Principal Issues: Whether paragraph 55(3)(a) of the Act would apply to the hypothetical situation described in the letter to exclude from the application of subsection 55(2) of the Act the deemed dividends resulting from the cross redemption of shares between two corporations as a result of an internal asset spin-off.
Position: General comments provided.
Reasons: Although none of the situations described in subparagraphs 55(3)(a)(i) to (v) seems to occur, the question of determining whether subsection 55(4) is applicable in the particular situation is a question of fact.
XXXXXXXXXX 2010-038066 J. Lafrenière (613) 941-2956
November 9, 2010
Subject: Request for technical interpretation - Subsection 55(2)
Dear Sir,
This is in response to your e-mail of September 16, 2010, in which you requested clarification regarding the application of subsection 55(2) of the Income Tax Act (the "Act") in a particular situation.
Unless otherwise indicated, any statutory reference herein is to a provision of the Act.
Unless otherwise stated, all statutory references to a statutory section or included provision in this letter are to a section of the Act or to one if its included provisions.
It appears to us that the situation described in your email and summarized below could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for its opinion. However, we can offer the following general comments that may be helpful to you. It should be noted that the application of one or more provisions of the Act generally requires an analysis of all the facts relating to a particular situation. As a result, and given that your email only provides a very brief description of a hypothetical situation, the comments below may not be fully applicable in a particular situation.
(1) The Particular Situation
You submitted the situation described below (the "Particular Situation") as part of your request for a technical interpretation:
(a) An individual ("Father") owns all the voting and non-participating shares as well as XXXXXXXXXX% of the non-participating preferred shares of the capital stock of a corporation ("Father Inc."). All the participating and non-voting shares of the capital stock of Father Inc. are held by a trust ("Trust").
(b) Trust is a family inter vivos trust whose beneficiaries are Father and his two children ("Son" and "Daughter"). The trustees are Father, Daughter and an unrelated third party.
(c) Son holds all the shares of the capital stock of a corporation ("Son Inc.").
(d) Daughter holds all of the shares of the capital stock of a corporation ("Daughter Inc.").
(e) Son Inc. and Daughter Inc. each hold XXXXXXXXXX% of the non-participating preferred shares of the capital stock of Father Inc.
(f) Father Inc., Son Inc. and Daughter Inc. hold respectively XXXXXXXXXX%, XXXXXXXXXX% and XXXXXXXXXX% of: (a) the participating and non-voting shares, and (b) the voting and non-participating shares of the capital stock of a corporation ("Holdco Inc.").
(g) Father Inc., Son Inc. and Daughter Inc. own, respectively, XXXXXXXXXX%, XXXXXXXXXX% and XXXXXXXXXX% of the other shares (preferred, non-voting and non-participating shares) of the capital stock of Holdco Inc.
(h) Holdco Inc. holds all of the shares of the capital stock of a corporation ("Opco 1 Inc.") and XXXXXXXXXX% of the shares of the capital stock of another corporation ("Opco 2 Inc."). The other XXXXXXXXXX % of the shares of the capital stock of Opco 2 Inc. is held by an unrelated third party.
The following transactions are intended to create a centralized real estate rental corporation:
(a) Creation of a new corporation ("Holdco 2 Inc."). The initial subscription in the capital stock of Holdco 2 Inc. is as follows: Father Inc. XXXXXXXXXX common shares (voting and participating shares) for XXXXXXXXXX per share.
(b) Thereafter, Son Inc. and Daughter Inc. each subscribe for XXXXXXXXXX common shares in the capital stock of Holdco 2 Inc. for XXXXXXXXXX per share.
(c) Father Inc. transfers preferred shares of the capital stock of Holdco Inc. having a total fair market value ("FMV") of $XXXXXXXXXX to Holdco 2 Inc. using the rollover rules provided in subsection 85(1). The elected amount is XXXXXXXXXX in total, which is equivalent to the paid-up capital ("PUC") and adjusted cost base ("ACB") of the transferred shares. In consideration, Holdco 2 Inc. issues to Father Inc. preferred shares of its capital stock with a total redemption value ("RV”) of $XXXXXXXXXX as well as a PUC and an ACB of XXXXXXXXXXX.
(d) Son Inc. transfers preferred shares of the capital stock of Holdco Inc. having an aggregate FMV of $XXXXXXXXXX to Holdco 2 Inc. using the rollover rules provided in subsection 85(1). The elected amount is XXXXXXXXXX in total, which is equivalent to the PUC and ACB of the transferred shares. In consideration, Holdco 2 Inc. issues to Son Inc. preferred shares of its capital stock with an aggregate RV of $XXXXXXXXXX and a PUC and ACB of XXXXXXXXXX.
(e) Daughter Inc. transfers preferred shares of the capital stock of Holdco Inc. having an aggregate FMV of $XXXXXXXXX to Holdco 2 Inc. using the rollover rules provided in subsection 85(1). The elected amount is XXXXXXXXXX in total, which is equivalent to the PUC and ACB of the transferred shares. In consideration, Holdco 2 Inc. issues to Daughter Inc. preferred shares of its capital stock with an aggregate RV of $XXXXXXXXXX and a PUC and ACB of XXXXXXXXXX.
(f) Holdco Inc. transfers all of the shares it holds in the capital stock of Opco 1 Inc., having a FMV of $XXXXXXXXXX, to Holdco 2 Inc. using the rollover rules provided in subsection 85(1). The elected amount is XXXXXXXXXX in total, which is equivalent to the PUC and ACB of the transferred shares. In consideration, Holdco 2 Inc. issues to Holdco Inc. preferred shares of its capital stock with an aggregate RV of $XXXXXXXXXX and a PUC and ACB of XXXXXXXXXX .
