The acquisition of control (AOC) rules in the Income Tax Act (ITA) are designed to prevent non-related persons or group of persons from trading in corporations that have unutilized losses for income tax purposes by restricting the corporation’s ability to deduct unutilized losses when control of the corporation has been acquired (i.e. change in shareholders).
We know that the AOC rules can apply when there is a change in the corporation’s shareholders that results in an acquisition of control in the corporation, but what does that have to do with trusts? Well, some corporate structures have shares issued to a trust, and a trust is controlled by its trustees. Therefore, a change in the trustees can affect the control of the trust, which can result in a change in the control of the corporation.
Usually, it is clear when an acquisition of control of a corporation has taken place. However, there are situations when it is not so clear, like when the corporation is controlled by a trust. Paragraph (i) of subsection 256(7) of the ITA was enacted in 2013 with Bill C-139 to provide clarity to situations where a corporation is controlled by a trust.
Paragraph (i) of subsection 256(7) of the ITA reads as follows:
If at any time after September 12, 2013 a trust controls a corporation, control of the corporation is deemed not to be acquired solely because of a change in the trustee or legal representative having ownership or control of the trust’s property if:
(i)the change is not part of a series of transactions or events that includes a change in the beneficial ownership of the trust’s property, and
(ii)no amount of income or capital of the trust to be distributed, at any time at or after the change, in respect of any interest in the trust depends upon the exercise by any person or partnership, or the failure of any person or partnership, to exercise any discretionary power.
The purpose of paragraph (i) is to protect against the acquisition of control rules where there is a change in the trustees. Unfortunately, the condition in subparagraph (ii) will prevent many trusts from relying on paragraph (i) to avoid the AOC rules. This is because most trusts provide trustees with discretion over distribution of income or capital, and it is this very discretion that prevents the trust from relying on this exception to the AOC rules. This can be a problem when there is a legitimate change of control in the trustees of the trust, and that trust holds shares in a corporation with losses.
The following example was presented to the Department of Finance by the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada on October 15, 2013 in which it was determined the AOC rules would still apply regardless of the proposed paragraph 256(7)(i):
Consider a situation where the trustee of a discretionary trust has not provided adequate supervision of the investment advisors to a subsidiary corporation of the trust such that significant losses have accumulated. The decision to replace the trustee would appear to result in the accrued capital losses in the corporation being subject to loss restrictions even though there has been no change in trust beneficiaries or beneficial ownership of the corporation.
The issue was revisited at the 2019 APFF conference during the CRA roundtable session with the presentation of another example. In this session, CRA was asked about the application of paragraph 256(7)(i) in respect of a change in trustees of a spousal trust that held shares in a corporation with losses, and the trust allowed the trustees to encroach on the capital for the benefit of the spouse. CRA stated that they are generally of the view that the trustees of such a trust, who have power to encroach on the capital, would have discretionary power. As a result, the AOC rules could apply in this situation.
With the broadly worded condition in subparagraph (ii) of subsection 256(7) of the ITA, the ability to avoid the application of the AOC rules will rarely materialize when there is an acquisition of control resulting from a change in trustees of a discretionary trust.