-
ations the business was not “active”, and that the company was a
personal corporation.
Similarly, in Manson v. M.N.R., 41 a company owned a building
which was rented to four tenants, a major tenant being a company
controlled by the appellant’s wife. The company claimed that it
carried on an active business because it obtained tenants, collected
rents, employed building staff and attended to maintenance. It had,
however, no office, clerk, or stenographer, and it did no advertising
or promotion. The gross rents totalled about $27,000 per year.
The Tax Appeal Board held that the company “was merely a
landlord in not a large way and what was done by it hardly merited
description as either an active financial or commercial business”.
Of the business, the Board said, “It may be a business, but if it is
such, I can only regard it as a passive and not an active business,”
adding that the company “had chiefly to receive rents and make
certain disbursements as a matter of routine”. Its operations were
not “large or busy”.
The judgment also pointed out that the volume or extent of the
assets and income was one important factor as an indication of the
extent and therefore the “activity” or otherwise of operations; that
the assets and income were much less in this case than in No. 74 42
which I have already discussed (the “B Finance” case), and that
40 (1952), 7 Tax A.B.C. 250.
41 (1952), 7 Tax A.B.C. 298.
42 Supra, n. 40.
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PERSONAL CORPORATIONS
even in the latter case it had been held that there was not an
“active” business.
2. Of significance also will be the question whether the company
has an office and employees, whether it engages in advertising,
promotion and contacts with the public and whether it maintains
full records and holds normal meetings.
These factors were lacking in both the cases which I have
discussed under principle No. 1.
Similarly in Finning v. M.N.R.,4 3 Company A was assessed as a
personal corporation but claimed to be carrying on an active busi-
ness. It purchased customers’ notes, principally from an operating
company (Company B) which was owned by the same family, and
then pledged them to the bank at lower interest rates in order to
obtain financing loans. Its profits consisted of the spread between
the two interest rates.
During the three years in question it purchased 863 such notes
from Company B and only four from outside interests. It had no
office, no telephone listing, no employees and did no advertising;
it was in fact entirely run by employees of the operating company B
from the latter’s office.
It was held that Company A did not carry on an active business
but on the contrary was passive in the sense that it “did nothing
with its own mind at all”. It was accordingly held to be a personal
corporation.
In Smith v. M.N.R.,44 a company which was assessed as a personal
corporation controlled six other companies which were active in
the field of oil drilling equipment. The company claimed that it
carried on the active business of managing these other companies
and was thus not a personal corporation. It had no office, no staff,
and no telephone listing. Its only income was a dividend of some
$25,000 from one of the six operating companies. Its expenses
amounted to $358.
Here again it was held that the company “virtually did nothing”
and was a personal corporation.
In Sawle v. M.N.R.,4 5 a company owned four small buildings
in Welland, Ontario. The annual rental from the largest was some
$24,000 and the annual rentals from the other three (in which there
were seven tenants) totalled approximately $12,300. The company
in addition had investment income of about $1,000.
43 [1961] C.T.C. 425.
44 (1963), 34 Tax A.B.C. 259.
45 [1967] Tax A.B.C. 757.
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The company employed a janitor who was supposedly full-time,
but really only worked part-time (his salary was $25 per week)
to look after the heating in the main building and to see that the
stairways and halls were cleaned.
The administrative expenses were negligible and the company
had no office or employees of its own but was run from the office
of one of its shareholders (who conducted an engineering practice)
in Ste. Catharines.
It was held that the company conducted very little activity and
was passive rather than active in the matter of carrying on business;
it was in consequence held to be a personal corporation.
By contrast, in No. 196 v. M.N.R. 4
16 the appellant was the principal
shareholder in two private companies which owned and administer-
ed (except for the actual leasing) three large commercial buildings
on a main street. There were sixty-one tenants and the gross rents
were about $91,000. The appellant had offices in one of the buildings
and took an active part in the administration. Holding that the
companies did “carry on an active business” the Tax Appeal Board
said “both corporations were operating actively the business of
managing and maintaining commercial buildings for the purpose
of deriving revenue therefrom”, and added that the supervision
and efficient operation of the buildings “could well be in the
category of a full-time occupation for each of the corporate owners”.
A borderline case which might have gone in the taxpayer’s
Favour had he been represented by counsel and realized that he had
to give actual evidence of the alleged activity, was Van der Voort v.
M.N.R. 47 The appellant and partners owned and operated two fairly
large apartment buildings from 1933 until 1953 when the buildings
were sold to a private company which operated them until 1955
and then sold them. The company reported as a personal corporation
until the buildings were sold in 1955 but then reversed its position
and claimed that it had not been a personal corporation because
of the active business functions of administering the buildings.
One gathers from the report that since there were two apart-
ment buildings involved, the submission of appropriate evidence
might have revealed a degree of activity approaching that which
was proved in No. 196 41 which I mentioned a moment ago. However,
the Tax Appeal Board held: 49
46 (1954), 11 Tax A.B.C. 312.
47 (1958) 21 Tax A.B.C. 28.
48Supra, n. 46.
49 Supra, n. 47, at p. 30.
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PERSONAL CORPORATIONS
No evidence was given before me as to the extent of the activities carried
on by Van der Voort Agency Limited other than the ordinary activities
connected with the looking after a block of apartments and receiving
the rents therefrom. Under these circumstances, I am of the opinion that
this cannot be considered as the carrying on of an active commercial
business.
3. The volume of business is important and is often related to the
question of closeness to personal or family-controlled operations
of an investment nature.
This point has already been made in No. 74,0 No. 196 ” and in
the Manson 52 case, all of which I have already discussed under
Principles Nos. 1 and 2 above in other contexts.
In Glaspie v. M.N.R.,53 the company concerned was a diversified
investment company, investing in securities, mortgages, real estate,
etc. The book value of its assets was approximately $1,500,000. For
various reasons its investment portfolio had been neglected for some
years and in 1959 a number of overdue revisions were carried out.
The evidence however was to the effect that there were no radical
changes and that what was done amounted to a reorganization of
the portfolio rather than dealing in securities, etc.
Two weeks before the end of its fiscal year the company had
bought for $300 a small smoking supply shop, which it operated for
the two weeks at a net loss of $91.44.
The company was held to be a personal corporation: its secu-
rities transactions did not constitute carrying on an active business
for the reasons stated above and, as for the tobacco shop, the Court
said: 53a “It would be ridiculous to hold that by reason of this one
small operation Glaspie Lumber Company Limited could be con-
sidered to be other than a personal corporation.”
In Portigal v. M.N.R.,54 a company was incorporated in 1959
for broad investment purposes, including power to invest and deal
in mortgages and other interests in land, to lend money, etc. During
1959 it made three loans against notes; in 1960, it made one mortgage
loan; in 1961, four mortgage loans; in 1962, three mortgage loans
and one loan against a note, and, in 1963, two mortgage loans; making
5 OSupra, n. 40.
51 Supra, n. 46.
52 Supra, n. 41.
53 (1963), 33 Tax A.B.C. 274.
53a Ibid., at p. 284.
54 [1967] Tax A.B.C. 1117.
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a total of fourteen loans which averaged $33,500 and bore interest
averaging about 10%.
The Minister treated the company as a personal corporation for
the first four years but in 1963 the company set up a reserve of
$8,000 for bad debts, paid the principal shareholder a salary of
$6,000, charged up $800 travelling expense, and took the position
that it was carrying on an active business and was not a personal
corporation in that year.
The Minister ruled that the company was still a personal corpo-
ration, disallowed the deductions, and attributed the company’s
income to its shareholders accordingly.
It was held that the company’s “activities were not sufficient
to qualify it as being in an active financial business for the purpose
of s. 68(1)(c) of the Act” and therefore remained a personal cor-
poration.
