Principal Issues: 1. A cash dividend would be paid to Holdco. Holdco would use the cash to purchase a building. Holdco would lease the building to Opco. What is the purpose of the dividend?
2. If Opco repurchases 99.99% of the shares of the capital stock of Opco held by Holdco instead of paying a dividend, would paragraph 55(3)(a) apply with respect to the deemed dividend considering that the cash paid to Holdco in consideration of the repurchase is not supported by safe income and considering that the ACB of the shares repurchased is nominal?
Position: 1. General comments.
2. We would have to analyze the potential application of subsection 245(2). This could be an abusive situation considering the purpose of subsections 55(2), 55(3) and 112(1). The CRA could find abusive a situation where cash is distributed to Holdco in consideration for the repurchase or redemption of shares of the capital stock of Opco (even if the cash was owned by Opco at the beginning of the series) if the cash does not come from income taxed in Opco.
Reasons: 1. Question of fact.
2. The offensive situations when a redemption or repurchase of shares is implemented are not limited to those mentioned in Question 11 of the 2015 CTF CRA Round Table. Another example would be where the repurchase and redemption of shares of the capital stock of a corporation is paid with assets owned by the dividend payer at the beginning of the series that includes the redemption and these assets do not come from a source of income that was taxed or that would be taxed as a result of the distribution as consideration for the shares redeemed or repurchased.
| XXXXXXXXXX | 2017-068351 Sylvie Labarre, CPA, CA |
May 12, 2017
Dear Sir,
Subject: Dividend or purchase for cancellation
This is in response to your e-mail of January 16, 2017, in which you requested our views with respect to the purpose tests provided in paragraph 55(2.1)(b) and with respect to the application of paragraph 55(3)(a) in the hypothetical situation described below.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act.
Hypothetical situation
Holdco holds 100% of the participating shares in the capital stock of Opco. It has no other property.
The participating shares in the capital stock of Opco have a market value equal to $100,000, which is the corporation’s retained earnings. The paid-up capital and the adjusted cost base of such participating shares are $1. The safe income attributable to the participating shares in the capital stock of Opco is nil.
Opco has a cash balance of $100,000 as an asset.
Opco could use its cash to acquire an immovable that would be used in carrying on its business.
Otherwise, an alternative transaction would be for it to pay a dividend of $100,000 to its shareholder, Holdco, in order for Holdco to acquire the immovable. Holdco would then lease the immovable to its subsidiary, Opco.
Questions
1. You inquired as to whether the Canada Revenue Agency (the "CRA") would consider that one of the purposes of the dividend paid to Holdco is described in subparagraph 55(2.1)(b)(ii).
2. Rather than paying a dividend of $100,000 to Holdco, whose purpose might be described in paragraph 55(2.1)(b), you stated that Opco could purchase for cancellation (by agreement with Holdco) 99.99% of the participating shares held by Holdco, for $99,999. You wish to know if CRA would challenge such an alternative transaction, the purpose of which would be to avoid the application of subsection 55(2).
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.
Question 1
In order for paragraph 55(2.1)(b) to not be applicable, it must be concluded that none of the purposes of an actual dividend is described by that paragraph. The determination of the purposes of a dividend is a question of fact.
Furthermore, the determination of the purposes of the dividend must be assessed in the light of objective and subjective factors.
Even if a dividend would normally result in a reduction in the value of a share, a reduction of the capital gain on a share or an increase in the cost of a dividend recipient’s property, these are the results of the dividend. For an actual dividend, paragraph 55(2.1)(b) requires that the purpose of the dividend be examined and not what the result is. Thus, it is necessary to establish the purpose and the motivation behind the purpose, in answering questions such as these:
- What did the taxpayer intend to accomplish by reducing the value of the shares?
- How would this reduction in value benefit the taxpayer?
- What actions did the taxpayer take in relation to this reduction in value?
In the current situation, the payment of a dividend for the purpose of acquiring an immovable must be assessed taking into account that the property could have been purchased by Opco instead of Holdco. There could therefore be a purpose similar to that of protecting the assets from risk inherent in the carrying on of the Opco business, a purpose that we have already characterized as the purpose of reducing the value of shares. It would be necessary to have all the relevant facts to be in a position to determine whether the purpose of the dividend was one of the purposes described under paragraph 55(2.1)(b). For example, it would be necessary to ascertain the reason why the immovable was purchased by Holdco, using a dividend that did not come out of safe income on hand attributable to shares in the capital stock of Opco held by Holdco.
Question 2
According to your hypothetical situation, the money received by Holdco in consideration for the purchase for cancellation of shares in the capital stock of Opco was held by Opco at the beginning of the series but did not originate from taxed income in the hands of Opco (and, thus, did not come out of Opco's safe income).
In such a situation, the utilization of paragraph 55(3)(a) respecting the purchase for cancellation of the shares in the capital stock of Opco held by Holdco, in order to replace a dividend not coming out of safe income, could be determined to be offensive.
Indeed, paragraph 55(3)(a) is intended to facilitate corporate reorganizations made in good faith by related persons but is not intended to accommodate the payment or receipt of dividends or transactions or events which seek to increase, manipulate or manufacture tax basis ["la base fiscale"].
Thus, the application of the general anti-avoidance rule in subsection 245(2) should be queried, considering that the money given to Holdco would not come from the income that had already been taxed in Opco and that the adjusted cost base of participating shares in the capital stock of Opco would be nominal.
In this regard, it should be noted that the response to question 11 of the CRA Roundtable, which took place at the Canadian Tax Foundation conference in 2015, provided only two examples and did not purport to provide an exhaustive list of situations where the utilization of paragraph 55(3)(a) would be considered to be offensive. Where the assets held by the dividend payer at the beginning of the series are transferred to the holder of shares on the redemption or purchase for cancellation of the holder’s shares, thus increasing the holder's tax basis, the CRA could find that the redemption or purchase for cancellation is offensive if the assets did not originate from sources of income already taxed in the corporation or if the transfer of the asset as consideration for the redemption or purchase for cancellation does not result in the realization of such safe income.
In support of the above statement, we refer to the response to Question 8 of the CRA Roundtable of the 2016 Canadian Tax Foundation Conference (Document 2016-0671501C6) and to document 2017-0693411C6 to be published shortly.
Consequently, in an actual situation similar to your hypothetical situation, there should be an analysis respecting tax benefit, avoidance transaction and abuse of the Act in considering the potential application of subsection 245(2).
We hope that our comments will be of assistance.
Urszula Chalupa, LL.B, M. Fisc.
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch