Holdco receives a dividend of $400,000 that is subject to Part IV tax of $153,333 (38.33% of $400,000) equalling the connected payer’s dividend refund and, in turn, pays a dividend to its shareholders resulting in a refund of the Part IV tax – so that the dividend received by Holdco is subject to s. 55(2).
If the dividend received by Holdco was originally taxed as a capital gain to Holdco, the refundable tax on the capital gain would be $61,333 ($400,000 x 50% x 30.66%).
Instead of having to pay the whole amount of $400,000 as a taxable dividend to established that the Part IV tax of $153,333 is fully refunded so that s. 55(2) applies, Holdco would only need to pay an amount of $160,000 as a taxable dividend ($61,333/38.33%) so that, at the same time, a capital dividend of $200,000 can be paid. This result is achieved because of circular calculations whereby the dividend received is deemed to be reduced by the application of s. 55(2) after each calculation, resulting in reduced Part IV tax - whereas the amount of the tax refund remains the same in each calculation. Does CRA agree?
Before concluding that the scheme of s. 55(2) does not support such circular calculations, CRA first noted that the example proposes that there is only a capital gain of $400,000 to be included in the tax return of Holdco, and that the refundable tax on such capital gain is fully refunded by the payment of a taxable dividend by Holdco of $160,000, and indicated that for a dividend to be subject to s. 55(2) based on a Part IV tax refund, such refund must be a real refund of real tax (as per Ottawa Air Cargo). Thus, the application of s. 55(2) does not eliminate the subjecting of the dividend to Part IV tax.
Using the numbers in the example, if Part IV tax of $153,333 is paid or payable, as declared in the initial tax return of Holdco, that Part IV tax is paid or payable for the taxation year. In the second return filed by Holdco, the Part IV tax paid for the taxation year remains unchanged, even though the amount of the dividend received has been reduced by the application of s. 55(2).
A capital dividend of $80,000 could be paid by Holdco after the receipt of the $400,000 dividend, due to the application of s. 55(2).