Osler, Hoskin & Harcourt LLP Box 50, 1 First Canadian Place Toro nto, On ta ri o, Canada M5X 1B8 416.362.2111 MAIN 416.862.6666 FACSIMILE Toronto May 17,2016 Montreal Calgary Onawa Vancouver New York OSLER Mahmud Jamal Direct Dial: -11 6.862.6764 mjamal@osler.com By E-Mail and Com·ier M s. Suzie Cadieux Clerk of the Committee Standing Committee on Finance Committees and Legislative Services Directorate House of Commons 131 Queen Street, 6th Floor Ottawa, Ontario KlA OA6 Dear Ms. Cadie ux: House of Commons Standing Committee on Finance, motion dated May 5, 2016 Thank you for your correspondence ad vising that the Ho use of Commons Standing Committee on Finance adopted the following motio n on May 5, 2016: That the Committee request KPMG to provide documents on the Isle of Man tax sheltering scheme and the names of KPMG employees responsible for the developm ent and marketing of the tax scheme before Wednesday, May 18, 2016. ln response to this motion, KPMG is pleased to provide the Committee with documents relating to the Isle of M an plan, known as the " Offsho re Company Structure" or " OCS", as well as the names of the KPMG partners or former partners responsible fo r developing and marketing the OCS plan. In the late 1990s w hen the OCS plan was developed, KPMG tax experts prepared several internal technical memoranda on a variety of issues, such as agency, attribution, whether the proposed offshore corporation in the Isle of M an cou ld be considered a resident of Canada for tax purposes under the In come Tax Act, RSC 1985, c 1 (5 1h Supp) (the "Act" ), the Canadian tax treatme nt of Eligible Persons in the OCS , and the po tential application of the General Anti-A voidance Rule or "GAAR" in s. 245 of the A ct. These internal technical memoranda are enclosed w ith this letter. As Mr. Greg Wiebe of KPMG advised the Committee during his testimony o n May 3, 2016 , to e nsure that the OCS plan complied w ith the Canadian Act and Isle of Man law, over and above its internal due diligence in 1999, KPMG obtained two independent external legal opinions, o ne from a leading Canadian national law firm and the other from an Isle of M an law firm . T hese legal opi nio ns are also enclosed with this letter. To date, LEGJ\ L_ l · WJ~~J \0. 1 osler.com OSLER Page 2 no court has adjudicated whether the OCS complies or does not comply w ith the Act. This issue is presently before the Tax Court of Canada. We have also enclosed samples or precedents of the client planning letter that was to be provided to the client before the client proceeded with the OCS plan. This letter set out the terms of the OCS plan and how the proposed offshore company was to be maintained. The precedent client planning letter also included two detailed tax memoranda as Appendices I and II, which could be provided to any KPMG clients who were considering whether to use the OCS plan. KPMG believes that the enclosed package responds full y to the Committee 's motion. In seeking to fully comply with that motion, the Committee will appreciate that KPMG is required to conduct itself within the legal constraints that Mr. Wiebe articulated during hi s testimony, including, in particular, the sub judice convention of the Constitution of Canada, which maintains separation between matters before Parliament and matters pending before the courts (including the KPMG OCS tax plan) , as well as KPMG ' s professional obligations of client confidenti ality throughout Canada and its obligation of professional secrecy in the Province of Quebec under art. 9 of the Quebec Charter of Human Rights and Freedoms, CQLR c C- 12. The Committee is also, of course, aware of s. 241 of the Act, which prohibits the disclosure of taxpayer information and makes it a crimjnal offence to disclose or require the di sclosure of such information. KPMG is also bound by the legal rules relating to settlement privilege. In KPMG 's effort to provide the Committee with as much information as the law permits, it would perhaps be helpful to elaborate briefly on these legal constraints. The sub judice convention As discussed, the compliance of the OCS plan with the Act is presently before the Tax Court of Canada (Tax Court File No. 2015-1 070(IT)G) , while the issue of whether KPMG must disclose client information in connection with the three remaining OCS plans that have not been disclosed is presently before the Federal Court of Canada (Federal Court File No. T -283- 13). Both these matters therefore fall within the sub judice convention restricting the discussion of matters that are presently before the courts. As explained in House of Commons Procedure and Practice (2nd edition, 2009), " restrictions are placed on the freedom of Members of Parli ament to make reference to matters awaiting judicial dec isions in order to avoid possible prejudice to the participants in the courts. This self-restraint recognizes the courts, as opposed to the House, as the proper forum in which to dec ide individual cases" (p. 627). LE(;A I _ I:39~95~30. 1 OSLER Page 3 The sub judice convention exists " to guarantee everyone a fair trial and to prevent any undue influence prejudicing a judicial decision" (p. 628). The conventio n serves not on ly to pro tect a person "from any prejudicial effect of public discussion of the issue", but also, importantly, "to maintain the separati on and mutual respect between legislative and judicial branches of government" (p. 628). By virtue of the sub judice convention, " the constitutional independence of the judiciary is recognized" (p. 628). As Mr. Justice Binnie stated for the unanimous Supreme Court of Canada in Canada (House of Commons) v. Vaid, [2005] I S.C.R. 667, the leading case on the scope and limits of parliamentary privilege: It is a wise principle that the courts and Parliament stri ve to respect each other's role in the conduct of public affair . Parliament, for its part, refrajns from comment ing on matters before the courts under the sub judice rule. The courts, for their part, are careful not to interfere w ith the workings of Parli ament (para. 20). The sub judice convention does of course cease to apply once a case has been finally determined before the courts (House of Commons Procedure and Practice, p. 629). The obligations of client confidentiality Quite apart from the o ngoing court proceedings, KPMG also remains con trained by its professio nal and legal ob ligations relating to client confidentiality. ln Ontario, Ru le 208 of the Chartered Professional Accountants of Ontario, Rules of Professional Conduct provides that "A member, student or firm shall not di sclose any confidential information concerning the affairs of any client , former client , employer o r former employer. " Counterparts of this rule ex ist across Canada. 1 In addition , the principle of professio nal secrecy under articl e 9 of the Que bec Charter of Human Rights and Freedoms provides constitutional imprimatur to KPMG's obligation not to disclose confidential client info rmation. Article 9 of the Quebec Charter provides that "Every person has a rig ht to non-disclosure of confidential information." This provision further states that "No person bound to professional secrecy by law [ ... ] may, See British Columbia, CPA Code of Prof essional Conduct, s. 208 ; Alberta, CPA Rules of Prof essional Conduct. s. 208; Saskatchewan. CPA Standards of Professional Conduct. s. 208.1 ; Manitoba, CPA Code of Professional Conduct, s. 208; Quebec. CPA Quebec Order, Code of Ethics of Chartered Professional Accountants, s. 48; Nova Scotia, Institute of Chartered Accounta nts o f Nova Scoti a, Rules of Prof essional Conduct, s. 208; Ne w Brunswick. CPA Code of Prof essional Conduct, s. 208; Ne wfoundl and and Labrador. CPA Rules of Prof essional Conduct, s. 208: and Prince Edward Isla nd, CPA Code of Professional Conduct, s. 208. I I ( ;AI._ I :3Y~Y5J.l0. 1 OSLER Page 4 even in judicial proceedings , di sclose confidential information revealed to him by reason of his position or profession, unless he is authorized to do so by the person who confided such information to him or by an express provision of law" (emphasis added). Finally, article 9 directs that "The tribunal must, ex officio, ensure that profess ional secrecy is respected." It is settled law that chartered professional accountants are bound to professional secrecy by law : see 9015-0178 Quebec Inc. (Syndic de), 2009 QCCS 3256, paras. 15-17; and St-Georges v. Quebec (PG), JE 88-336 (Sup. Ct.), p. 12. Section 241 of the Income Tax Act In a similar vein , as Canada Revenue Agency Commissioner Andrew Treusch and Deputy Assistant Commissioner Ted Gallivan both stated during their evidence before the Committee on May 5, 2016, s. 241 of the Act makes it a criminal offence for any government official to disclose or require the di sclosure of "taxpayer information", which is defined very broadly under the Act as "information of any kind and in any form relating to one or more taxpayers." T his criminal offence is punishable by a fine not exceeding $5,000 or to imprisonment for a term not exceeding 12 months, or to both (s. 239(2.2)); see also Lloyd v. Canada (Attorney General), 2016 FCA 115, para. 17 (breach of s. 24 1 a criminal offence). As the Supreme Court of Canada stated in Slattery (Trustee of) v. Slattery, [ 1993] 3 S.C.R. 430, p. 444: [s]ection 24 1 reflects the importance of ensuring respect for a taxpayer's privacy interests [ ... ] [A] ccess to financi al and related information about taxpayers is to be taken seriously, and such information can only be di sclosed in prescribed situations. Only in those exceptional situations does the privacy interest give way to the interest of the state. Settlement privilege Lastl y, as both Commissioner T reusch and Mr. Wiebe stated during their respective testimonies, settlement privilege prohibits KPMG as well as the Canada Revenue Agency from providing to the Committee information or documents relating to any settlement discussions or settlements. The Supreme Court of Canada in Sable Offshore Energy In c. v. Ameron International Co rp. , 201 3 SCC 37, [201 3] 2 S.C.R. 623 , paras. 1-2, recently explained the importance of encouraging settlements and the role of settlement privilege in promoting settlements as follow s: OSLER Page 5 The justice system is on a constant quest for ameliorative strategies that reduce litigation's stubbornly endemic delays, expense and stress. In this evolving mission to confront barriers to access to justice, some strategies for resolving disputes have proven to be more enduringly successful than others. Of these, few can claim the tradition of success rightfully attributed to settlements. The purpose of settlement privilege is to promote settlement. The privilege wraps a protecti ve veil around the efforts parties make to settle their disputes by ensuring that communications made in the course of these negotiations are inadmissible. Background to the enclosed documents Against the backdrop of these significant legal restrictions on what KPMG can lawfully provide to the Committee, we can provide the following context for the enclosed documents. As Mr. Wiebe stated during his testimony before the Committee, KPMG implemented the OCS pl an a total of 16 times, beginning in 1999, of which 13 are now known to the Canada Revenue Agency. The final implementation was almost a decade ago. At the time the OCS was developed as a possible plan for clients in 1999, KPMG's tax practice was structured to ensure that no individual tax practitioner within the firm could act alone, or outside of a defined series of processes, to develop and promote any plan to the firm's clients. The development of the OCS plan was prompted in large part by the announcement in the 1999 Canadian federal budget of proposed amendments to the Act related to, amo ng other things, the taxation of non-resident trusts. Over the next 14 years, the proposed amendments to the Act introduced in 1999 were substantially changed, with multiple proposed modifications arising from ongoing consultations. The amendments first proposed were not enacted and parts were ultimately abandoned. The changes to the nonresident trust rules were only enacted on June 26, 2013, a full 14 years after the amendments had first been proposed. The OCS plan was required to, and did , undergo a very extensive internal due diligence involving a broad array of specialized tax practitioners within KPMG to ensure that it complied with all applicable laws. This due diligence included: LEGAL_ I : .19~95~ .10. 1 OSLER Page 6 • Technical Review and Sign Off. This was the normal review procedure fo r tax ad vice requiring review by two qualified tax professionals. • Third Partner Review. This was a "cold" review by a qu alified tax partner who was not directly involved in the development of the plan. • General Anti-A voidance Rule ( "GAA R ") Committee Review. The GAAR Committee reviewed all tax pl ans. T he GAAR Committee consisted of two KPMG tax lawyers and two other senior KPMG tax practitio ners, three of whom would be involved in consideratio n of any particular matter. • National Tax Risk Managem ent Review and Sign -off. The National Tax Partnerin-Charge of Risk M anagement was also required to review and sig n-off on the planning, by ensuring that the third partner technical reviews were properl y conducted, and th at all other firm risk management procedures had been followed. As noted, to ensure that the OCS complied with the Canadian Act and Isle of Man law, in 1999 KPMG also obtained two independent ex ternal legal opinio ns, o ne from a leading Canadian national law firm and the other from an Isle of Man law firm. The names of KPMG partners or former partners With respect to the Committee's request for the names of the KPMG employees responsible for the development and marketing of the OCS , KPMG wishes to emphasize that the firm as a whole, rather than individual partners, was responsible for the development and marketing of the OCS plan. As explained in Mr. W iebe's testimony before the Comm ittee, KPMG stands behind the OCS plan as complying with all applicable laws. K PMG also wishes to emphasize that, as issues related to the OCS plan remain before both the Tax Court of Canada and the Federal Court of Canada, KPMG personnel involved in the OCS likely will be called upon to give evidence in court. In view of the s ub j udice convention and the constitutional importance of m aintaining a proper separation and mutual respect between legislative and judicial branches of government, the Committee would no do ubt wish to allow these persons to testi fy before the courts rather than before the Com mittee in order to ensure that the integrity of the ongoing judicial proceedings is no t in any way compromi sed by the Committee' s work. Nevertheless, in an effort to be fully responsive to the Committee's moti on, KPMG has identified the following persons as having had responsibility for the development and marketing of the OCS pl an: Barry Philp (reti red partner); Paul Hickey (retired partner); Lloyd Heine (retired partner); George Denier (retired partner); Denis Lacroix (partner); OSLER Page 7 and Kare n Aziz (retired partner). A ll o f these individuals were lo ng-standing KPMG partners at the relevant times. The names of other KPMG personnel who were not responsible fo r the development or marketing of the OCS plan have been redacted from the attached planning documents in o rder to pro tect their personal privacy in accordance with the KPMG Privacy Policy (May, 2009). * * * KPMG trusts that the e nclo ed information and documentatio n fully respo nd to the Committee's motion and hope that these materials are of ass istance to the Committee. Yo urs very trul y, ~· M ahmud Jamal c. Greg Wiebe, KPMG Peter Sahag ian, KPMG Enclosures I I GAl _ 1::194954.10.1 DOCUMENTATION PROVIDED BY KPMG TO THE HOUSE OF COMMONS STANDING COMMITTEE ON FINANCE IN RESPONSE TO THE COMMITTEE'S MOTION DATED MAY 6, 2016 LEGAL_ I :39385634.2 Tab 1. Sample Client Planning Letter 2. Summary of Canadian Taxation of Offshore Company 3. Implications of Canadian Corporation Residence 4. Legal opinion of Simcocks to KPMG dated August 31, 1999 5. Legal opinion of Fraser Milner to KPMG dated October 25, 1999 6. Sample Client Engagement Letter 7. Sample KPMG Isle of Man Engagement Letter to Offshore Companies 8. Sample Confidentiality Agreement 9. Schedule of Information Required to Form and Isle of Man Hybrid Company 10. Sample Members' Agreement 11. Sample Memorandum and Articles of Association 12. Sample Declaration of Gift 13. Sample Letter of Wishes 14. Initial Client Meeting "Script" 15. Canadian Tax Treatment of Eligible Persons in the Offshore Company Tax Product 16. Memorandum on Agency: Are the shareholders of Offshore Company agents for the individuals transferring property to the Offshore Company? 17. Memorandum on Attribution: Can income and/or capital gains be attributed to the transferor of property to Offshore Company? 18. Offshore Company Update Memorandum dated September 15, 2000 (discussing the potential application of ss. 94, 94.1 and 94.2 and proposed s. 233.2(4.1) of the Income Tax Act to the Offshore Company plan 19. Patrick Taylor, "Guarantee Companies: Their Nature and Some Possibilities", Offshore Tax Planning Review (1991-1992), vol. 2, issue 3, pp. 1-15 20. Charles A. Cain, "The common law foundation?", Offshore Investment, September 1998, pp. 31-32 21. Brian F. Trowbridge, "A Comparison of TCI Companies", Offshore Finance Canada, July/August 1998, pp. 52-55 LEGAL_ I :39385634_2 - 222. Meaning of "share", meaning of the term "corporation" 23. Various internal memoranda on s. 95(6) of the Income Tax Act 24. Memorandum dated November 3, 2000 on U.S. Gift Tax Implications of Contributions to and Distributions from the Offshore Company 25. Memo dated January 2, 2001 26. KPMG Privacy Policy, May 2009 LEGAL_ I :39385634.2 Clisr,! :!2: _ _ _ _ _ _ _ __ Prej:c:rc::d o·r -------- Revi·3'.nd b;•: - - - - - - - - :4 Private & Confidential 'J .:;p_,1 31r::;ter;y Sumri12i~1 ef2parcd Ye::; __ ~IA_ Mr. GSI SpGCiE.Iist ~ Re·:i~WSI (it ;~?p:i,·;._..~ic) • 1999 Draft For Discussion Purposes Only r.~;: Parlnm r\p;>ruv~l: Dear .>.l'f CCto: ____. - - - - - - Further to our engagement letter of _ _ , 1999, we are writing to outline the steps of a proposed plan that will assist you in achieving your asset protection and estate planning objectives. The structure presented in this letter is proprietary to KPMG and should not be disclosed to other persons without the express written consent of KPMG. ••• Under the proposed structure an offshore entity will be created, to which may be contributed for estate planning, asset protection and philanthropic purposes. There may also be tax benefits associated with this structure. Your decision whether to proceed with this structure should be independent of any potential tax benefits. There are risks inherent in the proposed structure. A discussion of these risks is set out under the heading "Risks" below. This discussion should be read carefully. If there is any aspect that you do not fully understand, please contact us and we will be happy to discuss it further with you. With respect to the legal implications of the proposed structure, other than tax, or the legal characterization of any a•pect of the arrangements proposed herein upon which we base our tax conclusions, we have obtained the advice of legal counsel either in the Isle of Man or in Canada or both, as appropriate. With respect to the tax implications of the proposed structure, our analysis is confined to or any other persons are residents of any other Canadian tax implications. If jurisdiction which applies an income, gift or estate tax, we should provide separate advice with respect to the implications of this plan to them in that jurisdiction. FACTS AND ASSUMPTIONS The proposed plan is based on our understanding of facts you have provided to us and certain assumptions. Please carefully review these facts and assumptions and advise us of 09199·0ffshorc Company. Planning Lener i'•' Page 2 , 1999 any omissions or inaccuracies as our conclusions and recommendations may be materially affected. I. Mr. [and Mrs. ] are persons resident in Canada. [Some of] their children are resident in Canada [and some are resident in the U.S]. _ _ _ is a corporation incorporated in _ _ _ __ 3. STEPS OF THE PROPOSED I'LAN I. A company ("Offshore Company") will be formed under the Isle of Man Companies Act, with Shareholders and a Non-Shareholder Member (hereinafter collectively "the Members") and liabilities limited by guarantee. 2. Offshore Company will have two classes of voting shares entitled to participate in distributions out of profits, retained earnings or assets of Offshore Company to a combined maximum of £Sterling4,000 per annum and to a return of the capital paidup thereon upon wind-up of Offshore Company. 