4. The old “corporate objects” test which was finally discarded by
the Supreme Court of Canada in the Sutton Lumber case 64a still
seems to be of some significance as regards s. 68(1)(c).
It will be remembered that this former doctrine maintained that
if a company had certain powers (notably powers to “sell” assets)
under its Memorandum of Association, and more particularly if the
inclusion of those powers in the Memorandum of Association was
unnecessary because the powers were already given by the relevant
Companies Act, the carrying out of any operations within the ambit
of those powers would result in the profit therefrom being of an
income nature because this was the “company’s business”.
Two cases seem to indicate that there are still, or were until
fairly recently, subsisting traces of this doctrine when it comes to
deciding whether a company is carrying on an “active business”
for the purposes of s. 68(1)(c).
In Baker Estates Ltd. v. M.N.R.,55 a company was formed “to
make investments”, including investments in real estate. It acquired
blocks of flats together with some vacant land and later purchased
more lands for the construction and sale of 30 two-unit dwellings.
It in fact built two apartment buildings on the land which it orig-
inally bought. These buildings cost $81,000 against an estimated
cost of $55,0000 – $60,000. The company then took advice as to the
feasibility of proceeding with the 30 two-unit dwellings, having
54a [1953] C.T.C. 237.
55 (1954), 11 Tax A.B.C. 391.
No. 3]
PERSONAL CORPORATIONS
regard to its financial resources and the probability that these
dwellings would also cost more than estimated. As a result of the
advice received, it abandoned the balance of its building plan and,
being unable to sell the land en bloc, sold the individual lots and
was assessed on the gains.
The Tax Appeal Board held that the company did not deviate
from its business as an investor. It did not dispose of the buildings
which it originally acquired or those which it later built itself. It did
dispose of investments which upon advice turned out to be an
unacceptable risk. Mr. Monet said: 55″a “The appellant did not
engage in the business of real estate transactions for the purpose
of realizing a profit or gain and consequently the profits it realized
are in the nature of capital gain.” He held that in consequence the
appellant was not disqualified as a personal corporation.
The point here relevant is that in the judgment considerable
emphasis was laid on the objects clause in the Memorandum of
Association as interpreting the true nature (“to make investments”)
of the operations which in fact took place.
In No. 585 v. M.N.R.,50 a company was incorporated on April 4th
1950, with the corporate powers of a contractor and builder. It
bought land and began to build a block of flats, borrowing money
from CMHC to do so. It then granted an option to sell the building,
and sold it in 1951. Meanwhile the building’ had been completed
and some rents had been received in 1951 before the building was
sold. Upon the sale of the building in 1951 the compaily changed
its name and altered its objects to those of a holding company. The
Minister treated the rent as income from a non-personal corporation
while the company contended that it was a personal corporation
since the apartment building was built for investment purposes
and the company did not carry on an active business.
The Tax Appeal Board held that the corporate objects (namely
those of a contractor and builder) were in the nature of trade and
were in fact carried out. The company bought lands, built apart-
ments, borrowed money, leased apartments, and sold its building
all as empowered in its charter. The name and the objects were
–
not changed until after this was done. The Board therefore held the
company not to be a personal corporation and in so doing attached
considerable significance to the corporate objects themselves.
Despite these cases the more recent tendency is, as in my opinion
it should be, to attribute prime importance to what the company
ua Ibid., at p. 398.
56 (1958), 21 Tax A.B.C. 56.
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in fact did rather than to what it was entitled to do or might
have done.
Thus in Stekl v. M.N.R.5 7 (a case which will be discussed more
extensively later upon a different point), the Court said:
Before commenting on the evidence I should refer to two arguments
advanced by counsel for the appellant. He submitted, in effect, that since
the Company’s memorandum of association provided that the object for
which it was incorporated was for investment purposes only it did not
have the power to engage in business and that if it did so its act was
ultra vires and void. But it is obvious that this cannot affect the tax-
ability of a profit made by it if such profit was from a transaction that
was a business transaction or an adventure or concern in the nature
of trade. The taxability of the profits of a corporation depends on the
true nature of its transaction, that is to say, on what it did, not on
what it was empowered or not empowered to do.
