12 June 2017

Why structure and design matter

All too often, managers tend to get rushed into implementing things that have never been fully thought out. While smaller decisions may be more easily reversed before the damage has fully set in, decisions implementing designs with fundamental flaws will always be messy.

For example, in the mid-1990s I was involved with a company that had achieved a reputation for performing rescue work on behalf of groups of investors in real estate limited partnerships formed in the early 1980s during the property boom that was going on back then. Among the challenges they took on was a group of investors in a condominium apartment building. I won't say where, but I'm given to understand that the given situation was used elsewhere.

Its initial formation by the promoter took on a framework similar to this:

At first glance, the concept appears to have been straightforward, but you have to keep in mind the fact that real estate has always had its share of irrational exuberance, which meant that little thought was given to what to do if things went wrong. Those of us who saw this in the early 1990s saw a lot of such disasters when prices imploded during that recession. In hindsight, it was easy to see the fatal flaws:

  • The premise given by the original promoter—who the investors subsequently kicked out, appointing us in their place—was that cash flows would be stable for the foreseeable future, and the cash distributions together with tax benefits arising from initial rental losses and annual capital cost allowance deductions would be sufficient to fund the initial payout on the promissory notes, followed by the required payments to mortgages on the individual condo units. Unfortunately, the recession later on caused occupancy rates to fall, thus restricting available cash for distribution to investors.
  • There were knock-on effects once the financial institutions started exercising their power of sale, seizing individual condo units, thus removing them from the CCA pool. This was a situation that was never envisaged in the original partnership agreement and connected financing arrangements, and the concept of stapled securities did not come onto the Canadian investment scene until the beginning of this century. The lenders did not bother to take on the related partnership interests, as the mortgages did not address that circumstance, and thus the limited partners still appeared to be part of the rental pool, thus diluting cash distributions and connected taxable income available to the investors. We had to take the position that the power of sale effectively squeezed the affected investor out of the partnership, but this was the result of a very wide interpretation of the provisions relating to voluntary withdrawals.
  • There was also a problem that had resulted from the previous history relating to cash distributions to investors. The definition of "distributable cash" that appeared in the partnership agreement only contemplated that sufficient amounts had to be held back to service current liabilities, but it was silent as to whether last month's rents were to be included in the holdback. The previous general partner decided that they were not included, and distributions were overestimated during the startup years of the LP. This became ugly when we calculated what amount was needed to make things square on the investors' withdrawal, as the overdistribution meant that we had to sent a bill for an amount that was fairly close to their pro rata portion of the LMR on hand. This proved to be rather ugly, but we did manage to collect the amounts in the end.
  • The provisions relating to voluntary withdrawal presumed that the investors would take over the underlying unit tied in to their interests, withdraw from the LP, and thereafter be free to sell it or take it on and thus become a member of the underlying condominium corporation. In the interim, the general partner would exercise control over the condominium corporation based on the units still within the partnership. Because of the powers of sale that had been exercised, the general partner was thus no longer in full control, as new owners came in and started exercising their rights as members of the corporation.
  • It didn't help matters that the condominium corporation was not properly managed before we came onto the scene, and there was a further complication in that the condominium, together with two other condominiums and another developer, controlled another condominium corporation that ran a central recreation centre!
There were other bizarre aspects to this story, but they are merely tangents in comparison to the central problems outlined here. Looking back twenty years on, especially given later developments in the legal and investing fields, the following would have greatly helped the situation:

  1.  Initial income and cash flow projections should be subject to realistic simulation and sensitivity analysis, to indicate upsides and downsides of a given investment. We have certainly come a long way since that time, but the investment prospectus still tends to be a sales tool instead of a truly informative document. Back then, they weren't even handed out to investors until after they had signed the agreements! I hope things have become more sophisticated now.
  2. The partnership and financing agreements should have addressed the issue of forced withdrawals head on. In that regard, the LP interest and underlying condominium unit should have been treated as a stapled security, and seizure under power of sale should have applied to both parts. A forced withdrawal would trigger a withdrawal from the partnership, thus giving clear title for the lender to be able to dispose, but the settlement on withdrawal would be direct with the lender, which he would have to record on the statement of adjustments that must be given to the original investor. That last item has only been recently been put in place by the courts, as some lenders had previously scooped up any cash they had collected on the sale in excess of the amount of debt in question.
  3. The cash held by the LP with respect to last month's rents should be held in escrow, and only released to apply against the last month's occupancy by the relevant tenants. This would help minimize the settlement amount due on withdrawal from the partnership and thus minimize the risk of disputes. I am unsure as to why this was not normal practice at the time, given that it appears to have been standard in many other jurisdictions.
  4. The connected condominium corporation(s) should be properly constituted once the condominium declaration has been filed. This will ensure that their funds and related reserves are kept separate from those of the limited partnership, further avoiding the risk of excess cash distributions. I have since heard too many horror stories of commingled funds that had occurred in such circumstances when segregation had not been enforced.
Other improvements could also be implemented, but the above would go a long way towards avoiding the really nasty experiences from occurring any time later on.

29 April 2017

The CPA Ontario merger will finally be implemented

Interestingly, the merger is taking place as part of the 2017 Ontario Budget, and appears as Schedule 3 of its implementation bill. Apart from a mention in the budget document and a media release from CPA Ontario, I find no mention of it anywhere else. Perhaps that is because the unification agreement adopted three years ago, together with a fair bit of nationwide advertising, has dampened the passions that abounded during the several years before. However, our legislation is finally going through, leaving only the Northwest Territories and Nunavut as the final laggards.