3. Offshore Company will have a class of non-shareholder members, with rights to vote with respect to certain matters (set out below) but no right to participate in the profits or assets of the company. The matters on which non-shareholder members will have a vote as set out in the Articles of Offshore Company are resolutions to: a. change the authorized or issued Share Capital of the Company; b. change the provisions of the Articles with respect to the distribution of income or capital or accumulated retained earnings or assets of the Company; c. change the number of the members of the Board of Directors or the persons who are members of the Board of Directors of the Company; d. put the Company into liquidation and appoint one or more liquidators for the purpose of winding up the affairs and distributing the assets of the Company; e. identify and appoint or remove any Eligible Persons; Page3 ' 1999 4. Non-Shareholder Members of Offshore Company will guarantee the liabilities of Offshore Company upon liquidation to a maximum of £Sterlingl0 each. 5. An Isle of Man corporation controlled by KPMG Isle of Man, Lochside Limited, will subscribe for 50 Class A Ordinary Shares of Offshore Company and an Isle of Man corporation controlled by Simcocks, Korderry Limited, will subscribe for 50 Class B Ordinary Shares of Offshore Company, for £50 each. 6. Mr. , a person not resident in Canada, will be appointed a NonShareholder Member of Offshore Company. 7. The members of the initial Board of Directors of Offshore Company will be set out in the Articles and will be: Mr. _ _ _ _ (alternate - - - - 1 Mr. (alternate _ _ _-J Mr. (alternate _ _ _) 8. The Members of Offshore Company will enter into a unanimous agreement (the "Members' Agreement") under the terms of which they will agree that: a) the Board of Directors of Offshore Company shall consist of one nominee of each of the Shareholders and the Non-Shareholder Member and the Members will vote their shares so as to elect such nominees; b) at a General Meeting called by the Non-shareholder Member following upon a failure of the Members to unanimously agree on a resolution with respect to items d. or e. set out under 3. above the Members will vote affirmatively for the liquidation of Offshore Company in accordance with the terms of the Articles and sanction a gift to Eligible Persons in accordance with any prior resolution of the Directors; c) "Eligible Persons" as that term is defined in the Articles shall consist initially of Mr. , Mrs. , their children and the [XYZ Charitable Foundation] . •• Page4 '1999 9. Mr. will transfer to Offshore Company as a gift pursuant to a is making an unconditional, deed of gift which will acknowledge that Mr. irrevocable, absolute gift which acknowledges that he understands that he will retain no control over the use or disposition of the donated property or Offshore Company. 10. Mr. may choose to write a non-binding letter to the Members and Directors of Offshore Company to provide guidance to them, insofar as they may have regard for his input, with respect to the conduct of the affairs of Offshore Company. ANALYSIS AND DISCUSSION OF THE PROPOSED PLAN Formation of Offshore Company The Shareholders will cause an Isle of Man corporation with liability limited by guarantee (Offshore Company) to be formed. The Shareholders will own the voting shares of Offshore Company for the purpose of electing its board of directors. The persons who will be appointed to the board of directors and other restrictions on what the Shareholders may do will be governed by the Articles and the Agreement. Efficacy of Offshore Company to Achieve Your [Asset Protection] [Estate Planning] [Philanthropic] Objectives . " l~ . The use of a corporation (Offshore Company) rather than a trust to hold the investments should achieve your asset protection objectives. No Eligible Person will have any enforceable rights viz. a viz. Offshore Company to claim or enforce gifts to him/her. Such gifts during the life of Offshore Company, if any are made, will be strictly at the discretion of the Directors, who it may be assumed will take account of the circumstances as well as the needs of the Eligible Persons, but may be completely arbitrary in deciding who will get what and when. A gift in liquidation of Offshore Company is also strictly at the discretion of the Members and dependent upon their unanimous agreement (which may be subject to binding arbitration if they fail to agree). Finally, Eligible Persons may be added and removed by unanimous agreement of the Members. On the basis of the foregoing, no Eligible Person should be considered to have an enforceable interest that could be subject to the claims of creditors[, including spouses or ex-spouses under community of property type Jaws]. However, it is possible that a donor to Offshore Company could be considered to have made a non-arm's length gift in order to avoid the claims of creditors under the relevant Page 5 '1999 law if such claims pre-date the donation or ante-date the donation within time periods specified in the relevant Jaw. Legal advice should be obtained by you with respect to the implications of these arrangements if these circumstances might apply. However, Offshore Company will be under no obligation to return the donation or otherwise assist the donor in satisfying such claims. The gift of Mr._ _ to Offshore Company will be unconditional, irrevocable and absolute, so that no part of the gift or the accumulated assets of Offshore Company should be considered to form part of the estate of Mr. . Such a gift by a Canadian resident is not subject to gift tax, although if the gift is of appreciated assets any inherent gain may be subject to income tax in Canada. Neither the gift nor the accumulated assets of Offshore Company should be subject to estate tax, death duties or probate fees under any jurisdiction based on present law, nor should any aspect of or purported interest in Offshore Company be the subject of probate with respect to Mr. _ _ 's will or subject to any challenge of his will. Since no Eligible Person will have any legal interest in or rights viz. a viz. Offshore Company, the same conclusions should hold with respect to their estates. Offshore Company will have the capacity to pursue philanthropic activities, at the discretion of the Directors. It will not be subject to any constraints in this regard, as would a registered Canadian private foundation. It will not be subject to any reporting requirements, disbursement quota or restrictions on the basis of the charitable status of recipients of donations or other assistance as would be the case with the latter. Offshore Company will not be constrained in any respect from mixing investment, business, family and philanthropic interests, all of which may be pursued at the discretion of the Directors and within the framework of the Memorandum and Articles and the Members Agreement. The use of a corporation (Offshore Company) rather than a trust to hold the investments should avoid the application of certain rules of the Act that would deem an otherwise non-resident trust to be resident in Canada or the beneficiary of the trust to be taxable on an accrual basis on the income of the trust. These rules apply only to trusts. Generally, Canadian residents holding shares of a non-resident corporation such as Offshore Company will be considered to have an investment which is subject to accrual income recognition in Canada either under the controlled foreign affiliate rules of Section 91 of the Act or under the offshore investment fund property rules of Section 94.1 of the Act. Page6 ' 1999 Persons who are members or owners of interests in incorporated entities without shares but with ownership interests divided into other forms of units of interest are considered by Revenue Canada to hold shares of a class of the shares of a corporation. Offshore Company should be neither a controlled foreign affiliate nor a foreign affiliate of any Canadian resident person since no Canadian resident owns any Offshore Company shares. If a Canadian resident person holds a Non-shareholder Membership in Offshore Company, it should not be considered to be a share of the corporation as it requires no investment of capital in Offshore Company, entitles the Non-shareholder Member to no distribution or benefit of any kind whatever but merely provides the Non-shareholder Member with voting rights, constituting less than I 0% of the votes, in certain limited circumstances. Assuming, as intended, that the donor of funds to Offshore Company makes the donation irrevocably, unconditionally and absolutely, the donor should not be considered to have any ongoing interest in Offshore Company that could be considered to be the ownership of a share or an interest in property. In this regard, it is critical that the conduct of all of the parties to this arrangement be such that there is no inference that the Shareholders or Directors of Offshore Company, or Offshore Company itself, are controlled by, acting at the behest of or acting as agents or nominees for the donor. lf the donor becomes a director or Non-shareholder Member of Offshore Company, it must be clear from the documentary evidence and conduct of the parties that he/she does so as one amongst three Members/Directors with no casting vote. In this regard, such person should never act as the Chairman of the Board or as the Managing Director of Offshore Company. Equally important, the other Directors and Members must act and be seen to act independent of the control of the donor. On the basis of the foregoing analysis and assumptions, the foreign affiliate rules should therefore be inapplicable to Canadian resident Eligible Persons, Non-shareholder Members and the donor. Section 94. I of the Act is a little more broad in scope. It will apply to include a prescribed amount in income if a taxpayer holds or has an imerest in property that is ... a share of the capital stock of, an illterest in, or a debt of, a non-resident entity ... or Gil interest in or a right or option to acquire such a share, interest or debt, and ... the main purpose for acquiring or having the property was to derive a benefit from the investments held by the non-resident entity in the form of a reduced tax rate. ;._, Page 7 '1999 "Property" is defined in the Act to mean property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the gmeraliry of the foregoing, includes ... a right of any kind whatever, a share or a chose in action ... Under the Memorandum and Articles of Offshore Company and Members Agreement, no Eligible Person will have any enforceable rights viz. a viz Offshore Company that would constitute an interest in property, in particular: no rights to vote or participate in management of Offshore Company, no rights to receive gifts out of income or capital (except completely at the discretion of the board of directors, a~suming that the Members unanimously agree that any such person is an Eligible Person from time to time, which is also completely at the unanimous discretion of the Members), and no rights or interest that is transferable to any other person. We have also been advised that ba,ed on corporate law Offshore Company will hold its assets for its own account and will not be considered to hold its assets in trust for its Members or any Eligible Person, nor will the Members or the members of the board of directors of Offshore Company be considered to owe any fiduciary duty as trustees of an express trust or a resulting trust to any Eligible Person. Since no Eligible Person resident in Canada has any enforceable rights viz. a viz. Offshore Company, its Members or board of directors, or any other interest in Offshore Company that could be construed to be an interest in property as defined in the Act, Section 94.1 should not apply to Eligible Persons in their capacity of Eligible Person. [Note: although it is not recommended, the following analysis addresses the circumstance of a donor becoming a Non-shareholder Member or Director of Offshore Company. If a Canadian resident donor to Offshore Company becomes a Nonshareholder Member, the voting rights as a Non-shareholder Member may be considered to be property as that term is used in the Act. However, since the donation will not increase the value of such rights (which have no economic value) nor does Nonshareholder Membership per se carry with it any right to any benefit from Offshore Company, Section 94.1 as presently worded or as proposed to be amended should not be applicable in these circumstances. If the donor is a Non-shareholder Member and is also an Eligible Person, the person will still have no enforceable rights of any kind whatever to receive a distribution, so that there should be no "designated cost" upon which to base the imputation of income under present rules. The absence of any entitlement to a distribution should also preclude any argument under proposed amendments to Section 94.1 that such person can compute a share of income or mark-to-market his/her "interest" PageS ' 1999 in Offshore Company. If the donor is an Eligible Person, a Non-shareholder Member and a Director of Offshore Company there is an undesirable inference that he/she may be able to control the Directors decision as to whether or not a gift is made to him/her or any other person upon whom he may wish to confer a benefit, such that his/her interest could be considered to have economic value. Although this position may be rebuttable on the basis that the individual is just one Director or Member amongst three, who must be unanimous in any decision to make a gift to an Eligible Person, such rebuttal would clearly depend heavily upon being able to demonstrate that such person did not control or unduly influence the conduct of the other Members and Directors. This situation should be avoided. It is strongly recommended that a donor shouid not be a Non-shareholder Member or Director of Offshore Company.] Since we conclude that the interest of Eligible Persons in Offshore Company is not a share or property of any kind, other provisions of the Act such as the general requirements to include income from property and from shares in income should not be applicable to Eligible Persons. Guarantee of Liabilities of Offshore Company The guarantee of the liabilities of Offshore Company by Mr. , a person not resident in Canada, will not attract any Canadian tax consequences. If the guarantee of the liabilities of Offshore Company were made by a Canadian resident, transfer pricing issues could arise under subsection 247(2) for the person giving the guarantee. Gift to Offshore Company The irrevocable, unconditional and absolute gift of to Offshore Company by _ _ _ should not have any Canadian tax consequences. The gift will be treated as contributed surplus by Offshore Company. Although is unlikely to be considered to deal at arm's length with Offshore Company with respect to this gift, since [his] [her][their] objectives are not commercial, but are primarily asset protection [,estate planning,] [and philanthropic], this should be viewed as a true gift, analogous to a gift to a non-charitable foundation. Investments made by Offshore Company At the time investments are made, Offshore Company must take into consideration local tax considerations including withholding tax on interest, dividends or royalties and/or Page 9 '1999 income taxes on any gain on sale. Investments in "taxable Canadian property" or other Canadian investments could result in Canadian income or withholding tax to Offshore Company. Distribution of Earned and Contributed Surplus made by Offshore Company The directors of Offshore Company will determine when surplus will be distributed. Offshore Company's Articles will permit gifts to persons who are Eligible Persons as unanimously agreed upon by the Members. Eligible Persons will initially include persons resident in Canada. There are no specific rules in the Act which would tax a Canadian resident person on gifts from Offshore Company. The specific provision dealing with distributions from nonresident corporations refers to "dividends on a share owned by the taxpayer of the capital stock of a corporation not resident in Canada". No shares of Offshore Company are owned by any Canadian resident person, nor should the "interest" that an Eligible Person has in Offshore Company be considered to be a share or property of any kind whatever. Although such a payment should be considered a gift in law, nevertheless, we are concerned that Revenue Canada could seek to apply the General Anti-avoidance Rule ("GAAR") to tax a Canadian resident recipient of gifts from Offshore Company (see Risks below). Characterization of Offshore Company Offshore Company should be considered an incorporated company under Isle of Man and Canadian law. This question is relevant because corporations in Canada, and indeed in most common law countries, do not have the ability to make payments to nonshareholders except in the ordinary course of business, although the concept of a company limited by guarantee is more common, and indeed is provided for under the Nova Scotia Company Act. Generally, in the absence of a trust or agency relationship corporation owns its assets in its own right. However, a corporation may act in a fiduciary capacity as a trustee of a trust if property is transferred to the corporation on condition that it hold that property for the benefit of other persons. In the proposed structure, Mr. 's gift to Offshore Company will not be subject to any such conditions. We have been advised by legal counsel, upon whom we rely, that Offshore Company will not be bound by any fiduciary obligations to anyone and that the Eligible Persons wiJI not have any enforceable rights, whether in accordance Page 10 ' 1999 with trust law or otherwise, viz. aviz. Offshore Company. Thus, Offshore Company should not be considered a trustee of a trust of any kind whatever. Characterization of the Shareholders and Directors It is also possible, in certain circumstances, that the Shareholders or Directors could be viewed as the trustees of a trust, the assets of which consist of the shares of Offshore Company and the beneficiaries of which consist of the Eligible Persons. This is a question of legal form and substance. In the proposed arrangements, no fiduciary undertakings will be required of the Shareholders or Directors, or given. _ _ __ to Offshore Company will be an unconditional gift to Offshore transfer of Company for its own use. We have been advised by legal counsel, upon whom we rely, that neither the Shareholders nor the Directors will be bound by any fiduciary obligations to the Eligible Persons and the Eligible Persons will not have any enforceable rights, whether in accordance with trust law or otherwise, viz. a viz. the Shareholders or the Directors. Thus, neither the Shareholders nor the Directors should be considered a trustee of a trust of any kind whatever. As discussed above, it is also critical to the conclusions reached above that the conduct of all of the parties to this arrangement be such that there is no inference that the Shareholders or Directors of Offshore Company, or Offshore Company itself, are controlled by, acting at the behest of or acting as agents or nominees for the donor. If the donor becomes a Director or Non-shareholder Member of Offshore Company (which we do not recommend), it must be clear from the documentary evidence and conduct of the parties that he/she does so as one amongst three Members/Directors with no casting vote. In this regard, such person should never act as the Chairman of the Board or as the Managing Director of Offshore Company. Equally important, the other Directors and Members must act and be seen to act independent of the control of the donor. Foreign Reporting Since Offshore Company should not be a trust or a foreign affiliate of any person resident in Canada, nor should any person resident in Canada have any interest in Offshore Company that may be described as an interest in property, neither Mr. · s gift to Offshore Company nor any other aspect of the proposed arrangement is subject to any information return filing requirement under the present rules of the Act. Page II '1999 Interests of Eligible Persons No Eligible Person will have any legally enforceable rights viz. aviz. Offshore Company. Thus, Eligible Persons will have no ability to force gifts to them at any time, or to claim any right to a gift on the basis that someone else has received a gift. Eligible Persons will have no salable or assignable rights. Therefore, no Eligible Person should be considered to have any rights that would be deemed to be disposed of upon ceasing to be a resident of Canada. RISKS Lack of Fiduciary Protections None of the Shareholders, Non-shareholder Members, Directors or Offshore Company will be under any fiduciary obligations to act in the best interests of anyone other than themselves. This structure does not provide any of the common law or statutory protections normally associated with trusts. The Members' Agreement and the constraints of the Articles and obligations of the Directors under corporate law provide the complete legal framework within which Offshore Company will operate. A donor to Offshore Company must recognize and accept that he/she will not be able to control nor, necessarily, influence the