1. New Financing Amounts

The maximum loan amount for a borrower has been increased from $1 to $1.15 million,  which includes:

• $1 million for term loans of which a maximum of $500,000 is comprised of (1) equipment and leasehold improvements of up to $350,000; and (2) $150,000 for intangible assets and working capital costs.

and

• $150,000 for lines of credit for working capital costs. This would be over and above the $150,000 that can be used for working capital costs under the term loan product (above).

2. Term Loans

The amendments include two new financing classes – intangible assets and working capital costs can now be financed as term loans.  Intangible assets are defined as non-monetary assets without physical substance that can be sold, transferred, licensed, rented or exchanged or that arise from a contractual or other legal right.  This includes franchise fees, goodwill, incorporation costs and permits and licenses.

Maximum Loan Term

All term loans used to finance real property, leasehold improvements, equipment and intangible assets and working capital costs can now be made for a maximum of 15 years.  Equipment and leasehold improvement loans that are already registered (or disbursed and not registered) can be amended to the new 15 year term.

Appraisal of Eligible Expenditures

The time period to finance expenditures or commitments for any term loan has been increased from 180 days to 365 days prior to the date the term loan is approved.  If the lender is required to obtain an appraisal to finance a term loan, the date that the appraisal is made has been changed from 180 days before the term loan is approved to 365 days before the term loan is disbursed.

Security

For real property and equipment term loans, lenders must continue to take security in the assets financed.  Lenders must take security in any assets of the small business for the value of the loan for the following items:  leasehold improvement, computer software, website, intangible assets and working capital costs.

3. Line of Credit

Eligible businesses can now access a line of credit to be used for working capital costs (costs necessary to cover the day-to-day operating expenses of the business). Examples include: inventory, expenses related to the creation and development of software and websites, printed materials, professional fees (e.g. legal, accounting, appraisal), research and development costs, payroll and rent.  The line of credit may be used to pay for ongoing expenditures or commitments that arise or were invoiced no more than 365 days prior to the date that the line of credit was authorized. Lenders will be required to take security in any assets of the small business for the authorized amount of the line of credit.

Term and Renewal

The maximum term for the line of credit is 5 years beginning on the day after the line of credit is opened by the lender.  Prior to the end of the 5 year term, borrowers will have the following 3 options:

1. Re-register the line of credit for a new period of 5 years. In this case, a new registration form and a registration fee of 2% on the renewed authorized line of credit amount must be submitted to the CSBFP.
2. Borrowers can also convert the line of credit amount to a CSBFP term loan with a maximum 10-year CSBFP coverage. Any such term loan would need to meet the following conditions:

• • The interest rate must not be greater than the prime rate plus 5%;
  • The terms of the loan conversion must be set out in a document signed by the lender and the borrower and that provides a minimum of one principal and interest payment each year, with the first payment scheduled to be made within one year of the date of the conversion; and
  • The borrower and lender must enter into an agreement to repay the balance of the line of credit with a conventional loan.

3. The borrower and lender may enter into an agreement to repay the balance of the line of credit with a conventional loan.

Claim Process Documents and CSBFP Liability

Lenders must submit an attestation form signed by the borrower at the time the line of credit is registered stating that (1) the line of credit is to be used to pay for working capital costs of the day-to-day operational expenses of the small business, and (2) the expenses paid through the line of credit did not arise (and were not invoiced) more than 365 days before the line of credit was authorized.

The CSBFP’s liability for lines of credit for a lender is limited to 15% of the total amount of the lines of credit authorized and registered by that lender, separate and apart from a lender’s liability calculation for its registered term loans.

.   .   .

As noted above, one of the most significant changes for franchisees and franchisors is that franchise fees can now be financed under the CSBFP.  Prior to these changes, franchise fees were ineligible for financing under the program and had to be paid for out-of-pocket or through other credit products offered by financial institutions.

At Sotos LLP, we advise franchisors on all aspects of their franchise sales process including how to inform prospective franchisees on the availability of financing. We also help franchisors establish lending programs offered by preferred financial institutions to their prospective franchisees. We also assist prospective franchisees in their purchases of franchises. We would be happy to assist to provide tailored advice relating to the changes created to this important financing program. Please contact Anna Thompson-Amadei (athompson-amadei@sotos.ca) or John Yiokaris (jyiokaris@sotos.ca).