The same reasoning would no doubt have applied in reverse
had the objects been of a business nature but the operations of an
investment nature.
Mention should also be made of the case of Mendel v. M.N.R.,5 8
in which a company met the requirements for being held to be a
personal corporation in 1960, but in 1961 acquired an active business
with effect from January 1st 1960. The Minister assessed the share-
holders on the basis that the company was a personal corporation
in 1960 and they appealed, claiming that, the effective date of
acquisition of the active business having been January 1st 1960, the
company could not have been a personal corporation in that year.
The Tax Appeal Board held that whatever effect the agreement
of acquisition of the active business in 1961 might have had between
the parties to it as regards back-dating its effect to January 1st 1960,
the Minister was right in assessing on the basis of the facts as they
actually existed in 1960, i.e. what the company actually did during
that year, and it did not in fact carry on an active business.
The four general principles or “signposts” which I have tried
to outline may perhaps be of some assistance in assessing first
of all the nature and secondly the extent of operations which will
be held to constitute an “active business”. It is obvious, however,
that each decided case has rested solely on its own facts and I
think that the only discernible overriding principle is that an “active
business” will only be reasonably certain to be held to exist and
be “carried on” if it is substantial in volume, divorced as far as
possible from business of an investment nature operated by a
57 [1959] C.T.C. 442, at p. 452.
58 (1965), 37 Tax A.B.C. 305.
No. 3]
PERSONAL CORPORATIONS
closely-held group, if it is a “real” business, preferably involving
offices, employees, contacts with the public, etc., instead of being
a “sham” or “token” business, and if it is conducted in accordance
with objects clauses indicating a business of a financial, commercial
or industrial nature.
It will be recalled that, entirely apart from personal corporation
considerations, a taxpayer can be subject to tax on the profit from
an isolated “adventure in the nature of trade”, because under
s. 139(1) (e) such a transaction, even though isolated, is a “business”.
We have also seen, however, that in order to fall outside the
definition of “personal corporation” on the business ground, the
business must be “carried on” and it must be “active”. Both elements
are lacking in the case of the isolated (even though itself taxable)
transaction.
This is aptly illustrated by the case of Stekl v. M.N.R. 59 The
company, which had been largely dormant until 1952, purchased
a large apartment block in that year; in 1953, it acquired a sub-
stantial portfolio of securities, and a timber license, the latter from
the appellant for $15,000.
The company was at all material times controlled by the
appellant.
In 1955 the company sold the timber license, in a transaction
which the Court held to be a trading nature, for net $47,000, i.e.
at a profit of $32,000. The company’s other income, all from invest-
ments, was just over $7,000.
The Minister ruled that the company was a personal corporation
and assessed the shareholders on its income of $39,000. The appellant
appealed as regards his share.
Dealing with the appellant’s contention that if the company was
engaged in business resulting in a taxable profit it could not be a
personal corporation, Thorson, P., said: r9a
The submission was based on Section 68(1)(c) of the Act which included
in the definition of a personal corporation the requirement that during
the whole of the taxation year in respect of which the expression was
applied the corporation ‘did not carry on an active financial, commercial
or industrial business’. In my opinion, even if the Company transaction
relating to the timber (sic) was an adventure in the nature of trade that
did not put it into the category of having carried on an ‘active’ business
in 1955 in such a way as to deprive it of its character as a personal
corporation.
59 [1959] C.T.C. 442.
wOa Ibid., at pp. 452-3.
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While this disposed of the appeal, and is undoubtedly good law,
a curious feature of the case is that no-one raised the point that
only $7,000 out of the company’s income of $39,000 (i.e. less than
25 %) arose from the sources listed in s. 68(1)(b), namely ownership
of or dealing in securities, lending money, receiving rents, royalties,
interest, dividends, etc., and income from estates or trusts. This
is quite a separate point from that with which the Court dealt, the
latter relating as it does to a different element of the definition of
“personal corporation”.
