Principal Issues: In a situation where Part III applies to part of a capital dividend (the Excessive dividend) and only part of the total dividend payable is actually paid, how to calculate the part of the Excessive dividend that is paid for the purpose of 12(1)j), 82(1) and 184(3(d)?
Position: The part of the Excessive dividend that is paid for the purpose of 12(1)j), 82(1) and 184(3(d) is computed by multiplying the amount paid divided by the proportion the Excessive Dividend is of the total dividend payable.
Reasons: Question of fact.
June 29, 2007
Ms. Manon Lemay Corporate Reorganization and Program officer Resource Industries Section T2 Specialized Processing and Resource Files Section 750 Heron Street Marc LeBlond Place Post Canada, East Tower (613) 946-3261 Ottawa ON K1A 0L5 2007-022943
Capital dividend
This is in response to your email of March 19, 2007, in which you asked for our comments on the above subject in relation to the situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
The situation
1. Mr. A is the sole shareholder of a corporation ("Corporation"). The Corporation is a "private corporation", as defined in subsection 89(1), with a "fiscal period", as defined in subsection 249.1(1), ending on XXXXXXXXXX.
2. In XXXXXXXXXX, the directors of the Corporation declared a total dividend of $XXXXXXXXXX on the outstanding shares of the share capital of the Corporation (the "Dividend").
3. The Corporation made an election pursuant to subsection 83(2), in the prescribed form and manner (T2054), in respect of the total amount of the Dividend for it to be deemed to be a capital dividend (the "Capital Dividend") equal to the amount in its "Capital Dividend Account" (the "CDA"), as defined in subsection 89(1), immediately before the Dividend became payable.
4. Following an audit, the Canada Revenue Agency (the "CRA") determined that the Capital Dividend was greater than the amount of the Corporation's CDA, immediately before the Dividend became payable, by an amount of $XXXXXXXXXX (the "Excess Dividend").
That audit also established that the Dividend did not involve a monetary movement by the Corporation in XXXXXXXXXX and that the amount of the Dividend was credited to the "Due to Shareholder" account of the Corporation. In addition to the Dividend, the only entries to the Corporation's "Due to Shareholder" account were as follows: in XXXXXXXXXX, salaries payable by the Corporation to Mr. A of $XXXXXXXXXX and interest payable by the Corporation to Mr. A of $XXXXXXXXXX were credited, while in XXXXXXXXXX, an amount of $XXXXXXXXXX was debited and paid to Mr. A. According to Schedule 3 "Dividends Received, Taxable Dividends Paid and Part IV Tax Calculation" of the Corporation's return of income for the XXXXXXXXXX taxation year, the Corporation did not pay any taxable dividends in that year.
5. Your office informed the Corporation of the existence of the Excess Dividend of $XXXXXXXXXX and that it was required to pay Part III tax on that amount pursuant to subsection 184(2). Subsequently, the Corporation filed a subsection 184(3) election in a timely manner and in the prescribed manner.
Your questions and comments
You asked whether, in the situation you have presented to us, the CRA could reassess Mr. A's return of income for the taxation year XXXXXXXXXX to include in the computation of his income for that year, pursuant to paragraph 12(1)(j) and subsection 82(1), the Excess Dividend ($XXXXXXXXXX) deemed to be a separate taxable dividend pursuant to paragraph 184(3)(c).
We understand that, in your view, it would be possible to reassess Mr. A in XXXXXXXXXX in respect of the Excess Dividend, if the Corporation's payment of $XXXXXXXXXX of the "Due to Shareholder" in XXXXXXXXXX were applied to first reduce the portion of the Dividend payable of $XXXXXXXXXX that is deemed to be a separate dividend (the Excess Dividend of $XXXXXXXXXX) and taxable, pursuant to paragraph 184(3)(a), rather than first reducing the portion of the Dividend payable of $XXXXXXXXXX that is deemed to be a Capital Dividend ($XXXXXXXXXX), or reducing the salary and interest payable to Mr. A.
Our Comments
Section 12(1)(j) reads as follows:
There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable […]
(j) any amount required by subdivision h to be included in computing the taxpayer’s income for the year in respect of a dividend paid by a corporation resident in Canada on a share of its capital stock;
[Emphasis added]
For the purposes hereof, the relevant parts of subsection 82(1) of subdivision h of the Act are as follows:
In computing the income of a taxpayer for a taxation year, there shall be included the total of the following amounts:
(a) the amount, if any, by which
(i) the total of all amounts, other than eligible dividends and amounts described in paragraph (c), (d) or (e), received by the taxpayer in the taxation year from corporations resident in Canada as, on account of, in lieu of payment of or in satisfaction of, taxable dividends,
[...]
[Emphasis added].
