Principal Issues: Whether subsection 55(2) applies to the dividend received in three proposed scenarios.
Position: Subsection 55(2) may apply depending on the circumstances.
Reasons: Wording of the Act and previous positions.
2008-029391 XXXXXXXXXX G. Gladu 613) 946-5344 February 16, 2009
Dear Sir,
Subject: Application of subsection 55(2) of the Income Tax Act (the "Act")
This is in response to your letter of September 8, 2008 and your e-mail of December 17, 2008 in which you asked for our comments on the above subject in relation to the situation described below.
It appears to us that the situation described in your letter and summarized above could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more transactions being completed, you should submit all relevant facts and documents to the appropriate Tax Services Office for their opinion. However, we are able to offer the following general comments that may be of assistance to you. It should be noted that the application of one or more provisions of the Act generally requires the analysis of all the facts relating to a particular situation. Accordingly, and given that your letter only very briefly describes a particular hypothetical situation, the comments we make below may not apply in full in a given particular situation.
Unless otherwise indicated, all legislative references herein are to the provisions of the Act.
1) The Particular Situation
(a) Individuals A and B respectively hold 50% of the Class A shares of the capital stock of XYZ Corp. ("XYZ Corp.") through their respective holding companies ("Aco" and "Bco"). These Class A shares are voting and participating and constitute the only issued and outstanding shares of the capital stock of XYZ Corp. We have assumed that Aco, Bco and XYZ Corp. are corporations resident in Canada.
(b) The assets of XYZ Corp. consist of excess cash in the amount of $25 and assets used in the business of XYZ Corp. in the amount of $75.
(c) The fair market value (the "FMV") of the Class A shares of the capital stock of XYZ Corp. held by Aco and Bco is $100.
(d) Bco would like to acquire all the shares in the capital stock of XYZ Corp. held by Aco. The acquisition price for such shares would be for their FMV, i.e. $50.
(e) In the particular situation, we have assumed that A and B are not related to each other within the meaning of subsection 251(2) and that Aco and Bco deal with each other at arm's length.
(f) Bco would finance the acquisition of the shares of the capital stock of XYZ Corp. held by Aco in part with a $25 note payable (or bank loan) and in part with $25 received from XYZ Corp. as a dividend. The latter amount of $25 is deductible by virtue of subsection 112(1) at the Bco level. In this regard, three scenarios are considered below.
(g) We have assumed that the dividend that would be received by Bco, in the three scenarios set out below, would not be subject to Part IV tax.
Scenario 1:
Bco acquires all of the shares of the capital stock of XYZ Corp. held by Aco for $50. Thereafter, XYZ Corp. pays a dividend of $25 to Bco.
Scenario 2:
XYZ Corp. repurchases, for their FMV, part of the shares of its capital stock held by Bco for an amount of $25. Thereafter, Bco acquires all of the shares of the capital stock of XYZ Corp. held by Aco for $50.
Scenario 3:
Bco acquires all of the shares of the capital stock of XYZ Corp. held by Aco for $50. XYZ Corp. then repurchases for their FMV a portion of the shares of its capital stock held by Bco for $25.
2) Your Question
You wish to know our position regarding the application of subsection 55(2) to the dividend that would be paid by XYZ Corp. and received by Bco in each of the three scenarios described above.
3) Your Comments
You are of the view that subsection 55(2) should not apply respecting the dividend received by Bco in Scenario 1 because none of the purposes of the dividend was to significantly reduce the portion of the capital gain that would, but for the dividend, have been realized as a result of the disposition by Aco of the shares of the capital stock of XYZ Corp. You are also of the view that subsection 55(2) should also not apply to the deemed dividend resulting pursuant to subsection 84(3) from the repurchase of shares subject (Scenarios 2 and 3).
4) Our Comments
Whether subsection 55(2) is applicable to a particular situation depends on a number of factors and requires an examination of all the facts and circumstances surrounding that situation. Thus, the application of this provision depends, inter alia, on the purpose of the transaction (the "Purpose Test") (or the result, in the case of a dividend referred to in subsection 84(3), the "Results Test"), the event or series of transactions or events under which a corporation resident in Canada receives a taxable dividend deductible by virtue of subsection 112(1). The application of subsection 55(2) in a particular situation also depends on the identification of transactions and/or events that are part of a series of transactions or events. In addition, the identification of transactions that are part of a series of transactions is necessary in order to establish the "safe-income determination time" within the meaning of subsection 55(1) and to determine whether subsection 55(3)(a) is applicable in respect of a particular situation.
Notwithstanding the foregoing, we are able to offer the following general comments with respect to the three scenarios described above.
Our comments on Scenario 1:
We are of the view that subsection 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, we wish to clarify that 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.
Our comments on Scenario 2:
We are of the view that subsection 55(2) would apply in respect of the deemed dividend received by Bco by virtue of subsection 84(3) 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" in respect of the series of transactions.
In Scenario 2, it should be noted that the Results Test, and not the Purpose Test, would be applicable.
In addition, in Scenario 2, it is our view that paragraph 55(3)(a) would not apply to exempt the dividend from the application of subsection 55(2). Indeed, the repurchase by XYZ Corp. of certain shares of its capital stock held by Bco would come within subparagraphs 55(3)(a)(i), (ii), (iii) and (v).
Our comments on Scenario 3:
We are of the view that subsection 55(2) would apply in respect of the deemed dividend received by Bco pursuant to subsection 84(3) 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" in respect of the series of transactions, and (2) paragraph 55(3)(a) did not apply.
In Scenario 3, it should be noted that the Results Test, not the Purpose Test, would be applicable.
Please note that this opinion is not an advance income tax ruling and, as stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, is not binding on the CRA in respect of any particular factual situation. In addition, we have not considered the potential application of other provisions of the Act.
We hope that our comments are 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.