It would certainly seem that if the point concerning less than
25% of the income having been derived from the sources mentioned
in s. 68(1) (b) had been raised, it would have sufficed to decide the
case the other way, whether or not as a separate matter the company
carried on an active business.
IV. Tax status
It will be recalled that if the company meets the definition of
“personal corporation” throughout its taxation year, it pays no tax
for the year but all its income is deemed to be distributed to the
shareholders as a dividend on the last day of the taxation year;
the shareholders however do not receive the 20% dividend tax
credit under s. 38 on this “global” dividend because that credit
only applies to dividends from taxable corporations (s. 38(1)).
Thus the general principle is to disregard the company for tax
purposes, as if it were a mere “conduit pipe” through which the
income passes directly from source to shareholders’ pockets and
is taxed in their hands as if received directly from source.
Simple though this concept may appear to be, it does involve a
number of complexities, some of which arise from the fact that
as a matter of corporate law the company is a separate entity from
its shareholders despite its being supposedly ignored for tax
purposes.
It is appropriate to comment briefly on the more important of
these.
1. If a company meets the definition of personal corporation
throughout its taxation year, it is automatically and conclusively
held to be a personal corporation for that year, i.e. there is no
option or election open to the shareholders as to the basis on which
they, or the company, or both, will be taxed (as there is, for example,
in the case of companies eligible, under s. 70, to be taxed as non-
resident-owned investment corporations).
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PERSONAL CORPORATIONS
2. S. 68(1) requires that to be a personal corporation a company
must meet all the requirements during the whole of the taxation
year in question. Therefore if any event occurs during the year
inconsistent with the definition, e.g. if the company begings to carry
on an active business, the company will not be a personal corpora-
tion for any part of the year.
The solution in such a case is to change the company’s fiscal
year with the consent of the Minister as provided in s. 139(1) (r), so
that the date of the change will be the end of a fiscal period, and
the personal corporation status will therefore be valid up to that
date. The reverse procedure could of course be followed if a com-
pany, not being a personal corporation but wishing to become one
during a fiscal year, should discontinue its active business and
concurrently terminate its fiscal year with the approval of the
Minister under s. 139(1)(r).
3. The company’s income is deemed to be distributed to its
shareholders as a dividend not in proportion to their respective
holdings of shares but in the proportions in which each of them
or their respective predecessor shareholders transferred or loaned
property to the company (s. 67(3)). A person who contributes all
or most of the assets therefore cannot shift the incidence of tax
by having some shares issued to others than himself.
4.
In cases where a company which has always been a personal
corporation actually pays a dividend, the dividend is of course not
taxable in the hands of the shareholders because it has already
been taxed to them as and when earned by the company.
If, however, a dividend is actually paid by a company which
has been a personal corporation in some years and not in others,
the dividend will be taxable to the shareholders who actually receive
it (i.e. not in the proportions in which they or their predecessors
contributed property to the company) to the extent that the dividend
is paid out of theretofore undistributed income of the company
earned in years in which it was not a personal corporation. S. 67(7)
lays down the rules for determining the amount of undistributed
earnings falling in this category.
5. Provision has to be made for the “flow-through”
to the
shareholders of such benefits as they would be entitled to receive
if the income came to them directly from the underlying sources.
For example to the extent that the income of a personal corporation
deemed to be received by a shareholder at the end of the corpora-
tion’s fiscal year consists of dividends received by the personal
corporation from taxable Canadian corporations, the shareholder
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receives the 20% dividend credit against his tax which he would
receive under s. 38 if the dividends were paid directly to him
(s. 67(10)). Similarly, to the extent to which the income of the
personal corporation which he is deemed to receive consists of
income from foreign sources upon which the foreign countries
concerned have levied withholding tax, the shareholder will be
entitled to credit for the withholding tax to the same extent as if
he had received the income directly from the foreign sources
(s. 67(11)).