conduct of the affairs of Offshore Company. Re-determination of the Tax Consequences Associated with Offshore Company Although you have indicated that your primary interest in the Offshore Company structure is to achieve your [asset protection] [estate planning] [philanthropic] objectives, in view of the fact that the arrangements proposed may result in tax benefits, we believe that there is some risk that Revenue Canada could seek to re-determine the tax consequences of these arrangements under the General Anti-Avoidance Rule ("GAAR") in section 245 of the Act. GAAR is intended to deny a tax benefit which would result, directly or indirectly, from an avoidance transaction or series of such transactions. An avoidance transaction is defined in subsection 245(3) as any transaction (or part of a series of transactions) that, but for GAAR, would result, directly or indirectly, in a lax benefit, unless that transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit. Subsection 245(4) clarifies that GAAR will not be applied to a transaction where it may reasonably be considered that the Page 12 , 1999 transaction would not result in a misuse of any of the provisions of the Act or an abuse of the Act read as a whole. The Federal Budget released February 16, 1999 recommends an amendment to the trust rules in the Act that will deem a non-resident trust to be resident in Canada (and therefore subject to Canadian tax) on all of its undistributed income, if a Canadian resident transfers or loans property to such trust. These new rules would apply whether or not the trust has any Canadian resident beneficiaries. The amendments will also provide that the Canadian resident transferor or lender will be jointly liable with the trust for any taxes payable by the trust. This reflects the rising concern of the Canadian government with tax avoidance (legal or otherwise) through offshore trusts. The proposed structure avoids these proposed rules. It is not unreasonable to expect that, if Revenue Canada were fully apprised of the proposed arrangements, they would seek to have Offshore Company treated as a deemed resident of Canada, in which case it would be taxable on its world income, or to tax any Canadian resident recipients of gifts from Offshore Company as being in receipt of dividends as if they owned shares in Offshore Company. It is also possible that Revenue Canada would seek to have any Canadian resident persons who might receive gifts from Offshore Company treated as owning an interest in Offshore Company upon emigration from Canada in order to attempt to tax them on the basis that they have a deemed disposition of such interest at fair market value, with tax on the capital gain. On the other hand, the Act contains a complex fabric of rules that determine when a Canadian resident person is taxable, whether on an accrual basis or on a received basis, with respect to interests in non-resident corporations or trusts. Since very specific rules have been legislated in this regard, it is not unreasonable to expect that a Canadian court might find that the proposed arrangement wa~ not a misuse of any specific provision of the Act or an abuse of the Act read as a whole. Furthermore, the courts are likely to be very reluctant to deem Offshore Company to be a resident of Canada without specific legislative authority. It is our view that it is unlikely that a court would find that a Canadian resident person who is an Eligible Person has "property owned by the taxpayer" as required for the deemed disposition rules on emigration to apply since such persons have absolutely no enforceable rights viz.~ viz. Offshore Company. Nevertheless, in light of the lack of case law with respect to the application of GAAR, professional advice cannot entirely remove the risk of a successful GAAR challenge. Page 13 • 1999 Mind & Managemellt If Offshore Company is found to be resident in Canada, it will be subject to Canadian tax on its worldwide income. It is therefore essential, if the incidental tax benefits of the proposed structure are to be obtained, that Offshore Company not be found to be a resident of Canada. This requires that the "central management and control" ("mind and management") of Offshore Company be. scrupulously maintained outside of Canada at all times. A majority of the board of directors of Offshore Company should therefore not be resident in Canada and Directors meetings must be held in person outside Canada. The Directors must have and be seen to exercise independent authority and responsibility over the operation of the affairs of Offshore Company. They must not be Mr. 's agents or mere nominees. Further guidance with respect to this mind and management issue is set out in an appendix to this letter. Cha11ge of Law There is a risk that the Canadian tax authorities will become aware of this structure and legislate to eliminate its advantages. We cannot provide any assurance that this will not occur. Agency It is absolutely essential to the conclusions set out above that none of the Members be considered to be acting as agents for Mr. . Whether or not this could ever be an issue depends upon the conduct of the parties. Mr. _ _ must accept that he has absolutely no control over the Shareholders or Directors and the Shareholders and the Directors must be scrupulous about exercising independent mind and authority in connection with the conduct of tbe affairs of Offshore Company. If the Shareholders were found to be agents of Mr. , Offshore Company would be a controlled foreign affiliate of Mr. _ _ and he would be required to include Offshore Company's income in his Canadian income on an accrual basis. L{)ans to Eligible Persons Offshore Company is not precluded from making loans to Eligible Persons. If an Eligible Person resident in Canada received a loan from Offshore Company that did not bear a interest at least at the prescribed rate, and the loaned property or property acquired out of the proceeds of the Joan was used to earn income, although there may be arguments to the contrary depending upon the circumstances, such income could be attributed to Mr. _ _ . We do not recommend such loans. Page 14 , 1999 SUMMARY The proposed plan should meet your [asset protection][, estate planning][philanthropic] objectives and may provide tax benefits as well. The careful implementation and maintenance of the structure in accordance with the steps set out above and the ongoing compliance with the limitations outlined above will help ensure that this offshore structure conforms with our interpretation of present Canadian tax Jaws. In our view, under present Jaw, subject to the potential application of GAAR, the investments held by Offshore Company and its accumulating income should be free of Canadian tax and should not result in attribution of income to any person resident in Canada. We trust this is to your satisfaction. Yours very truly B.M Philp Partner, International Tax (604) 691-3383 APPENDIX I SUMMARY OF CANADIAN TAXATION OF OFFSHORE COMPANY Is Offshore Company a company for Canadian tax purposes? This question 'is relevant because generally Canadian corporations are prohibited from making gifts to non-shareholders, except in the ordinary course of business. Whether or not Offshore Company will be respected as a corporation is critical to the proposed plan. We have been advised by legal counsel that Offshore Company should be treated as a corporation for Canadian income tax purposes. Although Offshore Company has one of the characteristics of a discretionary trust, i.e., the ability to make discretionary gifts to any Eligible Person to the exclusion of any other, the analysis of Patrick Taylor given in "Guarantee Companies: Their Nature and Some Possibilities" (see paper attached as Appendix Ill for a discussion of hybrid companies and their characterization) indicates that it would be treated as a corporation in common Jaw jurisdictions. In general terms, section 94 applies to non-resident trusts if a person resident in Canada is beneficially interested in the trust and the trust has acquired property from a beneficiary resident in Canada or a related person. If applicable, either the trust is deemed to be resident in Canada or the trust is deemed to be a non-resident corporation and the Canadian resident beneficiaries are deemed to be shareholders thereof. Since Offshore Company is not a trust for Canadian tax purposes, subsection 94(1) cannot apply to it. (The question of whether or not Offshore Company, its Members or its Directors could be considered trustees of an explicit or resulting trust is explored below.) Residence of Offshore Company Since Canada has no treaty with the Isle of Man, common Jaw principles will determine the residency of the company to be the place where the "central mind and management control" of the company is located. In general terms, central mind and management control is considered· to rest with the board of directors of a company, assuming that the board in fact exercises ultimate control over the company's affairs. The location of this "mind and management" is usually determined on the basis of where the board of directors meets. Therefore, a majority of the board members should reside outside of Canada, and the board should only hold its meetings in person outside Canada. The directors must have the authority and Page 2 Appendix II '1999 responsibility to carry out the business of Offshore Company, and they must exercise that authority and responsibility. They cannot be mere nominees. A more detailed discussion of mind and management issues is attached as Appendix II. Is Offshore Company a foreign affiliate of a Canadian resident taxpayer? A non-resident corporation is a foreign affiliate of a Canadian resident taxpayer where the taxpayer's equity percentage is 1% or more and the equity percentage of the taxpayer and persons related to the taxpayer is 10% or more. Equity percentage is defined in subsection 95(4) as the total of a taxpayer's direct and indirect equity percentages in the foreign corporation. ''Direct equity percentage" is also a term defmed in subsection 95(4). For each class of the issued shares of the capital stock of the corporation, direct equity percentage is determined on the basis of the proportion of 100 that the number of shares of that class owned by a person is of the total number of issued shares of that class. Since no one resident in Canada would own any of the shares in Offshore Company, the company should not be a foreign affiliate of any such resident. Since Offshore Company will not be a foreign affiliate of any person resident in Canada, the foreign accrual property income ("FAPI") rules should not be an issue in respect of any income earned by the company. Does current section 94.1 apply in respect of Offshore Company? Section 94.1 requires a minimum annual income to be reported in respect of investments in an "offshore investment fund property". Where section 94.1 applies, the taxpayer is required to include in income the product of the "designated cost" of his investment times a prescribed rate, less the income otherwise reportable in the year (other than capital gains). (The Federal Budget of 1999 proposes to amend these rules. The proposed amendments do not appear to impact upon the conclusions herein, but the legislation should be monitored carefully.) Offshore investment fund property is "an interest in property" which meets three tests: (l) The property is a share of, or interest in, or debt of, a "non-resident entity" or an option to acquire any of these. The term "non-resident entity" is defined broadly in paragraph 94.1 (2) to include: (a) a corporation not resident in Canada; (b) a partnership, fund or entity not resident in or not situated in Canada; (c) a trust subject to the rules of paragraph 94(1)(c) or 94(1){d). Page3 Appendix II ' 1999 (2) The underlying assets of the non-resident entity are "portfolio investments" in properties acquired to earn some form of investment income. (3) One of the main reasons for acquiring the property was to provide a benefit from the underlying portfolio investments while deferring or reducing the tax that would be payable if these investments were owned directly. With respect to the possibility that Canadian resident Eligible Persons might have an "interest in property", since_such persons have absolutely no legally enforceable rights to distributions or otherwise vis-a-vis Offshore Company, they should not be considered to have "an interest in property". Could Offshore Company or its Members or its Directors be considered trustees of a trust of which the Eligible Persons are beneficiaries which could be subject to current 8.94(1) or current 8.94.1? We have been advised by the legal counsel that neither Offshore Company nor its Members or Directors would be considered trustees of a trust with respect to the ownership of any of Offshore Company's property. In particular, based on the Memorandum and Articles and Members Agreement, counsel advises that Offshore Company will clearly be the beneficial owner of its own property and will not hold its property in trust for its shareholders, members or any other persons; and, neither the Members nor the Directors will be considered to owe any fiduciary duty under trust law to the Eligible Persons. Offshore Company's Directors are not obliged to deal with its assets in a predetermined manner. They would have full. capacity to manage the affairs of the company. The Directors are empowered, but are not obliged, to make gifts to Eligible Persons as determined from time to time. Any assets of Offshore Company will belong beneficially to the company and should not be considered "settled" property and there should not be considered to be any trust arrangement, whether explicit or resulting. Do proposed Sections 94.1 and 94.2 apply to Off.~hore Company? The new rules contained in proposed sections 94.1 and 94.2 generally apply onlv to a "participating interest" in a foreign entity that is a ''foreign investment entity". "Participatine interest" in an entity means (a) where the entity is a corporation, Cil Ciil a share of the capital stock ofthe corporation, and a right to acguire a share of the capital stock of the comoration; Page 4 Appendix II ' 1999 (b) where the entity is a trust. (i) (ii) a beneficial interest in the trust. and a right to acquire a beneficial interest in the trust. and (c) in any other case, an interest in the entity or a right to acquire an interest in the entity. The term "interest" is not defined for pumoses of sections 94.1 and 94.2. Black's Law Dictionary. Fifth Edition, defines interest as "the most general term that can be employed to denote a right. claim, title or legal share in something." Since the Offshore Company is a comoration at law, neither the non-shareholder member nor the eligible persons have ·a "panicipating interest" since they do not own shares of the capital stock of Offshore Company nor do they own a right to acquire any such shares. As discussed above. Offshore Company is not a trust. Furthermore. since it is a comoration under Isle of Man law. paragraph (c) above would not apply by virtue of the words "in any other case". Does proposed Section 94 apply to Offshore Company? Proposed section 94 will deem ceJtain non-resident trusts to be resident in Canada for Yarious purposes of the Income Tax Act. including tax on their worldwide income. Specifically, subsection 94(3), the charging provision of section 94. states the following: "Where a trust .. .is non-resident at the end of a taxation year of the trust and. at any time. there is a resident contributor to the trust or a resident beneficiary under the tntsl ... "(emphasis added). There is nothing in the proposed legislation which deems an entity which is not legally a trust to be a trust. Therefore. whether or not proposed section 94 applies to Offshore Company hinges solely on its legal characterization. Offshore Company should be considered an incorporated company under Isle of Man and Canadian law. Generally. in the absence of a trust or agency relationship. a comoration owns its assets in its own right. However, a corporation may act in a fiduciary capacity as a trustee of a trust if prope11Y is transfeiTed to the comoration on condition that it hold that property for the benefit of other persons. In the structures that have been put in place. the gift to Offshore Company was not subject to any such condition. We have been advised bv legal counsel that Offshore Company is not bound bv any fiduciarv obligations Page 5 Appendix II '1999 to anyone. Offshore Company should not be considered a trustee of a trust of anv kind whatever. It is also possible. in certain circum,tances. that the shareholders or directors of Offshore Company could be viewed as the trustees of a trust. the assets of which consist of the shares of Offshore company and the beneticiaries of which consist of the elif!ible persons. This is a guestion of le2al form and substance. In the structures which are now in place. no fiduciary undertakings were reguired of. or given by. the shareholders or directors. The transfer of property to Offshore Company is an unconditional gift to Offshore Company for its own use. We have been advised by legal counsel that neither the shareholders nor the directors will be bound by any fiduciary obligations to the eligible persons and the eligible persons will not have any enforceable tights. whether in accordance with trust law or otherwise. vis-a-vis the shareholders or the directors. Thus, neither the shareholders nor the directors should be considered a trustee of a trust of any kind whatever. Therefore, proposed section 94 will not applv to Offshore Company. How would gifts from Offshore Company to Canadian resident Eligible Persons be taxed? The directors of Offshore Company will determine when surplus will be distributed. Offshore Company's Articles will permit gifts to persons who are Eligible Persons as unanimously agreed upon by the Members. Eligible Persons will not have any rights to enforce or receive gifts. Such gifts will be strictly at the discretion of the Board of Directors and may be made to one Eligible Person to the exclusion of any others. There is no requirement in the Articles of Offshore Company that any such gifts be made. There are no specific rules in the Act which would tax a Canadian resident person on gifts from Offshore Company. The specific provision dealing with distributions from nonresident corporations refers to "dividends on a share owned by the taxpayer of the capital stock of a corporation not resident in Canada". No shares of Offshore Company are owned by any Canadian resident person. Although such a payment should be considered a gift, nevertheless, we are concerned that Revenue Canada would seek to apply the General Anti-avoidance Rule ("GAAR") to tax a Canadian resident recipient of gifts from Offshore Company. If this arrangement constituted an explicit or resulting trust of any kind whatever (see discussion below), such gifts could be taxable to the recipient under S.l04(13)(c). However, the general conclusion (subject to the application of S.247(2) or S.245 (GAAR) as discussed below), is that this arrangement should not constitute a trust arrangement of any kind whatever. Page 6 Appendix II '1999 It is also possible that the provisions of S.15(1) combined with S.56(2) could be applied to tax a person if that person could be construed to be a "shareholder" as contemplated by S .15(1) who either received or directed a gift to another Eligible Person upon whom he wished to confer a benefit. However, under no circumstance will a Canadian resident person be a shareholder of Offshore Company. However, it is possible that a Canadian resident person may be a Non-Shareholder Member of Offshore Company. Revenue Canada has indicated that interests in incorporated entities which do not have shares will be treated as shareholdings proportionate to the beneficial interests of the holders (IT-392, paragraph 3). Offshore Company Non-Shareholder Members will have no beneficial ownership interest in Offshore Company (entitlement to distributions out of the income or capital of Offshore Company), their primary role being to act as the guarantor of Offshore Company's liabilities in liquidation and to vote on certain matters. Although a NonShareholder Member will give no consideration for his membership, a Non-Shareholder Member might make a gift to Offshore Company. The Articles of Offshore Company do not entitle a Non-Shareholder Member to a return of any amounts contributed to Offshore Company. The Articles of Offshore Company provide that such Non-Shareholder Members cannot receive any distributions out of the income or capital of Offshore Company in any circumstances whatever. It is our view that such Non-Shareholder Members should not be capable of being construed as shareholders. In such case, it is our view that S.15(1) should not be applicable to a Non-Shareholder Member who is a Canadian resident. Are there any foreign reporting requirements in respect of Offshore Company? Since Offshore Company is not a trust or a foreign affiliate, nor does any "interest" in it constitute "specified investment property" with a "cost amount" in excess of $100,000, it should not be subject to any of the new foreign reporting requirements. No person resident in Canada will have an interest with a cost in excess of $100,000 that would qualify as "specified foreign property". The information retum filing requirements in proposed Subsection 233.2(4.1) in respect of "arrangements" which are similar to trusts will not apply to gifts made to Offshore Company bv residents of Canada before Januarv 1. 