A MIC’s Specified Shareholder, Related Persons and Prohibited RRSP Investment Considerations

What to consider and speak with your accountant, EMD or lawyer, when related persons, such as siblings, parents, children or spouses invest in your MIC.

To qualify as a MIC, under the Income Tax Act (the “Act”) a corporation must, throughout the taxation year and among other things, meet the conditions in subsection 130.1(6) of the Act. Paragraph 130.1(6)(d) of the Act requires that the number of shareholders of the corporation be not less than 20 and that no one shareholder hold, directly or indirectly, more than 25% of the issued shares of any class of the capital stock of the corporation. However, subsection 130.1(8) of the Act provides an exception which deems the corporation to have complied with paragraph 130.1(6)(d) of the Act throughout the first taxation year in which it carries on business if the test in paragraph 130.1(6)(d) of the Act is met on the last day of its first taxation year.  This means a MIC has until the last day of its first fiscal year to obtain at least 20 shareholders in total regardless of what class of shares they own.  By the first day of the MIC’s second fiscal year it must have at least 20 shareholders at all times!  This grace period however doesn’t apply to the specified shareholder rule where no shareholder can own more than 25% of the issued shares of any class.  If a MIC falls offside at anytime it no longer qualifies as a MIC, which, among other issues (e.g. the MIC is treated as regular corporation and must pay tax at the end of its fiscal year and the dividends issued are treated as dividends and not interest income to the shareholders), also means that the shares already issued to investors will no longer be a qualified investment for registered plans, such as RRSPs or TFSAs, and every shareholder who used their registered plans to invest in the MIC will instantly find themselves facing the consequences of the prohibited investment rules.

Albeit, shareholders can fall offside with their qualified investments through their registered plans even if a MIC remains qualified.  One of the ways for a qualified investment to turn into a prohibited investment is if an investor through holdings in their RRSP or other registered plans, has a significant interest in an entity it invested in, which could happen at anytime without the shareholder knowing.

For purposes of the definition of a “prohibited investment” that applies to RRSPs and other registered plans, and whether an investor (together with their related persons) that used his RRSPs to invest has a significant interest in a corporation, a specified shareholder’s “related persons” will include a spouse, child, brother, sister or parent’s investment in the same corporation that the investor invested in.  The Act defines “related persons” of an individual to include individuals connected by blood relationship, marriage, common-law partnership or adoption.

For MICs, however, under the Act, subparagraph 130.1(6)(d)(iv) modifies the inclusions of “related persons” for purposes of the definition of “specified shareholder” used in paragraph 130.1(6)(d).  Hence, for purposes of the MIC definition, a specified shareholder will not include the shareholder’s brother, sister or adult children (Note: to qualify, anyone seriously considering how to apply and interpret this section should first seek the advice of a tax professional, and note that the content here is simply for information purposes but not to be relied on).

Subparagraph 130.1(6)(d)(iv) of the Act amends the definition of “related persons” found in paragraph 251(2)(a) of the Act, for purposes of paragraph 130.1(6)(d), such that a related person means an individual and:

• the individual’s child, as defined in subsection 70(10), who is under 18, or
• the individual’s spouse or common-law partner.

Accordingly, related persons for purposes of subparagraph 130.1(6)(d)(ii) and the meaning of “specified shareholder” as modified in paragraph 130.1(6)(d), will include an individual’s minor child, spouse, common-law partner or any corporation directly or indirectly controlled by it, and not an individual’s brother, sister or parents.