While the “conduit pipe” and “flow-through” concepts have
developed progressively over the years since the “personal corpora-
tion” was first introduced into the Income War Tax Act in 1926,
it is not yet true to say that the existence of the corporation is
100% ignored for tax purposes and that the shareholder is treated
100% as if the corporation did not exist.
For example, there is no provision in the Act for the deduction
of charitable donations from taxable income by a personal corpo-
ration because the corporation has no taxable income (administra-
tively, however, the Department does allow equivalent relief to the
shareholders, but this is still not a matter of statutory right);
further, if a shareholder lends money to a personal corporation, the
interest received is fully taxable and the shareholder is not entitled
to relief in the form of the 20% credit in respect of dividends from
the underlying securities, or of credit for foreign withholding taxes
imposed by the country of origin, as mentioned above.
Again, ss. 8(1) and 137(2) of the Act, taxing benefits conferred
by corporations on their shareholders, appear to be applicable to
personal corporations and to be contrary to the pure “conduit-pipe”
concept. Losses sustained by a personal corporation which is wholly
owned by another personal corporation have been held (Richardson
v. M.N.R.) o not to be deductible from the income attributed to a
shareholder of the latter corporation because the two corporations
were “separate taxable persons”P
On the whole, however, it is fair to say that the “conduit-pipe”
principle, which involves ignoring the existence of the personal
corporation for tax purposes, has gradually evolved reasonably
closely to completion. Each case involving the contemplated use
of a personal corporation should, nevertheless, be minutely scru-
tinised on all of its particular facts, to see whether any of the fore-
60 [194041] C.T.C. 258.
61 Per Maclean, I., at p. 263.
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PERSONAL CORPORATIONS
going or other imperfections in the “conduit-pipe” theory are likely
to prove to be of consequence.
V. Personal Corporation – To use or not to use?
At the beginning of this article I pointed out that any corpora-
tion (not necessarily a personal corporation as defined in s. 68)
could serve as a vehicle to which to transfer one’s securities for
certain of the purposes commonly desired, i.e. to centralize the
administration and the situs of the securities both before and after
one’s death.
I also suggested that, if tax on the income from the securities
is a consideration, the investor should first calculate what the total
income tax impact would be if he transferred the securities to an
ordinary (non-personal) corporation, the impact in that case con-
sisting of tax on the income in the company’s hands when received,
and in the investor’s hands when paid out by the company to him
(a step which, together with payment of the tax thereon, could be
postponed at the will of the investor if he controlled the company).
The intervening material will, I venture to hope, enable the
investor to compare these calculations with the tax impact which
would result if a personal corporation were used, i.e. there would
be no tax on the company’s income, but the income would be deemed
to be distributed to the shareholders as a dividend at the end of
each year and taxed in their hands accordingly.
Finally, the investor should decide just what he wishes
to
achieve, and evaluate the respective roles which the two types of
company can play in achieving his objectives.
Some examples follow.
1. A very common (indeed perhaps the most common) objective
is to “freeze” the value of the investor’s holdings at their present
levels for succession duty and estate tax purposes, whilst providing
that future capital enhancement will enure to the eventual benefit
of his children.
Here a personal corporation should definitely be used. There
are sections of the Income Tax Act (notably s. 138A but others
besides) under which the Department of National Revenue can
attack a wide variety of transactions, including estate-planning
arrangements of the type here under discussion, and one result of
these attacks can be to impute taxable benefits to the investor as
a result of events which occur after he transfers his securities and
so attempts to “freeze” their value.
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This is a separate and highly complex area of income tax law,
but it will suffice for present purposes to say that the Department
is much less likely to move, against a plan based on a personal
corporation than on a non-personal corporation, because in the
former case the taxpayer is obviously not trying to reduce current
taxes by accumulating income in a company:
the income of the
company is all deemed to be paid out to him as a dividend at
the end of each year anyway, on the “conduit-pipe” principle.
Care should obviously, and for the same reason, be taken to
see that such a company retains its “personal corporation” status
at all times.
2.
If the investor wishes the “personal corporation” status to
survive his death and the company to be administered by his
executors for his beneficiaries, he should ensure that the bene-
ficiaries will themselves constitute a group as defined in s. 68(1) (a)
and 68(2), i.e. an individual resident in Canada, or such an indi-
vidual and one or more of: his spouse, sons and daughters, also
resident in Canada.
Thus the investor’s widow and children, in whatever proportions
and with whatever interests inter se, would constitute such a group;
two children each entitled to 50% would not; one child with 51%
and another with 49% would, etc.
3. An investor seeking to achieve the objectives set out in both
Nos. I and 2 above could therefore proceed somewhat as follows:
(a) cause a company to be incorporated, with voting preferred
shares and common shares.
(b) subscribe (himself) for sufficient preferred shares to ensure
voting control, and have his children (or trustees under irrevocable
trusts for them) subscribe for common shares. The numbers of
shares issued need not be large, provided that the proper pro-
portion between voting preferred shares and common shares is
created and maintained, the voting preferred always retaining
control.
(c) sell his portfolio of securities to the company at their market
value against further preferred shares, or debentures, or open-
account debt, of the company. Some care should be devoted to
this choice on technical grounds, but in any case the investor can
receive during his lifetime, in the form of preferred dividends or
interest, the entire income of the company, on which he pays tax
in any event, and also have voting control of the company, while
any enhancement in the value of the underlying securities increases
the value of the common shares, which are owned by or for the
children.
No. 3]
PERSONAL CORPORATIONS
565
(d) provide in his Will that the income of his estate be paid
by his executors to his widow during her lifetime, and the capital
after her death to his children in equal shares.
4. The plan outlined above (or one of many admissible vari-
ations of it) will secure personal corporation status until the death
of the widow, when the capital (which includes the controlling pre-
ferred shares) is divided between the children. The status could be
preserved for still longer by providing, for example, that the pre-
ferred shares would not go to the children equally on the widow’s
to one child and 49% to the other or others,
death but say 51%
together with (if desired) a provision that the shares would remain
in the hands of the executors until the children reach stated ages
well above majority.
5. Moving into an area wider than (but including) estate plan-
ning, it will be evident that the “active business” aspect in the
definition of a personal corporation not only constitutes the greatest
pitfall in the matter of accidentally falling into or out of the defi-
nition, but also provides a mechanism for coming into or out of
the definition at one’s own will. The self-imposed “ground rules”
should be:
(a) if you want personal corporation status, keep as far away
from “active business” as you can.
(b) if you do not want the status, conduct a genuine, substantial
business and not a “sham” or a “token” one.
(c) if you want to change the status, and the new status to
become effective immediately, either commence or discontinue the
active business (as the case may be) at the end of the company’s
fiscal year if possible; otherwise change the fiscal year with the
Minister’s consent, under s. 139(1)(r), so that the date of commen-
cement or discontinuance of the active business will constitute a
new fiscal period.
VI. Conclusions
It will be seen that the personal corporation need only be used
(as distinct from a non-personal corporation) as a vehicle for taking
ownership of an individual’s securities when, in addition to securing
centralization of administration and situs of the securities, the in-
vestor desires to accomplish one or both of the following objectives:
1. to pay personal income tax on the entire annual income from
the security portfolio on the “conduit-pipe” principle; and
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2. to freeze the value of his securities at their present value for
succession duty and estate tax purposes in connection with the
planning of his own estate, and in conjunction therewith to ensure
that all enhancement in value of the underlying securities from
the time of vesting them in the corporation onwards will enure to
the benefit of his children.
In all other cases there will be some element of option as to
whether to use a personal corporation or a non-personal corpo-
ration but if the decision is to use the personal corporation the
greatest care is necessary to comply at all times with all elements
of the statutory definition which look relatively simple but which
in fact contain many pitfalls.
