A corporation uses proceeds of an arm's length borrowing to pay an amount equaling its retained earnings ("RE") for the purpose of paying a dividend to its shareholders, with such RE having been generated is part from the receipt, immediately before the borrowing, from a subsidiary. Is the interest deductible?
Before indicating that it had insufficient information to answer, the Directorate stated:
For this purpose, it is our view that a particular corporation's accumulated profits generally represent its RE, calculated on a non-consolidated basis, while investments are recorded at cost and generally reflect transactions that occur in the normal course of business between parties not dealing with each other at arm’s length. We consider that the impact on accumulated earnings of other non-arm's length transactions must be considered in light of the facts of each particular situation.
Paragraph (c) of the definition of "amount" in subsection 248(1) provides that the amount of any stock dividend is the amount by which the paid-up capital of the corporation that paid the dividend is increased by reason of the payment of the dividend.