Upon Royal Assent, the Chartered Professional Accountants of Ontario Act, 2017 will contain several provisions that are unique, in comparison to implementation legislation adopted in other jurisdictions:

  • The governing Council and officers of the Institute of Chartered Accountants of Ontario become the governing Council and officers of the new CPA Ontario. This is because the ICAO has been operating under the business name of CPA Ontario since the adoption of the unification agreement in 2014.
  • CMAs and CGAs will finally become full members of CPA Ontario. Until now, they had only been associate members of the ICAO.
  • The Certified Public Accountants Association of Ontario, which had been inadvertently abolished in July 2007 and which had been the ICAO's previous shelter for protecting the initials "CPA" in Ontario, is acknowledged only in a transitional provision that effectively provides for the transfer of the CPAAO's assets and liabilities to CPA Ontario. This effectively bypasses the law relating to escheats, but there is no provision for reviving any of the former provisions to save whatever other actions may have taken in the past ten years.
  • The disciplinary provisions extend not just to current members, but also to those whose membership has ceased due to resignation or revocation, and this covers memberships in the predecessor bodies of CPA Ontario. This is subject to a two-year limitation period from the time the event occurred. Although not specifically stated, any consequential court proceedings would be circumscribed by the limitation periods found in the Limitations Act, 2002.
  • As of the date of the 2018 Annual General Meeting, the Council will no longer be prevented from passing bylaws that would have the effect of preventing a member of a predecessor body from having "access to any aspect of the accounting profession" that they may have had through such prior membership. I am puzzled as to the rationale of this provision, or what potential effect this might have.

There are some provisions in the bill that I find highly surprising, in that parliamentary draftsmen are normally more diligent in their deliberations and more elegant in their results, and I wonder how much consideration of the wording really happened before this was brought forward:

  • There is an unusually expansive definition as to who may not call themselves an accountant. No individual who is not a member of CPA Ontario may "take or use a [protected] designation ... or initials ..., whether alone or combined or intermixed in any manner with any other words or abbreviations."  This appears to have been included because a failed attempt by CGA Ontario to bar the use of the CGMA (Chartered Global Management Accountant) designation in Ontario. It may also explain why "certified public accountant" was not specifically included as a protected designation in this bill in order to rectify the 2007 repeal of the former CPA Act. It still constitutes an extraordinary attempt to block other accounting bodies from establishing a foothold in the Province.
  • Interestingly, while the Act "does not affect or interfere with the right of any individual who is not a member of CPA Ontario to practise as an accountant", "[n]othing ... affects or interferes with the right of a person to use any term, title, initials, designation or description identifying himself or herself as an accountant, if the person does not reside, have an office or offer or provide accounting services in Ontario." This is a "cut and paste" from the previous Acts governing the predecessor bodies that was originally intended to prevent turf wars happening amongst themselves, and I wonder why this was preserved in the current bill.
  • There is no statutory definition for "accounting services", unlike what has been achieved in other jurisdictions. A definition for "public accounting services" exists in the Public Accounting Act, 2004, but that only covers a portion of what "accounting services" would encompass as a whole. That in itself will lead to problematic litigation in future.

What are "accounting services"?

It might be worthwhile to recap what constitutes "public accounting services" in Ontario. Under the Public Accounting Act, 2004, they constitute:

  1. Assurance engagements, including an audit or a review engagement, conducted with respect to the correctness, fairness, completeness or reasonableness of a financial statement or any part of a financial statement or any statement attached to a financial statement, if it can reasonably be expected that the services will be relied upon or used by a third party. Such engagements may or may not include the rendering of an opinion or other statement by the person who is providing the services.
  2. Compilation services, if it can reasonably be expected that all or any portion of the compilations or associated materials prepared by the person providing the services will be relied upon or used by a third party, but they do not include compilations that contain a notice in prescribed form that provides that any assurance given by the person is limited to the accuracy of the computations required in order to complete the compilation.
Therefore, "public accounting" in Ontario covers audit, review and compilation engagements, other than compilations accompanied by a prescribed "Notice to Reader". This begs the question as to what scope "accounting services" would cover in a more general sense. An idea as to a more comprehensive definition of "professional accounting" can be found in the BC Act:

47  (1) The practice of professional accounting comprises one or more of the following services:
(a) performing an audit engagement and issuing an auditor's report in accordance with the standards of professional practice published by the Chartered Professional Accountants of Canada, as amended from time to time, or an audit engagement or a report purporting to be performed or issued, as the case may be, in accordance with those standards;
(b) performing any other assurance engagement and issuing an assurance report in accordance with the standards of professional practice published by the Chartered Professional Accountants of Canada, as amended from time to time, or an assurance engagement or a report purporting to be performed or issued, as the case may be, in accordance with those standards;
(c) issuing any form of certification, declaration or opinion with respect to information related to a financial statement or any part of a financial statement, on the application of
(i) financial reporting standards published by the Chartered Professional Accountants of Canada, as amended from time to time, or
(ii) specified auditing procedures in accordance with standards published by the Chartered Professional Accountants of Canada, as amended from time to time.

(2) No person, other than a chartered professional accountant member in good standing, a professional accounting corporation or a registered firm that is authorized by the CPABC to do so, may provide or perform the services referred to in subsection (1).

(3) Subsection (2) does not apply to the following:
(a) a member who is not authorized by the CPABC to provide or perform the services referred to in subsection (1) or a student if the member or student is providing or performing the services referred to in subsection (1) under the direct supervision and control of a chartered professional accountant member in good standing, a professional accounting corporation or a registered firm that is authorized to provide and perform the services referred to in subsection (1);
(b) a person performing a service for academic research or teaching purposes and not for the purpose of providing advice to a particular person;
(c) an employee in relation to services provided to her or his employer or in her or his capacity as an employee of an employer that is not a registered firm;
(d) a person providing advice based directly on a declaration, certification or opinion of a chartered professional accountant member in good standing, a professional accounting corporation or a registered firm that is authorized to provide and perform the services referred to in subsection (1);
(e) a person providing bookkeeping services, consulting services or income tax return preparation and processing services that do not purport to be based on the standards of the Chartered Professional Accountants of Canada;
(f) a person acting pursuant to the authority of any other Act.

Given that BC's Act has been in place for two years already, it is surprising that this wording, with necessary modifications, was not included in the Ontario bill. Perhaps this could be rectified before passage of the bill, but I think that would be highly unlikely given the lack of interest of the current provincial Government in wanting to manage the parliamentary timetable at the Legislative Assembly. In addition, time allocation procedures that are sometimes invoked with respect to Budget bill debates may not allow for discussion as to why certain decisions were taken on the wording, or on why implementation was inordinately delayed. The overarching debate will probably dwell on more high-profile aspects of the Budget, thus distracting attention from this matter. Let's see what develops.

21 April 2017

Nonresident and speculation taxes: the return of an idea

The Grits in Ontario have announced a nonresident speculation tax that will be effective as of today, 21 April 2017. We'll have to wait until next week to see the implementing bill's details, as the Legislative Assembly is currently in recess, but the announcement can be seen here. Briefly, it will charge a tax of 15% of the purchase price upon closing, and will cover the following real estate transactions:
  •  the transfer of land which contains at least one and not more than six single family residences,
  • being acquired by an individual who is neither a Canadian citizen nor a permanent resident of Canada, or by a corporation not incorporated in Canada or which is incorporated in Canada but is controlled in whole or in part by a foreign national or other foreign corporation not listed on a Canadian stock exchange, or is controlled directly or indirectly by a foreign entity for the purposes of section 256 of the Income Tax Act (Canada).
A foreign national who receives confirmation under the Ontario Immigrant Nominee Program to immigrate to Canada, or who is conferred the status of “convention refugee” or “person in need of protection” (“refugee”) under the Immigration and Refugee Protection Act at the time of the purchase or acquisition, or who purchases a property with a spouse who is a Canadian citizen, permanent resident of Canada, “nominee” or “refugee, will be exempt from the tax.

Tax will be rebated where the foreign national:
  • becomes a Canadian citizen or permanent resident of Canada within four years of the date of the purchase or acquisition;
  • is a student who has been enrolled full-time for at least two years from the date of purchase or acquisition in an “approved institution”, as outlined in Ontario Regulation 70/17 of the Ministry of Training, Colleges, and Universities Act; or
  • has legally worked full-time in Ontario for a continuous period of one year since the date of purchase or acquisition.


We've been here before


The Land Speculation Tax

In 1974, Ontario imposed the Land Speculation Tax, which had a dramatic effect on a previous round of speculation. It had a short history, and was eliminated completely by 1979. The legislative history was as follows:
  • 3 June 1974: original imposition, retroactive to 9 April 1974, of a 50% tax on the capital gain of most real property;
  • 10 December 1974: technical amendments, together with a reduction of tax to 20%, after Ottawa refused to allowed it as a closing cost for purposes of calculating a capital gain under the Income Tax Act, all of which were retroactive to the original imposition;
  • 6 February 1975: further technical amendments retroactive to the original imposition;
  • 12 July 1977: various technical amendments, retroactive to 20 April 1977;
  • 24 November 1978: the tax ceased to be imposed as of 24 October 1977 with respect to transactions after that date, or which were in the process of being closed at that time. In addition, any statutory liens for tax liability not registered against title for any property as of 1 January 1979 were deemed to be discharged as of that date.
 Its scope was broad:
  • it covered the disposition of any real property in Ontario, other than
    • a mineral resource property, 
    • a principal residence, 
    • property less than 20 acres in size that was used as a principal recreation property,
    • property transferred from one family member to another,
    • property transferred to shareholders upon the winding up of a corporation in which more than 50% of the assets consisted of designated land,
    • a tourist resort, 
    • property upon which a building or structure was constructed (or where renovation occurred at a cost of at least 20% of the property's cost or fair market value), 
    • property disposed by a municipality, 
    • property acquired by statutory notice, or
    • property sold to the Crown or one of its agencies.
  • the proceeds of disposition consisted of:
    • the selling price of the property,
    • where transferred under the terms of an option, the total of the option price and the exercise value, or
    • the fair market value of any other type of disposition, but
    • transfer under the terms of a will was not included.
  • the proceeds were deducted from the fair market value of the property as at 9 April 1974, or at the selling price (or fair market value of the transfer) if acquired after that date, to arrive at the taxable value on which tax was charged.
  • a deduction was allowed for every 12 months the property was held, for the lesser of 10% of the starting value of the property or  the total of its maintenance costs and the closing costs upon its disposition;
  • where the land was used for farming, a further deduction of 10% of the starting value, calculated at compound interest, was allowed for periods preceding 9 April 1974 in which the property was held;
  • the liability for tax constituted a lien upon the property which did not need to be registered against title, which continued until the Minister issued a certificate that no lien would be claimed with respect to a specific disposition.
As noted at the top of this section, the effect was sudden and quite brutal, causing many deals to collapse. It was repealed at a time when mortgages shot upwards to over 20%, which proved to be a more effective damper on housing prices.

The Land Transfer Tax (nonresident rate)

This had a very interesting history.

