PRINCIPAL ISSUES: An individual would receive a preferred share of the capital stock of Opco having a value of $1 at the time of its issuance in payment of a stock dividend of $1 paid on the common shares in that capital stock he held. The preferred share would be transferred to a holding corporation. A discretionary dividend equal to the safe income of Opco would be paid on the preferred share after the transfer of the share to the holding corporation. Whether subsection 55(2) would apply with respect to the discretionary dividend paid on the preferred share.
POSITION: At the time of the stock dividend, there would be no transfer of safe income from the common shares to the preferred share because the stock dividend would be $1. There would be no transfer of safe income at the time of the transfer of the preferred share to the holding corporation because no safe income would have accumulated on the preferred share before the transfer. According to the facts of the particular situation, there would be no safe income accumulated in Opco since the holding corporation holds the preferred share. Therefore, there would be no safe income on hand that would contribute to a capital gain on the preferred share computed using the assumptions of paragraph 55(2.1)(c). Subsection 55(2) would apply if all the other conditions are met. The answer would be the same if, instead of the payment of the discretionary dividend, it was an increase of the PUC of the preferred share.
REASONS: Wording of the Act. Previous positions with respect to the accumulation of safe income beginning when the holding period of the share starts.
7 OCTOBER 2016 APFF ROUNDTABLE ON FEDERAL TAXATION - 2016 CONFERENCE
Question 15
Application of subsection 55(2) or of GAAR in context of safe income strip
Mr. X holds all of the 799,999 Class "A" common shares of Opco. The safe income and FMV of the Opco shares are $1 million and $1.8 million, respectively. Mr. X is a resident of Canada.
The common shares have voting rights and are participating. The proposed reorganization:
1. Opco pays a dividend in Class "B" shares (1 share only) to Mr. X. The share would be voting, participating and would include a discretionary dividend clause. The paid-up capital ("PUC") of the Class "B" shares would be fixed at $1 and the value of such share at the time of its issuance would be $1 (the Class "B" share is redeemable at the amount of PUC at the time of issuance, i.e., $1).
2. Mr. X incorporates Holdco.
3. Mr. X transfers his Class "B" share to Holdco under subsection 85(1) and designates an agreed amount of $1.
4. Opco pays a cash dividend equal to the $1 million safe income on hand ("SIOH") on the Class "B" shares.
5. Mr. X then disposes of all the Opco shares for $799,999 and Holdco also disposes of its Class "B" share for $1.
Questions to the CRA:
(a) Would the CRA seek to apply subsection 55(2) or the GAAR to this series of transactions?
(b) If Opco proceeded by way of PUC increase rather than cash dividend, would the CRA's response be the same?
CRA response to Q.15(a)
On the time of the issue of the Class “B” share in the capital stock of Opco to Mr. X in payment of the stock dividend of $1 declared by Opco, it must be determined what the value of the class "B" share was at the time of its issue. This is a valuation question on which the CRA cannot pronounce in a hypothetical situation.
Based on the hypothetical facts stated above, the Class "B" Opco share capital would have a value of $1. Based on this value, the stock dividend did not result in the transfer of an unrealized capital gain to the Class "B" share nor decrease an unrealized capital gain on the Class "A" shares. Given this result and taking into account our long-standing position on the transfer of safe income on a stock dividend, there would be no transfer of safe income to the class "B" share in the capital of Opco in this situation.
Thereafter, the Class "B" share in the capital stock of Opco would be transferred to Holdco and the subsection 85(1) rollover rules would be used respecting the transfer. Since there would be no SIOH attributable to the Class "B" share owned by Mr. X, there would be no transfer of such safe income to Holdco. Furthermore, the holding period of the Class "B" share would begin at the time of the transfer to Holdco.
Thus, due to the payment of the discretionary dividend of $1 million, it must be determined what was the SIOH of Opco from the time Holdco held the Class "B" share in the capital stock of Opco until the safe income determination time. According to the facts stated above, there would be no safe income attributable to that holding period. Consequently, the dividend of $1 million paid to Holdco would exceed the SIOH of Opco from the beginning of the holding period by Holdco until the safe income determination time and no SIOH would contribute to the hypothetical capital gain on the class "B" share in the capital stock of Opco held by Holdco, according to the assumptions referred to in paragraph 55(2.1)(c).
If all other conditions were satisfied, subsection 55(2) would apply in respect of the dividend of $1 million.
Furthermore, the response of the CRA to question (a) relates only to the application of subsection 55(2) and is not intended to address any other provision of the Income Tax Act that could be applied in this situation.
CRA response to question Q.15( b)
If Opco proceeded with an increase in PUC rather than a cash dividend in this case, the CRA would have the same answer as for question (a).
Similarly to the answer to question (a), the response of the CRA to question (b) relates only to the application of subsection 55(2) and is not intended to address any other provision of the Income Tax Act that could be applied in this situation.
Sylvie Labarre
(613) 670-9014
October 7, 2016
2016-065299