Appendix D

Control in fact

The concept of “control in fact” is sometimes referred to as “de-facto control”. It is a concept applied by the courts to determine the realities of how certain arrangements are designed to operate in practice.

The different control tests and contexts in which the concept of “control in fact” is applied must also be considered when applying the principles established by the case law.

Day-to-day “control in fact” over the operation of the scheme

In Australia, the concept is relevant when determining whether an unincorporated association is a managed investment scheme for the purposes of the Corporations Act.

If the substance is that all the members have day-to-day “control in fact” over the operation of the scheme by making all the decisions and implementing what is agreed [actually managing or carrying out the routine, ordinary, everyday activities that comprise the scheme’s operations], then the scheme will not be a managed investment scheme.

However, if the substance is that the members contributions are either pooled for use as the property of the scheme [typical of partnership and unit trust-based “investment” arrangements], or not pooled but used in a common enterprise that constitutes the scheme [typical of co-ownership contract-based “common enterprise” arrangements], to produce financial benefits, or benefits consisting of rights or interests in property, and the members collectively appoint a person to operate the scheme [with the authority to actually manage or carry-out the routine, ordinary, everyday activities that comprise the scheme’s operations] on behalf of the group, then the scheme will be a managed investment scheme (whether or not they have the right to be consulted or give directions).

It is a negative test in the sense that for the arrangements to be a managed investment scheme they must be such that the members do not have day-to-day “control in fact” over the operation of the scheme, prospectively viewed from the time when the arrangements are made.

Furthermore, the management activities of a person who is the “promoter” or “operator” are not to be imputed to the members in determining whether the members have day-to-day control over the operation of the scheme.

In ASIC v Chase Capital Management Pty Ltd, Owen J held:

[67] “… The question is whether the members have day-to-day control. It is not difficult to discern the distinction that the legislature was attempting to make. Very broadly, it is between the investment activities of an individual and that of a group. By the express terms of the applications, the investors have delegated “management” of the investment to CCML. There is no reservation of day-to-day or any other control or functions. I am not sure that the appointment of a committee of some of the investors to monitor the investments would make much difference. The question still remains: who has the day-to-day control”.

In Enviro Systems Renewable Resources Pty Ltd v Australian Securities & Investments Commission, Martin J said:

[36] “In my opinion, when the scheme documentation is analysed in its entirety, the intent of the scheme is that Enviro will control the day-to-day operations of the scheme from beginning to end. Enviro offers a total package which is presented in such a way that potential participants are encouraged to take up the entire package. Notwithstanding the assertions that participants will be running their own businesses. Enviro does not intend that the participants should take any active role in the day-to-day operations of any aspect of the scheme. The success or otherwise of the scheme is entirely dependent upon Enviro. In reality, although it is possible that some participants may choose to take an active role, the scheme is designed to attract passive investors.

[37] “The purpose or object of the legislation and the regulatory regime created pursuant to the legislation would be easily defeated if the court felt obliged to rely solely upon a strict view of the the legal rights and duties created by the documentation and was required to ignore the realities of the scheme as it was designed to operate in practice”.

In ASIC v IP Product Management Group Pty Ltd, Byrne J noted:

[22] “It will be recalled that under paragraph (iii) … The existence of a right in a member to be consulted or to give directions as to the operation of the scheme does not necessarily lead to the conclusion that that member has day-to-day control over its operation. The law contemplates, therefore, some greater involvement”.

In ASIC v Pegasus, Davies AJ said:

[55] “The word “operate” is an ordinary word of the English language and, in the context, should be given its meaning in ordinary parlance. The term is not used to refer to ownership or proprietorship but rather to the acts which constitute the management of or the carrying out of the activities which constitute the managed investment scheme.

In Burton v Arcus McClure J said:

[2] “… The word “operate” in the context of s601ED (5) and s601EE is to be given its ordinary meaning. The term is not used to refer to ownership or proprietorship but rather to acts that constitute the management of or the carrying out of the activities comprising the managed investment scheme: see Australian Securities and Investments Commission v Pegasus Leveraged Options Group Pty Ltd (2002) 41 ACSR 561 at 574”.

[4] “… The phrase “day-to-day” means routine, ordinary, everyday management or operational decisions. I am of the view that the term “control” in the definition means authority to decide and direct and not merely to participate in decision-making”.

n Burton v Arcus Buss JA said:

[73] “The term “day-to-day” connotes routine, ordinary, everyday. See The Shorter Oxford Dictionary (1993), page 598; The Macquarie Dictionary (Third Edition), page 492”.

[74] “As the Privy Council observed in Bermuda Cablevisions Ltd v Colica Trust Co Ltd [1998] AC 198 at 207, expressions such as “control” take their colour from the context in which they appear: there is no general rule as to the meaning of the word “control. The expression “day-to-day control” is not a term of art. It must be given the meaning which the context requires. …”.

[79] “In my opinion, the third element in para (a) of the definition is concerned with control in fact as distinct from the legal right to control. It is also concerned with control in fact by the members of a scheme as a whole. The members as a whole may not have control in fact even though the constructive document for the scheme may confer on them the legal right to control”.

