Background
Somerset Limited, incorporated in British Columbia in 1943, was a Canadian-controlled private corporation (CCPC) that owned two apartment buildings in Vancouver. In October 2018, Somerset agreed to sell these properties to an arm’s length purchaser for $34.02 million, generating a capital gain of approximately $32.2 million. Facing substantial tax liability under section 123.3 of the Income Tax Act (which imposes a 38.67% refundable tax on investment income of CCPCs), Somerset undertook a continuation into the British Virgin Islands on December 10, 2018—nine days before the closing date of December 17, 2018. Somerset believed that by ceasing to be incorporated in Canada, it would no longer qualify as a CCPC and thus escape the section 123.3 tax.
The company then reorganized its shareholdings and paid substantial dividends to its shareholders and their holding companies. The Canada Revenue Agency subsequently reassessed Somerset for its 2019, 2020, and 2021 taxation years, imposing section 123.3 tax on the taxable capital gain and investment income, and disallowing the general rate reduction. The central dispute turned on whether Somerset remained a CCPC after its continuation into a foreign jurisdiction.
The Court’s Holding
Justice MacPhee held that Somerset remained a CCPC despite the continuation into the British Virgin Islands. The definition of CCPC in the Income Tax Act requires that the corporation be a “Canadian corporation,” defined in section 89(1) as a corporation resident in Canada that either (a) was incorporated in Canada, or (b) was resident in Canada throughout the period beginning June 18, 1971. The court found that paragraph (b) applies to corporations not incorporated in Canada that have continuously maintained Canadian residency since 1971 or earlier. The deeming provision in section 250(5.1), which deems a continued corporation to have been incorporated in the jurisdiction of continuation, meant that Somerset no longer satisfied the definition under paragraph (a). However, this same provision placed Somerset squarely within paragraph (b): deemed to have been incorporated outside Canada while remaining resident in Canada continuously since 1943.
The court rejected Somerset’s argument that paragraph (b) applies only to corporations that were factually (not merely deemed to have been) incorporated outside Canada. Interpreting the disjunctive “or” between paragraphs (a) and (b), the court concluded that the two provisions describe distinct pathways to CCPC status: paragraph (a) encompasses corporations incorporated in Canada at any time, while paragraph (b) captures foreign-incorporated corporations resident in Canada since before June 18, 1971. The legislative purpose, reflected in 1971 Tax Reform Technical Notes, confirmed this interpretation: foreign corporations resident in Canada before 1971 would retain Canadian corporation status indefinitely so long as they remained resident in Canada.
Key Takeaways
- Corporate continuation to a foreign jurisdiction does not automatically strip CCPC status if the corporation remains resident in Canada and was resident continuously since June 18, 1971 or earlier.
- The definition of “Canadian corporation” in section 89(1) encompasses two disjunctive pathways: incorporation in Canada (any time) or foreign incorporation with unbroken Canadian residence since mid-1971.
- Deeming provisions that change a corporation’s deemed place of incorporation may flip which subsection applies, but do not necessarily eliminate CCPC status altogether.
- A corporation’s primary residence (not its place of incorporation) is the critical factor for CCPC status under paragraph 89(1)(b), provided historical residency requirements are met.
Why It Matters
This decision significantly narrows a potential tax avoidance strategy that some Canadian businesses had begun to explore: using corporate continuations to foreign jurisdictions to shed CCPC status and the associated section 123.3 refundable tax on investment income. The Tax Court’s interpretation of section 89(1) makes clear that such continuations, standing alone, will not achieve this objective if the corporation remains Canadian-resident and satisfies the historical residency test. The ruling effectively closes what taxpayers may have viewed as a window to recharacterize the tax treatment of large capital gains and investment income.
The decision also serves as a reminder that statutory interpretation of tax legislation requires careful attention to structure (the disjunctive “or” between paragraphs), legislative history, and the interaction of multiple provisions (sections 89(1) and 250(5.1)). While the court acknowledged that a general anti-avoidance rule analysis could have provided an alternative path to the same result (following the Federal Court of Appeal’s decision in Canada v. DAC Investments), the statutory interpretation route was more direct and leaves no ambiguity about the durable scope of CCPC definition going forward.