Principal Issues: Whether subsection 55(2) would apply to the dividends received by GESCO and SOEURCO in the two scenarios described in the letter?
Position: No
Reasons: No disposition or significant increase of interest described in subsection 55(3)(a).
XXXXXXXXXX 2005-015978 R. Gagnon (613) 957-2108 July 18, 2006
Dear Sir,
Subject: Subsection 55(2) and paragraph 55(3)(a) of the Income Tax Act
This is in response to your letter of November 21, 2005, in which you asked us about the application of section 55(2) and section 55(3)(a) in the two scenarios described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Facts and Assumptions
Scenario 1
1. Parentco, Holdco, Sisterco, Subco and Independentco, are "taxable Canadian corporations" as defined in subsection 89(1).
2. Mr. X is an individual who is resident in Canada for the purposes of the Act.
3. Mr. X holds all of the issued and outstanding shares of the capital stock of Parentco. For the purposes of the Act, Mr. X has effective (de jure) control of Parentco, Holdco, Sisterco and Subco.
4. Parentco holds all of the issued and outstanding shares of the capital stock of Sisterco and Holdco. The issued and outstanding shares of the capital stock of Sisterco and Holdco constitute capital property as defined in section 54 to Parentco.
5. The issued and outstanding shares of the capital stock of Subco consist of only 100 common shares. The "paid-up capital" ("PUC"), as defined in subsection 89(1), of the 100 issued and outstanding common shares of Subco's capital stock is nominal.
6. Subco is a corporation carrying on business in Canada. The fair market value ("FMV") of the 100 issued and outstanding common shares of the capital stock of Subco is greater than the PUC and the adjusted cost base ("ACB") as defined in section 54 of the shares. The safe income on hand of Subco that is attributable to the 100 issued and outstanding common shares of the capital stock of Subco is positive but less than the FMV of the shares.
7. Holdco holds 88 common shares of the capital stock of Subco. Independentco holds 12 common shares of the capital stock of Subco. The 100 issued and outstanding common shares of the capital stock of Subco constitute capital property within the meaning of the definition in section 54 to the holders thereof.
8. The ACB of the 88 common shares of the capital stock of Subco held by Holdco is nominal. The ACB of the 12 common shares of the capital stock of Subco owned by Independentco is nominal.
9. Parentco, Holdco, Sisterco and Subco are related persons within the meaning of section 251(2). Independentco is not a related person, within the meaning of section 251(2), to Parentco, Holdco, Sisterco and Subco.
10. Independentco has recently expressed the wish to withdraw as a shareholder of Subco within the next 12 months, without any solicitation from Mr. X.
11. The transactions described in paragraphs 12 through 16 below will be carried out to extract from Holdco the 88 shares of the capital stock of Subco held by Holdco. The 88 common shares of the capital stock of Subco held by Holdco will be transferred to Sisterco in order to protect such assets from Holdco's creditors.
The transactions will be carried out in the following order.
12. Holdco will transfer to Sisterco its 88 common shares of the capital stock of Subco, and will receive as consideration 88 Class A preferred shares (non-voting, non-participating) in the capital stock of Sisterco. The FMV and redemption value of the 88 Class A preferred shares of the capital stock of Sisterco will each be equal to the FMV of the 88 common shares of the capital stock of Subco transferred to Sisterco.
Holdco and Sisterco will make the election provided for in subsection 85(1) in the prescribed form and within the time period provided for in subsection 85(6), in respect of the 88 common shares in the capital stock of Subco. The amount agreed to by Holdco and Sisterco will be the ACB to Holdco of the 88 common shares of the capital stock of Subco.
The PUC of the 88 Class A preferred shares of the capital stock of Sisterco will correspond to the ACB, to Holdco, of the 88 common shares of the capital stock of Subco transferred to Sisterco.
13. Parentco will transfer to Sisterco a portion of its common shares of the capital stock of Holdco, and will receive, as consideration, 100 Class B preferred shares (non-voting, non-participating) of the capital stock of Sisterco. The FMV and redemption value of the 100 Class B preferred shares of the capital stock of Sisterco will each be equal to the FMV of the common shares of the capital stock of Holdco transferred by Parentco to Sisterco.
The FMV of the common shares of the capital stock of Holdco to be transferred by Parentco to Sisterco will be equal to the redemption value of the 88 Class A preferred shares of the capital stock of Sisterco.
Parentco and Sisterco will make the election provided for in subsection 85(1) in the prescribed form and within the time period provided for in subsection 85(6), in respect of the common shares of the capital stock of Holdco transferred by Parentco to Sisterco. The amount agreed to by Parentco and Sisterco will be the ACB to Parentco of the common shares transferred.
The PUC of the 100 Class B preferred shares of the capital stock of Sisterco will correspond to the ACB, to Parentco, of the common shares of the capital stock of Holdco transferred by Parentco to Sisterco.
14. Sisterco will redeem the 88 Class A preferred shares of its capital stock owned by Holdco, for an amount corresponding to their redemption value.
Sisterco will pay the redemption value of the 88 Class A preferred shares of its capital stock by issuing to Holdco a non-interest bearing demand note ("Note1"), the principal amount of which will be the redemption value of the 88 Class A preferred shares of its capital stock. Holdco will accept Note1 as full and absolute payment for the redemption of the 88 Class A preferred shares of the capital stock of Sisterco.
The excess of the redemption value of the 88 Class A Preferred Shares of the capital stock of Sisterco over their PUC will be deemed under subsection 84(3) to be a dividend paid by Sisterco and received by Holdco. Sisterco will not have a dividend refund within the meaning of paragraph 129(1)(a) for its taxation year in which the redemption of the 88 Class A preferred shares of its capital stock occurs.
The exception in paragraph 55(3)(b) will not apply in respect of the deemed dividend received by Holdco.
15. Holdco will purchase for cancellation all of the common shares of its capital stock held by Sisterco, for an amount (the purchase price) equal to their FMV.
Holdco will pay the purchase price for the common shares of its capital stock held by Sisterco by issuing to Sisterco a non-interest bearing demand note ("Note2"), the principal amount of which will be the FMV of the common shares of its capital stock owned by Sisterco. Sisterco will accept the Note2 as full and absolute payment for the purchase of its common shares in the capital stock of Holdco.
The excess of the purchase price of the common shares of the capital stock of Holdco held by Sisterco over their PUCs will be deemed by virtue of subsection 84(3) to be a dividend paid by Holdco and received by Sisterco. Holdco will not have a dividend refund within the meaning of paragraph 129(1)(a) for its taxation year in which the purchase of the common shares of its capital stock occurs.
The exception in paragraph 55(3)(b) will not apply in respect of the deemed dividend received by Sisterco.
16. Note1 and Note2 will be extinguished by compensation [i.e., set off] pursuant to Article 1672 of the Civil Code of Québec.
17. Subco will purchase for cancellation the 12 common shares of its capital stock owned by Independentco, for a cash amount equal to their FMV.
This transaction will be carried out because Independentco wishes to withdraw as a shareholder of Subco.
Scenario 2
The facts and assumptions described in paragraphs 1 to 16 of Scenario 1 above are also applicable to Scenario 2. In addition, the following transactions will be carried out after the transaction described in paragraph 16 above.
17. Subco will pay a cash dividend on the 100 issued and outstanding common shares of its capital stock in an amount equal to the safe income on hand of Subco which is then attributable to the 100 common shares.
18. Shortly after the payment of the dividend described in the preceding paragraph, Independentco will dispose of its 12 common shares in the capital stock of Subco to Sisterco, for an amount in cash equal to the FMV of the common shares.
The transactions described in paragraphs 17 and 18 above will be carried out because Independentco wishes to withdraw as a shareholder of Subco.
Your Questions
1. In Scenario 1, will Subco's purchase of the 12 common shares of its capital stock held by Independentco (as described in paragraph 17), be part of a series of transactions or events within the meaning of subsection 248(10) ("series of transactions") that will also include the transactions described in paragraphs 12 to 16?
2. In Scenario 2, will the payment of the dividend by Subco (as described in paragraph 17) and the sale by Independentco of its 12 common shares of the capital stock of Subco (as described in paragraph 18), be part of a series of transactions that will also include the transactions described in paragraphs 12 to 16?
3. Assuming that all of the transactions described in paragraphs 12 to 17 of Scenario 1 were part of a single series of transactions for the purposes of the Act, would the CRA be of the view that subsection 55(2) will not apply to the deemed dividends received by Holdco and Sisterco in Scenario 1, by virtue of subparagraph 55(3)(a)(i)?
4. Assuming that all of the transactions described in paragraphs 12 to 18 of Scenario 2 were part of a single series of transactions for the purposes of the Act, would the CRA be of the view that subsection 55(2) will not apply to the deemed dividends received by Holdco and Sisterco in Scenario 2, by virtue of subparagraph 55(3)(a)(i)?
Our Comments
It appears to us that the Scenarios described in your letter could be actual situations involving taxpayers. The Canada Revenue Agency ("CRA") does not generally provide written opinions on proposed transactions otherwise than by way of advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received appropriate tax treatment. We can, however, offer the following general comments which may not be fully applicable to the situations submitted.
Questions 1 and 2
The question of whether certain transactions are part of a series of transactions for the purposes of the Act is one of fact that we cannot decide without examining all the facts and circumstances surrounding a particular situation. The CRA is not prepared to make a determination based solely on the facts available in your request.
Question 3
In Scenario 1, subsection 55(2) would not apply to the deemed dividends received by Holdco and Sisterco if none of the events described in subparagraphs 55(3)(a)(i) to 55(3)(a)(v) occur as part of the series of transactions in which the dividends were received. It is not only the exception in subparagraph 55(3)(a)(i) that is relevant for the purpose of determining whether subsection 55(2) would apply.
In Scenario 1, it appears to us that Independentco would be the only "unrelated person" within the meaning of paragraph 55(3.01)(a) (vis-à-vis each "dividend recipient", i.e. Holdco and Sisterco), that would be relevant for the purposes of determining whether any of the facts described in subparagraphs 55(3)(a)(i) to 55(3)(a)(v) occur in connection with the series of transactions.
In Scenario 1, based on the only information available, it appears to us that there would be no facts as described in subparagraphs 55(3)(a)(i) to 55(3)(a)(v) in the context of the series of transactions.
Question 4
In Scenario 2, subsection 55(2) would not apply to the deemed dividends received by Holdco and Sisterco if none of the facts described in subparagraphs 55(3)(a)(i) to 55(3)(a)(v) occur as part of the series of transactions in which the dividends were received. It is not only the exception in subparagraph 55(3)(a)(i) that is relevant for the purpose of determining whether subsection 55(2) would apply.
In Scenario 2, it appears to us that Independentco would be the only "unrelated person" within the meaning of paragraph 55(3.01)(a) (vis-à-vis each "dividend recipient", i.e. Holdco and Sisterco), that would be relevant for the purposes of determining whether any of the facts described in subparagraphs 55(3)(a)(i) to 55(3)(a)(v) occur in connection with the series of transactions.
In Scenario 2, based on the only information available, it appears to us that there would be no facts as described in subparagraphs 55(3)(a)(i) to 55(3)(a)(v) in the context of the series of transactions.
Please note that this opinion is not an advance ruling and, as stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, is not binding on the CRA with respect to any particular factual situation.
We apologize for the delay in responding to your request.
Best regards,
for Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch