Can a corporate director contribute shares of the corporation to a TFSA?

Canadian taxpayers can take advantage of various registered plans offered by the Government of Canada, including registered retirement savings plans ("RRSP") and tax-free savings accounts ("TFSA"). Taxpayers must ensure that the investments contributed to such plans are qualified investments, as set out in the Income Tax Act ("ITA") and its regulations.

Most securities listed on a designated stock exchange, such as shares of corporations, are considered qualified investments. However, in some instances, the ITA could deem certain shares of a corporation to be a prohibited investment.

As explained in the Canada Revenue Agency("CRA")'s Income Tax Folio S3-F10-C2, "a prohibited investment for a registered plan is generally an investment to which the plan's controlling individual is closely connected." The ITA imposes two special and potentially onerous taxes when a registered plan holds a prohibited investment: i) a 50% tax on the value of the investment, which is refundable in certain circumstances; and ii) a 100% tax on any income or capital gain derived from the investment.

Subsection 207.01(1) of the ITA defines a prohibited investment for a registered plan as any of the following: i) a debt of the controlling individual of the plan; ii) a debt or share of, or an interest in, a corporation, trust or partnership in which the controlling individual has a significant interest; iii) a debt or share of, or an interest in, a person or partnership with which the controlling individual does not deal at arm's length; or iv) an interest in, or a right to acquire, a debt, share or interest described in the first three examples above.

This article will focus on a recent case study involving the third criteria, and more specifically, a share of a person with which the controlling individual does not deal at arm's length.

In a recent audit conducted by the CRA , the controlling individual of a registered plan ("Controlling Individual") received a letter from the CRA, which proposed to assess the Controlling Individual on the basis that a corporation's ("Canco") shares contributed to the Controlling Individual's TFSA were a prohibited investment. The Controlling Individual was a director of Canco. The CRA argued that because the Controlling Individual was a director of Canco, the Controlling Individual did not deal at arm's length with Canco.

However, it is a question of fact whether a corporate director deals at arm's length with the corporation. The following facts were highlighted as being relevant in the present case. Canco is a publicly traded company on a Canadian exchange. The Controlling Individual was one of six independent members of Canco's board of directors. He was not at any time an officer of Canco.  The Controlling Individual's role as a board member required only approximately 25 hours of his time per year. Finally, the Controlling Individual held an immaterial amount of Canco's common shares (i.e. much less than one percent).

The Tax Court of Canada considered the question of whether a corporate director was dealing at arm's length with the corporation in both Gestion Yvan Drouin Inc. v. The Queen^[1] and Del Grande v. The Queen.^[2] In Gestion Yvan Drouin, Archambault, J.T.C.C. held: "I do not believe that, in the absence of other special circumstances, the fact that a taxpayer was at once a shareholder, a director and an officer of a corporation necessarily means that there was a de facto non-arm's-length relationship between the taxpayer and the corporation." Archambault J.T.C.C. then referenced Justice Bowman's decision in Del Grande where he found that a shareholder, director and officer of a corporation holding 25% of the common shares of that corporation with an option to purchase shares entitling him to increase his interest to 50% was not de facto dealing with the corporation other than at arm's length immediately after the option was granted.

The appellant in Del Grande was clearly dealing with the corporation of which he was a director at closer proximity than the Controlling Individual was dealing with Canco in our case study. Given that the appellant in Del Grande was found to be dealing at arm's length with the subject corporation, this would support a determination that the Controlling Individual was certainly dealing at arm's length with Canco. Consequently, the Controlling Individual's investment of Canco shares in his TFSA should not be considered a prohibited investment.

In our experience with situations like this, CRA auditors can sometimes make mistaken preliminary determinations when examining a question of fact, such as whether a director deals at arm's length with a corporation. A correct analysis requires a review of the facts, as well as the relevant case law, instead of merely relying on CRA publications such as Income Tax Folios. While these CRA publications can be useful tools, they may not always sufficiently address the issue at hand and are ultimately secondary sources which do not take precedence to the jurisprudence. This case study serves as a reminder that a detailed review of the facts and case law at the audit stage, rather than following the issuance of a notice of reassessment and the preparation of a notice of objection, can save taxpayers substantial time, money and unnecessary stress.

Should you have any specific questions about this article or would like to discuss it further, you can contact the author or a member of our Tax Dispute Resolution Group.