Principal Issues: Are there income tax consequences resulting from the issuance of discretionary shares?
Position: Subsection 15(1) or paragraph 69(1)(b) could apply, depending on the facts and circumstances surrounding the particular situations.
Reasons: Subsection 15(1) may apply where a benefit is conferred by the corporation. For example, this could be the case where shares are issued by a corporation for consideration that is less than the fair market value of the said shares. If the benefit is conferred by a shareholder rather than by the corporation, paragraph 69(1)(b) may apply to the shareholder. Finally, the potential application of subsection 245(2) should be considered in any particular situation.
XXXXXXXXXX 2010-036413 Sylvie Labarre, CA May 19, 2010
Dear Sir,
Subject: Discretionary dividend shares
This is in response to your letter of April 15, 2010, in which you asked for our views on the tax consequences of purchasing discretionary dividend shares under the following different scenarios.
Unless otherwise indicated, any reference to a statute of law or one of its provisions in this document is a reference to a section of the Income Tax Act or any of its provisions.
Facts
The following facts apply to all the situations.
The capital stock of Opco consists of two classes of shares. The Class A shares are voting and participating pari passu with the remaining shares of the corporation in the event of winding up. In addition, they have a right to a discretionary dividend. The Class B shares are non-voting and would participate pari passu on a winding-up. The Class B Shares would also have a right to a discretionary dividend.
Upon the incorporation of Opco, X subscribed for 100,000 Class A shares of the capital stock of Opco with a total paid-up capital of $1,000.
All of the issued and outstanding shares of the capital stock of Holdco are held by X.
Case A
Upon incorporation, Holdco subscribed for one Class B share of the capital stock of Opco with a paid-up capital of $0.01.
This structure was put in place with the objective of paying dividends to Holdco in order to shelter excess cash from potential creditors and to maintain Opco's status as a "small business corporation" ("SBC").
Case B
Ten years after X's initial subscription, Holdco subscribed for one Class B share of the capital stock of Opco for $5 when the Class A shares held by X had a value of $500,000.
That structure was also put in place with the objective of paying dividends to Holdco in order to shelter excess cash from potential creditors and to maintain Opco's SBC status.
Case C
Upon incorporation, X's spouse subscribed for one Class B share of the capital stock of Opco with a paid-up capital of $0.01.
The purpose of this structure was to effect income splitting by paying dividends to X's spouse.
Case D
Ten years after X's initial subscription, X's spouse subscribed for one Class B share of the capital stock of Opco for $5 when the Class A shares held by X had a value of $500,000.
Opco's articles provided that Opco could never pay a dividend to X's spouse that would have the effect of reducing the market value of the 100,000 Class A shares held by X to less than $500,000.
The purpose of that structure would also be to effect income splitting by paying dividends to X's spouse.
Case E
Upon incorporation, an unrelated employee subscribed for one Class B share of the capital stock of Opco with a paid-up capital of $0.01.
The purpose of that structure was to eventually pay dividends to the unrelated employee.
Question
You wish to know whether, in the Cases you submitted to us, the subscription for Class B shares and the payment of discretionary dividends would result in tax consequences for Opco shareholders and Opco.
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency ("CRA") not to issue written opinions regarding proposed transactions otherwise than by way of advance income tax rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments which may be helpful to you. These comments, however, may not apply to your particular situation in certain circumstances.
It is a question of fact whether, in the various scenarios discussed above, the amount paid on the subscription for the Class B shares of the capital stock of Opco would represent the fair market value of the shares of that class. Since the determination of that value is not the responsibility of the Income Tax Rulings Directorate, we cannot make general comments with respect to that fair market value.
Consequently, we cannot confirm that the Class B shares were subscribed for in an amount equal to their fair market value.
The tax consequences of subscribing for Class B shares would depend, inter alia, on the fair market value of such shares at the time of subscription.
An analysis of certain factors such as the agreements between the parties, the objective of the implementation of the planning, and the intention with respect to the payment of dividends to the holder of the Class B shares could lead us to conclude that an economic benefit was conferred on the holder of the Class B shares.
Thus, in certain situations, we are of the view that it could be argued that Opco conferred a benefit described by subsection 15(1) on the holder of the Class B shares when such shares were issued. For example, we might reach this conclusion in a situation where the amount paid for the Class B shares did not represent the fair market value of the Class B shares at the time of subscription. On the other hand, in Case E where an unrelated employee acquired the shares, the benefit may have been conferred qua employee rather than qua shareholder and could have been taxable by virtue of section 6 rather than by virtue of section 15.
On the other hand, there may be circumstances where we would be of the view that X conferred the benefit and not Opco. At that time, we might consider that subsection 69(1) applied rather than subsection 15(1). If subsection 69(1) applied, X would have disposed of a right or interest in Opco to the subscriber for the Class B shares. X would therefore be deemed to have received consideration equal to the fair market value of the property disposed of as a result of such a disposition under paragraph 69(1)(b). In this regard, we refer you to, inter alia, The Queen v. Kieboom, 92 DTC 6382 (F.C.A.).
In addition, if X disposed of any right or interest in Opco to X's spouse, as in Case D, we could also argue that the attribution rules in subsection 74.1(1) would apply to reallocate to X any dividends paid on the Class B shares held by X's spouse.
We should also consider all of the facts and circumstances surrounding a particular situation to determine whether the use of discretionary dividend shares in that situation would result in the application of subsection 245(2) to that particular situation.
Subject to the application of the attribution rules or subsection 245(2) to a particular situation, the normal dividend taxation rules would apply in respect of discretionary dividends received by a shareholder.
These comments are not advance income tax rulings and are not binding on the CRA in respect of any particular situation.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
for the Director
Corporate Reorganizations and Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.