2002. This is due to the fact that proposed Subsection ?33.?(4.1) onlv applies to contJibutions made to "similar arrangements" after 2001 and it onlv applies in the year of the cont1ibution (i.e., there is no ongoing annual requirement to file an information return under Subsection ?33.2(4.1 ll. There is no filing requirement under proposed Subsection 233.2( 4.1) in respect of contributions to Offshore Companv made at any time bv non-residents of Canada. This is due to the fact that in order for the reporting requirement to apply, there must be a Canadian resident cont1ibutor. Page 7 Appendix II • 1999 There is also no filing reguirement under proposed Subsection 233.2(4.11 where a Canadian comoration issues shares to Offshore Company (for example. in an estate freeze). This is due to the fact that in order for proposed subsection 233.2(4.]) to applv, there must be a transfer or Joan of property to the "similar arrangement". Under general legal principals. a comoration does not transfer propeny when it issues shares. Could the tax consequences of the Offshore Company arrangement be determined as if it was a trust or a foreign affiliate under S.247 or GAAR? S.247: Section 247 requires that, for tax purposes, non-arm's length parties conduct their transactions under terms and conditions that would have prevailed if the parties had been dealing at arm's length with each other. More specifically, subsection 247(2) applies in situations where a taxpayer and a non-resident person with whom the taxpayer does not deal at arm's length are participants in a transaction or series of transactions and • the terms or conditions of the transaction or series differ from those that would have been made between persons dealing at arm's length, or • the transaction or series would not have been entered into between persons dealing at arm's length and may reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit. Where the above conditions are met, proposed subsection 247(2) may adjust the amount of the transfer price or re-characterize the nature of the transaction. 'Transactions" (which includes "an arrangement or event") between Canadian resident persons and any non-resident persons for these purposes might include the participation, in the sense of being the directing mind(s) behind, the formation of Offshore Company and the gift to Offshore Company. As noted above, for subsection 247(2) to apply, the transactions entered into must, in the first place, be of a sort that arm's length persons would not have entered into. Arguably, the proposed arrangement is a type that would be entered into by an arm's length party with Offshore Company to achieve his/her asset protection, estate planning, tax planning and succession objectives. Incorporated entities, including companies which have different attributes than conventional Canadian corporations, are frequently used outside of Canada for such planning. It is possible that the use of a Offshore Company for this purpose may become more common in Canada. Furthermore, it may be argued that Offshore Company is at arm's length with Eligible Persons in the same fashion that a company with an independent board is at arm's length with its founder. However, in the final analysis, we cannot be certain whether or not a Court would find that this is an arrangement that arm's Page 8 Appendix II '1999 length parties would enter into, or whether or not particular parties deal at arm's length. Accordingly, we cannot rule out the possibility that Revenue Canada could seek to apply paragraph 247(2)(d) tore-characterize the formation of and gift to Offshore Company as the formation and settlement of a trust. However, we think that it is much more likely that, if inclined to do so, Revenue Canada would choose GAAR as their tool to attack the arrangement, as explained below. We also cannot rule out the possibility that Revenue Canada could seek to apply paragraph 247(2)(d) to the gift to Offshore Company to characterize it as a contribution by a guarantor for which an arm's length guarantor would require a return. However, as a matter of law, is not a guarantor of Offshore Company's debts. Therefore it would seem very difficult for Revenue Canada to successfully argue that [he][she][they] should be treated as a guarantor. It is also possible that Revenue Canada could seek to apply this provision to recharacterize the Eligible Persons as having shares in a foreign affiliate. However, we do not think that this line of attack would succeed because it is a requirement of S.247(2)(d) that the transaction be re-characterized as one that would have been entered into between persons dealing at arm's length. Since Eligible Persons will have no right to receive gifts or any other legally enforceable rights, we do not think that any of them have anything that should reasonably be re-characterized as shares if such relationships were arm's length. GAAR: GAAR is intended to deny a tax benefit which would result, directly or indirectly, from an avoidance transaction or series of such transactions. An avoidance transaction is defined in subsection 245(3) as any transaction (or part of a series oftransactions) that, but for GAAR, would result, directly or indirectly, in a tax benefit, unless that transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit. Subsection 245(4) clarifies that GAAR will not be applied to a transaction where it may reasonably be considered that the transaction would not result in a misuse of any of the provisions of the Act or an abuse the Act read as a whole. Subsection 245(5) outlines some of the ways in which GAAR may be applied by Revenue Canada, including: • denial of a deduction (in whole or in part) in computing income, taxable income, taxable income earned in Canada, or taxes payable; • denial of the allocation to a person (in whole or in part) of a deduction, income, loss or any other amount; • re-characterization of any payment or other amount; and Page 9 Appendix II ' 1999 • ignoring of the tax effects that would otherwise result from the application of other · provisions of the Act. If funds were distributed by Offshore Company directly to Canadian residents, Revenue Canada clearly might seek to invoke GAAR to re-characterize the gifts as dividends from a foreign corporation, taxable under section 90. Under subsection 245(2) where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit". Thus, GAAR is potentially capable of being used to determine the tax consequences of the proposed arrangements to be different than an analysis of the specific provisions of the Act would indicate. It is possible that this may be limited to characterizing any gifts as dividends. It is less likely, but remotely possible, that the tax consequences would be determined as if Offshore Company was either a controlled foreign affiliate to Eligible Persons resident in Canada, or a trust which had acquired property from such persons. In the first case, the income of Offshore Company would be taxable to the Canadian resident Eligible Persons on an accrual basis; in the second case, the income of the company would be taxable in Canada as the 1999 Federal Budget proposes that a trust which has acquired property from a resident of Canada would be a deemed resident of Canada. However, in this event it is, in our view, extremely unlikely that a court would fmd Canadian resident Eligible Persons jointly and severally liable for the tax of Offshore Company under the 1999 Federal Budget proposals, without a very specific statutory provision giving them such a liability. There are a number of potential defenses to a GAAR challenge in these circumstances, including the arguments that: 1. ____ has bona fide non-tax estate planning and asset protection objectives; 2. these arrangements do not rely on any specific provision of the Act for their consequences, but rather rely on the inapplicability of any provisions of the Act and thus are not a misuse of any such provision; 3. these arrangements are not an abuse of the provisions of the Act read as a whole because Parliament has gone to great lengths to specify whether and when Canadian resident persons are taxable on income accruing to or received from non-resident entities and there are very detailed and specific provisions of the Act which apply to Page 10 Appendix II '1999 non-resident trusts and foreign affiliates, and if arrangements do not come within these specific provisions they should not be subject to their provisions. However, in the absence of high level court precedents and considering the administrative position of Revenue Canada on the application of GAAR, we cannot rule out the possibility of a successful challenge of the proposed arrangements under GAAR. Do the proposed transactions constitute a sham? A "sham" consists of acts done or documents executed by the parties thereto which are intended to give the appearance of creating between the parties enforceable rights and obligations different from the actual enforceable rights and obligations (if any) which the parties intend to create. For acts or documents to be a "sham", all the parties thereto must have a common intention that the acts or documents are not to create the enforceable rights and obligations which they give the appearance of creating. The proposed structure creates enforceable rights and obligations which are consistent with what all parties involved intend them to be. The structure is therefore not a "sham". Does the doctrine of "agency" apply in this situation? Provided that the shareholders of Offshore Company have the right to elect and replace the board of directors and are not mere nominees or agents for persons resident in Canada, and provided that the directors are not mere nominees or agents for persons resident in Canada, the corporate ownership structure and residence of the respective entities should be respected. Whether or not this will be the case depends entirely upon the course of conduct of the participants. The shareholders and directors should be selected on the basis that they will have and exercise real independent authority in their respective roles. APPENPIXII IMPLICATIONS OF CANADIAN CORPORATE RESIDENCE A Canadian resident corporation is taxable in Canada on its world income. A corporation which becomes a resident of Canada is deemed to dispose of and acquire all of its assets (except "taxable Canadian property") at fair market value. A corporation which ceases to be a resident of Canada is deemed to dispose of all of its assets at fair market value, is subject to corporate income tax on any gains which have accrued on its assets since it last became a resident, and is subject to a ''departure tax" of 25% (subject to reduction under a tax treaty) of its net assets. Thus, there can be very adverse tax consequences to inadvertently taking up or giving up residence in Canada. CANADIAN LAW ON CORPORATE RESIDENCE The law in Canada with respect to corporate residence derives from both statutory and common law, and may be affected by an applicable tax treaty. Corporations which are incorporated in or granted articles of continuance in Canada are statutorily deemed to be residents of Canada. A corporation not incorporated or continued in Canada may be a resident of Canada if its "mind and management" is located in Canada. This latter concept is discussed more fully below. MIND AND MANAGEMENT The common law has generally established that a corporation is resident in the country where its central management and control is exercised. Usually central management and control exists where the members of the board of directors hold their meetings and exercise their authority over the corporation. However, if the board of directors of a company does not in fact exercise authority and control over the company, and the management and control of the company is actually exercised by some other party, such as the directors of its parent company or its principal shareholder, resident in another country, the company will be considered to be resident in that other country. The central management and control test has been considered many times in case law (it is commonly known as the "mind and management" test). The essential thrust of the Canadian jurisprudence is that a foreign corporation will not be considered to have its mind and management in Canada if a majority of its directors are not resident in Canada, all directors meetings take place in a foreign jurisdiction, a majority of the non-Canadian resident directors attend these meetings, substantial independent thought is exercised by Page2 Appendix II • 2000 the directors and the foreign corporation's directors do not simply implement business decisions made in Canada. It should also be noted that other countries besides Canada, notably the U.K., may establish corporate residence on the basis of mind and management. Nominee Directors Problems can arise if the directors of a foreign subsidiary are mere nominees for others who are the real mind and management of the company. A corporation is considered to be a resident of the country where the control of the corporation is actually exercised, either by the directors of the corporation or by others. The location of directors' meetings is a strong indicator of where the mind and management of the company is located; however, if the decisions made at such meetings outside Canada merely implement or "rubberstamp" decisions actually made within Canada, then the residence of the corporation could be considered to be in Canada. Independence of Directors from Shareholders There is ample authority, both corporate and tax related, that the common law residence of a corporation is not determined by nor dependent upon the residence of its shareholders, despite the influence that shareholders may have over the affairs of the company by virtue of their share ownership and power to appoint and remove directors. The directors are not the agents of the shareholders nor bound to comply with the directions given by them. The responsibility of the directors and officers is to the company itself and their duties are controlled by the rules and the constitution of the company. Case law supports the view that a foreign subsidiary can be resident in a foreign jurisdiction notwithstanding that the board of the subsidiary may act upon the wishes of the parent. Although a board might do what it is told to do by the parent, it does not follow that the mind and management of the company lies with the parent so long as the board exercised its discretion when coming to its decisions and would have refused to carry out an improper or unwise transaction. Page3 Appendix II '2000 GUIDELINES FOR AVOIDING CANADIAN CORPORATE RESIDENCE In order to establish and assure that central management and control of Offshore Company is outside Canada, the following steps should be taken: 1. Directors' meetings should be held regularly (at least semi-annually) outside Canada and preferably in the desired jurisdiction of residence, in person (not over the phone). At such meetings the directors should establish corporate policy, give directions to the employees or management company as to how the corporation's business should be carried on, authorize significant or material transactions and adopt whatever resolutions are necessary to carry on business (e.g. annual appointment of auditors, etc.). Comprehensive minutes of all such meetings should be carefully kept. 2. A majority of the directors should be non-residents of Canada, and at least one should be resident in the desired jurisdiction of residence. 3. Shareholders' meetings, including the annual meeting, should be held outside Canada, preferably in the desired jurisdiction of residence. 4. Anyone with signing, contracting and decision-making authority should not be resident in Canada, and should preferably be resident in the desired jurisdiction of residence. 5. A head office with phone numbers and addresses should be established in the desired jurisdiction of residence. The company should have an employee or engage a management company to conduct its day to day affairs. It should display its ·company name at its premises and should maintain regular business hours. It should have its own stationary, business forms and business cards. Accounting and banking for the business should be performed at the head office. The legal, accounting and other general books and records of the corporation should be retained at this office. 6. The foreign company should comply with all statutory requirements of the desired jurisdiction of residence, including incorporating procedures and tax filing requirements. 7. The foreign company should open a bank account preferably in the desired jurisdiction of residence to be used for all business transactions, including transactions with related companies, which should be invoiced and settled in a timely manner. Page4 Appendix II '2000 8. Material contracts for the business should be negotiated, drawn up, and executed outside Canada, preferably at the foreign head office, in the registered name of the foreign company. The contracts should also be subject to the laws of a jurisdiction other than Canada. There should be no requirement for overriding approval of Canadian resident persons or corporations. 9. All suppliers, creditors and customers of the company should be aware that they are dealing with the company and not with a Canadian resident, or any of its shareholders. 10. The local management should make all decisions on the day-to-day running of the business without any direction from Canada. 11. Communication between the foreign company and non-arm's length Canadian residents should be kept to a minimum and confined to the exchange of information as opposed to the giving of instructions or directions. "'-. ... ... ,-,,.., ~ r •..., .... .. ,.,.r- ·IC.IC' ~ ,......_. •Ml'Gl1624 GOU1 -U4(11)11l24~ 'rtri' ' ncoc.ld..com lm8'nol lmp:JJ~m ' __ .., ............. ..... ....... .._ We n*t 10 1bC: 11110v: and ;ywr 1 - of'23n11une 19!19 lind. your reque:st 10 blwc an opinion on two matleh il5 ~= I. 'that bO "Wiglhlel'cmcln· willllave ~ Jqal riglliS ~vis Hyb>idco whicb mYid 'be SIM 10 COI!Slitdte liD iulueat in ptOPMy, ill panicuhr DO lisb!s Ill> ~ ar to JWtio;ipalri;: ia 1hc m-semc:mt of' H)'bridco, DO righ\s to l'f!JCei..c ~ out of i4comc: oc capiml. lUll! uo rigbts of b - wbic:b 'tUt1 be: traostl::noblc w my pc:x!IOIL 2. As :a matter ofi!Qjpoziilo: law, that BybtidIms heh>g pati!DDB llli8J"bbc to~ ia tile di!nribudcm of Cllpital 01' i»crcPe ar IIDCUiilulaled n:tumed cemmp . . - oflbc: -Dpiltay dlmAg 1lw: rue o£rbe COM.l*i.f and an a wn.diD,g lip ottbc c:ompmy. 'IlK ool;y Catll'd .... ..... hrt:ltt,.... ~~ C.lsLOW» ... Of)Ml\ ... 1f,..Q ~ ..... 'III:Maa.At ~ 4tC411Q&&Uft .......... p. .&\I:~•P,Il . . . . oLM.~·III.I.~·Il.K.,_., ~C.:LC. .... .._._.I.K....._, ,_........,._.,~....,.,. I ........ ........................,....._ln.,.,_. --..............."-" 'lll ...... ~ .... ~ -~-..,. . ·--~· -2olhcor lc:fi::<......, to eligible m~ ls lit claaaC 88 of" lhc ~ 8ild Artieleo wbid! ~ inla' alia t1ua 1ile Dit"CICIJ3l'B may, ar their absOIUic diacteliOXi, Dlllb: d\stribulions of =z profit whemer = = t or rcEBilled or c:apitaJ or c:oalrilmtable smp1us 1D 'Elii!Mo PwWill or aqo 011e or more of them i:o sudiiiDWin!5 IIId ~ &S they (u. the Direclots) aba11 d"'e:mrino bur IbM lbc sball be 'PUder - o\Wgzoinn to Ulakc sudl di9Dibuliau ar liD)' time during the Hfeofthc ""'''RPIY lllld 1111 ODe ono"" Elilll"blc: , _ , flhall be l!!tl!ith:d 10 requixctlz I>im:torB (0 df1HWinc l!pOilliey cliatributian liQI"fo ~n ll:t JW: IDII!!Dt;T and. dl:ciJ;iQIIS afftle Din:elora Jdlaius 10 lbe ~ UmiDg ar reciplam. of auy Ws1ribanion tll\tfli1DinM by thl: ~ on""""' any h is a m1111r:r of CCD>pan.Y law tbaf a campllb)' ill ~illcd by im Direc1Dn till" the bc:Dcfi& of lbc sbaR:holdcts ....l it is a..ty the """"hers 'MJo wiD be able 1D Cll1brc:e lillY ri~ in 1!x: of "<"''I'*' 'Y cilba by . . _ of" lbBir abilit:)' to :EC:WD\11: and appoint Dhc:ams or ID call b !he wind!D8 up oftbc '""' 1'4W;Y ~111ldcz- a yghml:aly liquidation or lhrough aliquldalian by Diller 1DC11DS BS d 6 - ~ ln the Cmnpeni.., Ju:ts mtbc Isle: ofMml. Tbe rigla of the mnnbers ale >~~ada clear !bat iD oo tar as !he appuiunuenr ofPliglble Pei90115 Ibis llll.i1 ODiy be ~ by au ._.,;moos dccisiDD of all tbCI mnnbcn bolb 1b: gwuw mcmbczs andlbe ~ m-""rrl 111111 lbe!e ri&f1ll am e1cmty 11et OUI in thl: Mewbc:a:$ Ayeeo•... •• nu..e are 110 .rlgms wbBtloewr vested iD 1hc Eligible 1'c:rsom; and !bey will DDly be in a posilian 10 recem: 1111\Y- uf'lbe mmpany lqxm the~ by 1lle J>inLam; to tblll £ffi>ot It is QIJit.e doar ill !be Aniclcs tbu !he DDecJIJls will not be in any way obligak:dro lbc eligible~ witll fbc llllly • t••m bc:ltts oa a ~ up and ~ !ben it is lit 1bc diocn:tia:l oftlx Dil1:ciQrs as to wbidl Eligible 1'cn101l will """"""'1booc ~ • The Elipble 1'erslm. IW 110 l!l'elllllll' ri8bll 10 p&opc:sly as Ill)' Owily 'WOIIld llave wbicb il1:10t spa:ifically JIQmiilared to JCCdve money ftom a CbAriulb1e CotiiPW)' wbidl is \leing sec 11p rD make elvnjtth!e ckmllrioa& Tboso: donaliDas will wholly d"P"'"" ~ llba dceildOD ot lbe Directuts and liD cbarity will be able tD c:laim rigbss un1£,.s 1lud c:barily ~ r;p"Cifial • beiuc 1be only recopaed n:cipierll ofllle p:Clf>UIY 8Dd no disGrctian il '¥csted in lhe Dh:w 1D ~ e>lher' ri!Jaritjeo or ch81ities ot lhe type: that ill refeuod in the MtmomDdmn md Arliclcs of AsllociatiiOIL We~ are nt- opini$lu 'I1Ja lhc Eligible P£rSOD bas 110 rigbra iD pmpat~y iPid liD righ1s ID ar patliclpllte iD 'llle 'P"'MgcmN!I ot Hyt.idco. Neidlcf bas the :mlgi'ble ~ II11Y tight 10 rcc:ciwe dlstribul:iona 011t ofio • •• aad Qpita!IIXIII m Eights or iaren:ll: wbidl JXJay be tnousfi!r.oblc 10 any Vlber J'"'r.lg dJe type o!Mr:moran4'1111lllll4 ,,,pa.ay .... ~ Simct:~d:s -· - ,. :'. ~ .... i:: ~ ' ' -' .. .. ... / -3.A:rbcles as """ out by (his Act eea. to mala! gi1tB to '!hiM pjll"lic:s. We 01111 confirm 1!w in this pmicu!IIJ :Rtnanoa, 1l>e ~ lllld Arliclc:5 ot .Asooci.t!iOn do 110t haw :my re!!tlilsiom as sw:h and 1tJCJ eli:uc the ....-.rap""}' can make gjfis to third ~ who 8l'C nOt m-bers af !be \711>1J>""Y• n.: =- 0.... 8C<:DDd llspect is 'llllbedJ<,r oc UOt Hybridoo holdll. its assets lts 8CCOUdt Ott is CGIJIIideml to ht>ld iB U9Cill ill l!ll5t i:ls ~ ... :my Ellgih1e Pez:9ao_ In the 171h c:cmury tbe above r:oneepr the genenl'lliSIII' or !be ~ bllt this view ~ eMy in tbe 19th ca~tuty lllld sizlcc thell it bas rtmKi!!IPQny been W lbBt tbe !lhllrc:blllder arc not tbc ownas 111: law or In l'q1lity of tile complllly'$ ptoperty and I! !be r,nrnpany doc:s bold its psopc:~ 11p011 a triiS!. it is siUJply a tndt to IDII!>IIl;l:: the propcny in aceorda!lce wi'lh lts mod•rino> 11114 tbc m"""'- Ii8)Ds are c:uufincd to te<:eiviz!t: !be pro1ito au:ao::d by doin&,.... A ollan-'bold~h -bcr doe!; liOl IWcO hlrve m ClljDibiblc lic::o on 1hc ~ property. llimillcr 10 a poll"lliGI'a licit to f!IQ!areibc it ispropaly appJiad in ronfumritywiah 1be o111sq•~ t*" 4 '"'•Jtirm 1!1 mneb•e:iOI'l. if 1he wem'beros have ao rigbl to the propc: """uJd n:fi:r ytJu 10 1be followi~~& o;ases; Dlye _.,._nzem (t837)2Y & C E.x26S Myeas ..,_ Paip1 (1851) 20c G M &. G 599 Wmon -v- Spmtlty (1854) to l!xl;h m Bcuhmds T . . - -v- Steal BtOibctB &: Co Lid [1~1) ICh 279 _Youn fllithfblly J>AtJL 1 V DOUGfffiRIV lUTI'L P.B4 FRASER MILNER Barristers & Solicitors JOEL A. NITIKMAN DirectLine: (604)443-7115 Internet: JoeLNitilcman@FraserMilner.com October 25, I 999 VIA COURIER KPMGLLP Chartered Accountants 9th Floor, 777 Dunsmuir Street Vancouver, B.C. V7Y JK3 Attention: Barrie Philp Dear Sirs: Offshore Company You have asked for our opinion on the Canadian Federal income tax consequences of the proposed transactions described below. No person other than you may rely on this opinion without our written consent. Our opinion is based on the facts assumed; any material change in the facts may affect our opinion. Our opinion is based on the law as of the date of this opinion and on proposed changes to the law that have been announced publicly. Any material change to the law may affect our opinion. In giving this opinion we have assumed without attempting to verifY that the opinion given by Simcocks to you dated 3 I" August !999, a copy of which you delivered to us on October 22, I 999 is and will remain correct at all times relevant to this opinion. A mistake in Simcocks' opinion or a material change in the law referred to therein may affect our opinion. 1.0 Assumed Facts For purposes of this opinion we have assumed only the following facts: 15 111 Floor, Thr: Grosv~hor Building, 1040 West Georgia Street, Vancouvrr, B.C., Canada V6E 4H8 Telephone {6041687-4460 Fu (604)68)-5214 www.frasermilner.com Vancouver Calgary Edmonton Toronto Ottawa ----- FRASER MILNER 1.1 Page2 Mr. Smith is a hypothetical Canadian resident for purposes of the Income Tax Act (Canada) (the "Act"). 1.2 Mr. Smith has a significant sum of money at his disposal. 1.3 Mr. Smith has a spouse and children (and possibly other relatives) resident in Canada. 1.4 Mr. Smith is engaged in various businesses and other pursuits in respect of which he could incur liabilities. 1.5 Mr. Smith is interested in protecting his assets from such potential liabilities. In addition, he is interested in passing on his accumulated wealth to his spouse and children without paying probate fees. If possible, but not as a sine qua non of any potential transaction, Mr. Smith is interested in saving income tax on the interest and other returns currently generated by the sum of money. 1.6 Mr. Jones is a non-resident of Canada for purposes of the Act who is known to Mr. Smith. 1.7 The Isle of Man allows for the creation of a "hybrid" company, the details of which are described below. A hybrid company allows for the existence of both shareholder members and non-shareholder members. 2.0 Proposed Transactions 2.1 KPMG's affiliated company in the Isle of Man ("KPMGIM"), together with a company controlled by Isle of Man legal counsel ("Simcocks"), will create a hybrid corporation ("Offshore Company"). 2.2 Offshore Company's Memorandum and Articles of Association will be essentially the same as the draft Memorandum and Articles you sent to us on October 22, 1999. ~ FRASER MILNER Page 3 -· 2.3 KPMGIM and Simcocks will be equal shareholders of Offshore Company; Jones will be the sole non-shareholder member of Offshore Company. The shareholders and Jones are collectively the "Members" of Offshore Company. 2.4 The Members and Offshore Company will enter into a Members Agreement essentially the same as the draft Members Agreement you sent us on October 22, 1999: 2.5 Mr. Smith will make a gift of money to Offshore Company under a Deed of Gift essentially the same as the Deed you sent to us on October 22, 1999. 2.6 Under the Articles the Members have the right to appoint certain persons ("Eligible Persons") to receive funds from Offshore Company. Although not bound to do so, we assume the Members will appoint Mr. Smith, his spouse and/or children and possible Mr. Smith's other relatives as Eligible Persons. Jones may consult with Mr. Smith from time to time as to whether the Eligible Persons should be changed, but such consultations will not be binding on the Members or Jones. 2.7 From time to time, as permitted by the Articles, the Members may pay out or lend funds from Offshore Company's capital or income to Eligible Persons. Under the Articles, any surplus remaining after repaying the Members their original capital must go to the Eligible Persons in the amounts agreed to by the Members or, in case of disagreement, in the amounts determined by an arbitrator as provided for in the Articles. Opinion 3.0 Residency of Offshore Company for purposes of the Act 3.1 For purposes of the Act a corporation will be resident in Canada only if (a) it is deemed under various provisions of the Act to be resident in Canada or (b) its "mind and management" is in Canada. None of the deeming provisions apply to Offshore Company. 3.2 Under the mind and management test, a corporation will be resident where its "central management and control" is exercised. Ordinarily this will be where its board of directors meets and exercises the powers of the board, but this is a question of fact and it may be that in a given situation the central management is exercised by someone other than the board. ----- FRASER MILNER 3.3 Page 4 The Articles requtre Offshore Company's board to meet outside Canada. Assuming that the board will never meet in Canada and that the Members are not merely agents for Mr. Smith who is the true directing mind of Offshore Company (this is discussed further below), our opinion is that Offshore Company will not be a resident of Canada for purposes of the Act. 3.4 In this part of our opm10n we have assumed that Offshore Company is a "corporation" for purposes of the Act. Subsection 248(1) defines a "corporation" as including an incorporated company". The case law indicates that in determining how a foreign entity should be classified for purposes of the Act, regard should be had to (a) the characteristics of the foreign entity under foreign law and (b) how those characteristics would be classified under Canadian law 1• Revenue Canada appears to take the same approach. Paragraph 2 of IT -343R states: 2. A corporation is an entity created by law having a legal personality and existence separate and distinct from the personality and existence of those who caused its creation or those who own it A corporation possesses its own capacity to acquire rights and to assume liabilities, and any rights acquired or liabilities assumed by it are not lhe rights or liabilities of those who control or own it. As long as an entity bas such separate identity and existence, the Deparunent will consider such entity to be a corporation even !hough under some circumstances or for some purposes !he law may ignore some facet of its separate existence or identity. 3.5 Revenue Canada has applied this paragraph to determine that a number of foreign entities are corporations for purposes of the Act, even if their members have liability for the obligations of the corporation2 . 3.6 Based on our understanding of the characteristics of Offshore Company from Simcocks' opinion (separate entity under Isle of Man law with separate capacity) it is our view that Offshore Company will be viewed as a corporation for purposes of the Act. Spire Freezers Limited v. The Quee!), 99 DTC 5297 (FCA); Backman v. The Queen, 99 DTC 5602 (FCA). also Memec pic v. Inland Revenue Commissioners, (1998] STC 75 (CA), where the UK Court of Appeal applied lhe same melhodology to detennine the nature of a German entity for UK tax purposes. 2 e.g. Teclmical Interpretations #9503045 (Dutch BY) and #9408!95 (Nova Scotia Unlimited Liability Corporation). ----- FRASER MILNER Page 5 4.0 Foreign affiliate status 4.1 Under the Act a shareholder m respect of whom a foreign corporation IS a controlled foreign affiliate ("CFA") must include in income for each year his pro rata portion of the foreign accrual property income ("F APr') earned by the corporation that year. 4.2 Taking together the definitions in the Act of CF A, foreign affiliate and equity percentage, a CFA in respect of a particular person is a corporation that is not resident in Canada· in which that person owns directly at least 1% of the shares of that corporation, persons related to that person own at least I 0% of the shares of that corporation and that persons or certain other non-arm's length persons own at least 51% of the voting shares of that corporation. 4.3 In our opinion no Eligible Person will own shares in Offshore Company merely by reason of being an Eligible Person. Hence Offshore Company cannot be a CFA in respect of any Eligible Person. Further, assuming the Members are not agents for Mr. Smith, as discussed - below, Mr. Smith will not own shares in Offshore Company and hence Offshore Company cannot be a CFA in respect of Mr. Smith. 4.4 The general rule is that any definition in the Act prevails over a common law definition, but in the absence of a definition in the Act a court will apply a common law definition. 4.5 The Act defines a "share" as follows: "share" means a share or fraction of a share of U1e capital stock of a corporation and. for grealer cenainty, a share of the capital stock of a corporation includes a share of the capital of a cooperative corporation (witltin the meaning assigned by subsection 136(2)) and a share of the capital of a credit union. 4.6 The Act further defines a "shareholder" to include "a member or other person a entitled to receive payment of dividend". 4.7 Thus, for purposes of the Act a person owns a "share" if he is entitled to an aliquot portion of the capital stock of a corporation, especially if he is entitled to dividends. - ------------- FRASER MILNER 4.8 Page 6 These definitions in essence mirror the common law definitions. In K. J. Beamish Construction Co. Limited v. MNR3 the Court defined a "share" as follows: "A share is intangible property, a chose in action, a relationsbip between the shareholder and the company involving rights and duties": Thorson P., Bratm v. The Custodian, [1944] Ex. C.R 30 at p. 40. See also Palmer's Company Law, 23rd (1982) ed. at p. 384: A share in a company is the ex]Jression of a propriet.aJy relationship: the shareholder is the proportionate owner of the company but be does not own the company's assets which belong to the company as a separate and independent legal entity. 4.9 As noted above, a "shareholder" is defined by the Act to include a person who is entitled to dividends. Dividends have been defined as follows 4 : According to the Oxford Dictionary, a dividend is the sum payable as the ,Profits of a joint stock company and received by an tmdivided holder as his share . 4.10 - Thus, just as a share is a portion of the capital stock of the corporation, a dividend is a share of the profits of that corporation. 4.11 The Articles make it clear that no Eligible Person has a right to receive a dividend nor does any Eligible Person have a legal or equitable interest in the capital stock of the corporation. Accordingly, in our view an Eligible Person per se is not a shareholder for purposes of the Act and hence Offshore Company cannot be a CFA in respect of such a Person. 5.0 Trust status 5.1 Certain unfavourable tax rules apply to Canadian residents who set up nonCanadian trusts for their Canadian relatives. Although in form Offshore Company IS a corporation, it is not inconceivable for Revenue Canada to argue that it is really a trust. 90 DTC 1584 (fCC) at 1596. 4 Dupuis Freres Limited v. The Minister of Customs and Excise, I DTC I 04 (Ex. Ct.), followed on this point in Moose Jaw Flying Club Ltd. v. MNR 49 DTC 655 (Ex. Ct.) at 661. ' for a similar definition Revenue Canada Technical Interpretation #5-7819, September 5, 1989, sununarized in Access to Canadian Income T!IJ(. Vol. 2, 89 RCT 49. --------- FRASER MILNER Page 7 The Act does not define a trust. The case law 6 in Canada accepts that a trust is: 5.2 ... an equitable obligation, binding a person (who is called a trustee) to deal with property over which he has control (which is called trust property), for the benefit of persons (who are caUed the beneficiaries or cestuis que trust), of whom he may himself be one, and any of whom may enforce the obligation. 5.3 which A trust is a method of conveying property, as opposed to an agency relationship, JS a contractual agreement whereby one person has the right to enter into legal relationships with third parties that are binding on another person in law. In our view the Articles make it clear that no Eligible Person has any right to 5.4 demand any portion of Offshore Company's capital or surplus, nor does any Eligible Person have any right to remain as an Eligible Person, nor does any Eligible Person have any right to demand that the directors or Members look after the interests of that Person. To put it another way, none of the directors or the Members appear to have any fiduciary duty to the Eligible - Persons. In these circumstances Offshore Company cannot be a trust 6.0 7 . Partnership Status 6.I For purposes of the Act a partnership is a relationship between or among two or more persons carried on with a reasonable expectation of profits. Where some entity other than the partners carry on the business it cannot be a partnership. In this case, any business is carried on by Offshore Company and hence there cannot be partnership among the Members. In any case, if Offshore Company were a partnership the Eligible Persons could not be partners as they have no right to share any profits of the business and no obligation to contribute to the losses of the business9 6 Markovzki v. The Ouee!!. 98 DTC 2040 (TCC). The existence of a fiduciary duty is the core of a trust relationship without which no trust can exist. the series of articles by David Hayton at [1992] JTCP 3, [ 1996] JTCP 3 and [1999] JTCP 67, esp. at footnote I. • 9 Spire Freezers Ltd., B!P!l!- In so stating we assume that partnership law in the Isle of Man is essentially similar to partnership law in Canada. -------- FRASER MILNER Page 8 7.0 Section 94.1 10 7.1 Under section 94.1 a person who "holds or has an interest in" an offshore investment fund property may be required to include in income an amount equal to a prescribed interest rate times the cost of the property. Paragraph 94.l(l)(a) requires that the interest be a share, a debt or an "interest" in the offshore entity. The Eligible Person will not, for the reasons expressed above, have a share of Offshore Company. They will not own any debt of Offshore Company. A debt requires the obligation to repay 11 and here there is none. Therefore, the issue is whether an Eligible Person will have an "interest" in Offshore Company. 7.2 The word "interest" in not defined for this purpose and we can find no Revenue Canada publication on point. In our view "interest" in this context means a right enforcable in a court of law of equity 12 . We understand from Simcocks' opinion that this is not true under the law of the Isle of Man in respect of an Eligible Person, and hence in our view section 94.1 cannot apply to the Eligible Personsn 8.0 Nature of the Distribution from Offshore Company to Eligible Persons 8.1 It follows from our analysis above, which concludes that an Eligible Person has no legal or equitable interest in Offshore Company, that a payment from Offshore Company to an Eligible Person is essentially a gift 14 We assume from Simcocks' opinion that Offshore 10 II The February 1999 Federal Budget proposes to amend section 94.1. No draft legislation has been released to date. Based on the Budget proposals we expect that the requirement to have an "interest" in the off· shore investment fund will continue and hence the following analysis should apply even to the amended 94.1. However, no assurance in this regard can be given until draft legislation is released. Loman Warehousing Ltd. v. The Oueen,Jl999]4 ere 2049 (fCC). " Black's Law Dictionary (7"' ed. 1999) "interest"; MNR v. Canada Trust Co., 71 DTC 5041 (Ex. Ct.) at 5045; Flintoft v. MNR 5 I DTC 505 (ex. Ct.) at 508-9. An interest is not merely some possible advantage that might be derived from Offshore Company. Supermarche Ste-Croix Inc. v. The Queen (1997), 212 N.R. 250 (FCA). ll It follows from this conclusion that an Eligible Person does not own "property" for purposes of section 9 of the Act. I< For purposes of the Act a gift is a voluntary transfer of property made without expectation or right to receive consideration in return. That appears to be tlte case here, as Offshore Company will not receive any consideration and has no right to receive any consideration from an Eligible Person, nor does Offshore Company have any obligation to pay tlte funds to any Eligible Person. -------------- FRASER MILNER Page 9 Company is not prohibited from making such a gift under Isle of Man law. The issue here is the nature of the gift to Eligible Persons for purposes of the Act. 8.2 The gift, in our view, is not income to an Eligible Person for purposes of the Act. Section 3 outlines various sources of income under the Act. Apart from section 3 sources, specific income inclusions are required by various other provisions, but none apply here. Under section 3 the gift is not income from any of the listed sources (business, employment, property or capital gains). Section 3 also provides for a generic source concept. However, to come within that concept the taxpayer (here the Eligible Person) must have done something to earn the income 1s. Here, any payment is entirely voluntary on Offshore Company's part and no Eligible Person has any right to receive or expectation of receiving any amount. Hence, the gift is not mcome. 9.0 Attribution 9.1 Under the attribution rules in the Act, a taxpayer who transfers property to a spouse or children under 18 must include in his income any income earned by the transferee from the property. 9.2 In our view the attribution rules could potentially apply because the transfer by Mr. Smith to Offshore Company probably comes within the words "directly or indirectly, in any manner whatever 16". However. as the Eligible Persons are not earning "income" from Offshore Company there is nothing to attribute to Mr. Smith. 9.3 The corporate attribution rule in subsection 74.4 cannot apply because the Eligible Persons are not shareholders. 10.0 Miscellaneous Anti-Avoidance Rules 10.1 In our view subsection 56(2) will not apply to the proposed transactions. Any payment by Offshore Company to Mr. Smith would not be income for the reasons set out above, and hence cannot be caught by the last condition of paragraph 56(2). 15 " Frank Beban Logging Ltd. v. The Queen, 98 DTC 1393 (fCC). Riverin v. The Ouee!!. 99 DTC 5356 (FCA). --------- FRASER MILNER Page 10 -10.2 Subsection 56(4) will not apply because Mr. Smith has gifted the capital of the money to Offshore Company and not just the right to the income from that capital 17 10.3 Except as discussed below, subsection 56(4.1) will not apply because the proposed transactions do not result in any indebtedness. 10.4 Subsection 246(1) provides that if one person (Mr. Smith) confers a benefit on a taxpayer directly or indirectly, in any manner whatever, then the amount of the benefit is included in the taxpayer's income if it would have been included had the person paid the amount directly to the taxpayer. 10.5 A payment directly by Mr. Smith of the principal of the money gifted to Offshore Company to the Eligible Persons would not have been included in their incomes, because gifts are not income. Similarly, any interest or other returns earned by Mr. Smith on the principal would be taxed in his hands, not the Eligible Persons', and hence any gifts of such returns would not be income to the recipient. Therefore, in our opinion a gift by Offshore Company to an Eligible Person of either capital or income will not be caught by subsection 246(1). 11.0 Agency 11.1 If the Members or Offshore Company were the agents of Mr. Smith, then Mr. Smith would be seen as owning shares in Offshore Company or as earning directly the income earned by Offshore Company. 11.2 As stated above, an agency relationship is an express or implied contractual agreement between a principal and an agent whereby the agent is entitled to enter into contracts that are legally binding on the principal. There is no express agency in the proposed transactions; the issue is whether such an agreement is implied. 11 ._,_, MFC Bancoro Limited v. 11Je Oueel!. WJTeponed, August 18, I 999, TCC. ------- FRASER MILNER - 11.3 Page II In our opm10n no implied agency would exist m this case. First, based on Simcocks' opinion it appears that Offshore Company and not Mr. Smith will own its assets in its own right. Second, we assume that none of Offshore Company, its Members or its directors will hold themselves out to anyone as acting as an agent for Mr. Smith. Third, Mr. Smith is not at risk for any obligations owed by Offshore Company, its Members or directors. These three facts demonstrate that Mr. Smith is not the principal in any agency relationship involving Offshore Company, its Members or directors 18 . 12.0 Status of the Gift 12.1· In our view the gift by Mr. Smith to Offshore Company will be a true gift in law. This issue was considered in Jabs Construction Ltd. v. The Oueen 19 Jabs was a successful owner of commercial real estate. It was controlled by Mr. Jabs. He and his wife also incorporated Felsen, a registered private charitable foundation. Mr. Jabs, his wife, and his adult children were also the directors ofFelsen. 12.2 Following the settlement of litigation between Jabs and a third party, Callahan, it was determined that a 50"/o interest in 13 ofJabs' properties ("the Properties") was to be sold by it to Callahan. To do this. Jabs gifted its interest in the properties to Felsen and elected to make the transfer for proceeds of disposition equal to the Properties' ACB, under subsection II 0.1 (3) of the Act. Felsen then sold the Properties to Callahan. The resulting ·capital gain escaped tax in Felsen's hands as a registered charity. 12.3 There was no suggestion that any of the steps taken in the said senes of transactions were shams. They created genuine legal relationships. Hence, in the Court's view, the deeds of gift were effective to convey the beneficial interest in the properties to Felsen. 12.4 Applying this reasoning to Mr. Smith, assuming the Deed of Gift is carried out according to its terms, and that Mr. Smith receives no tangible benefit in return for the gift, in " The Queen v. Glengarrv Bingo Association. 99 GTC 7101 (FCA); Evergreen Forestrv SeiVices Ltd. v. The ~ 99 GTC 3130 (fCC). 19 99 DTC 729 (fCC). ------------ FRASER MILNER Page 12 our view the gift will be viewed as a true gift in law, that is, an irrevocable gift notwithstanding it can be paid to the donor or his family. 13.0 Loans to Eligible Persons 13.1 Offshore Company's Articles allow Offshore Company to lend money to Eligible Persons. Certain provisions of the Act20 refer to a taxpayer (Mr. Smith) making a loan to another person "directly or indirectly, in any manner whatever". Given the broad meaning attributed to those words in Riverin, supra, our view is that a loan from Offshore Company to an Eligible Person would be caught by those provisions. To prevent income from the loans from being imputed to or attributed to Mr. Smith, the loans would have to carry a prescribed interest rate and such interest would actually have to be paid to Offshore Company. 14.0 14.1 Reporting The Act contains a number of rules 21 that require Canadian residents to report the creation of non-Canadian entities, the holding of non-Canadian assets, distributions from nonCanadian trusts and transactions with non-Canadian non-arm's length persons. 14.2 pnder the new reporting rules, the following taxpayers must file information returns: Canadians or their corporations who have contributed property to an offshore trust (section 233.2, form Tll41); Canadians who own property situated outside Canada with a cost of more than $100,000 (section 233.3. form TI 135); taxpayers who own interests in corporate or trust foreign affiliates (section 233.4, form Tl 134); and taxpayers who have received distributions of property from or become indebted to a non-resident trust (section 233.5, form Tl142). 14.3 Based on our conclusion that no Eligible Person has any interest in Offshore Company and our conclusion that Offshore Company is not a foreign affiliate in respect of any such Persons nor could it be considered a trust or partnership, it is our opinion that neither Mr. Smith nor an Eligible Person is subject to any reporting under sections 233.1-233.7 of the Act in respect of the creation of or a distribution from Offshore Company. 20 Notably section 94.1, subsection 56(4.1) and the attribution rules. 21 Sections 233.1-233.7. ~ FRASER MILNER Page 13 15.0 GAAR 15.1 Section 245 of the Act (the General Anti-Avoidance Rule or GAAR) allows a court to determine the tax consequences of a series of transactions or of one or more transactions within a series in the manner that is reasonable to eliminate the "tax benefit" created by the series or those transactions, where the transactions are "avoidance transactions." This rule does not apply if there has been no misuse of any particular provision of the Act and no abuse having regard to the Act read as a whole. 15.2 A "tax benefit" is essentially the tax avoided by the transactions. While the courts have acknowledged that in some situations it may be difficult to determine the quantum of the tax benefit 22 , in our view a court would likely determine the tax benefit in Offshore Company's case to be the tax not paid by Mr. Smith on the investment income earned by Offshore Company on the money gifted to it by Mr. Smith. ...• ...,- 15.3 An avoidance transaction is one that is carried out primarily to obtain the tax benefit. This definition implicitly acknowledges that transactions may result in favourable tax consequences without being caught by GAAR 23 Only those transactions that are undertaken primarily to obtain the tax benefit are caught by GAAR. 15.4 The definition of an avoidance transaction speaks to the objective intention of the 4 taxpaye~ . That is, a court will determine his intent by reference to the natural consequences of 22 McNichol v. TI1e Queell. 97 DTC Ill (TCC). Husky Oil Limited v. The Quee!!, 99 DTC 308 (TCC). " ln OSFC v. The Queen. discussed below, the Court said: ln the present context (of GAAR]. then, the onus on tl1e (taxpayer] is to produce an explanation which is objectively reasonable thai tl1e primary purpose for the series of transactions was sometlling other tll31l to obtain the tax benefit. · This requires that I exanline the subjective evidence of (the taxpayer] against the more objective backdrop of the documents ... and common sense. Thus, a taxpayer's testimony is not irrelevant but tl1e imputed intention discerned from the documents and "common sense" will be given more weight. . ----- FRASER MILNER Page 14 his actions viewed objectively. If his actions naturally tend to create a given result, a court will infer that he intended that result to occur. 15.5 A variety of possible purposes can be imputed to Mr. Smith when he makes the gift to Offshore Company: the wish to avoid probate taxes; the need to protect against future creditors; the ability to avoid dependents' relief legislation 2s; the desire for anonymity; the possibility of avoiding the Divorce Act (Canada) and similar Provincial legislation. In addition, of course, is the possibility of avoiding tax on Offshore Company's investment income. Revenue Canada will naturally tend to view the latter purpose as Mr. Smith's primary purpose, but it appears to us that each of the former purposes is equally the natural and probable result of gifting money to Offshore Company. Hence, such a gift implies that Mr. Srnith has all such purposes equally and does not point more to tax avoidance than any other suggested purpose. 15.6 Furthermore, while it might be possible to view a transaction where a person retains control over money but avoids tax on its income as an avoidance transaction, it seems much more difficult to view a transaction where the corpus of the money is given away as a transaction designed to avoid tax. It would seem that the primary purpose is to give away the money. The fact that this avoids tax on any income the cash might have earned seems to be a by-product of the gift rather than its purpose. This point was essentially made in Jabs26 where the Court noted that if that case resulted in an avoidance transaction then every gift to charity of appreciated property would be an avoidance transaction. In our view, therefore, it is not impossible that a court would accept that Mr. Smith's primary purpose in gifting money to Offshore Company was not to obtain the tax benefit. Whether it would in fact so accept this would depend on the individual facts of each case27 . 15.7 GAAR states that it will not apply if there is no misuse or abuse. Although there have now been several decisions on GAAR, this phrase has not been defined with any precision. In McNichol, supra, the Court held that subsection 245(4): " " That is, legislation that allows children or other dependents to attack one's last Will. 21 Furthermore, of course, there is no cenainty Offshore Company will earn any income from the invested funds. Jabs Construction Ltd. v. The Quee!!, 99 DTC 729 (TCC). --------- FRASER MILNER Page 15 must have been intended to make allowance for transactions which the legislature sought to encourage by the creation of tax benefit or incentive provisions or which., for other reasons, do no violence to the Ac~ read as a whole. It is evident from section 245 as a whole and paragraph 245(5)(c) in particular that the section is intended inter alia to counteract transactions which do violence to the Act by taking advantage of a divergence between the effect of the transaction, viewed realistically, and wha~ having regard only to the legal form appears to be the effect. 15.8 These words were essentially adopted by the Court in RMM 28 , although by contrast the Court there stated: "To take advantage of such provisions and to enjoy the tax benefits they provide does not constitute a misuse of the provisions of the Act." 15.9 In Nadeau v. The Oueen 29 the Court interpreted subsection 245(4) as meanmg that: "any transaction or series of transactions designed to achieve indirectly what the Act does not permit an individual to do directly is an abuse of the Act." 15.10 In Jabs, supra, the Court said of subsection 245(4): I fail to see how the use of a specific provision of the Act that allows the tax consequences of a charitable gift to be mitigated can by any stretch of the imagination be a misuse of the provisions of the Act or an abuse within the meaning of subsection 245(4 ). It is simply a use of a provision of the Act - not a misuse or abuse -for the very purpose for which it was designed30 Section 245 is an extreme sanction. It should not be used routinely every time the Minister gets upset just because a taxpayer structures a transaction in a tax effective way. or does not structure it in a manner thai maximizes the taX. 28 RMM Canadian Enterprises Inc. v. The Queen, 97 DTC 302 (TCC). 29 99 DTC 324 (TCC) (French version). 30 A similar comment was made in SheU Oil Limited v. TI1e Queen, unreported, October 15, 1999, SCC. Although this case was decided under old section 245, the Court held that using paragraph 20(J)(c) for the . purpose for which it was intended could not offend the object and spirit of that provision. ------------ FRASER MILNER Page 16 -15.11 In OSFC31 , the Court said: Counsel for the Appellanl argues !hal subsection 18(13) is not misused in this case, because the resull for which he conlends is the very result that the subsection dictates in the circumstances, Thai will always be the case when a section of the Act is put to a use for which il was not intended in funherance of an avoidimce transaction, or a series of avoidance transactions. That unintended application of the section is the very mischief at which GAAR is aimed. 15.12 Furthermore, in that case the Court discerned an abuse of the Act read as whole because the Act does not sanction the transfer of losses to arm's length parties and that was what was achieved by the taxpayer. 15.13 This review of the decided cases on subsection 245(4) does not produce any clear interpretation of that provision. 15.14 In our view, the proposed transactions do not take advantage of any particular provision of the Act but rather avoids various provisions. Therefore, the only issue is whether - there has been an abuse having regard to the Act read as a whole. 15.15 The underlying purpose of the Act as far as income splitting through gifts is concerned appears to be that if the corpus of the property is gifted at the same time as the income from the property, then no attribution will apply (subsection 56(4.1)). but if the donor somehow retains control, directly or indirectly, over the gifted property the!} attribution will apply (see the attribution rules, the F API rules and the off-shore trust rules 32 ). In our view, once it is accepted 31 32 OSFC Holdings Limiled v. The Ouee!!, [1999) 3 CTC 2649 (TCC). The February 1999 Budget proposes to change the basis of paragraph 94(1)(c) from a test of control over propeny (through having relaled beneficiaries in Canada) to a test based on the residency of the donor. However, in our view the proposed gift lo Offshore Company does no1 abuse any policy behind the new test. The Act contains separate rules for off-shore corporations and trusts. The Act defines a trust to be a corporation or vice-versa only in Iimiled circumstances ( curren1 paragraph 94(l)(d), which we assume will be repealed under the Budget amendmeniS, and subseclion 149(5)). Thus, when a taxpayer chooses a corporation there is no policy thai would allow Revenue Canada or a court to treat him as if he bad chosen a trust. Although the proposed transactions avoid the FAPI rules, we do nol Ulink it would be an abuse to choose a corporation rather than a trust thai ntighl bave been subject to the amended 94(1)(c). As the Supreme Coun said in Shell, "a laXp8yer is entitled to be !axed based on what it actually did, not based on wbal it could bave done, and certainly not based on what a less sophisticated taxpayer might bave done." ----------- FRASER MILNER Page 17 that the gift is a true gift, that Mr. Smith does not control Offshore Company and that the Members are not Mr. Smith's agents, then there has been no abuse because he has gifted the property away without retaining control over it. In these circumstances there should be no reason for a court to attribute to Mr. Smith any income from the gifted property. Yours truly, FRASER MILI)IER _:jan 115-14399-100-01 ·- cc: Howard Kellough Private & Confidential Mr. [and Mrs.] , 1999 Dear [Asset Protection] [Estate] [Philanthropic] Planning Further to our recent discussions, this Jetter sets out the terms of our engagement to provide advice and assistance with respect to [creating a sound asset protection structure] [estate planning] [carrying out an estate freeze and creating an appropriate ownership structure for Inc.("_")] [restructuring the _ _ family trust][creating an your interests in efficient philanthropic structure]. Facts and Assumptions Our understanding of the facts is and our assumptions are as follows: 1. You are and each of your family members is a resident of Canada. 2. [_is a Canadian controlled private corporation which acts as a holding company for the shares of a number of Canadian and non-Canadian companies engaged in the business of _ _.] 3. [Recently, a block of the common shares of_ was sold at arm's length for a price of C$0._ per share ("the __ transaction"). You believe that this transaction establishes objective evidence of the value of the shares of_ at this time.) 4. Our Understanding of Your Requirements You are primarily concerned with [asset protection[, including protection from community of property laws]] [estate planning, including avoiding challenges to your will, minimizing probate fees, estate and death taxes and avoiding forced heirship). You wish to [establish an offshore company that has the flexibility to invest and carry on business for the longterm benefit of your family/charity) [freeze the value of your present interests in_ at the transaction, with the growth shares in_ to be held current value based on the 09199-0ffshore Company-Engage Ltr Page 2 for the long-term benefit of your family /charity], and achieve your [asset protection] [estate planning] [philanthropic] objectives. Your decision whether to proceed with the structure should be independent of any potential tax benefits. We have given preliminary verbal advice that a vehicle that would achieve your objectives is an Isle of Man corporation with liabilities limited by guarantee and which may make gifts to non-shareholders that we call an "Offshore Company". [The growth shares of_ would be held by the Offshore Company through a Barbados structure that we will recommend.] We understand that you will require [us to retain Fraser Milner, Barristers & Solicitors] our advice [to obtain their opinion] in writing with respect to how the Offshore Company will function and its efficacy with respect to your [asset protection] [estate planning] [philanthropic] objectives. In addition, you will require our [Fraser Milner's] advice with respect to the Canadian tax implications of such a structure. You also will require full implementation assistance, including the assistance of our Isle of Man [and Barbados] firm[s] in incorporating the company[ies] necessary to accomplish the plan objectives, as well as attendance to all of the required filings to obtain incorporation and tax exempt status in the Isle of Man [and in Barbados and an exchange control exemption in Barbados]. We will also provide all other necessary assistance to implement the structure [excluding any legal assistance that you may require to effect the freeze/reorganization of ]. ____ [We understand that you will engage Mr. to incorporate a new Canadian holding company, draft purchase and sale agreements with respect to transfers of shares and attend to any other legal requirements that will be required to accomplish the freeze at the Canadian level. We will review these documents and advise with respect to their effectiveness to accomplish the plan objectives, but we will not be responsible for Mr. ___ services or fees.] Confidentiality The plan that we will propose to you, and the supporting analysis, is proprietary to KPMG Canada. It is in the best interests of yourself and other clients with whom we have shared this analysis that information about this approach be kept confidential. If you choose to engage us, you will be bound by acceptance of this agreement to maintain this confidentiality and will be required to execute a separate confidentiality agreement setting out your undertakings in this regard. Page3 The incorporating documents and complementary agreements will be drawn by Isle of Man and Barbados legal counsel whom we have retained. No other legal counsel or other professional advisor [except Fraser Milner, as set out above] is to be informed or consulted with respect to these arrangements. Timing We will proceed with this engagement immediately upon receipt of a signed copy of this engagement letter and the retainer set out below. We expect that the main components of the structure should be capable of being put in place within the next two to three weeks, barring any unforeseen impediments. Fees