Prior to a sale by Holdco of its Class "A" voting and participating shares of Opco (which have a paid-up capital, adjusted cost base, safe income and fair market value of $100, $100, $700,000 and $1,000,000, respectively), Opco pays a dividend on those shares consisting of preferred shares with an FMV and PUC of $700,000 and $1, respectively, resulting in the FMV of the Class "A" shares being reduced to $300,000. What are the tax consequences of the stock dividend and redemption?
CRA noted that, by virtue of s. 55(2.2) the amount of the dividend (which otherwise would be $1) would be deemed to be $700,000 for purposes of s. 55(2) to (2.4) – and given that the safe income on the Class A shares would be reduced by $700,000 under s. 55(2.3)(b), the ACB of the preferred shares also would be $700,000.
CRA then stated respecting the $699,000 deemed dividend arising on the redemption of the preferred shares:
Subsection 55(2) would apply in this situation if the dividend of $699,999 was not subject to Part IV tax or was subject to Part IV tax that was refunded as a consequence of the payment of a dividend by the corporation. If subsection 55(2) applied, the amount of $699,999 would be deemed not to be a dividend and would be deemed to be included in the proceeds of disposition of the preferred shares. By reason of the adjusted cost base in this situation, the gain would be nil.
On the other hand, if subsection 55(2) did not apply because, for example, of the dividend being subject to Part IV tax, the dividend of $699,999 would be taxed as a dividend. In such a case… [the loss] would be deemed to be nil by virtue of subsection 112(3).