Principal Issues: A corporation ("Opco") redeems the shares of its capital stock held by another corporation ("Holdco"). This redemption of shares generates a deemed dividend pursuant to subsection 84(3). Subsection 55(2) applies. However, Holdco makes a designation under paragraph 55(5)(f). (1) Whether the credit to Holdco's capital dividend account ("CDA") would occur at the time of the share redemption. (2) Whether the moment of the credit to Holdco's CDA would change if Holdco does not make a 55(5)(f) designation. (3) Whether the moment of the credit to Holdco's CDA would change if Holdco makes a late-filed 55(5)(f) designation.
Position: (1) Yes. (2) No. (3) No.
Reasons: Wording of the Act.
2009-031025 XXXXXXXXXX G. Gladu (613) 946-5344 September 17, 2009
Dear XXXXXXXXXX,
Subject: Request for Technical Interpretation - Interaction between Sections 89 and 55
This is in response to your letter of February 13, 2009, in which you requested our comments on the above subject regarding the situation described below. We apologize for the delay in responding to your request.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the "Act").
1) Particular Situation
(a) A particular corporation ("Opco") redeemed shares of its capital stock held by another corporation ("Holdco"). A deemed dividend resulted from the redemption by virtue of subsection 84(3).
(b) Subsection 55(2) was applicable to the redemption of the shares.
(c) The safe income on hand attributable to the redeemed shares ("Safe Income") was less than the deemed dividend that resulted from the share redemption.
(d) Holdco made a designation pursuant to paragraph 55(5)(f) in its return of income filed for the taxation year in which the dividend was received.
2) Your Questions
a) You wish to know when the non-taxable portion of the capital gain, which resulted from the application of subsection 55(2) to the redemption of Opco's shares of capital stock, would be included in the calculation of Holdco's capital dividend account ("CDA").
b) You wish to know whether our position would be the same if no designation under paragraph 55(5)(f) was made by Holdco.
c) You wish to know whether our position would be the same if a designation under paragraph 55(5)(f) was made by Holdco but at a late date.
3) Our Comments
Context
Under subparagraph (b)(i) of the definition of "disposition" in subsection 248(1), any transaction or event by which a share of the capital stock of a corporation is redeemed in whole or in part or is cancelled constitutes a disposition of that share.
Furthermore, subsection 55(2) generally applies where a corporation resident in Canada has received a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1) as part of a transaction or event or a series of transactions or events, one of the purposes of which (or, in the case of a dividend under subsection 84(3), one of the results of which) was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of capital stock immediately before the dividend and that could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the safe-income determination time for the transaction, event or series.
In this regard, paragraph 55(2)(b) provides that where a corporation has disposed of the share, the amount of the dividend deemed not to be a dividend is instead deemed to be proceeds of disposition of the share except to the extent that it is otherwise included in computing such proceeds.
Paragraph 55(5)(f) permits minimization of the consequences of subsection 55(2) to the extent that the Safe Income in respect of the shares is less than the amount of the taxable dividend. More specifically, a designation may be made by the corporation so that the portion of the dividend received that is attributable to the Safe Income is deemed to be a separate taxable dividend, which would not be re-characterized under subsection 55(2).
Furthermore, paragraph 38(a) provides that a taxpayer's taxable capital gain for a taxation year from the disposition of any property is equal to one-half of the taxpayer's capital gain for the year from the disposition of the property.
Subsection 39(1) provides that a taxpayer’s capital gain from the disposition of any property is the taxpayer’s gain determined under subdivision c of the Act. In summary, paragraph 40(1)(a) provides that a taxpayer's gain from the disposition of any property is the amount, if any, by which the proceeds of disposition exceed the total of the adjusted cost base to the taxpayer of the property.
Furthermore, the relevant part of the definition "capital dividend account" in subsection 89(1) reads as follows:
capital dividend account of a corporation at any particular time means the amount, if any, by which the total of
(a) the amount, if any, by which
(i) the total of all amounts each of which is the amount if any, by which
(A) the amount of the corporation’s capital gain from a disposition (other than a disposition that is the making of a gift after December 8, 1997 that is not a gift described in subsection 110.1(1)) of a property in the period beginning at the beginning of its first taxation year (that began after the corporation last became a private corporation and that ended after 1971) and ending immediately before the particular time (in this definition referred to as “the period”)
exceeds the total of
(B) the portion of the capital gain referred to in clause (A) that is the corporation’s taxable capital gain
(...)
Response to Question (a):
Based on the foregoing, the non-taxable portion of the capital gain resulting from the redemption of the shares of the capital stock of Opco would be included in Holdco's CDC at the time of the disposition of such shares of the capital stock of Opco, i.e., at the time of their redemption.
Response to Question (b):
To the extent that Holdco did not make a designation by virtue of paragraph 55(5)(f), the total of the dividend referred to in subsection 84(3) would technically be deemed to be proceeds of disposition pursuant to paragraph 55(2)(b). That said, the inclusion in Holdco's CDA of the non-taxable portion of the capital gain resulting from the redemption of the shares of the capital stock of Opco would continue to occur on the disposition of those shares.
Response to Question (c):
If Holdco made a late designation pursuant to paragraph 55(5)(f) and that designation was accepted by the Canada Revenue Agency ("CRA"), such designation should be taken into account for the purposes of subsection 55(2). While such a designation would affect the amount to be included in Holdco's CDA as a result of the redemption of the Opco shares, it would not affect the timing of such inclusion. Thus, the inclusion in Holdco's CDA of the non-taxable portion of the capital gain resulting from the redemption of the Opco shares would continue to occur at the time of the disposition of the Opco shares.
In closing, because your letter only briefly describes a hypothetical situation, it is impossible for us to comment on any other tax consequences that may result from the Particular Situation.
Please note that this opinion is not an advance income tax ruling and, as stated in paragraph 22 of Information Circular 70-6R5 of May 17, 2002, is not binding on the CRA in respect of any particular factual situation.
We hope that our comments will be of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
Manager
Mergers and Acquisitions Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.