and Other Costs Our fees for the advisory services set out above and implementation of our recommendations, including fees and charges of our other offices [and Fraser Milner], will be C$[100,000] [115,000] [122,500]. This includes all set-up costs, plus the minimum annual director, corporate secretarial services, license and registered office fees for the Isle of Man] [and Barbados]. It should be anticipated that a minimum annual retainer after the first year of at least £_ _ for Isle of Man services [and US$6,600 for Barbados services] will be required for two directors in the Isle of Man [and a director for the two Barbados companies] and the annual license, registered office and corporate and secretarial services in each year after the first year's fees (included above for the first year). These are minimums. Actual charges will depend upon the nature and the extent of the services that the Offshore Company [and its subsidiaries] require, as agreed with the directors of the Offshore Company from time to time. Payment We require a retainer of $50,000 before proceeding with this work and the balance will be due and payable immediately upon completion of the incorporation of the Offshore Company [and the Barbados subsidiaries]. Accounts unpaid for more than thirty days will bear interest from the overdue date at the rate of 1.25% per month, calculated and compounded monthly (16.08% per annum), or such other amount of interest as the finn may advise. Our fees are exclusive of GST. GST is applied to all invoices for fees and expenses related to professional services rendered, unless such services are rendered to non-resident persons. We understand that our fees are to be billed to the Offshore Company as we understand that you are engaging us on behalf of the Offshore Company to Page4 be formed. However, in the event that the Offshore Company fails to pay our accounts when rendered, or our fees are found to be subject to GST, you agree to be responsible for any such unpaid fees or GST. The structure that will be proposed will be designed primarily to achieve your [asset protection] [estate planning) [philanthropic] objectives. The structure that will be proposed will be designed taking account of the provisions of the Income Tax Act, Canada ("the Act") as they exist today, and will also take account of proposed legislation and administrative practices that are publicly known today. We [Fraser Milner] cannot be responsible for changes in the law at a later date, and accept no responsibility for assuring that the proposed arrangements will continue to work as contemplated at this time. There may be tax benefits associated with the structure that will be proposed. Under the general anti-avoidance rule ("GAAR") of the Act, transactions undertaken for the primary purpose of obtaining a tax benefit may be re-characterized to deny the tax benefit, unless it can be shown that the transactions do not result in a misuse of particular provisions of the Act or an abuse of the provisions of the Act read as a whole. In light of the limited case law with respect to GAAR, it is not likely that we [Fraser Milner] will be able to provide a firm opinion that GAAR will not apply. There may be other tax risks associated with the proposed structure, including the possibility that the Offshore Company could be found to be resident in Canada or that other persons could be found to be acting as a trustee or your agent or nominee, which depend upon how the affairs of the Offshore Company are conducted. We [Fraser Milner] will provide technical analysis and practical guidance with respect to these issues in the planning memorandum, but we [Fraser Milner] cannot control how the parties to the arrangement conduct themselves after implementation, nor guarantee how such conduct will be interpreted by a court in Canada. The Offshore Company is intended to be independently managed by its board of directors. Any contribution that you make to the Offshore Company will be an unconditional, irrevocable and absolute gift and will give you no rights to direct or control its disposition or the affairs of the Offshore Company. Nor will the members, directors or officers of the Offshore Company owe any duty to you. Their duty will arise strictly from the Memorandum and Articles of the Offshore Company. Although as a founder of the Offshore Company the members and directors may be interested in your wishes and may PageS consult with you as to the conduct of the affairs of the Offshore Company, they will be under no obligation to do so. Liability Limitation KPMG is a registered Limited Liability Partnership ("LLP") established under the Jaws of the Province of Ontario. The Firm is a partnership, but its partners have a degree of limited liability. A partner is not personally liable for any debts, obligations or liabilities of the LLP that arise from a negligent act or omission by another partner or any person under that other partner's direct supervision or control. The legislation does not, however, reduce or limit the liability of the Firm. All the Firm's assets and insurance protection remain at risk. The Firm's insurance exceeds the mandatory professional indemnity insurance requirements established by the various Institutes/Ordre of Chartered Accountants. In addition, all partners of the LLP remain personally liable for their own actions and/or the actions of those who they directly supervise or control. Of course, the Firm and all its resources stand fully behind the work of all of its partners and employees. If you are in agreement with the terms of engagement set out above and wish us to proceed, please sign below on both copies of this letter and return one signed copy to us. Yours truly, Barrie M. Philp Partner, International Tax (604) 69/-3383 ******* Agreement on Tax Services [On behalf of and as authorized agent for all of the addressees above,) I hereby engage KPMG to [retain and instruct Fraser Milner as set out above and] provide advisory and implementation services in accordance with the terms set out above. Signed Date Overtype name, date and headingAfter Dear - insert addressees name. Do not delete Our Ref - insert reference at next tab. Your Ref - insert reference at next tab OR delete if you do not have one to insert.KPKk KPMG Isle of Man - Engagement Letter to Offshore Companies IF KPMG directors, add company name to mR company schedule If this standard is changed, new global engagement letter will need to be issued WThe Directors{PRIVATE } [line 8) •Company name and address •• Your ref Our ref • • fs/11 .Oate [line 16) Dear Sirs [line 20] •Company name We are writing to set out the services which you have requested we provide to you, and the respective rights and obligations which you and we shall have in connection with our engagement as administrators of the above company[ies]. Please read the terms of this engagement letter carefully. If you have any questions or disagree with anything in this letter please contact us immediately. Services We will provide the following services: • Provision of registered office Compliance with statutory company secretarial requirements including maintenance of statutory records, Annual Return, AGM, and application for and maintenance of required tax status 1 Other company secretarial matters which may arise from time to time I Maintenance of accounting records I Preparation of financial statements 1 Application for VAT registration and ongoing compliance I General administration of the company's affairs 1 Audit of financial statements* I Preparation and submission of tax returns* 1 09 J 99~0ffshore Company~ KPMG Isle of Man. Engagement Letter Page 2 • • Taxation advice* Other (specify) '*The terms and conditions in respect of•tax advice, audit work and ongoing tax compliance will be covered by a separate engagement letter. Incidental Investment Business Senices We may in the course of the other professional services set out in this engagement letter, advise you on the acquisition and disposal of investments. As a matter of policy, we do not give Investment Advice other than as to the claSs or type of investment (eg, gilts, blue chip securities etc). If, as a result of such generic advice, you require us to arrange or effect a transaction, we shal1 require a written statement of your instructions (this may be in the form of a board resolution) before we can act on your behalf. We may give advice to you by telephone or in writing. Please bear in mind that we may not undertake any more extensive investment business advice on your behalf without agreement as to the tenns and conditions that will apply. Unless specifically requested, we shall not go into the basis on which judgement leading to the advice was made. If you require more detailed investment advice then you should appoint an Authorised Third Party. The rules of the Institute of Chartered Accountants of England and Wales aliow us to introduce a suitable Authorised Third Party who could perform such services for you. If you wish us to introduce a selection of suitable Authorised Third Parties please advise us accordingly. Please note, we are not a party to any agreement which you reach with an Authorised Third Party and merely act on the instructions of the Authorised Third Party who is your nominated agent. In some circumstances, commissions or other benefits may become payable to us in respect of transactions which we may arrange for you, although it is not our policy to seek such commissions. ln any case where commissions arise, you will be notified in writing of the amount and terms of payment. You consent to such commissions or other benefits being retained by the finn. The fees that would otherwise be payable by you will, however, be abated by the amount of any such commissions or other benefits received. Terms and conditions In order to avoid any misunderstanding at a later date, please note our general terms and conditions which are detailed below. Fees Our fees are charged on a time spent basis. apart from our minimum standard annual company secretarial maintenance fee which is set out in our standard schedule of costs as issued from time to time; a copy of our current fee scale is attached to this letter. Page 3 Standard annual company secretarial services include the preparation and filing of the annual return, preparation of AGM documentation, •application for tax exemption/renewal of non~resident tax status and provision of registered office address. Fees for additional company secretarial, administration, bookkeeping and accountancy work etc are charged and are commensurate with the time, nature and responsibility involved. These are normally payable quarterly in arrears, depending upon the volume of work undertaken. Company fees are billed in advance upon formation and annually in advance in January. Fees are subject to annual review. The annual company secretarial maintenance fee is normally non-refundable. Our terms of payment are for settlement within 30 days. If terms are not adhered to we reserve the right to charge interest on overdue accounts at 1% per month. Fees (excluding disbursements to the Government) may be subject to VAT. currently at 17.5%. Government fees are at current rates and are subject to change. Fees are subject to annual review and change without notice. All disbursements incurred on behalf of the company, eg bank charges, courier charges, will be recharged to the company. 2 Transfer of administration In the event that administration is transferred elsewhere, a minimum charge of £250 will be made to cover the work involved. 3 Financial statements It is a legal requirement for financial statements to be prepared (and audited, unless the company's articles contain the appropriate provision to dispense with an audit and the company is eligible to be audit exempt) and presented to shareholders annually. Our policy is that companies administered by us should comply with statutory requirements. This means that the directors should ensure that accounts are prepared within nine months of the financial year end for presentation to the shareholders. Fees for the preparation (and audit where necessary) of financial statements are charged on a time spent basis; the costs will vary depending upon the level ofthe company's activity but will be agreed with you in advance of any work being undertaken. 4 Undertakings from the Company For reasons which I am sure you will appreciate, and in order to meet our high standards of service provision, we need to be kept informed of the Company's activities. Whilst we have no reason to believe otherwise, we are obliged to ask for certain assurances and undertakings from you, as follows: • Page4 • Any asset introduced to the Company will be lawfully introduced and will not be connected with any illegal activity; • The Company will not be engaged or involved directly or indirectly in any unlawful activity or be used for any unlawful purpose and you will keep us adequately informed as to the nature of the Company's activities; • You will notify us if there is any substantial change to the activities of the Company; • At our request, you shall disclose to us any and all information concerning the Company or its business ('Know Your Client' regulations may oblige us to ask for this information from time to time); • You will use your best endeavours to ensure that the Company is run in a proper and business-like manner and complies with all applicable laws and regulations; • Where we do not provide full administration services, you will ensure that the Company complies with all filing requirements in any applicable jurisdiction and that all taxes and governmental dues payable by the Company are discharged; • The address, telephone and fax numbers of Singer & Friedlander Trust Company (Isle of Man) Limited ("Singer & Friedlander .. ) shall not. without our prior written consent, appear on any letterhead or other documentation of the Company, or in any advertising material. 5 You acknowledge that in certain circumstances Singer & Friedlander or its employees may be obliged to give evidence and information to courts or authorities in connection with the affairs of the Company. Disclosure will not normally be made to third parties unless required by law or where the failure w make such disclosures would in our opinion be prejudicial to us. 6 We are authorised. to act on instructions. requests or advice from you or any person we believe to be duly authorised by you in all matters concerning the Company's affairs. Instructions may be given w us in writing. by facsimile or by telephone. Instructions given to u~ will nor take effect until actually received by us. If we accept telephone or facsimile instructions, we may act on them before receipt of any original written confirmation unless specifically requested by you not to do so. We shall not incur any liability for any failure on our part to comply wholly or partly with any instruction received by any method other than in writing and by non-electronic means, in the absence of gross negligence. 7 You undertake at all times to hold Singer & Friedlander and its employees harmless and to indemnify them against all actions, suits, proceedings, claims. demands, cosls, expenses and liabilities whatsoever which may arise or accrue or be taken, commenced, made or sought from or against Singer & Friedlander or its employees in connection with the Company or arising from the provision of the services or any of them PROVIDED THAT this indemnity will not extend to any actions, suit, proceedings. claims. demands. costs, expenses and liabilities which may arise or accrue or be taken, commenced, made or sought from or against any of Singer & Friedlander or its employees in respect of any fraudulent act or omission of such firm or person. Page 5 8 All information and data held by KPMG on any computer system is the sole property of KPMG and for our sole use and the Company shall have no right of access thereto or control thereover. 9 On the cessation by KPMG of the whole or any part of its duties, you undertake that the indemnities referred to in Clause 7 remain valid in the absence of gross negligence. 10 On the cessation by KPMG of the whole or any part of our duties, we shall be entitled to make such retentions and receive such indemnities as we may require in respect of any actual or contingent liabilities. II In the event that: (a) any demand is made against the Company for payment of any sum due by the Company to any person including but not limited to any taxes, duties, fees or other governmental impositions and such payment has not yet been made; or (b) we require instructions from the Company and have been unable to obtain instructions which in our absolute discretion we consider adequate and proper, then, subject as hereinafter provided, we may proceed in any one or more of the following ways: (i) take no further action on a particular matter; (ii) take no further action at all in relation to the Company; (iii) request you to utilise any assets of the Company in or towards the satisfaction of any such demand. No liability shall attach to KPMG or its employees in respect of or arising out of any action or inaction which is in accordance with the provisions of this clause. 12 Please note that if you fail to observe any of the tenns and conditions and obligations to be observed by you, and we give you appropriate notice, our obligation to provide the services shall cease. 13 From time to time it may be necessary to provide services which are not expressly stated in this letter. These terms and conditions will apply in respect of all services actually provided by us. 14 This engagement letter may be varied or superseded at any time by agreement in writing between us, but any such variation shall not affect any rights or obligations of either of us already accrued. You or we may initiate such variations. Either of us may terminate this engagement letter by written notice at any time. 15 Complaints procedure ~ngagement partner name in bold will seek to ensure that our service is satisfactory at all times. If, however, at any time you are unable to deal with any difficulty through him please let us know by telephoning in our office. We undertake to look into any complaint promptly and to Page6 do what we can to resolve the position. If you are still not satisfied you may of course take up the matter with the Institute of Chartered Accountants in England and Wales. 