Paragraph 4900(1)(c) of the Income Tax Regulations (the “Regulations”) permits a share of a MIC to be a qualified investment for a registered plan such as RRSPs provided the MIC does not hold as part of its property any indebtedness of a person who is a connected person under the registered plan. Subsection 4901(2) of the Regulations defines a “connected person” to include the registered plan holder or any person who does not deal at arm’s length with the registered plan holder.  Subsection 207.01(1) of the Act, explains the term “prohibited investment” for a registered plan, such as RRSPs, to prohibit closely-held investments in relation to the registered plan holder. Such that an investment will be a prohibited investment where the registered plan holder has a “significant interest” in the investment. For the purpose of determining whether a registered plan holder has a significant interest, an interest in the investment held by a person not dealing at arm’s length with the registered plan holder is also taken into account (i.e. connected persons).  Furthermore, in accordance with subsection 207.01(4) of the Act, an individual has a significant interest in a corporation at any time if the individual is a specified shareholder of the corporation at that time. In general, subsection 248(1) of the Act defines a “specified shareholder” as a taxpayer, including a person with whom the taxpayer does not deal at arm’s length, who owns, directly or indirectly, at any time in the year, not less than 10% in total of all the issued shares of any class of capital stock of the corporation or any other corporation that is related to the corporation. Consequently, if the registered plan holder, and persons not dealing at arm’s length with the registered plan holder, individually or together own directly or indirectly 10% or more of any class of shares of the MIC, the investment in the MIC will be considered a prohibited investment for the registered plan holder.

For purposes of the above, and pursuant to the definitions of “arm’s length”, “related persons” and “blood relationship” in section 251 of the Act, a registered plan holder and their brother, sister or parent, are persons who do not deal with each other at arm’s length.  Naturally, founders, with controlling or significant voting interests (at least 10%), even though such shares may have no dividend rights or participation rights may not be able to invest using any of their registered plans.  Given that most MICs will have about 4 founding shareholders with respect to their controlling class of shares, inherently, the founding shareholders together with their related persons (e.g. siblings, parents, children, spouses or corporations they control) should not then later participate in any class of shares using their registered plans as they are considered non-arm’s length with the MIC.

When corporations issue shares in “series” or by “classes”, the Act considers the use of either word, interchangeable.  Under subparagraph 248(6) a “class” of shares issued in series is defined “in its application in relation to a corporation that has issued shares of a class of its capital stock in one or more series, a reference in this Act to the “class” shall be read, with such modifications as the circumstances require, as a reference to a “series of the class.”

Therefore it is possible for a registered plan holder to be offside when using any combination of their registered plans or cash to invest in any classes or series of shares of a MIC, such as the same registered plan holder using its RRSP to invest in 4% of a MIC’s preferred shares, and then again using its TFSA or cash to invest in 6% of the MIC’s preferred shares, which would overall be a prohibited investment.  To complicate matters even more, and make it more difficult for a MIC to manage, is when a MIC begins issuing a class of shares in series, which would require the MIC and its investor to monitor his percentage interest of each such investment in every series of shares issued to that investor.  One more complication to this is when the same investor’s related persons (e.g. parents, siblings, children, spouses or controlled corporations) also invest in the MIC using cash or registered plans.  If a husband (father, brother or son) invests through his registered plans in a MIC by acquiring 6% of its preferred shares, and then his wife (daughter, sister or mother) invests in the same MIC by acquiring 4% of the preferred shares using cash or her registered plan, their investment in the MIC would be considered a prohibited investment.

Finally section 2.9 of Income Tax Folio S3-F10-C2, Prohibited Investments – RRSPs, RESPs, RRIFs, RDSPs, FHSAs and TFSAs says: “In the case of a corporation that has issued shares of a class in more than one series, the ownership test in the specified shareholder definition is based on each series of the class of shares in accordance with subsection 248(6).”  Therefore in both cases when qualifying as a MIC and ensuring compliance under the Prohibited Investment Rules, a shareholder of the MIC cannot own more than 25% of any class (or series) of the MIC’s capital stock and by also taking into consideration (i.e. adding to) the shares owned by their spouse or common-law partner, children under 18 and controlled corporations, unless the shareholder had invested, in whole or in part, through the use of funds from one of its registered plans (eg. RRSPs or TFSAs), in which case the shareholder cannot own 10% or more  in total of any class (or series) of the MIC’s capital stock and by also taking into consideration (i.e. adding to) the shares owned by their spouse or common-law partner, children, brothers, sisters, parents and controlled corporations.

