Principal Issues: Preferred shares having a paid-up capital of $1 and a value of $700,000 would be paid as a stock dividend on common shares where the safe income on hand attributable to the common shares would be equal to $700,000. What would be the tax consequences arising from this stock dividend and what would be the tax consequences arising from the redemption of those preferred shares immediately after their issuance.
Position: At the time of the stock dividend and considering the facts of the particular situation, subsection 55(2) would not apply because the value of the preferred shares would not exceed the safe income on hand of the common shares before the stock dividend. The safe income on hand of the common shares would be reduced by the value of the preferred shares and the preferred shares would have an ACB equal to the reduction of the safe income on hand of the common shares. When the shares are redeemed, the tax consequences would depend on whether there would be Part IV tax paid on the deemed dividend that would not be reimbursed (or whether or not subsection 55(2) applies). If subsection 55(2) applies, there would be no tax consequences because of the high ACB of the preferred shares disposed of.
Reasons: Wording of the relevant legislative provisions of the Act.
XXXXXXXXXX 2016-066834 Sylvie Labarre, CPA, CA December 12, 2016
XXXXXXXXXX,
Subject: Stock dividend
This is in response to your e-mail of September 28, 2016 in which you requested our view on the tax consequences of the payment of a stock dividend followed by the redemption of the shares.
Unless otherwise indicated, all statutory references herein are references to the provisions of the Income Tax Act (hereinafter the "Act").
Hypothetical situation
1. X holds 100% of the shares of the capital stock of Holdco, a corporation incorporated under the Canada Business Corporations Act.
2. Holdco is the sole shareholder of Opco, a corporation also incorporated under the Canada Business Corporations Act. The only issued and outstanding sharess of Opco are 100 Class "A" shares (voting and participating). The tax attributes of these shares are paid-up capital, $100; adjusted cost base $100; safe income, $700,000; and fair market value, $1,000,000.
3. Holdco signs an offer to sell all of the shares of Opco's capital stock to an unrelated third party.
4. Prior to the sale of the shares, Opco pays a dividend on the 100 Class "A" shares in its capital stock consisting of preferred shares with a fair market value of $700,000 and a paid-up capital of $1.
5. Following the payment of the stock dividend, the fair market value of the 100 Class "A" shares is $300,000.
Questions
You wish to know what the tax consequences would be of a stock dividend following the coming into force of new subsections 55(2.2) and (2.3).
Assuming that the preferred shares are redeemed immediately after their issuance, you would also like to know the tax impact of this redemption occuring immediately after the stock dividend.
Our comments
This technical interpretation provides general comments on the provisions of the Act and related legislation, where referenced. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
The special rule in subsection 55(2.2) for determining the amount of dividends applies only for the purposes of subsections 55(2), (2.1), (2.3) and (2.4). It does not apply for purposes of the taxation of dividends under other statutory provisions. For the purposes of subsections 55(2), (2.1), (2.3) and (2.4), the amount of the stock dividend would be $700,000.
However, for the other purposes of the Act, the amount of the stock dividend would be $1 if the paid-up capital was $1. On the other hand, there is no provision in the Act that provides for an increase in paid-up capital by reason of the application of subsection 55(2.2).
The safe income on the Class A shares would be reduced by $700,000 pursuant to new paragraph 55(2.3)(b).
Consideration should also be given to the proposed changes in the calculation of the adjusted cost base of the shares received as a stock dividend. Thus, pursuant to subparagraph 52(3)(a)(ii), their adjusted cost base would be equal to $700,000 in this situation.
Upon redemption of the preferred shares, consideration should be given to whether there is a safe income that would contribute to the hypothetical capital gain on the preferred shares. We are of the view that, in the situation presented, there would be no hypothetical capital gain as the fair market value of the preferred shares would be equal to the adjusted cost base calculated in accordance with subparagraph 52(3)(a))(ii). Thus, the amount of the deemed dividend would be greater than the safe income calculated in accordance with paragraph 55(2.1)(c). 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 taxable as a dividend. In such a case, there would be a loss computed as a result of the disposition of the preferred shares, but it would be deemed to be nil by virtue of subsection 112(3).
We trust that our comments will be of assistance.
Stéphane Charette, CPA, CMA, MBA.
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch