Principal Issues: Whether 55(2) could apply in a given fact situation.
Position: Yes.
Reasons: 55(3)(a)(ii) applies.
XXXXXXXXXX 2006-017092 Marc LeBlond February 6, 2007
Dear Sir,
Subject: Application of subsection 55(2) of the Income Tax Act
This is in response to your email of February 10, 2006, requesting our comments on the application of subsection 55(2) of the Income Tax Act (the "Act") in the situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Act.
The Situation
- Mr. X and Mr. Y each hold 50% of the shares of Holdco Inc.
- Holdco Inc. is the sole shareholder of Opco Inc.
- Holdco Inc. and Opco Inc. are "Canadian-controlled private corporations" as defined in subsection 125(7).
- Holdco Inc. and Opco Inc. do not have "refundable dividend tax on hand" as defined in subsection 129(3).
- Mr. X and Mr. Y are not "related persons" as defined in subsection 251(2) and each of them is not related to either Holdco Inc. or Opco Inc.
The following transactions are carried out on the same day, in the order they are presented, and are part of a series of transactions for the purposes of the Act.
- Mr. X and Mr. Y subscribe equally for voting and non-participating shares of Opco Inc. Following those subscriptions, Messrs. X and Y together hold more than 50% of the voting shares of the capital stock of Opco Inc.
- Opco Inc. transfers to Holdco Inc. a building and land ("eligible property", as defined in subsection 85(1.1)) at their fair market value ("FMV") and receives from Holdco Inc., in consideration for the transfer of the transferred "eligible property," shares of the capital stock of Holdco Inc. (the "Rollover Shares") with a FMV and a redemption value equal to the FMV of the transferred "eligible property". Opco Inc. and Holdco Inc. make a joint election in respect of the transferred "eligible property" pursuant to subsection 85(1) to transfer the property on a rollover basis.
- The Rollover Shares are redeemed for their redemption value. Under subsection 84(3), Holdco Inc. is deemed to have paid a dividend to Opco Inc. and Opco Inc. is deemed to have received a dividend equal to the amount by which the amount paid by Holdco Inc. exceeds the "paid-up capital" of the Rollover Shares. The deemed dividend is a "taxable dividend", as defined in subsection 89(1), in respect of which Opco Inc. would be entitled to a deduction by virtue of subsection 112(1).
Your Questions
You asked whether, in the situation you have presented, subsection 55(2) could apply to the dividend received by Opco Inc.
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of our Directorate not to issue written opinions on proposed transactions otherwise than by way of advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that may, however, under certain circumstances, not apply to your particular situation.
In our view, in the particular situation, section 55(2) could apply. Our conclusion is based on the following observations.
The conditions of subsection 55(2) are satisfied and subsection 55(3) does not apply to prevent subsection 55(2) from applying to the dividend received by Opco Inc.
In the particular situation, the requirements of subsection 55(2) are satisfied because Opco Inc. is a corporation resident in Canada that has received a taxable dividend in respect of which it is entitled to a deduction pursuant to subsection 112(1), the dividend that Opco Inc. is deemed by subsection 84(3) to have been received in connection with a transaction, event or series of transactions or events that results in a significant reduction in the portion of the capital gain that, but for the dividend would have been realized on a disposition of a rollover share at fair market value immediately before the dividend (the "Hypothetical Capital Gain") and it is reasonable to regard such portion of the Hypothetical Capital Gain otherwise realized as being attributable to something other than income earned or realized by Holdco Inc. after 1971 and prior to the safe-income determination time in respect of the transaction, event or series.
Subsection 55(2) applies if either of paragraphs 55(3)(a) or (b) does not apply.
In the situation you have submitted, paragraph 55(3)(b) does not appear to apply as there does not appear to be a "distribution" as defined in subsection 55(1).
Furthermore, paragraph 55(3)(a) could not apply in this situation because one of the facts described in that paragraph occurred as part of the series of transactions or events in which Opco Inc. received the dividend. In particular, the event described in subparagraph 55(3)(a)(ii) occurred because there was a substantial increase in the total direct interest in Opco Inc. of Mr. X and Mr. Y, who are "unrelated persons" within the meaning of paragraph 55(3.01)(a), immediately before the time of that increase in interest in Opco Inc.
Indeed, Mr. X and Mr. Y are "unrelated persons" within the meaning of paragraph 55(3.01)(a), since Opco Inc., the dividend recipient, is not related to either Mr. X or Mr. Y.
For the reasons set out above, we therefore believe that, in the particular situation, subsection 55(2) could apply to the dividend amount received by Opco Inc.
We apologize for the delay in responding to this request.
Best regards,
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