All in all, founders should not have any investment in the MIC using their registered plans, directly or indirectly, through related parties, affiliated corporations etc… to avoid the complicated prohibited investment rules and being offside.  Naturally, founders usually have a significant interest in the controlling class of shares (that’s what makes them founders), and so naturally they would be offside.  For example, if a founder owned 25% of the common voting shares of a MIC (which is common) and later invest in any other class or series of shares of the MIC using their registered plans, they would be immediately offside with the prohibited investment rules.

Section 130.1(6) Specified Shareholder Rule for MICs under the Act can be read here as follows together with its other referenced provisions/definitions:

• (d) there were 20 or more shareholders of the corporation and no person would have been a specified shareholder of the corporation at any time in the year if
  • (i) the portion of the definition specified shareholder  in subsection 248(1) before paragraph (a) were read as follows:

    “specified shareholder of a corporation at any time means a taxpayer who owns, directly or indirectly, at that time, more than 25% of the issued shares of any class of the capital stock of the corporation and, for the purposes of this definition,”

  • (ii) paragraph (a) of that definition were read as follows:
    • “(a) a taxpayer is deemed to own each share of the capital stock of a corporation owned at that time by a person related to the taxpayer,”
  • (iii) that definition were read without reference to paragraph (d) of that definition, and
  • (iv) paragraph 251(2)(a) were read as follows:
    • “(a) an individual and
      • (i) the individual’s child (as defined in subsection 70(10)) who is under 18 years of age, or
      • (ii) the individual’s spouse or common-law partner;”

• (a) a taxpayer shall be deemed to own each share of the capital stock of a corporation owned at that time by a person with whom the taxpayer does not deal at arm’s length,
• (b) each beneficiary of a trust shall be deemed to own that proportion of all such shares owned by the trust at that time that the fair market value at that time of the beneficial interest of the beneficiary in the trust is of the fair market value at that time of all beneficial interests in the trust,
• (c) each member of a partnership shall be deemed to own that proportion of all the shares of any class of the capital stock of a corporation that are property of the partnership at that time that the fair market value at that time of the member’s interest in the partnership is of the fair market value at that time of the interests of all members in the partnership,
• (d) an individual who performs services on behalf of a corporation that would be carrying on a personal services business if the individual or any person related to the individual were at that time a specified shareholder of the corporation shall be deemed to be a specified shareholder of the corporation at that time if the individual, or any person or partnership with whom the individual does not deal at arm’s length, is, or by virtue of any arrangement may become, entitled, directly or indirectly, to not less than 10% of the assets or the shares of any class of the capital stock of the corporation or any corporation related thereto, and
• (e) notwithstanding paragraph (b), where a beneficiary’s share of the income or capital of the trust depends on the exercise by any person of, or the failure by any person to exercise, any discretionary power, the beneficiary shall be deemed to own each share of the capital stock of a corporation owned at that time by the trust; (actionnaire déterminé)

• Definition of related persons

  (2) For the purpose of this Act, related persons, or persons related to each other, are

  • (a) individuals connected by blood relationship, marriage or common-law partnership or adoption;
  • (b) a corporation and
    • (i) a person who controls the corporation, if it is controlled by one person,
    • (ii) a person who is a member of a related group that controls the corporation, or
    • (iii) any person related to a person described in subparagraph 251(2)(b)(i) or 251(2)(b)(ii); and
  • (c) any two corporations
    • (i) if they are controlled by the same person or group of persons,
    • (ii) if each of the corporations is controlled by one person and the person who controls one of the corporations is related to the person who controls the other corporation,
    • (iii) if one of the corporations is controlled by one person and that person is related to any member of a related group that controls the other corporation,
    • (iv) if one of the corporations is controlled by one person and that person is related to each member of an unrelated group that controls the other corporation,
    • (v) if any member of a related group that controls one of the corporations is related to each member of an unrelated group that controls the other corporation, or
    • (vi) if each member of an unrelated group that controls one of the corporations is related to at least one member of an unrelated group that controls the other corporation.

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