At the same time in 1974, a rate of 20% was imposed on sales of real estate to non-residents occurring after 9 April 1974. In that regard:
  • a "nonresident person" was defined as:
    • an individual not ordinarily resident in Canada, or who, if ordinarily resident in Canada, was neither a Canadian citizen nor a permanent resident, and an individual ordinarily resident in Canada included those who had sojourned in Canada for 366 days in the 24 months preceding the transaction, those lawfully admitted into Canada for permanent residence, or members of the Canadian Forces, the foreign service or workers in an international development assistance programme required to be stationed outside Canada, including the spouses thereof;
    • a partnership, syndicate, association or any other kind of organization, where more than one-half of the members or in which beneficial interests of more than 50% of the partnership's property was held by nonresident persons;
    • a trust established by a nonresident person, or where nonresident persons held more than 50% of the beneficial interests in it; and
    • a nonresident corporation. being one where 50% of the voting rights were owned by nonresident persons or where 25% of the voting rights were owned by one nonresident person (or where direct or indirect control by one or more nonresident persons existed in such circumstances), or where more than one-half of the corporation's directors were nonresident persons.
  • such rate was also charged where a nonresident person held land in joint tenancy with a resident person, or where land conveyed to resident persons could not be readily distinguished from land conveyed to nonresident persons;
  • deferral or remission could be made where the Minister was satisfied that the land was being acquired for commercial, industrial or residential development with resale to persons who were not nonresident persons.
The scope of the tax was significantly restricted on 20 April 1977, when the nonresident rate was no longer applied to property designated under a zoning bylaw or order to commercial or industrial purposes, or was assessed for residential assessment, or was lawfully used or occupied for commercial, industrial or residential purposes. However, this did not cover land that was assessed or used for farming and agricultural purposes, woodlands, recreational land or as an orchard. The rate was finally abolished on 7 May 1997.

Then compared to now

The 1974 measures had a more pronounced effect, and were much broader in scope, when compared to the 2017 proposals. The newer ones appear to be tailored more for effect, and, dare I say, for pandering for votes in the coming 2018 election. It will be interesting to see what transpires in the coming weeks.

13 February 2017

He haunts us still...


It can be a blessing or a curse to have a distant relative who was rather famous. Take, for example, J.R. Booth, shown above, who died in 1925. To put it briefly, he was my paternal grandmother's maternal grandmother's half-uncle, and probably the richest man in Canada when he passed on. Sadly, none of that wealth came our way, although my grandmother used to brag about receiving a gold coin at Christmas from him. As she was born in 1910, there would not have been that many, and none were found in her estate when she passed away in 1997. This was another of the mysteries she took to her grave. But I digress.

His name came up in an English court case this month, because of his involvement in a company that mined for nickel. His main interests were in the  lumber industry, and he also controlled the largest railway in the world owned by a single person, the Canada Atlantic Railway. He also owned a cement company, which became part of Canada Cement in 1910. Nickel mining, however, was a completely different business. In 1915, the Ontario Nickel Commission was appointed to inquire into the province's nickel industry, and its 1917 report gives some fascinating background to what was going on. A report by the Canadian Department of Mines in 1912 also provides useful information.

Involvement with Dominion Nickel-Copper

In 1904, the Dominion Nickel-Copper Company was formed to take over ownership of the Whistle Mine, which can be seen here:

Booth, together with M.J. O'Brien and other associates,took over Dominion Nickel-Copper in 1907, as reported here. O'Brien is not mentioned in the original report, as the acquisition was attributed to the Booth and McFadden Syndicate. McFadden appears to be J.J. McFadden of Renfrew, where O'Brien also lived, so it appears one was the agent for the other. McFadden would later make his fortune after the war through lumber mills in Blind River and Thessalon.

That company bought the Murray Mine, the site of the first nickel find in the Sudbury Basin, in 1912, and sought  to revive the operation and make it a viable competitor against International Nickel, controlled by J.P. Morgan.

 Acquisition  by British America Nickel

Their reach probably exceeded their grasp, as in 1912 they later granted an option to the British America Nickel Company, formed by F.S. Pearson and controlled by the British Government and Kristiansand Nikkelraffineringsverk A/S of Norway, to take over the company. British America also controlled other copper-nickel interests in the Sudbury region, including the later-famous Falconbridge properties. That option was exercised in 1913. The extent of the deal was detailed in a report in the Canadian Mining Journal:

Note the significant players mentioned here. William Mackenzie was involved in the successful deal with Pearson—understandable, as the two were already associated together in Brazilian Traction, Light and Power—but the Guggenheims of New York wanted to get in instead. This was quite the rarified atmosphere, even back then. The original name "Canadian Nickel Corporation" was not used, as the actual incorporation papers were in the name of "British America Nickel Corporation, Limited" as reported here.

What made British America's business model unique was that they aimed to be the only nickel miner in Ontario that would also smelt and refine on site, instead of sending the ore for further treatment outside the Province. It would also have exclusive North American rights to the Hybinette smelting process developed by its Norwegian investor.

As a result of the 1913 disposition, J.R. Booth became the second-largest bondholder in British America, second only to the British Government itself. O'Brien, with some others, had much smaller amounts. There was also an issue of debenture stock secured by a floating charge, which was held by the British Government and the Norwegian company. It was that whole arrangement that would cause some awkward circumstances later on.

In 1916, the British Government signed a ten-year contract to purchase all the nickel output of British America, and the bonds were replaced by a new issue of mortgage bonds, secured by the assets of the company. The terms of the underlying deed of trust could be altered at any time by a vote of the bondholders, representing at least ¾ of the bonds' value.

The dispute

At the end of the war, the nickel market took a real beating, and the Canadian Bank of Commerce was granted a prior lien bond in 1920 which had priority over the mortgage bonds. British America then defaulted on an interest payment in 1921, and a reorganization was proposed, in which the mortgage bonds would be replaced by 'A' Income Bonds, which would have a lower priority to First Income Bonds having a first charge on the property of the corporation. 'B' Income Bonds could be issued later on which would rank pari passu with the 'A' Income Bonds, but the latter could be converted into other securities at any time through extraordinary resolution. The remainder of the supply contract with the British Government would also be cancelled. A committee of four people would be appointed to make the decision, thus bypassing any requirement of an extraordinary resolution by the bondholders.

In order to make this work, J.R. Booth had to give his support, because of the significant holding of bonds he had. He was induced to approve, after being promised a gift of shares bearing a par value of CAD 2 million in British America.

O'Brien, to put it mildly, was not a happy camper. This move would strip any real security from the bonds he held, and the possibility of later conversion into other securities could effectively make them worthless if any other adverse developments in the nickel industry were to happen. He took the matter to the Supreme Court of Ontario to get the result overturned. He won, and the result was later upheld at the Appellate Division of the court. Both rulings can be found here.

That was not the end of it. The final court of appeal in those days was the Judicial Committee of the Privy Council, and they upheld the Ontario courts in 1927.  They described the whole affair thus:

At the trial in the Supreme Court of Ontario Kelly J. held that what was really done was that the majority at the meeting did not act in the bona fide exercise of the rights which the majority might exercise, but in consideration of what would benefit the Nickel Corporation and the personal interests of those whose votes were to be secured. The vote had been influenced by special negotiations in advance of the meeting. … There was an appeal to the Appellate Division, where Ferguson J.A. delivered the judgment. He agreed with Kelly J. in holding that the votes neither of Mr. Booth nor of the British Government would have been given for the scheme had they been influenced only by what was most in the interest of the bondholders. Both of these may, he thought, have acted honestly if mistakenly. But what really moved them was not a legitimate consideration of the improvement of their security, but that they felt that a refusal to approve the scheme would result in serious loss to other persons who had lent to or invested in the corporation. They wished to give these persons a chance, even if a risk to the bondholders had to be taken in doing it. This the Appellate Division held to have been improper.

The law that governs this type of decision-making has consequentially been expressed in these terms:

To give a power to modify the terms on which debentures in a company are secured is not uncommon in practice. The business interests of the company may render such a power expedient, even in the interests of the class of debenture holders as a whole. The provision is usually made in the form of a power, conferred by the instrument constituting the debenture security, upon the majority of the class of holders. It often enables them to modify, by resolution properly passed, the security itself. The provision of such a power to a majority bears some analogy to such a power as that conferred by s. 13 of the English Companies Act of 1908, which enables a majority of the shareholders by special resolution to alter the articles of association. There is, however, a restriction of such powers, when conferred on a majority of a special class in order to enable that majority to bind a minority. They must be exercised subject to a general principle, which is applicable to all authorities conferred on majorities of classes enabling them to bind minorities; namely, that the power given must be exercised for the purpose of benefiting the class as a whole, and not merely individual members only. Subject to this, the power may be unrestricted. It may be free from the general principle in question when the power arises not in connection with a class, but only under a general title which confers the vote as a right of property attaching to a share. The distinction does not arise in this case, and it is not necessary to express an opinion as to its ground. What does arise is the question whether there is such a restriction on the right to vote of a creditor or member of an analogous class on whom is conferred a power to vote for the alteration of the title of a minority of the class to which he himself belongs.

In other words, no dirty tricks are allowed in proceedings like these, and decisions must be taken in the best interests of the class of investors. But some people just can't help but try.

Consequences to this day

That is what happened in the English case this month. Two companies were seeking to merge under a scheme of arrangement, which under English law must receive the approval of a majority of investors, together representing ¾ of the value of the shares. In order to thwart the merger, one employee shareholder gave away one share each to 434 people, and registered the transfers immediately prior to the meeting taking place to approve the scheme, as sanctioned by the Court. All 434 intended to vote against the transaction, but the Chairman of the meeting disallowed their votes, resulting in the scheme's approval. The Court ruled that the Chairman acted properly, and what J.R. Booth did in the 1920s was quoted prominently to explain why this had to be so.

It was explained here that meetings that are sanctioned by the Court operate under slightly different principles than shareholders' general meetings that are governed by normal corporate legislation:

50. There was some debate also in the course of argument as to the powers of the chairman of a court meeting to reject votes cast of his own motion. It seems to me that the court must indeed have an inherent power to direct the mode in which meetings are to be held .... Moreover, once a court has directed that a meeting take place, I cannot see why the chairman should not conduct the meeting in accordance with normal principles. He may have many decisions to make in order to achieve the objective of the meeting. The court would normally, I think, only interfere with such decisions if they were perverse, made in bad faith, contrary to the court's directions, or on the basis of a mistaken understanding of the law .... It seems to me that the validity of votes cast at the court meeting is to be judged as at the time of that meeting and not with the benefit of hindsight that may be acquired after the meeting and before the sanction hearing. Conversely, the sanction of the court is to be evaluated as a matter of discretion on the basis of all the facts placed before the court at that hearing.

51. In directing the chairman to hold a court meeting, the court is effectively directing him to take all appropriate steps to hold a fair meeting for the purpose of ascertaining the votes of the class for or against the scheme. He must, for example, be able to reject proxies if they obviously do not emanate from the member in question. The court would, it seems to me, wish to respect the decisions made by its appointed chairman as to the proper conduct of the court meeting, unless one of the defaults mentioned above were established. 

