The only issued and outstanding share of Opco (which has retained earnings of $500,000) is 1 Class A common share, with a fair market value of $1,000,000 owned by Mr. A. Opco issues to Mrs. A, for nominal consideration, 1 non-voting Class B preferred share, which is redeemable and retractable “for the fair market value for which it is issued” and entitled to discretionary dividends as and when declared.
In Scenario 1, Opco immediately declares and pays out a $100,000 dividend on the Class B preferred share, which would have the effect of reducing the FMV of Opco and the 1 Class A common share by the same amount.
In Scenario 2, Opco does not declare and pay the $100,000 dividend until after it has earns an additional $100,000 of income, and the FMV of Opco after the dividend is at least $1,000,000.
What would be the consequences for Opco and its shareholders of such issuance and dividend? CRA responded:
Consistent with… Neuman….generally, subsection 56(2) will not apply to arrangements involving the payment of dividends by a corporation, provided that the applicable taxpayer does not have a pre-existing entitlement to the dividends and provided that proper consideration was given for the shares when issued. …
While we have considered the application of subsection 245(2) in respect of the Neuman type income splitting arrangements in the past and have taken the position that GAAR does not apply, we have also specifically stated that this comment regarding the non-application of GAAR relates only to the Neuman case.