The relevant parts of section 184(3), for the purposes hereof, are as follows:
Where, in respect of a dividend payable at a particular time after 1971, a corporation would, but for this subsection, be required to pay a tax under this Part equal to all or a portion of an excess referred to in subsection (2) of this section or subsection 184(1) of the Income Tax Act, chapter 148 of the Revised Statutes of Canada, 1952, it may elect in prescribed manner on or before a day that is not later than 90 days after the day that is the later of December 15, 1977 and the day of mailing of the notice of assessment in respect of the tax that would otherwise be payable under this Part, and on such an election being made, subject to subsection 184(4), the following rules apply:
[...]
(c) the amount by which the excess exceeds any portion deemed by paragraph 184(3)(b) to be a separate dividend for all purposes of this Act shall be deemed to be a separate dividend that is a taxable dividend that became payable at the particular time; and
(d) each person who held any of the issued shares of the class of shares of the capital stock of the corporation in respect of which the full amount of the dividend was paid shall be deemed
(i) not to have received any portion of the dividend, and
(ii) to have received at the time the dividend was paid the proportion of any separate dividend, determined under paragraph 184(3)(a), 184(3)(b) or 184(3)(c), that the number of shares of that class held by the person at the time the dividend was paid is of the number of shares of that class outstanding at that time except that, …
[Emphasis added]
It follows from paragraph 12(1)(j) and the foregoing portions of subsections 82(1) and 184(3), inter alia, that in order to include a dividend in computing a taxpayer's income for a particular taxation year, the corporation must have paid a taxable dividend (as defined in subsection 89(1)) and the taxable dividend must have been received by the shareholder in the particular year.
The question of when a payment is received or whether a shareholder intended to make a bona fide loan to a corporation in a particular situation is a question of fact that must be resolved taking into account all the circumstances and particularities of each case.
Based on the information you have provided to us, we have assumed that the entry on the books of the Corporation, in its XXXXXXXXXX taxation year, in respect of the $XXXXXXXXXX Dividend did not represent the absolute payment of that dividend. Otherwise, the CRA could assess Mr. A's return of income for the XXXXXXXXXX taxation year to include in computing his income for that year, pursuant to paragraph 12(1)(j), subsection 82(1) and subparagraph 184(3)(d)(ii), the full amount of the Excess Dividend of $XXXXXXXXXX.
Where a corporation has a "Due to Shareholder" account with a balance consisting of several amounts payable of different kinds (including a dividend payable), none of which represents a true loan, and the corporation pays part of the balance of the account, it is necessary to establish what the corporation intended to pay in order to determine what was actually received by the shareholder. Of course, the question of what the intention of a corporation was in such a situation is a question of fact which must also be resolved taking into account all the circumstances and particulars of each case.
In the situation you have presented to us, the Corporation, in paying $XXXXXXXXXX of the "Due to Shareholder" in XXXXXXXXXX, may have intended to pay either the unpaid wages of $XXXXXXXXXX or the unpaid interest of $XXXXXXXXXX or part of the Dividend of $XXXXXXXXXX or a combination of those three amounts.
In order to determine what the Corporation's intent was in paying the $XXXXXXXXXX, you might consider, for example, whether the Corporation issued Mr. A T4 or T5 information forms in respect of wages and interest. For greater certainty, in the situation you have presented to us, if you determine that half of the $XXXXXXXXXX payment was for wages and interest, necessarily the other half of the $XXXXXXXXXX payment would be considered a partial payment of the $XXXXXXXXXX dividend.
With respect to unpaid wages and interest by the Corporation, in the situation presented, it is possible that section 78 could apply if the payment of $XXXXXXXXXX was not used to pay the wages and interest payable to Mr. A. In general, where an amount in respect of deductible expenses owing by a taxpayer remains unpaid beyond the period provided for in either subsection 78(1) (e.g., interest) or subsection 78(4) (e.g., salaries), those provisions could apply and require reassessment of the debtor and/or creditor.
On the other hand, where the total amount of a dividend is paid in part as in the present situation, for the purposes of paragraph 12(1)(j), subsection 82(1) and subparagraph 184(3)(d)(ii), we are of the view that the amount of the taxable dividend received by the shareholder should be prorated as follows:
Amount of separate taxable dividend
_______________________________________ X Amount paid
Total amount of dividend payable
If you would like our assistance in finalizing your file, please contact Marc LeBlond at (613) 946-3261 or the undersigned at (613) 957-2099.
Access to Information
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope you find our comments of assistance, and thank you for bringing these issues to our attention. Should you require any additional information regarding this matter, please do not hesitate to contact us.
Maurice Bisson, CGA
Manager
Corporate Reorganizations and Resource Industries Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.