Principal Issues: (1) Is technical interpretation F9906255 still valid? (2) The situation in technical interpretation F9906255 was one where: Gesco received from Canco (its subsidiary) a taxable dividend of $2 M to which subsection 55(2) applied, Gesco had safe income on hand of $300,000 in respect of its shares of Canco and Canco received a dividend refund of $25,000 on total dividends paid of $2.1M. The second issue raised is what would be Gesco's Part IV tax if in this situation Canco's dividend refund instead of $25,000 was $400,000, and, what would be the part of the dividend to which subsection 55(2)(a) would apply?
Position: (1) No. (2) Part IV tax would be approximately $380,950 and subsection 55(2)(a) would apply to $857,143.
Reasons: (1) and (2) Because of the approach adopted by the Tax Court of Canada in 943963 Ontario inc. v. HMQ (99 DTC 802).
XXXXXXXXXX 2008-026619 Marc LeBlond January 21, 2009
Dear Sir,
Subject: Technical Interpretations Nos 9711005 and 9906255
This is in response to your email of January 22, 2008 in which you asked for our comments on the above subject. We apologize for the delay in responding to your request.
Unless otherwise indicated, all legislative references herein are to the provisions of the Income Tax Act (the "Act").
Background
In your email, you referred to two technical interpretations we issued, the first in 1997 (number 9711005) (the “1997 Interpretation") and the second in 1999 (number 9906255) (the “1999 Interpretation").
1997 Interpretation
The 1997 Interpretation deals with the amount that would be subject to subsection 55(2) where the corporation receiving the dividend is subject to tax under Part IV of the Act on a portion of the dividend received. The following comments were made in that interpretation.
It is our view, that when a corporation receives a dividend, part of which is attributable to safe income on hand and part subject to tax under Part IV of the Act, it is not possible to treat the part attributable to safe income on hand as not subject to Part IV tax. Any dividend paid by the payer corporation is considered to be paid first out of the safe income on hand attributable to the recipient corporation's shares of the payer corporation. Where a particular corporation is subject to Part IV tax because a payer corporation is connected with the recipient corporation and the payer corporation receives a dividend refund as a result of the payment of the taxable dividend, by virtue of paragraph 186(1)(b), the Part IV tax will be attributable to the first part of the dividend which is equal to 4 times the dividend refund receivable by the payer corporation. Therefore, the portion of the dividend received by the recipient corporation that would be subject to tax under Part IV of the Act would also include any safe income attributable to the shares of the payer corporation held by the recipient corporation. Consequently, the recipient corporation would not have to designate any amount under paragraph 55(5)(f) of the Act in any situation where the portion of the taxable dividend that is subject to tax under Part IV of the Act exceeds the safe income on hand of the corporation.
[Emphasis added]
1: Multiplier applicable at the time.
The 1999 Interpretation
The question in the 1999 Interpretation was, in the particular situation, what was the amount of Part IV tax payable by Holdco?
The situation given in the 1999 Interpretation can be summarized as follows:
1. Holdco held all of the common shares of the capital stock of Canco. The preferred shares of Canco were held by individuals.
2. In its 1998 taxation year, Canco paid taxable dividends of $100,000 on the preferred shares. Canco then increased the paid-up capital of the common shares by $2,000,000, resulting in a deemed dividend pursuant to subsection 84(1).
3. Canco received a "dividend refund" (the "DR"), as defined in subsection 129(1), of $25,000 in respect of dividends paid in the year. Canco's common shares were then sold to an unrelated person.
4. The safe income on hand in respect of the Canco common shares was $300,000. A designation under paragraph 55(5)(f) was made such that Holdco designated two separate dividends, one for $300,000 and the other for $1,700,000.
5. Paragraph 55(2)(a) deemed the $1,700,000 dividend not to be a dividend received by Holdco.
In the 1999 Interpretation, we confirmed that the calculation of the amount of tax payable by Holdco under Part IV of the Act under paragraph 186(1)(b) was as follows:
|
DR received by Canco |
$25,000 |
|
|
X |
(i) Dividend received by Holdco |
$300,000 |
|
/ |
(ii) Total taxable dividends paid by Canco |
$2,100.000 |
|
= |
$3,571 |
|
Your Questions
Your first question is whether the 1999 Interpretation is still valid.
