Federal Court of Appeal decision in Deans Knight creates uncertainty with new test for loss utilization

Published by Natasha Kisilevsky & Jessica Guo

The Federal Court of Appeal (the “FCA”) recently released its highly anticipated decision in Canada v. Deans Knight Income Corporation, 2021 FCA 160. The case represents the FCA’s first consideration of an alleged abuse of the “control” threshold for loss restriction in subsection 111(5) of the federal Income Tax Act (the “Act”)[1] in the context of a “corporate restart” transaction.  In rendering its decision, the FCA relies upon a novel concept of “actual control,” which is not defined in the decision and thereby creates considerable uncertainty regarding the “control” threshold.


Subsection 111(5) prohibits a company from utilizing historical non-capital losses after an acquisition of “control.” While “control” is not defined in the Act, it has a well-established meaning in jurisprudence (Duha Printers, 1998 CanLII 827 (SCC)): “effective control” over the affairs and fortunes of the corporation, as manifested in ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the board of directors, i.e., 50%+1 of the voting shares of the company.  The jurisprudential definition of control is referred to as de jure, or legal, control and is distinguished from a separate, broader control concept of de facto, or factual, control that is used elsewhere in the Act.

The Courts have recognized that in rare cases it may be necessary to look beyond the constating documents of a company to determine whether 50%+1 of the voting shares have been acquired.  For example, where there is a unanimous shareholders agreement (a “USA”), the terms of the USA may affect the voting rights attached to shares and may be relevant in applying the 50% +1 control test (Duha Printers).

A corporate restart transaction generally involves an investor acquiring a significant equity interest in a company with historical losses or other tax attributes, but less than 50% of the voting shares of the target company. Following the investment, the target company acquires a new business and utilizes its historical losses to reduce its taxable income from the new business.  Prior to the enactment of section 256.1, provided that legal (de jure) control of the target company was not acquired by the investor,[2] subsection 111(5) did not apply to restrict the target company from utilizing its historical losses.  Section 256.1 was enacted in 2013 to deem control to have been acquired where the investor’s equity interest exceeds 75% and a non-controlling position was intentionally taken by the investor so that the target company’s future use of its historical losses will not be restricted.  The transactions in Deans Knight were completed several years before the enactment of section 256.1.

The Deans Knight case involved a corporate restart transaction. The Canada Revenue Agency (“CRA”) viewed the transaction as offensive loss trading, abusive of the control threshold for loss utilization in subsection 111(5). The CRA applied the general anti-avoidance rule in section 245 of the Act (the “GAAR”) to restrict loss utilization by the target company following the investment transaction.

On appeal to the Tax Court of Canada, the taxpayer succeeded in convincing the Court that the GAAR did not apply because “effective control” of the taxpayer was not acquired.  The FCA overruled this result and applied the GAAR on the basis that “actual control” of the taxpayer had been acquired.

The Deans Knight Transactions

By way of background, prior to the transactions in question, the taxpayer carried on a biotechnology business and its shares were publicly traded. In carrying on that business, it suffered substantial non-capital losses.

In early 2008, the taxpayer (“Forbes”) entered into an investment agreement with another company, Matco Capital Ltd. (“Matco”). Immediately prior to entering into that agreement, a company controlled by an individual with a connection to Matco (who did not enter into the investment agreement) purchased a small voting shareholding in Forbes.

Pursuant to the investment agreement, inter alia:

  • Forbes’ existing business, would be transferred to a new company (“New Forbes”);
  • Matco agreed to purchase a debenture (the “Debenture”) for $3 million, convertible into 35% of the voting common shares and 100% of the non-voting common shares of Forbes;
  • Matco guaranteed that the remaining 65% of the voting common shares of Forbes (the “Remaining Shares”) could be sold for a minimum of $800,000 (the “Guaranteed Amount”);
  • Matco had one year to present a suitable business opportunity to Forbes that could generate sufficient profit against which Forbes’ existing non-capital losses could be deducted (the “Corporate Opportunity”);
  • if Forbes rejected the Corporate Opportunity, which it was free to do, Matco would be relieved of the obligation to pay the Guaranteed Amount.

Importantly, both the taxpayer and New Forbes required the consent of Matco before taking a number of common corporate actions. These included actions which could affect shareholdings and voting rights, such as: issuing shares; paying dividends; any action that could give rise to a change of control; entering into, assigning, terminating, or amending any contract; or incurring any debt.

Matco ultimately presented the taxpayer with an opportunity to change its name to Deans Knight Income Corporation, make an initial public offering (the “IPO”), and acquire a new business. The taxpayer considered and accepted that opportunity. Prior to the IPO, Matco exercised its option to convert the Debenture into voting and non-voting shares of Forbes. The Remaining Shares were purchased by Matco for the Guaranteed Amount shortly after the IPO.

Following the IPO, the taxpayer (now named Deans Knight), acquired a new business and commenced earning income from the new business.  In the taxation years that followed, the taxpayer applied its historical losses from the biotechnology business against income from the new business.

At court, the sole issue in was whether there was abuse of subsection 111(5) by virtue of the investment agreement such that the GAAR should apply. Answering this question required the FCA to determine: 1) the object, spirit and purpose of subsection 111(5); and 2) whether the transactions circumvented and thereby frustrated the purpose of subsection 111(5).

FCA’s Analysis

Step 1: The object, spirit and purpose of subsection 111(5)

The FCA considered the Tax Court’s conclusion at paragraph 134 of its decision that the object, spirit and purpose of subsection 111(5) is “to target manipulation of losses of a corporation by a new person or group of persons, through effective control over the corporation’s actions.”

The FCA found that the term “effective control” lacked clarity, and rearticulated the object, spirit and purpose as “to restrict the use of specified losses, including non-capital losses, if a person or group of persons has acquired actual control over the corporation’s actions, whether by way of de jure control or otherwise.”[3] [Emphasis added.]

The FCA rejected the taxpayer’s submission that subsection 111(5) restricts loss carryover only where there is an acquisition of de jure control. According to the FCA, while Parliament has enacted specific rules to restrict loss carryover, it is not a “comprehensive scheme that is fully reflected in the text of the provisions” and they “do not reflect a policy that the GAAR has no application to them.”[4] The FCA primarily relied on two historical statements by government officials in coming to that conclusion, and justified departing from the definition of control adopted by the Supreme Court of Canada in Duha Printers by suggesting that enactment of the GAAR was a Parliamentary response to the Duha Printers transactions.[5]  This suggestion would be surprising to most tax practitioners.

According to the FCA, for the purposes of the abuse analysis in applying the GAAR, the relevant control test under subsection 111(5) is “actual control”.  However, the FCA does not define “actual control” other than to say that it is different from de facto control and that the object, spirit and purpose of subsection 111(5) includes forms of de jure and de facto control, notwithstanding that the text of subsection 111(5) refers only to de jure control.[6]

Step 2: Whether the transactions frustrate the purpose of subsection 111(5)

The FCA found the investment agreement gave Matco “actual control” over the taxpayer and the approval of the Corporate Opportunity. The FCA emphasized the investment agreement’s “severe restrictions” on the actions of New Forbes and the taxpayer. It characterized the restrictions as:

i. New Forbes shall not enter into any contract or agreement in respect of the taxpayer;

ii. the taxpayer shall not engage in any activity other than related to a Corporate Opportunity and New Forbes will ensure that the taxpayer complies with this obligation; and

iii. New Forbes shall use commercially reasonable efforts to satisfy (or cause the satisfaction of) its obligation to cooperate with Matco in the implementation of a Corporate Opportunity.

The FCA also characterized the Corporate Opportunity as one that will not realistically be rejected by New Forbes or the taxpayer since otherwise there will be no public market for the Remaining Shares and the Guaranteed Amount was the only assurance that it would receive more than $3 million for the Tax Attributes. It is noteworthy that the FCA disagreed with the Tax Court’s factual findings in respect of the restrictions on the taxpayer and New Forbes and made its own factual findings from the appeal record.[7]

According to the FCA, “the Investment Agreement resulted in New Forbes and the [taxpayer] handing over actual control of the [taxpayer] to Matco. New Forbes and the [taxpayer] realistically could do nothing relating to the actions of the [taxpayer] other than to ensure that they fulfilled their obligation to assist Matco with the implementation of the Corporate Opportunity.”[8]  In this respect, the FCA appears to treat the investment agreement as akin to a USA affecting legal control of the taxpayer and rendering transactions abusive of the purpose of subsection 111(5).

As “actual control” of the taxpayer was acquired by Matco to facilitate the corporate restart transaction by which the taxpayer’s historical losses could be used against income from a new business, the transactions frustrated the purpose of subsection 111(5) and the GAAR applied to restrict the taxpayer from utilizing its historical losses.


The decision in Deans Knight adds to the recent body of FCA jurisprudence interpreting the policy rationale of specific tax provisions broadly by reference to economic results. Several practitioners have criticized the judgment and the uncertainty created thereby. Of particular concern is the FCA’s adoption of a new and undefined concept of “actual control” that is distinct from the two clearer control concepts – de jure (legal) and de facto (factual) control – which are used throughout the Act and have an extensive body of jurisprudence analyzing them.  Private practitioners and taxpayers are left to speculate the circumstances in which “actual control” might be found, and whether it could have broader impact to numerous other provisions in the Act.

The taxpayer has applied for leave to appeal the decision to the Supreme Court of Canada. Hopefully the Supreme Court of Canada grants leave to address the increasing dissonance between the Tax Court and FCA in GAAR cases and the uncertainty created by the FCA’s decision in Deans Knight.

[1]              As it formerly read. At the relevant time, subsection 111(5) read:

“(5) Where, at any time, control of a corporation has been acquired by a person or group of persons, no amount in respect of its non-capital loss or farm loss for a taxation year ending before that time is deductible by the corporation for a taxation year ending after that time and no amount in respect of its non-capital loss or farm loss for a taxation year ending after that time is deductible by the corporation for a taxation year ending before that time except that …”

[2]               Taking into account certain supplemental provisions that may deem the 50%+1 control threshold to have been surpassed, such as paragraph 251(5)(b) and subsection 256(8).

[3]              Para 72.

[4]              Para 76.

[5]               Para 85.

[6]               Para 83.

[7]               Para 98.

[8]              Para 105.