[80] “The members of a scheme will have “day-to-day control over the operation of the scheme” if:

a. the members as a whole participate in making the routine, ordinary, everyday business decisions relating to its management; and

b. the members as a whole are bound by the decisons that are made“.

“Conversely, if the members as a whole do not participate in making the routine, ordinary, everyday business decisions relating to the management of the scheme or if the members as a whole are not bound by the decisions which are made, they will not have day-to-day control over its operation”.

[81] “The concept of “day-to-day control over the operation of the scheme”, within para (a) of the definition, does not, of course, require that there be activities in relation to the scheme on each and every day or even on most days during the term of the scheme”.

[82] “In my opinion, the circumstance that the promoter or operator of a scheme manages the scheme (or certain aspects of it) on behalf of the members does not mean that the members by their agent, the promoter or operator, have day-to-day control in fact over the operation of the scheme. In other words, the management activities of the promoter or operator in relation to a scheme are not to be imputed to the members in determining whether the members have such day-to-day control”.

[83] “My construction of the third element in para (a) of the definition gives effect to the evident legislative purpose or object embodied in the definition and Ch 5C. If:

  1. the third element in para (a) of the definition was concerned with the legal right to control and not control in fact; or
  2. the management activities of the promoter or operator in relation to the scheme were to be imputed to the members in evaluating whether the third element was satisfied or not, with the consequence that if the promoter or operator had “day-to-day control over the operation of the scheme” then the members, by their agent, the promoter or operator, would have day-to-day control,

the legislative framework for the regulation of managed investment schemes would be seriously, if not entirely, eroded”.

“Control in fact” of an entity

The following paragraph is quoted from an Advisory Note titled “The Federal Court of Appeal clarifies the de facto control test” issued by Canadian Law Firm Gowling WLG on 14 June 2016:

“In Canada, control is a concept that is relevant to a number of income tax rules. There are two types of control: de jure control and de facto control. Determining de jure control is straight forward, as it exists where a person (or group) has the power to elect a majority of the board of directors. De facto control is less concrete, requiring a determination of whether a person (or group) has direct or indirect influence that, if exercised, would result in factual control [as defined in subsection 256(5.1) of the Income Tax Act (Canada) (the “ITA”)]”. While the de facto control concept is relevant for a variety of the provisions in the ITA, it is particularly relevant for determining under various tax rules whether a corporation is a “Canadian-controlled private corporation” and whether corporations are “associated” for purposes of the ITA”.

The seminal Canadian cases on de facto control are Silicon Graphics Limited v Canada [2002 FCA 260] and McGillivray Restaurant v Canada [2016 FCA].

The judgment in the Silicon Graphics case established that a person or group of persons would have de facto control if such a person or group has “a clear right or ability to effect a change in the board of directors or the powers of the board of directors or to influence in a very direct way the shareholders who would otherwise have the ability to elect the board of directors”.

Subsequent cases expanded the test by introducing factors concerning operational control of the business, creating ambiguity and challenges in determining de facto control, until McGillivray in 2016, which clarified the de facto control test, reaffirming the test in Silicon Graphics.

The facts in McGillivray concerned an attempt to split 3 restaurants into two corporations – to increase access to the small business deduction. That meant making sure the two corporations were not “associated”, such as by the husband’s “de facto control. The TCC judge (Boyle) had held that they corporations were associated, even though the husband might have no right to control appointment of the board of directors.

The FCA rejected that broad interpretation of ITAs. 256(5.1) control test:

[46] “I reject any assertion that the test for control in fact is based on “operational control”. De facto control, like de jure control, is concerned with control over the board of directors and not with control of the day-to-day operations of the corporation or its business. Paragraph 256(1)(b) and subsection 256(5.1) specifically refer to control of a corporation and not to control of the corporation’s business or operations …”.

[48] “…, in my view, a factor that does not include a legally enforceable right and ability to effect a change to the board of directors or its powers, or to exercise influence over the shareholder or shareholders who have that right and ability, ought not to be considered as having the potential to establish de facto control”.

Although the FCA concluded that the TCC judge used the wrong control test, it came to the same conclusions as he. The FCA accepted that the husband and wife had an oral agreement that she would always appoint him as director. That was enough to ensure that the husband had de facto control thus rendering ineffective this tax avoidance scheme. [see e.g., paras 54, 55 and 57].

This case clearly establishes that, for the purposes of the control test in section. 256(5.1), the difference between de facto control and de jure control is limited to the breadth of factors that can be considered in determining whether a person or group of persons has effective control, by means of an ability to elect the board of directors of a corporation. That said, it remains the case that the list of factors that may be considered when applying the Silicon Graphics test is open-ended. However, a factor that does not include a legally enforceable right and ability to effect a change of the board of directors or its powers, or to exercise influence over the shareholder or shareholders who have that right and ability, ought not to be considered as having the potential to establish de facto control.

Determining whether a person controls an entity is also relevant in circumstances throughout the federally regulated institution (FRFI) statutes, which are the Bank Act, the Insurance Companies Act and the Trust and Loan Companies Act. See Advisory Note titled “Control in Fact” issued by Office of the Superintendent of Financial Institutions Canada, January 2020.