I've known meetings in the past where such squeeze plays breezed through quite easily. It's obvious these days that such unfairness will not be tolerated, but it's taken some considerable time and effort to get there. Not just the lawyers, but all other parties, should be glad that's the case.

11 December 2016

The Canadian tax reach

Some time back, I posted about the extent to which the US tax authorities can tax the income of foreign corporations. There are similar considerations at hand for when foreign corporations operate in Canada, albeit on different principles. The most important questions are:
  • Is a corporation resident in Canada?
  • Is it carrying on business in Canada?
These must be read together with the basic requirements of s.2 of the Income Tax Act, where liability to tax arises where:
  • a person is resident in Canada, or otherwise
  • a person is employed in Canada, carries on a business in Canada, or disposes of a taxable Canadian property.
This is reinforced by the requirement in s. 150(1)(a) to file the appropriate returns, which also covers other circumstances where tax is payable, or the income is exempt is exempt as provided under the provisions of an applicable tax treaty. In the latter case, a return must be filed together with the specified declaration claiming treaty protection.

Who is a Canadian resident?

We must first deal with where persons are deemed to have such status or not:
  • s. 250(4) deems any corporation incorporated in Canada after 26 April 1965 to be a Canadian resident, as well as any similar corporation formed before 27 April 1965 that was a Canadian resident or carried on business in Canada.
  • if an applicable tax treaty so provides, s. 250(5) will deem a corporation to be resident in the other country and not resident in Canada.
Otherwise, common law principles govern whether a corporation is resident in a jurisdiction or note. This is said to be "where the central management and control resides." This is said to be the place where the board of directors holds its meetings, but that cannot be said to automatically apply. A recent case in the High Court of Australia held several foreign corporations to be resident there, as the meetings of the board acted only as a rubber stamp to actions undertaken by a principal in Sydney. This was held to be distinct from a previous case where the board did not blindly accept the actions of others, as it actively discussed whether such moves would indeed be appropriate to accept. Tax treaties with the UK and Switzerland did not act to shield the taxpayers in the recent case, as the act of incorporating within those jurisdictions was insufficient to override where the actual management and control were taking place. The impact of this decision could be huge, and it will be interesting to see if the CRA picks up on it.

Who carries on business in Canada?

Common law principles govern whether business is carried on, and s. 253 deems certain activities undertaken by a non-resident as constituting such activity. Applicable tax treaties will usually specify that income earned by a non-resident is taxable only where it can be attributable to a permanent establishment.

The most important factor in determining where a business is being carried on is the place where the contract is made. Other factors such as the place of delivery and the place of payment (among others) may also play a role, but the analysis can be quite complicated.

The definition of a permanent establishment is generally left up to the tax treaties, but the following situations can arise:
  • a fixed place of business will constitute a PE
  • an agent authorized to conclude contracts on behalf of the foreign corporation can also be said to be a fixed place
  • in some circumstances, office space made available by a subsidiary to a parents' employees can be a fixed place
  • executives who can act on behalf of both a parent and subsidiary are problematic, as their presence in the other country's office can also constitute a PE
  • similarly, it can be argued that a foreign corporation that is constantly seeking guidance from a manager in a Canadian parent can be said to possess a Canadian PE
  • certain tax treaties (such as the one with the US) can specify that, where services are being provided, days spent in the other country will trigger a PE when the total passes a specified threshold
  • there can be other complications, such as in the manner that e-commerce platforms are structured
This is not an exhaustive list, and discussions are taking place at the international level as to whether such scope should be widened. That is an area that should be watched closely.


This is a very short article on a very complex topic, and I have known of many companies that did not get this right. Foreign corporations must consider the various issues carefully before proceeding to enter the Canadian market. Similar issues also arise in assessing whether foreign entities are subject to GST/HST, but the rules are slightly different and must be assessed separately.

05 September 2016

Domicile: it still matters

Depending upon the nature of the critical event, and where it took place, the question will arise as to whether you should take into account a person's:
  • residence;
  • citizenship; or
  • domicile.
The last factor will strike some as rather surprising, but it can have surprising results. I will discuss this first, and address the others in separate entries.

Why domicile matters

The general rule

A person can only have one domicile at any given time, which signifies where his permanent home will be for the foreseeable future.  The domicile of origin is acquired at birth. That continues until the age of majority is reached, at which time he (or she) can adopt a domicile of choice. That arises from permanently moving to a new place, and being legally able to do so. Therefore, you cannot permanently move to a new country if you only have a temporary visa to go there, or if you are only attending a post-secondary institution. Neither the intent nor the ability are there. The domicile of choice can revert back to the domicile of origin when you permanently move away from the latter without yet establishing a new permanent home. This can get ugly, especially when more than two jurisdictions come into play, as seen in an Alberta case in 2011.

There is also a domicile of dependency, is conferred on legally dependent persons by operation of law. It will be that of the person on whom the person is dependent, and will change when that latter person's domicile changes. This currently extends only to people who are mentally incapable.

Domicile is normally that of the nation, but it is normally that of the Province or State in ones that are organized in a federal structure. In the United Kingdom, domicile exists in England and Wales, Scotland, or Northern Ireland, and the Isle of Man and the Channel Islands of Jersey and Guernsey (all being Crown dependencies) have separate domiciles as well

The historical rule

Historically, at birth, a child acquired the domicile of its father where the father was still alive at the time of birth. Otherwise, it will acquire the mother's domicile if the father is no longer alive, or if it is born out of wedlock. Where there were no known parents, as in the case of a foundling, the domicile will be that in which the child was found.

