The participating and non-voting Class AA shares of Opco, which were held equally by two unrelated individuals (A and B), were worth $500,000 and had a safe income of $300,000 on January 1, 2016, and had a nominal paid-up capital and adjusted cost base. Nominal-value voting shares of Opco were held by Holdco, which was owned equally by A and B. On January 1, 2016, Holdco also subscribed $100 for 100 Class X shares of Opco, which were entitled to participate annually in Opco’s profits proportionately with the number of issued and outstanding AA and X shares and with the shares' redemption value reflecting the undistributed amount of such profits plus their initial subscription price.
On December 31, 2016, Opco had accumulated $100,000 in after-tax profits and safe income, and on January 1, 2017, Opco paid a dividend of $50,000 to Holdco pursuant to a strategy of eliminating excess liquidity in Opco in order to qualify the Class AA at all times for the capital gains deduction and also for asset protection purposes, thereby causing the Class X shares’ redemption value to decrease to $100.
Q.1:
Would the purpose of the transactions be to reduce a capital gain or reduce the market value of a share as described in s. 55(2.1)(b)? CRA responded:
[P]aying a dividend with the goal of [so] purifying the corporation…would certainly be a relevant factor that should be taken into account. However, it also should be ensured that the dividend has no other purpose described in paragraph 55(2.1)(b). For example, if the dividend paid to the corporation exceeds the amount that would be required to transfer the surplus assets, this could be a sign that the dividend has another purpose, which was one of those referred to in paragraph 55(2.1)(b).