The Canada Revenue Agency (the "CRA") recently issued Tax Ruling #2007- 0224741R3 "Capital of a Municipal Corporation". The Ruling has particular significance in the context of municipal financing opportunities as it has expanded the scope of ownership rights that can be held by a third party without adversely affecting the tax-exempt status of a municipal corporation.


One of the most valuable attributes of a municipal corporation is its tax-exempt status. To achieve and maintain this status however, the municipal corporation must satisfy ownership restrictions specified under the Income Tax Act (Canada) (the "Act").

Subsections 149(1)(d.5) and 149(1)(d.6) of the Act impose both ownership and source of income restrictions on municipal corporations. Accordingly, such corporations have been colloquially referred to as "d.5" corporations or "d.6" corporations.

In order for a d.5 corporation to maintain its status as a tax-exempt entity, one or more Canadian municipalities must own not less than 90% of its share capital. Proposed amendments to the subsection would also permit shares of a d.5 corporation to be held by any public body performing the function of government in Canada, such as a provincial government as well as an entity established under the Indian Act, to qualify as part of the 90% share ownership threshold

For a d.6 corporation, the share ownership restrictions are satisfied only if all of its share capital is owned by a corporation that itself qualifies as either a d.5 corporation or d.6 corporation.

Anti-avoidance rules exist under the Act to ensure that these ownership restrictions are not circumvented. From a policy perspective, the government wants the tax exemption to be available only to a business entity, for which substantially all of the income is distributed to a municipality or government entity and not to a private-sector taxpayer.

One anti-avoidance provision, under subsection 149(1.1) of the Act, applies if a private sector taxpayer (i.e., any person other than the Crown, a municipality or a tax-exempt municipal corporation) has a right to acquire shares of the municipal corporation. The effect of subsection 149(1.1) is that where one or more persons (other than the Crown, a municipality, or a tax-exempt municipal corporation), has any type of right to acquire shares of a tax-exempt municipal corporation, and the exercise of such right would cause the corporation to lose its tax-exempt status, then the corporation is deemed not to be a tax-exempt entity as described in, inter alia 149(1)(d.6) of the Act. The concept of "right" is broadly defined to include any type of contingent, immediate or future right related to the acquisition of shares. This is a challenging provision to interpret, and the CRA’s new tax ruling sheds some light on the provision.

A second anti-avoidance provision, under subsection 149(1.3) of the Act, currently provides that the 90% ownership test for a d.5 corporation will be satisfied only if the government entities that own the shares are entitled to at least 90% of the votes that could be cast at an annual meeting of the shareholders of that corporation. Proposed amendments to subsection 149(1.3) broaden significantly the situations in which a private sector taxpayer could exceed the 10% ownership limit. There are two principal changes. The first amendment deems share ownership in situations where the private sector taxpayer holds shares that carry with them the right to cast votes in any shareholder meeting, not just at the annual meeting, as is currently the case.

The second proposed amendment deems a municipal corporation to lose its status as either a d.5 or a d.6 corporation in situations where it is "controlled directly or indirectly in any manner whatever" by a private sector taxpayer. This phrase is defined in the Act, and is commonly referred to as the de facto control test.


The fact situation involved a private sector taxpayer that invested funds in exchange for a 10% ownership position in a d.5 corporation and provided additional financing to the municipal corporation in the form of a shareholder loan. The only other shareholder of the d.5 corporation was a municipality. This investment was supported by a shareholders’ agreement, which provided it with certain governance rights, certain drag along rights, and a right of first refusal ("ROFR") granted to the investor in respect of the shares of the d.5 corporation held by the municipality, in the event that the municipality wished to sell its ownership stake.

The significant aspect of the situation was the additional financing provided by the investor in the form of a shareholder loan, and the possibility of providing further capital support to the d.5 corporation through an operating lease. Although the Tax Ruling redacted most of the loan details, it did reference a participation feature, which, in the right circumstances, could be structured to allocate a portion of the profits of the d.5 corporation to the investor. In this fashion, the participating interest rate could possibly be used to confer additional economic value to the investor, supplementing its 10% share ownership.

The Tax Ruling concludes that: (1) such additional financing will not cause the d.5 corporation to lose its status as a tax-exempt municipal corporation by reason of the de facto control test described above; and (2) the ROFR conferred on the investor is not a contingent right to acquire shares, as contemplated by subsection 149(1.1) of the Act.


The tax-exempt status that can be conferred by the Act to a d.5 corporation and a d.6 corporation is a significant financial benefit that virtually all municipally-controlled business corporations would wish to preserve. The CRA Tax Ruling provides some examples as to how one might creatively finance a municipal corporation using private sector funding, while preserving the tax benefits available to that corporation. Moreover, it should provide some comfort that the restrictions imposed on contingent share acquisition rights under subsection 149(1.1) of the Act are not as onerous as one would suspect.