[1] https://ised-isde.canada.ca/site/canada-small-business-financing-program/en/find-loan-your-small-business/about-program/helping-small-businesses-get-loans
[2] https://ised-isde.canada.ca/site/canada-small-business-financing-program/en/documentation-centre/bulletins/2022-changes-canada-small-business-financing-program

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This package shed some light on uncertainties regarding unenacted trust beneficiary reporting rules announced in 2018 that were originally intended to apply for taxation years of trusts that ended after December 30, 2021. After some confusion regarding its implications for the current year, the Canada Revenue Agency (CRA) has since clarified that the proposed changes to trust reporting will apply to taxation years of trusts that end after December 30, 2022, but the exact date these changes will come into effect has not yet been specified. If the legislation is enacted as and when currently predicted, the first T3 tax returns in which additional disclosures would have to be reported to the CRA are those to be filed in early 2023 for the 2022 taxation year. For now, trustees and others engaged in trust tax compliance have another year to collect the required personal information on beneficiaries and other required persons.

Current Trust Reporting Requirements (as of March 2022)

At present, a trust that does not earn income or make distributions in a year is generally not required to file an annual (T3) return of income. A trust is required to file a T3 return if the trust has tax payable or it distributes all or part of its income or capital to its beneficiaries. Even if a trust is required to file a return of income for a year, there is no requirement for the trust to report the identity of all its beneficiaries.

Given the above, the Government perceives that there are gaps in the information they currently collect with respect to trusts and seeks to close such gaps. Budget 2017 announced the Government’s intention to examine ways to expand information collected with respect to trusts.

Proposed Federal Trust Filing and Reporting Measures

The draft amendments to the Income Tax Act (ITA) and related regulations were first released in July 2018, and provided that:

1. trusts resident in Canada will be required to file a tax return every year regardless of whether the trust has tax payable or distributes a portion of its income,
2. trusts resident in Canada and non-resident trusts that are required to file a return will be required to list each person who at any time in the year was a trustee, beneficiary or settlor or had the ability to exert control over trustee decisions over the allocation of trust income or capital, and to provide certain personal information about those persons (name, address, date of birth (for individuals), the jurisdiction of residence and social insurance number or other applicable taxpayer identification number) (“Beneficial Ownership and Control Information”),
3. new penalties will be introduced for failure to file a return containing trust Beneficial Ownership and Control Information — including, notably, a penalty of no less than 5% of the highest fair market value of the trust property during the year where the failure to file was done knowingly, or due to gross negligence.

Pursuant to the draft legislation released on February 4, 2022 (see sections 14-18), disclosure of Beneficial Ownership and Control Information on a T3 return is not required if the information is subject to solicitor-client privilege.

The draft legislation also provides that bare trusts, which are arrangements under which a trust can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust’s property, are now explicitly subject to the new trust filing and reporting measures. Previously, bare trusts were generally not required to file T3 returns.

For more information please reach out to a member of our team.

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Key Takeaways

1. “Individuals with Significant Control” Must Be Disclosed – Starting January 1, 2023, privately-held Ontario corporations will be required to create and maintain a register of “individuals with significant control” (ISCs) over those corporations. Ontario private corporations should begin to review existing corporate records and procedures to prepare themselves and their shareholders for the new information reporting requirement.
2. Annual Returns Must Be Filed with the Ontario Business Registry (OBR) – Effective October 19, 2021, Ontario Corporations must file their Annual Returns using the Ontario Business Registry. They can no longer file through the Canadian Revenue Agency as part of their T2 Corporation Income Tax Return. Affected corporations should ensure they have their company key to file their Ontario CIA return directly through the OBR or arrange for an intermediary who can file without a company key.

Disclosure Update

On January 1, 2023, amendments to the Ontario Business Corporations Act (OBCA) addressing continuing disclosure requirements for privately-held Ontario corporations will come into effect. From that date forward, Ontario corporations will be required to create and maintain a register of ISCs. Although new to Ontario, similar recordkeeping requirements have previously been adopted federally and in many other Canadian jurisdictions to address tax evasion and financial crime concerns.

Who is an Individual with Significant Control?

A person will be considered an ISC requiring disclosure if the person:

• is the registered or beneficial owner of, or has direct or indirect control or direction over, a “significant number of shares”.
• has any direct or indirect influence that, if exercised, would result in “control in fact” of the corporation.
• is an individual to whom prescribed circumstances apply.[1]

A “significant number of shares” is defined as owning, controlling, or directing 25% or more of the voting rights attached to the corporation’s outstanding voting shares or 25% or more of all of the corporation’s outstanding shares based on the fair market value of the shares.[2]

The phrase “control in fact” is determined by considering all relevant factors in the circumstances; however, the legislation does not state those relevant factors.[3]

Two or more individuals may be connected through their interest in the corporation so as to be considered to be a single ISC, requiring the details of both to be included on the register.[4] This is because an individual meets the definition of ISC if they own or control a significant number of shares with one or more individuals. For example, an individual may individually own less than 25% of a corporation’s shares, but has an agreement with other shareholders to vote o the shares the same way.  If this group of individuals collectively owns 25% or more of a corporation’s shares, each member of the group is considered an ISC and needs to be recorded in the register.

What Must be Disclosed in the Register?

There is no proscribed form for the register. It can be created as a logbook, database or spreadsheet. For each ISC, the register of ISCs must include;

• name,
• date of birth,
• address,
• country (or countries) where the ISC is considered a resident for tax purposes,
• the date when control started (for example, when the ISC purchased 25% or more of the corporation’s shares),
• the date when control ended,
• a description of how the ISC has significant control (for example, a description of their interests and rights in respect of shares of the corporation),
• a description of each step taken to identify all ISCs.[5]

New information is required to be recorded in the register within 15 days of the corporation becoming aware of it. This register should be kept with the corporation’s minute books at the registered officer or at another place in Ontario designated by the directors.

The corporation, officers, directors and shareholders could all be found guilty of offences for failure to uphold their new disclosure obligations. Corporations that fail to uphold their record-keeping and disclosure requirements in regard to ISCs are guilty of an offence and could be liable to multiple fines of $5,000. Directors and Officers who knowingly authorize, permit or acquiesce in the contravention of the corporation’s disclosure requirements, or in the recording or provision of false or misleading information are guilty of an offence and could be liable for fines of up to $200,000 or imprisonment up to 6 months, or both. Shareholders who fail to meet their disclosure obligations may likewise be found guilty of an offence and could be liable for similar fines.

Annual Returns Update

Filing Annual Returns with the OBR

On October 19, 2021, Ontario launched the OBR. The OBR is intended to provide instant, 24-hour fulfillment of search and registration requests.

This is a major change from the previous registry system in which, for over 20 years, Ontario corporations were required to file a Corporations Information Act Annual Return (CIA return) with the Canada Revenue Agency (CRA). Accountants would routinely complete and file the CIA returns with the CRA on behalf of their clients – but this is no longer possible under the new system.  Commencing October 19, 2021, corporations must file their CIA returns directly online using the OBR or through an authorized third-party service provider (they can no longer be filed through the CRA).

To access the OBR, corporations must have a company key. For new corporations, a company key is automatically assigned through the OBR when businesses and not-for-profit corporations are incorporated or when non-Canadian corporations file an Initial Return for an Extra-Provincial Corporation. For pre-existing corporations in Ontario, a company key must be requested through the OBR, which will be mailed to the corporation’s registered address.

Note that corporations may still use intermediaries, such as lawyers and authorized service providers, to file their CIA returns and otherwise transact on the OBR. Law firms, through authorized service providers, are able to file documents on the OBR without a company key. If you do not have a company key and do not have much time to wait for one to come in the mail, you may need to request your law firm to submit the required documents on the OBR for you.

For more information on these or other corporate responsibilities please reach out to a member of our team.

[1] OBCA s 1.1(2)

[2] OBCA s 1.1(1)

[3] OBCA s 1.1(5)

[4] OBCA s 1.1(4)

[5] OBCA s 140.2

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Such amendments, if enacted, would be effective January 1, 2023 and would introduce beneficial ownership information requirements as a means of preventing and better detecting the use of corporations for tax evasion, money laundering, or other illicit financial activities.

These proposed modifications to Ontario’s legislation come on the heels of similar changes to the Canada Business Corporations Act (the ‘CBCA’) on the federal level and British Columbia’s Business Corporations Act.

The amendments, if implemented, would require privately-held provincially-registered corporations to collect and maintain beneficial ownership information with respect to “individuals with significant control” (‘ISC’) that can be provided on request to regulatory authorities such as tax authorities, law enforcement, the Ontario Securities Commission, and other regulatory authorities as may be defined in the legislation. Corporations would not be required to file such information externally but would be required to update this information in their own records each fiscal year and within 15 days of any changes.

To what corporations will the new requirements apply?

Although it has not been explicitly stated, the likelihood is that the new requirements will apply only to privately-held corporations registered under the OBCA, and not to reporting issuers, since comparable information is collected for those entities by other means.

Who will constitute an Individual with Significant Control?

An ISC would be defined as an individual who:

• Owns, controls, or directs 25 per cent or more of the voting shares of the corporation or shares that are worth 25 per cent or more of the fair market value of all outstanding shares of the corporation; or
• Has direct or indirect influence over the corporation without owning at least 25 per cent of the shares.

As an anti-avoidance measure, a person would also be captured as an ISC if they own or control a significant number of shares jointly with other people. In addition, if a group of related persons collectively controls at least 25 per cent of the shares of a corporation, then each person would be an ISC. A related person would include an individual and their spouse, son or daughter, or any other relative living in the same house.

What information will need to be maintained by corporations?

Corporations would need to maintain the following information on each ISC:

• Name, date of birth and address;
• Jurisdiction of residence for tax purposes;
• Date of becoming or no longer being an ISC;
• A description of how the individual has significant control over the corporation, including a description of any interests and rights in shares of the corporation; and
• A description of the steps the corporation takes to keep this information current each year.

What are the non-compliance risks and who can access the beneficial ownership information?

The issues of what repercussions corporations that fail to comply with these new requirements would face and who can access such beneficial ownership information have yet to be addressed by the Ontario government as of the date of writing. However, we note that the penalties for non-compliance and authorization to access ISC information in the Ontario legislation could turn out to be similar to those imposed at the federal level. Under the federal requirements, non-compliance can result in a fine to the corporation of up to $5,000. Furthermore, a corporation’s directors, officers, or shareholders who knowingly authorize, permit, or acquiesce in the contravention of the new requirements or knowingly record or provide false or misleading information in relation to the ISC are personally liable for a fine of up to $200,000, imprisonment for a term of up to six months, or both. Under the federal requirements, currently law enforcement and the Canadian Revenue Agency may access the ISC records in the course of an investigation.

Next Steps

In anticipation that these proposals will become law in the near future, and from a practical point of view, corporate secretaries ought to prepare and circulate a questionnaire to each registered shareholder shown on the records of private corporations to identify individuals with significant control and such results should be kept in the minute books of the corporations or in other easily accessible data-bases.

At Sotos LLP, our team of experts has been advising businesses on their legislative obligations for decades. If you wish for more information regarding your Ontario private corporation’s new obligations under the proposed changes to the OBCA, contact Lou Alexopoulos at lalexo@sotos.ca,  416.977.5024.

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In joint venture franchising, the franchisor, in addition to its traditional franchises, takes an equity interest in the franchisee, hence the term “joint venture franchising”.  The franchisee will be a corporation, limited partnership, or some other suitable investment vehicle.  The franchisor grants a standard franchise agreement to the joint venture franchise as it would with any other unit franchisee.  In addition, because the franchisor has an equity stake in the new joint venture, it also signs a joint venture agreement, unanimous shareholder’s agreement, partnership agreement, or some document that stipulates the respective parties’ rights and obligations.  Frequently, these franchisors also serve as the joint venture’s lenders, and there would be appropriate loan and security agreements.  The franchisor could also be the sublandlord pursuant to a sublease.

A small minority of franchisors have adopted, to significant economic advantage, the less-well known joint venture franchising model domestically as an alternative to traditional franchising in order to accelerate growth objectives.

ADVANTAGES OF DOMESTIC JOINT VENTURE FRANCHISING

Greater control

By virtue of the joint venture relationship, the franchisor has an actual seat at the franchisee’s board table.  As such, the franchisor has access to every detail of the franchisee’s business.  In fact, in most cases, the franchisor undertakes all of the franchisee’s back office functions because it is more efficient at such tasks than individual franchisees.

This greater level of control can allow franchisors to nurture new franchisees to minimize the risk of making avoidable mistakes. This is particularly helpful in fairly sophisticated businesses where the initial training does not come close to equipping the franchisee with the necessary know-how to build and run a business efficiently. Ultimately, the franchisor’s investment in the franchisee underscores its commitment to the success of the franchisee.  However, this comes at the cost of the franchisor having to expend far greater resources in joint venture franchises than it would under the traditional franchise model.

Perhaps the greatest advantage of joint venture franchising results from the high alignment of franchisor and franchisee economic interests.  Since the franchisor realizes most of its income from each joint venture franchisee’s bottom line, the sale of goods and services to the franchisee occur at true cost. This eliminates the economic inefficiencies resulting when franchisors gerrymander this function in order to shift income – an activity that is rarely efficient.

Another advantage of the joint venture franchise following its successful establishment is that the franchisor’s interest can be reduced or completely bought out all at fair market value. The relationship would then move closer towards the traditional franchisor-franchisee relationship. However, a future buy-out is not necessary to have a joint venture franchise, and a franchisor might want to have a higher level of control (and investment) on a long-term basis.

Undercapitalized individuals

Joint venture franchising works particularly well in fairly complex businesses heavy on capital investment with access to competent, trustworthy individuals who would make desirable franchisees but who otherwise would not have the finances to acquire a franchise.

Store managers at franchisor-owned locations (or those at direct competitors) with a proven track record of success in that role but without the financial resources to fund a new franchise make the joint venture franchise model an optimal vehicle for franchise expansion without the hit and miss results of traditional franchising.

Another common scenario for when a joint venture franchise would be desirable is where the employment of regulated professionals is a business requirement.  For example, a franchisor of pharmacies or medical clinics would have to recruit pharmacists and doctors.  Often recently graduated professionals in these fields will carry student debt and would otherwise not be able to raise the substantial capital for a franchise, no matter how promising they might be. Joint venture franchises present an opportunity for these franchisors to work with young, eager, and freshly trained professionals who would otherwise not be in the pool of franchisee candidates.

Tax advantages

Another advantage for joint venture franchises is potentially significant tax advantages for the franchisor. As long as the joint venture franchise is a Canadian-controlled private corporation (CCPC) and is eligible for the small business deduction, and is properly structured, then there is a substantial tax advantage for the franchisor to have some of its revenue come directly from its equity in the joint venture franchise. This assumes the nature of income does not include interest, dividends, or capital gains, as the joint venture is considered to be an active business Corporation. In cases where the franchisor is receiving income considered passive which does include interest dividends or capital gains, the Corporation is deemed to be considered a specified investment Corporation unless more than 5 employees work for the Corporation. This along with other tax planning can re-classify a specified investment Corporation to being active once again.

Income eligible for the small business deduction of up to $500,000 taxable income is subject to a federal rate of 9%, and if the Corporation is resident in Ontario, the combined total rate is 12.2% effective January 15^th 2020. By comparison, general income is taxed starting at a federal rate of 15%, increasing to 26.5% for Ontario corporate residents.

Since many franchisors will not meet the small business deduction requirements, they would normally pay the full corporate tax rate on income remitted to them from their franchisees.  On the other hand, franchisees would be more likely to qualify for the small business deduction. With joint venture franchises that qualify for the small business deduction, the amount that the franchisor earns through its ownership share of that franchisee could be taxed at the lower small business rates. This strategy can be repeated by the franchisor across its business, potentially owning equity in multiple joint venture franchises to gain access to the lower tax rate on dividends generated by the joint venture.  Of course, the income that the joint venture franchisee pays to the franchisor as part of the standard franchise agreement would be taxed at the normal corporate rates.

Ultimately it is the level and type of income combined that determine the assessment of tax. Optimizing such combinations could result in possible reduction of the tax burden.

POTENTIAL ISSUES WITH JOINT VENTURE FRANCHISES

While joint venture franchising offers substantial advantages, there are also potential risks, though many of them can be avoided with good legal and other professional advice.

For example, the franchisor should avoid blurring the lines between its role as a franchisor and as partner in the joint venture franchise.  If the franchisor gets too involved in decisions such as employee recruitment or dismissals for example, it could be exposing itself to liability for being a joint employer.  Franchise agreements and joint venture arrangements should be clearly and separately maintained with clear delineation of the franchisor’s function in both of its roles.

Similarly, the joint venture agreement should be well-drafted so that each party is clear on what each is contributing to the joint venture and what additional obligations each might have (e.g. non-disclosure, confidentiality). It should also set out what happens if there are irreconcilable differences between the joint venture partners and termination is necessary.

All in all, joint venture franchising is an underutilized business model for franchises in domestic markets. Depending on the context, it can have significant advantages over traditional franchisor-franchisee arrangements. The associated risks can be managed with proper legal and professional advice and can be outweighed by the benefits of properly used joint venture franchising.

Sotos LLP has over forty years of experience in advising on all aspects of franchise structuring, growth and expansion.

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