The doctrine of dependency extended to married women, who acquired the husband's domicile upon marriage, and to minors (then called infants) who took on the relevant parent's subsequent domicile of choice.

Perverse effects of the rule

Here is a relatively simple application of the rules. A person is born in Ontario, whose father was then working in Canada on a temporary work visa. The father then decides to become a landed immigrant, and settles in Ontario permanently. Upon attaining the age of majority, the child then decides to leave Ontario, but dies before being able to establish a permanent home elsewhere. In which jurisdiction should the child's will be probated?

It would be England. The child's domicile of origin is England, because his father was not able to establish an Ontario domicile by the time of the birth. The child would then acquire a domicile of dependency at the time the father became a landed immigrant. However, when the child leaves to seek his fortune elsewhere, his domicile will revert to his domicile of origin, and will remain that way until a new domicile of choice has been established. And that can happen even if the child has never set foot in England!

There is another example I can across which is even more over the top but still accurate. A goes from England (in which he is domiciled) to India, intending to return to England when he reaches 60 after having made his fortune. He marries in India and has child B there, who grows up with similar intentions. A dies in India. B marries in India as well and has child C there, who grows up with similar intentions as well. B dies in India.

C's domicile is in England. This is because domicile arises from permanent intentions, as well as permanent presence in a particular place. Because A always intended to return to England, India never became a domicile of choice. B's domicile of origin therefore was England and, because he always intended to go to England to retire, India never became a domicile of choice either, and therefore C's domicile of origin is England as well. This could extend indefinitely, as long as each generation desires to eventually move to England eventually, and thus decides not to make India the domicile of choice once the age of majority is reached.

Effect on marriage and death

A valid marriage depends on two components: It has to be valid under the law where the ceremony is performed, and it has to be valid under the law of the parties’ ante-nuptial domicile. If crossing borders may be involved, it is still a good idea to double-check the rules of each jurisdiction before you go ahead.

Under current law, a Canadian divorce is effective if one of the parties has been resident in a province for at least one year. From 1968 to 1986, there had been an additional requirement that the petitioner had to have been domiciled in Canada. Prior to 1968, the requirement was for domicile in a province where divorce was available (which ruled out proceedings in Quebec and Newfoundland).

If annulment is sought, the grounds become murkier. Generally speaking, a wife can gain a domicile of choice and then petition to annual a void marriage (on grounds of consanguinity, being underage, or bigamy). However, she can only petition in a court in her husband's domicile where the marriage is voidable (because of lack of valid consent or the marriage not being consummated).

The other area where domicile is important in Canada is when a person dies, and his estate is governed by the law governing his domicile at that time in all respects other than for real (or immoveable) property situated beyond its borders.

Reform of the law in Ontario

Ontario has simplified the law of domicile in several stages. In 1958, the adoption laws were changed to effectively provide that an adoptee's domicile of origin would become that of his adoptive parents as if born in wedlock, and that came into force on 1 January 1959.

The age of majority was reduced from 21 to 18 effective 1 September 1971. This was followed by the abolition of illegitimacy effective 31 March 1978. On the same date, s. 68 of the Family Law Reform Act, 1978 granted separate legal personality for married women, and simplified the law of domicile as it applied to minors:

68. Subject to subsection 2, a child who is a minor, 

(a) takes the domicile of his or her parents, where both parents have a common domicile; 
(b) takes the domicile of the parent with whom the child habitually resides, where the child resides with one parent only; 
(c) takes the domicile of the father, where the domicile of the child cannot be determined under clause a or b; or 
(d) takes the domicile of the mother, where the domicile of the child cannot be determined under clause c . 

(2) The domicile of a minor who is or has been a spouse shall be determined as if the minor were of full age.

The latest rule is found at s. 67 of the Family Law Act, effective 1 March 1986:

67. The domicile of a person who is a minor is, 

(a) if the minor habitually resides with both parents and the parents have a common domicile, that domicile; 
(b) if the minor habitually resides with one parent only, that parent’s domicile; 
(c) if the minor resides with another person who has lawful custody of him or her, that person’s domicile; or 
(d) if the minor’s domicile cannot be determined under clause (a), (b) or (c), the jurisdiction with which the minor has the closest connection.


Legal impact

You can see that most of the reforms have been to domicile by dependency. Domicile of origin, together with the doctrine of reversion, has remained essentially intact.

The 1978 reform relating to illegitimacy appears to have been retrospective. The following key dates appear to be prospective only:
  • 1 January 1959: replacement of domicile of origin upon adoption.
  • 1 September 1971: ability of those between 18 and 21 to acquire a domicile of choice.
  • 31 March 1978: the ability of married women to acquire a separate domicile of choice.
The effect of the reforms relating to the domicile of minors appears to merely displace the effects of the existing common law rules on domicile of dependency.

Does it matter anywhere else?

Are there other instances where domicile may become a concern? The answer is yes, and more than you might realize:
  • Many US states use domicile to determine liability for their income taxes, including New York and California, and residency is used as a position to sweep in other potential taxpayers within its scope.
  • The US has a federal estate tax in which US domicile attracts liability on the value of the worldwide estate, while non-residents face liability only on the value of property located within the US. Most States have similar provisions.
  • The UK uses domicile to determine liability for its inheritance tax. In fact, its scope only excludes those estates where domicile is outside the UK, and there are no UK assets in it. Domicile has historically been the basis for its income tax, but the UK has significantly expanded its statutory residence tests to widen the scope for collection, and those taxpayers who are UK-resident but not so domiciled must pay a significant levy to protect their previous status.
  • Australia gives priority to domicile in its income tax system.
Those are the most relevant cases for Canadians to think about, but other nations have their own unique rules which may catch people unawares. For instance, I do not know anything about how China (as in the PRC) would affect Chinese-Canadians, so experts in that field would need to be consulted if circumstances warrant.

01 September 2016


I've been digging into some personal history lately, after having heard that several people I knew back in the early 1980s have recently passed away. I worked with them in a company that had a wonderful work ethic and environment, that also made a lot of money. It no longer exists, because of events that overtook it then, but the perpetrators themselves are no more.

I have written about Canadian Glass Industries Limited before, on another blog. However, how it collapsed would provide a great case study. I will just give a broad outline of it here.

Canadian Glass was previously known as Glaverbel Industries Inc, and it was taken over by Pilkington Glass Industries Limited (then a subsidiary of Pilkington plc) in 1976. As a condition of its acquisition, Pilks was required to keep Canadian Glass at arm's length to determine its own strategy and direction. The head office was moved to Toronto in 1979, and it occupied premises separate from Pilks, although only several blocks apart. The acquisition did reveal several surprises, such as the fact that CGIL could borrow money at prime, but PGIL had to pay prime plus 1! That was the first of several embarrassments, including the equally unavoidable fact that CGIL was a much more profitable operation. PGIL's Contract Division was its only operation elsewhere in the group that even came close to matching those results.

I joined Canadian Glass as its Corporate Controller in September 1980, and enjoyed it immensely. The job had broad scope, I had full responsibility for issuing consolidate financial results and preparing and filing all corporate and capital tax returns, and I was required to travel to all divisions across Canada to check on how things were happening out in the field. I got along well with everyone there, and the feeling was mutual, as my boss soon advised me.

In December 1980, Ford Motor Company reached an agreement with Pilks plc to acquire its Canadian operations. As part of its negotiations with Ottawa, Ford got the conditions relating to the 1979 Glaverbel acquisition cancelled. Ford's takeover occurred in the spring of 1981. That resulted in a particular witches' brew of corporate cultures coming into play:
  • Ford had (and still has) a particularly forceful brand of management, where specific targets are set and pressure is brought throughout the organization to ensure such targets are achieved. In the early 1980s, the focus was on reducing headcount throughout all activities within an organization. I really do mean all activities, and not just through voluntary measures such as incentives for early retirement (which tends towards somewhat patchy results). I should also mention that Ford had a fairly unified management structure, where top managers crossed over quite often between management and finance functions and back again. I was familiar with this, having grown up listening to my father's stories about how this had been applied at Ford's Oakville operations.
  • Pilkington had a decentralized country-by-country management structure, and the Canadian operation was fairly regimented in its approach. The finance side was quite humourless, and initiative was not expected but obedience was. There was a fair bit of bureaucracy there, which tended to slow things down. On the other hand, they always felt they were superior to CGIL, contrary to the evidence at hand.
  • Canadian Glass was quite relaxed in comparison, and collaboration was encouraged at all levels. At each division, the General Manager and Controller had equal authority and responsibility, and I was expected to deal with all of them. Response to any concerns was quite quick in both directions, and no issues were allowed to fester. Again, financial results were quite good throughout all divisions.
Note the priority of the cultures involved. Looking back now, it was quite predictable who was bound to lose when headcount reductions were forced through. The Pilks crowd were essentially looking for job security. As one of the first steps, the CGIL head office was closed in April 1982, and all of us moved across to the Ford Glass offices. And then the reductions started, albeit discreetly at first.

I sawit then occurring in a rather blatant manner in 1983, when I was given a survey form to identify what proportion of my time was spent on various activities. I noted that no-one else was being given such forms, and it didn't take a rocket scientist to figure out what was going to happen. I just gave some (*ahem*) wild guesses, and it was shortly after that I was told that my position was now redundant. Several weeks after that, I heard through the grapevine that those managers were shocked to discover that I was doing the workload of six of their people combined , and they really had to scramble to try and figure out how to divide up what had to be done!

I went ahead and got my RIA the following year, which was transformed into the CMA designation in July 1985. There have been interesting moments since that time, but none were ever as exciting or as enjoyable.


And what happened to that operation since? It has essentially gone the way of all flesh:
  • In 1988, Ford sold its entire glass operation to Asahi Flat Glass (owned by Mitsubishi), which is now known as AGC.
  • Their float glass manufacturing plant in Scarborough,originally established in 1967, was shut down around 1999. Another float plant had been established at St-August-de-Demaures in Quebec in 1992, but that one shut down in 2008 because of manufacturing overcapacity in the North American market.
  • All of the fabrication, contracting and retail centres in Canada have now been sold off or closed. There is only one automotive glass facility here now, as shown on AGC's map.
On a broader scale, I believe I got off a lot better than many others then. Many accountants came face to face with job losses for the first time in their lives. At Coopers + Lybrand, now part of PwC, the practice for articling students had been to allow them three chances to write the UFE (the CA final exam) before they would be told to leave if they still could not pass. Around that time, that was cut back to allow them only one kick at the can, as most UFE graduates decided to stay on at the firm instead of having a large proportion decamping to positions in private enterprise. From that point on, the senses of job security and loyalty were permanently shaken, and they have never really settled back down since. These days, it can be said that many actually suffered from a type of post-traumatic stress disorder from these events, although it was never described as such, and that had wide-ranging effects over the following decades that have never been discussed.

The desire for headcount reductions continues unchecked everywhere, and almost every acquisition seems to result in another head office being hollowed out as a result. I've heard it said that the fat has now been trimmed off everywhere, and now we're cutting into the bone!

I see the potential for several case studies and/or theses in several academic fields. I wonder who would be interested in following up on this?