Scenario (a)
Mr. X, who holds all of Opco, exchanges all of his Opco common shares for retractable preferred shares of Opco. Mr. X then subscribes to 65% of the common shares of Opco, and a newly-incorporated corporation held by key employees (“Employeeco”) subscribes to 35% of the common shares of Opco. Mr. X disposes of 35% of his preferred shares to Employeeco, with Employeeco paying the purchase price by retracting the preferred shares so acquired by it.
Scenario (b)
Employeeco uses funds borrowed from a financial institution to acquire the 35% of the Opco common shares held by Mr. X, with the loan being repaid out of dividends paid out of future profits.
Scenario (c)
Same as (b) except that the purchase price is owing by Employeeco to Mr. X until paid off out of OPco dividends.
Scenario (a)
CRA indicated that (similarly to 2014 APFF Roundtable, Q. 2.4) it did not appear that Employeeco had a separate economic interest in acquiring the Opco preferred shares held by Mr. X, other than to accommodate Mr. X, and that the funds required for this acquisition would invariably come from Opco, which was and would continue to be controlled by Mr. X. Accordingly, it was “very likely that Mr. X and Employeeco would not, factually, be dealing at arm's length in respect of Mr. X's disposition of the Opco preferred shares” so that a dividend would be deemed to be paid by Employeeco to Mr. X under s. 84.1(1)(b). As a secondary position, CRA would consider applying s. 245(2) on a surplus-stripping rationale.
Scenarios (b) and (c)
CRA stated that “nothing would lead us to believe, at first glance, that Mr. X and Employeeco would not be dealing with each other at arm's length’ given that “Employeeco seems to have a separate economic interest in acquiring 35% of the common shares of the capital stock of Opco from Mr. X and such transaction does not seem to have been effected to accommodate Mr. X” so that’s. 84.1(1) would probably not apply. A review of s. 245(2) would require more facts.