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 appeared to indicate that it could be difficult to seek to apply s. 56(2) in light of Neuman, but it was more likely that s. 15(1) could be applied “particularly if the amount that is being paid by Mrs. A as consideration for the share does not represent the fair market value of such share at the time of subscription.” CRA then stated:
Alternatively, it may be possible that the circumstances of a particular situation would suggest that Mr. A rather than Opco is conferring the benefit to Mrs. A. If it could be demonstrated that there was a transfer of economic interest in Opco from Mr. A to Mrs. A similar to the situation...Kieboom...Mr. A would be considered to have disposed of a right, interest or right to dividends in Opco to Mrs. A. Under these circumstances, because Mr. A and Mrs. A are spouses, the automatic rollover provision in subsection 73(1) would apply such that the disposition of Mr. A’s economic interest would be at cost.