Second, you asked us what our conclusion would be if, in the situation given in the 1999 Interpretation, the amount of the DR was $400,000 rather than $25,000 for Canco, the payor corporation.
Finally, you asked us how to reconcile the 1999 Interpretation with the 1997 Interpretation.
Our Comments
The 1999 Interpretation is no longer valid as a result of the decision in 943963 Ontario Inc. v. S.M.R. ("943963 Ontario"), [1999] TCC No. 97-2855 (99 DTC 802).
We are of the view that as a result of that case, the amount of Part IV tax payable by Holdco in the 1999 Interpretation should be calculated as follows:
|
DR received by Canco |
$25,000 |
|
|
X |
(i) Dividend received by Holdco |
$2,000,000 |
|
/ |
(ii) Total taxable dividends paid by Canco |
$2,100.000 |
|
= |
$23,810 |
In addition, in the situation set out in the 1999 Interpretation, if instead of obtaining a DR of $25,000 Canco obtained a DR of $400,000, we are of the view that the amount of tax payable by Holdco under Part IV of the Act would be approximately $380,950, which amount would be calculated as follows:
|
DR received by Canco |
$400,00 |
|
|
X |
Dividend received by Holdco |
$2,000,000 |
|
/ |
Total taxable dividends received by Canco |
$2,100.000 |
|
= |
$380,952 |
Our conclusions are based on the following observations.
In general, where a corporation resident in Canada has received a taxable dividend in respect of which it is entitled to a deduction by virtue of subsection 112(1) or (2) or 138(6) and the dividend substantially reduces the portion of the hypothetical gain (as described in subsection 55(2)) that is attributable to something other than safe income on hand (calculated for the period prescribed by subsection 55(2)), subsection 55(2) provides that,
… notwithstanding any other section of this Act, the amount of the dividend (other than the portion of it, if any, subject to tax under Part IV that is not refunded as a consequence of the payment of a dividend to a corporation where the payment is part of the series)
(a) shall be deemed not to be a dividend received by the corporation;
[...]
[Emphasis added]
For the purposes hereof, the relevant parts of subsection 186(1) read as follows:
Every corporation … that is at any time in a taxation year a private corporation or a subject corporation shall, on or before its balance-due day for the year, pay a tax under this Part for the year equal to the amount, if any, by which the total of
[...]
(b) all amounts, each of which is an amount in respect of an assessable dividend received by the particular corporation in the year from a private corporation or a subject corporation that was a payer corporation connected with the particular corporation, equal to that proportion of the payer corporation’s dividend refund (within the meaning assigned by paragraph 129(1)(a)) for its taxation year in which it paid the dividend that
(i) the amount of the dividend received by the particular corporation
is of
(ii) the total of all taxable dividends paid by the payer corporation in its taxation year in which it paid the dividend and at a time when it was a private corporation or a subject corporation
exceeds 1/3 of the total of …
[...]
[Emphasis added]
In 943963 Ontario, a situation similar to that described in the 1999 Interpretation, 943963 Ontario was deemed by subsection 84(3) to have received a dividend of $1,199,268 in 1992 as a result of the purchase for cancellation of the shares of the capital stock of HSP Graphics Ltd ("HSP") that it owned. 943963 Ontario and HSP were connected to each other; the amount of the $1,199,268 dividend was subject to both subsection 55(2) and tax under Part IV of the Act. HSP's DR on the $1,199,268 dividend was limited to its remaining "refundable dividend tax on hand" (as defined in subsection 129(3)) of $141,730 and HSP's safe income on hand attributable to the redeemed shares of its capital stock was $252,265.
In that case, the Court held, in paragraphs 24 and 25 of the reasons for judgment, that the portion of the dividend represented by safe income on hand (or "safe income") was not exempt from tax under Part IV of the Act, for purposes of determining the amount of the dividend deemed not to be a dividend under paragraph 55(2)(a), as follows:
[24] The words "the amount of the dividend" in subsection 55(2) that appear immediately before the last set of parenthesis preceding paragraph (a) refer to the phrase "where a corporation resident in Canada has received a taxable dividend ...", that is, the opening words of subsection 55(2). The words "the amount of the dividend" also applies to amounts of all dividends designated by a corporation pursuant to paragraph 55(5)(f). Thus, "the amount of the dividend" is the full amount of the dividend the appellant received from HSP and the portion of the dividend subject to Part IV tax is the portion of the taxable dividend of $1,199,268 that is subject to Part IV tax.
[25] There is nothing in the Act liberating the portion of the taxable dividend equal to safe income from Part IV tax. The whole of the taxable dividend of $1,199,268 that is deemed by subsection 84(3) of the Act to be paid by HSP to the appellant and received by the appellant as a private corporation is subject to Part IV tax by virtue of section 186. The phrase "notwithstanding any other section of the Act" preceding the words "the amount of the dividend" in subsection 55(2) do not affect the character of the receipt as a taxable dividend, whether or not subject to Part IV tax. All amounts in the introductory paragraph of subsection 55(2) (and the dividends referred to in paragraph 55(5)(f)) are amounts of taxable dividends; it is only in paragraphs (a), (b) and (c) that the deeming provisions arise and that the "notwithstanding" phrase applies to these deeming provisions only.
[Emphasis added]
The 1997 Interpretation proposed exactly the same calculation principle as that adopted in 943963 Ontario: namely, that the portion of the dividend representing safe income on hand was subject to Part IV tax.
Furthermore, it can be inferred that, in that case, both the parties and the Court set the Part IV tax payable by 943963 Ontario at $141,730, despite the fact that a portion of the dividend deemed received under subsection 84(3) by 943963 Ontario was deemed not to be a dividend received by virtue of paragraph 55(2)(a).
Indeed, nothing in that judgment suggests that the amount of Part IV tax payable by 943963 Ontario may have been different as a result of the assessment by virtue of paragraph 55(2)(a). On the contrary, the following excerpt from the reasons for judgment, at ¶ 31, suggests that the Part IV tax payable by 943963 Ontario was $141,730.
[31]... In the case at bar, HSP's dividend refund was limited to the amount of its refundable dividend tax on hand account, that is, $141,730. Whether HSP paid a dividend of $566,920 (four times $141,730) or $1,000,000, the refund payable to HSP would be the same, $141,730. And a dividend received by the appellant in excess of $566,920 would not result in a Part IV tax greater than $141,730; …
[Emphasis added]
It follows, therefore, that the amount of the assessable dividend received for the purposes of subparagraph 186(1)(b)(i) remains the same despite the fact that a portion of the dividend may be deemed not to be a dividend by virtue of paragraph 55(2)(a).
Based on the comments above, in the situation set out in the 1999 Interpretation, if instead of obtaining a DR of $25,000, Canco obtained a DR of $400,000, for purposes of applying subparagraph 186(1)(b)(i), the amount of the eligible dividend received by Holdco for purposes of computing its Part IV tax payable by Holdco would be $2 million and its tax payable under Part IV of the Act would be approximately $380,950, as previously calculated.
Furthermore, in such a situation, for the purposes of applying paragraph 55(2)(a) to Holdco, we are of the view that the following calculations could be made:
| Total | |||
Deduct:
|
$300,000 ($300,000) |
$1,700,00 - |
$2,000,000 |
|
($300,000) |
|||
Deduct:
Dividend subject to Pt. IV tax, i.e., 3 X $380,952 = $1,142,857 Deduct: |
$0 - |
$1,700,000 $842 857) |
$1,700,000 |
|
($842 857) |
|||
|
$0 | $857,142 | $857,143 |
We hope that our comments are of assistance.
Best regards,
Maurice Bisson, CGA
Manager
Corporation Reorganizations and Resource Industries Section
Corporation Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.