A and B each hold 50% of the voting common shares of XYZ Inc. (whose assets consist of excess cash of $25 and active business assets of $75, such that those common shares have an FMV of $100) through their respective holding companies (Aco and Bco). An acquisition by Bco of Aco’s XYZ Inc. shares (to be financed with a $25 bank loan or note payable, and a $25 dividend) proceeds as follows under Scenarios 1, 2 or 3:
- Bco acquires such shares from Aco for $50, and thereafter receives a $25 dividend from XYZ Corp.
- XYZ Corp. repurchases a portion of its shares held by Bco for $25, and Bco acquires all of Aco’s XYZ Corp. shares for $50.
- Bco acquires all of Aco’s XYZ Corp. shares for $50, and XYZ Corp. repurchases a portion of its shares held by Bco for their FMV of $25.
As to the application of s. 55(2) in the three scenarios, CRA stated:
Scenario 1
[S]ubsection 55(2) would be applicable in respect of the dividend received by Bco to the extent that (1) the Purpose Test is satisfied (i.e. that one of the purposes of the series of transactions in which the dividend is received by Bco is to significantly reduce the portion of the capital gain that would have been realized on the disposition by Bco of the shares of the capital stock of XYZ Corp. at FMV; (2) it would be reasonable to regard that dividend as being attributable to something other than safe income on hand attributable to the shares of the capital stock of XYZ Corp. held by Bco and before the "safe income determination time" in respect of the series of transactions, and (3) paragraph 55(3)(a) does not apply.
Furthermore … the Purpose Test contained in subsection 55(2) must, as a technical matter, be considered in respect of a disposition of any share of the capital stock of XYZ Corp.
Scenario 2
[S]ubsection 55(2) would apply in respect of the deemed dividend received by Bco … to the extent that the dividend could reasonably be considered to be attributable to something other than safe income on hand, attributable to the shares of the capital stock of XYZ Corp. held by Bco and before the "safe income determination time" … .
[P]aragraph 55(3)(a) would not apply to exempt the dividend … [as] the repurchase by XYZ Corp. … would come within subparagraphs 55(3)(a)(i), (ii), (iii) and (v).
Scenario 3
[S]ubsection 55(2) would apply in respect of the deemed dividend received by Bco … to the extent that (1) the dividend could reasonably be considered to be attributable to something other than safe income on hand attributable to the shares of the capital stock of XYZ Corp. held by Bco and before the "safe income determination time" … and (2) paragraph 55(3)(a) did not apply.