16 These tenns and conditions shall be governed by and construed in accordance with the laws of the Isle of Man. If you agree that the above accurately reflects your requirements, will you please sign the enclosed copy letter and return it to this office. Yours faithfully KPMG Enclosures [•copy of current scale fees to be enclosed~ delete this line] Page 7 I/We confinn that 1/we have read your standard terms and conditions, and I/we hereby accept your offer to provide the services upon such tenns and conditions. Director's signature Director's signature KPMG 777 Dunsmuir Street PO Box 10426 Pacific Centre Vancouver, B.C. V7Y 1K3] Attention: Date Dear Sirs Offshore Company Confidentiality Agreement I [We] have expressed interest in obtaining information relating to a structure that you have proposed ("the Offshore Company structure") for the purpose of evaluating the desirability of entering into an arrangement utilizing such information about the Offshore Company structure that will be provided by KPMG, including without limitation of the foregoing the form of Memorandum of Association and Articles and the related Members' Agreement associated with the Offshore Company structure ("the information"). A brief description of a part of the Offshore Company structure is set out in the Appendix hereto. You consider the Offshore Company structure in which you have a proprietary interest to be confidential. In consideration of your disclosing the information, I [we]: 1. acknowledge that such information is confidential; 2. acknowledge your proprietary rights in the Offshore Company structure and the information; 3. shall not use the information relating to the Offshore Company structure which I [we] are required hereunder to keep confidential for any purpose other than to evaluate and determine our interest; 4. will not make copies in any manner whatsoever of the information relating to the Offshore Company structure without your prior written consent; all such copies will remain your property and will be returned to you upon your request; 09199·0ffshore Company-Confidentiality Agreement Page 2 5. will not publish the information or any other information with respect to the Offshore Company structure and its possible applications without your prior written consent; 6. agree that the information and the Offshore Company structure will only be used with your prior written consent; 7. agree that neither this Agreement nor the disclosure of information relating to the Offshore Company structure shall be construed as granting to us any license or rights; 8. acknowledge that this Confidentiality Agreement is executed and delivered by us individually and agree that this Confidentiality Agreement shall bind every entity that either of us are associated or affiliated with; 9. attorn and submit to the jurisdiction of the Supreme Court of British Columbia and the Courts of the Isle of Man and agree that damages would be an inadequate relief from my [our] breach of the terms of this Confidentiality Agreement and consent to such Court(s) granting an interim injunction based upon the undersigned or his [her] associates allegedly breaching this agreement and agree that KPMG is entitled to equitable relief, including injunction or specific performance in addition to all other remedies available; and, I 0. agree that these undertakings will survive termination of our discussions, engagement of KPMG to implement the structure and completion of such engagement and continue in force so long as KPMG maintains a proprietary interest in the information relating to the Offshore Company. I [We] indicate my [our] acceptance of the foregoing by signing and dating this letter. Yours very truly For Enclosures: [Himself][Herself][Itself] and Related Entities Appendix APPENDIX TO OFFSHORE COMPANY CONFIDENTIALITY AGREEMENT The strategy uses a special type of corporation ( "Offshore Company") that emulates private foundations that have been used by wealthy Europeans. • Offshore Company functions as a foundation through its board of directors. • Objectives and checks and balances are embodied in the Memorandum and Articles and a Unanimous Members Agreement ( UMA). • Articles provide for gifts to "eligible persons" as defined in the UMA. 09199-0ffshore Company-Confidentiality Agreement Schedule of information required to form an Isle of Man Hybrid Company (Page 1 of4) Proposed company names in order of preference (please print) [Please note that there are restrictions on certain names such as "Trust", "Fiduciary'\ "International" which require a greater paid up share capital] Limited II Limited iii Limited If a client has no preference, KPMG can allocate one of the names reserved for their use. (Please tick if required) 0 2 Details of proposed activity of the company (if insufficient space please continue on separate page) 3 The amount and source of funds to be introduced to the company (if insufficient space please continue on separate page) 4 Details of share capital a) Authorised: Standard is £100 comprised of500 A ordinary shares of£1 each and 500 B ordinary shares of £1 each. Please state if other required b) Issued: 500 A ordinary shares of £1 and 500 B ordinary shares normally issued on incorporation. Please advise if anything different required Schedule of information required to form an Isle of Man Hybrid Company (Page2of4) 5 Financial statements a) Accounting year end b) Reporting currency c) Expected turnover over 12 month period 6 Non-shareholder member- please provide a copy of passport and utility bill certified (as true copy and true likeness in case of passport), by a KPMG Partner, Notary Public or Commissioner for Oaths. In case of a company, copy Certificate of Incorporation and Memorandum & Articles certified as above together with latest audited accounts. Full name Residential Address Nationality Occupation NB Reference regarding good standing will also be required ifNSM also Eligible Person. 7 Director - nominated by non-shareholder member (must be an individual) - please provide a copy of passport and utility bill certified (as true copy and true likeness in case of passport) by KPMG Partner, Notary Public or Commissioner for Oaths Full name Address Nationality Occupation j 8 Reference regarding good standing The following reference(s) are attached: Referee name Firm Length of time known directing mind Schedule of information required to form an Isle of Man Hybrid Company (Page 3 of 4) 9 Tax status of company Tax exempt I0 Directing mind Please provide full details of directing mind and attach copy of passport and utility bill certified by KPMG Partner, Notary Public, or Commissioner for Oaths. Continue on separate sheet if necessary. Full name Address Nationality Occupation II Reference regarding good standing The following reference(s) are attached: 12 Referee name Firm ......-....••............... ~·····-······--·-··········-···-···- ..........----·--·······-····-·-·····-·····-·······-··············· Length of time known directing mind ~-··········- ..-··············-·········-················-··· Introducer of funds Please provide full details of every introducer of funds, if different from directing mind and attach copy of passport and utility bill certified by KPMG Partner, Notary Public, or Commissioner for Oaths. Continue on separate sheet if necessary. Full name Address Nationality Occupation ' Schedule of information required to form an Isle of Man Hybrid Company (Page4of4) 13 Reference regarding good standing The following reference(s) are attached: Referee name Firm Length of time known introducer of funds Before sending, please ensure this is fully completed and necessary certified documentation is attached ., "! MEMBERS AGREEMENT This Agreement made as of the _ _ day of _ _ _ _ _, 1999 BETWEEN: • (Hereinafter called "Shareholder No. I") AND: • (Hereinafter called "Shareholder No.2") AND: • (Hereinafter called "Non-Shareholder Member No. 1") AND: • (Hereinafter called "Company") WHEREAS: A. The authorised share capital of the Company is 100 Ordinary Shares with a par value of £1 per share, of which the following are issued and outstanding as fully paid and nonassessable: Shareholder Nurn ber and Class of Shares Shareholder No. I Shareholder No. 2 50 A Ordinary Shares 50 B Ordinary Shares B. The Company will carry on the business of managing and investing its assets for the benefit of its Members as defined in the Articles. C. Shareholder No. I, Shareholder No. 2, Non-Shareholder Member No. I and the Company desire to enter into this Agreement in order to record their respective rights and obligations. 09199-0ffshore Company-Members Agreement NOW THEREFORE THIS AGREEMENT WTINESSES that in consideration of the premises and of the mutual covenants and agreements hereinafter set forth, the parties hereto agree each with the other as follows: I. Definitions 1.1 In this Agreement, the following words and phrases will have the following meaning: (a) (b) (c) (d) (e) 2. "Articles" means the Articles of Association of the Company. "Board" means the Board of Directors of the company. "Eligible Persons" means Eligible Persons as defined in Article !(g). "Non-Shareholder Member" means a Non-Shareholder Member as defined in Article !(f). "Shareholder" means a Shareholder as defined in Article !(e). Conduct of the Affairs of The Company The Shareholders shall vote their shares and the Non-Shareholder Members shall vote so that the Board shall be comprised of either three Directors or five Directors so that: (a) the majority of the Board shall at all times consist of persons who are not resident in Canada; (b) if the Board is comprised of three Directors, one nominee of each Shareholder and one nominee of the Non-Shareholder Members as a group who meets with the approval of all of the Shareholders is a Director of the Company; (c) if the Board is comprised of five Directors, two nominees of each Shareholder and one nominee of the Non-Shareholder Members as a group who meets with the approval of all of the Shareholders is a Director of the Company; (d) if there is more than one Non-Shareholder Member, the Non-Shareholder Members shall nominate one director by unanimous agreement. If the Non-Shareholder Members cannot agree unanimously on the nomination of a Director or if a director nominated by a Non-Shareholder Member or the Non-Shareholder Members as a group does not meet with the approval of all of the Shareholders, the Shareholders shaH nominate and appoint a Director on their behalf; - ~ .( (e) the quorum necessary for the transaction of business of the Directors shall be three, provided that one of the three Directors shall be the nominee of the NonShareholder Member or Members or the Director nominated by the Shareholders on his/their behalf; (f) in the event that a nominee or nominees to the Board of one of the Shareholders or the Non-Shareholder Member or Members shall fail to vote and act as a Director to carry out the provisions of this Agreement, then the Shareholders and the NonShareholder Member or Members agree to exercise their right as Shareholder and Non-Shareholder members of the Company in accordance with the Articles to remove such nominee or nominees from the Board and to elect in the place or stead thereof such persons who will use their best efforts to carry out the provisions of this Agreement. 3. Eligible Persons (a) The Shareholders and Non-Shareholder Members hereby unanimously agree that the first Eligible Persons shall be: Name Address or any corporation controlled by any such person or persons, any partnership in which any such person or persons hold the majority interests or any trust created for the benefit of such person or persons; 4. (b) no person who is a Shareholder or Non-Shareholder Member of the Company or, a person related to such Shareholder or Non-Shareholder Member, or, in the case of a corporate Shareholder or Non-Shareholder Member, a shareholder, employee, director, officer, agent or affiliate of such corporate Shareholder or Non-Shareholder Member shall be an Eligible Person; (c) no person shall be added or removed as an Eligible Person except by unanimous agreement amongst the Shareholders and the Non-Shareholder Members; Transfers of Shares or Memberships No Shareholder shall transfer his shares and no Non-Shareholder Member shall transfer his Membership and no share shall be issued and no new Non-Shareholder Membership shall be granted to any person not a party to this agreement unless such person shall have entered into an agreement with the other Shareholders and Non-Shareholder Members and the Company by which such person shall be bound by the provisions of this agreement. 5. Winding-Up If the Shareholders and the Non-Shareholder Members: (a) cannot agree unanimously in respect of the matters specified in Article 24.2 of the Articles or: (b) ( a Shareholder or Non-Shareholder Member wants to transfer his shares or membership to another person, the Directors decline to approve such transfer pursuant to Article 16 of the Articles and the Shareholder or Non-Shareholder Member no longer wants to continue to be a Shareholder or a Non-Shareholder Member of the Company; the Shareholders shall vote their shares and the Non-Shareholder Members shall vote to put the Company into liquidation and wind-up the affairs of the Company pursuant to the provisions of Article 99 of the Articles. 6. General (a) The Shareholders, the Non-Shareholder Members and the Company shall execute such further assurances and other documents and instruments and do such further and other things as may be necessary to implement and carry out the intent of this Agreement; (b) The provisions herein together with the Articles constitute the entire agreement between the Shareholders, the Non-Shareholder Members and the Company and supersede all previous expectations, understandings, communications, representations and agreements, whether verbal or written, between them with respect to the subject matter hereof; (c) If any provision of this Agreement is unenforceable or invalid for any reason whatever, such enforceability or invalidity shall not affect the enforceability or validity of the remaining provisions of this Agreement and such provisions shall be severed from the remainder of this Agreement; (d) Any notice required to be given hereunder by any party shall be deemed to have been well and sufficiently given if telefaxed to, or delivered at the address of the other party herein set forth: (i) if to Shareholder Number]: (ii) if to Shareholder Number 2: (iii) if to Non-Shareholder Member Number I: (iv) if to the Company. or at such other address as any party may from time to time direct in writing. Any such notice shall be deemed to have been received if telefaxed 48 hours after the time of telefaxing, and if delivered, upon the date of delivery. If normal telefax service is interrupted by strike, slow-down, force majeure, or other cause, a notice sent by the impaired means of communication will not be deemed to be received until actually received, and the party sending the notice shall utilise any other such services which have not been so interrupted or shall deliver such notice in order to ensure prompt receipt thereof; (e) this Agreement shall be governed by and construed in accordance with the laws of the Isle of Man; (f) should there be a disagreement or dispute between the parties hereto with respect to this Agreement (including, without limitation, any determination or valuation required thereunder) or the interpretation thereof, the same shall be referred to a single arbitrator pursuant to the Arbitration Act 1976 and/or the Arbitration International Disputes Act 1983 as appropriate as the same may be amended or replaced by similar legislation from time to time, and the determination of such arbitrator shall be final and binding upon the parties hereto; (g) the headings in this Agreement form no part of this Agreement and shall be deemed to have been inserted for convenience only; (h) it is the desired intention of the parties hereto that this Agreement be accorded a broad and liberal interpretation consistent with its purpose and the intentions and objectives of the parties herein set out; (i) whenever the singular or masculine is used throughout this Agreement, the same shall be construed as meaning the plural or the feminine or body corporate where the context or the parties so require; Gl this Agreement shall enure to the benefit of and be binding upon the parties to this Agreement and their respective personal heirs, executors, administrators, representatives, successors and assigns . .( IN WITNESS WHEREOF the parties hereto have executed these presents under their hand and seal in the case of the individual parties and the presence of their proper officers duly authorized in the case of the parties which are corporations as of the day and year first above written. SIGNED AND DELIVERED by _______ in the presence of: (Director) (Director) SIGNED AND DELIVERED by _ _ _ _ _ _ _ _ in the presence of: (Director) Director ) SIGNED AND DELIVERED by _________ inilie presence of: Name ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) _ _ _ _ _ _ _ _ _ lis _ _ _ _ _ _ _ _ _ lis _ _ _ _ _ _ _ _ _ _ _ lis Company number: • Memorandum and Articles of Association of • A private company limited by £Uarantee and having a share capital Incorporated in the Isle of Man under the Companies Acts 1931- 1993 On the • day of • 2000 The Companies Acts 1931 · 1993 Isle of Man Private company limited by guarantee and having a share capital Memorandum of Association of Limited The Name of the Company is Limited. 2 The Company is a Private Company. 3 All requirements of the Companies Act 1986 in respect of matters relating to registration and of matters precedent and incidental thereto have been complied with. 4 The liability of the Members is limited. 5 Every Member other than a shareholder of the Company undertakes to contribute such amount as may be required (not exceeding Stg £10 (Sterling Pounds ten only) to the assets of the Company in the event of its being wound up while he is a Member or within one year after he ceases to be a Member for payment of the debts and liabilities of the Company contracted before he ceases to be a Member, and of the costs. charges and expenses of winding up. and for the adjustment of the rights of the contributors amongst themselves. 6 The authorised share capital of the Company consists of £100 divided into 50 A Ordinary Shares with a par value of £1 each and 50 B Ordinary Shares with a par value of£ I each. We, the several persons whose names and addresses are set out hereunder, are desirous of being formed into a Company in pursuant of this Memorandum of Association. Number of shares taken by each subscriber Names, address and descriptions of subscribers ... Total nwnber of shares taken Dated this day of 1999 Witness to the above signatures: Name: Address: Occupation: 2 h When any provision of the Act is referred to the reference is that provision as modified by any statute for the time being in force. Unless the context otherwise requires, expressions defmed in the principal Act or any statutory modification thereof in force at the date at which these regulations become binding on the Company shall have the meanings so defmed. 1.1 J Expressions referring to writing shall, unless the contrary intention appears, be construed as including references to printing, lithography, photography, and other modes of representing or reproducing words in visible form. k Any references to the masculine gender shall be deemed to include the feminine gender and vice versa. Tables A and D of the Companies (Memorandum and Articles of Association) Regulations 1988 shall not apply to the Company. PRIVATE COMPANY 2 The Company is a "Private Company" within the meaning of Section 26 of the Companies Act, 1931, and accordingly no invitation shall be issued to the public to subscribe for any shares in or debentures of the Company. MEMBERSHIP 3 The membership of the Company shall consist of: a The subscribers to the Memorandum of Association, b Such persons as may be registered as Shareholders of the Company from time to time. c Non-Shareholder Members who are registered as such from time to time. 3.1 A person may be a Member of the company without holding a share in the capital of the Company. 3.2 The fact that the name of a person has been entered in the Register of Members shall be conclusive evidence of that person's membership. 4 If at any time the membership or share capital is divided into different classes of membership or of shares, the rights attached to any class may be varied only with the consent in writing of three-fourths of the Members of any such non-shareholder class, or of the holders of three-fourths of the issued shares of any such class, or with the sanction of an Extraordinary Resolution passed at a separate General Meeting of the Members or holders of the shares of the class. To every such separate General Meeting the provisions of these Articles apply, but so that the necessary quorum shall be two persons at least present in person or by proxy. 5 Any preference or other class of shares may be issued on the terms that they are redeemable or are liable to be redeemed at the option of the Company or the holder and such redemption may subject to 4 the provisions of Sections 46 and 46A of the Companies Act 1931 be effective on such terms and in such manner as the Board may from rime to time determine. CLASSES OF MEMBERSHIP 6 Membership of the Company shall consist of two classes of persons (i) Shareholders; and (ii) Non-Shareholder Members. SHAREHOLDERS 7.1 Each Shareholder shall hold at least one share in the capital of the Company, and each shall have the right to attend and vote at all General Meetings of the Company. At all Meetings where a Shareholder is entitled to vote, each Shareholder shall have one vote for each share that he holds. 7.2 The subscribers to the Company shall be Shareholders. SHARES 8.1 Except as required by law no person shall be recognised by the Company as holding any share upon trust, and the Company shall not be bound by or recognise any equitable, contingent, future or partial interest in any share or any interest in any fractional part of a share, or (except only as by these presents otherwise expressly provided) any other right in respect of any share except an absolute right to the entirety thereof in the registered holder. 8.2 Every person whose name is entered as a Shareholder in the Register of Members shall, without payment, be entitled to a certificate specifying the share or shares held by him and the amount paid up thereon, provided that in respect of a share or shares held jointly by several persons the Company shall not be bound to issue more than one certificate, and delivery of a certificate for a share to one of several joint holders shall be sufficient delivery to all. 8.3 If a share certificate is defaced, lost, or destroyed, the Directors may authorise its renewal on payment of such fee, and on such terms as to evidence and indemnity, and the payment of such outof-pocket expenses of the Company for investigating evidence as they may determine fit. 9 No part of the funds of the Company shall directly or indirectly be employed in the purchase of, or in loans upon the security of, the Company's shares, but nothing in this regulation shall prohibit transactions mentioned in the proviso ro Section 45(1) of the Act. .' SPECIAL RIGHTS AND RESTRICTIONS ATTACHED TO THE SHARES OF THE COMPANY 10. The Ordinary Shares shall have attached thereto the following rights and restrictions: (a) The holders of the Ordinary Shares shall be entitled to one vote in respect of each Ordinary Share held at any annual or extraordinary General Meeting of the Members of the Company. 5