(g) Holdco Inc. transfers land and a building with a total FMV of $XXXXXXXXXX to Holdco 2 Inc. using the rollover rules provided in subsection 85(1). The elected amount is $XXXXXXXXXX, which is the total of the undepreciated capital cost of the transferred building and the ACB of the transferred land. In consideration, Holdco 2 Inc. issues to Holdco Inc. preferred shares of its capital stock having an aggregate RV of $XXXXXXXXXX and a PUC and ACB of $XXXXXXXXXX.
(h) Holdco Inc. redeems the preferred shares of its capital stock held by Holdco 2 Inc. in consideration for a note for $XXXXXXXXXX. The redemption results in the payment to Holdco 2 Inc. of a deemed dividend of $XXXXXXXXXX.
(i) Holdco 2 Inc. redeems the preferred shares of its capital stock held by Holdco Inc. in consideration for the cancellation of the note referred to in (h) above. The redemption results in a deemed dividend of $XXXXXXXXXX to Holdco Inc.
(j) In addition, you state that in your opinion:
- Holdco Inc. is related to Father Inc. by virtue of subparagraph 251(2)(b)(i).
- Holdco 2 Inc. is related to Holdco Inc. by virtue of subparagraph 251(2)(c)(i).
- Son Inc. is related to Holdco Inc., inter alia, by virtue of subparagraph 251(2)(b)(iii).
- Son Inc. is related to Holdco 2 Inc., inter alia, by virtue of subparagraph 251(2)(b)(iii).
- Daughter Inc. is related to Holdco Inc., inter alia, by virtue of subparagraph 251(2)(b)(iii).
- Daughter Inc. is related to Holdco 2 Inc., inter alia, by virtue of subparagraph 251(2)(b)(iii).
- Son Inc. and Daughter Inc. are related to Father Inc., inter alia, by virtue of subparagraph 251(2)(b)(iii).
- Son Inc. and Daughter Inc. are not related for the purposes of paragraph 55(3)(a).
- in that context, Holdco Inc. and Holdco 2 Inc. are related to each other, and both are related to each of Father Inc., Son Inc. and Daughter Inc.,
- the exception in paragraph 55 (3) (a) would apply to ensure that subsection 55(2) does not apply to either of the two dividends deemed to have occurred on the redemptions.
(2) Your Question regarding the Particular Situation
Assuming that there are no other transactions in the above-described series of transactions and that there is no safe income on hand attributable to the preferred shares redeemed by Holdco Inc. and Holdco 2 Inc., would subsection 55(2) apply to the deemed dividends paid in the Particular Situation?
(3) Our comments on the Particular Situation
For the purposes of this analysis, we have assumed that, in the Particular Situation, on the one hand, all of the above transactions are part of a series of transactions or events and, on the other hand, that they constitute the totality of the transactions that are part of the series of transactions or events.
Similarly, we have assumed that all increases in an interest in a corporation resulting from the transactions described in the Particular Situation are significant increases in the interest in the corporation.
It can be seen, as indicated, that there are several transactions involving a disposition of property or a significant increase in an interest in a corporation that would be described in subparagraphs 55(3)(a)(i) to (v) if, in the case of a disposition, it were made to an unrelated person immediately before the time of the disposition or, in the case of a substantial increase in a person's total direct interest in a corporation, it was a substantial increase for one or more persons who were unrelated persons immediately before the time of the substantial increase in an interest in the corporation.
Consequently, the question is whether such dispositions or substantial increases in interests in the Particular Situation involve unrelated persons immediately before the particular time.
Pursuant to subparagraph 55(3.01)(a)(i), a person, other than the dividend recipient, to whom the dividend recipient is not related is an unrelated person for the purposes of paragraph 55(3)(a).
In addition, subparagraph 55(5)(e)(i) provides that persons are deemed to deal with each other at arm's length and not to be related to each other if the person is the brother or sister of the other person. Consequently, Son and Daughter are not related persons for the purposes of section 55.
In the Particular Situation, the dividend recipients are Holdco Inc. and Holdco 2 Inc.
In general, and based on the facts set out in the Particular Situation, the exception in paragraph 55(3)(a) would appear to apply in respect of deemed dividends resulting from the cross-redemptions between Holdco Inc. and Holdco 2 Inc.
We note, however, that in the Particular Situation, Father controls Father Inc., Holdco Inc., Holdco 2 Inc. as well as Opco 1 Inc.
In this regard, subsection 55(4) provides inter alia that, for the purposes of section 55, where it can reasonably be considered that one of the main purposes of one or more transactions or events was to cause persons to be related to each other so that subsection 55(2) would (but for subsection 55(4)) not apply to a dividend, that relationship is deemed not to exist. Under this provision, therefore, it must be demonstrated that none of the main reasons for the events or transactions is to cause persons to become related to each other so that subsection 55(2) would not apply to a dividend.
We cannot make a determination on the application of subsection 55(4) without examining all the facts and circumstances surrounding a particular situation. Based solely on the information provided in your request, it is not possible for us to determine whether subsection 55(4) could be applicable in the Particular Situation.
Furthermore, this Directorate has previously issued advance rulings on the application of subsection 55(4) to transactions for certain family business reorganizations. For example, this Directorate has previously taken the position that subsection 55(4) should not apply where the principal reason for a shareholder holding a sufficient number of shares of the capital stock of a corporation to control it was to protect the economic interests of the shareholder.
We hope that these general comments are of assistance.
Best regards,
Maurice Bisson, CGA
Manager
Corporate Reorganizations and Resource Industries Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.