Sep 18th, 2020
May 10th, 2019
By Joy Elkeslassy
This article was first published by the Canadian Tax Foundation in (2019) 9 :2 Canadian Tax Focus
In Jencal Holdings Ltd. v. The Queen (2019 TCC 16), the TCC applied the deemed association rule in subsection 256(2.1) to force the corporations involved to share the $500,000 business limit because tax reduction was held to be one of the main purposes of the corporations' separate existence.
The case concerns a business with multiple subsidiaries owned by the Kal Tire Partnership, a partner of which was a corporation ("Kal Tire Ltd.") wholly owned by Kal Tire Holdings Ltd. ("KT Holdings"). The common shares of this latter corporation were held by a trust for the benefit of the owner's children. The common shares were later distributed to the five children; subsequently, they transferred their shares to five Holdcos, each with a 20 percent interest in KT Holdings, in both votes and value.
Under the old structure, KT Holdings and Kal Tire Ltd. could not claim the SBD because their combined taxable capital employed in Canada was too high. Under the new structure, each Holdco (including the appellant) was associated with KT Holdings. Pursuant to paragraph 256(2)(a), two corporations (the Holdcos) that are associated with the same corporation (KT Holdings) are deemed to be associated with each other. However, KT Holdings made an election under paragraph 256(2)(b) not to be associated with the Holdcos for the purposes of section 125. This meant that each Holdco was able to maintain its $500,000 small business limit.
The subsection 256(2.1) anti-avoidance rule deems corporations to be associated where it may reasonably be considered that one of the main reasons for the separate existence of those corporations is to reduce the amount of taxes otherwise payable. To make this determination, the court should first assess the subjective intent of the appellant and then determine, on an objective basis, whether there is enough evidence to support that intention. As stated in Lenco Fibre Canada Corp. v. The Queen (79 DTC 5292 (FCTD)), the word "main" must be given significance; the reduction of taxes payable could be a reason but "a judgment must still be made as to whether it was a main or principal reason." The TCC concluded that the appellant did not adduce sufficient evidence to establish that the reduction of taxes was not one of the main reasons for the separate existence of the Holdcos. Emphasis was put on various documents from a large accounting firm that detailed the plan to multiply the SBD and showed that tax reduction was emphasized on multiple occasions. The appellant brought forward other reasons for the separate existence of the Holdcos, but the only one held to be valid by the TCC was estate planning.
Interestingly, the appellant submitted that investment planning was a main reason to consider, because it allowed each child to choose to what extent dividends would be used for personal expenses or money would be left inside the Holdcos and invested at the corporate level. This is usually an important reason for people to use separate holding corporations, in addition to creditor protection. However, the TCC refused to consider this as a main reason because the Kal Tire Partnership had a policy of not distributing profits, and KT Holdings had a history of making modest distributions. Would the court's conclusion have been different had there been no such policy and substantial dividends were paid to the Holdcos during the years under appeal?
Also, the method used by the Holdcos to generate ABI on which to claim the SBD is noteworthy. Their strategy was to generate interest income, through a series of intercorporate dividends and loans, that was deemed to be ABI under paragraph 129(6)(b). As a result of an amendment to subparagraph 125(1)(a)(i), effective for taxation years beginning after March 21, 2016, this type of ABI is ineligible for the SBD if an election under subsection 256(2) is made.