Mr. and Mrs. A (both over 30) respectively own 100 voting and 100 non-voting common shares of Investco which wholly-owns Opco (with a non-services business). Only Mr. A is actively engaged in Opco’s business on a regular, substantial and continuous basis. Historically, Opco has dividended its earnings to Investco, with Investco then investing in dividend-bearing shares of publicly-traded corporations (the “portfolio”).
If Investco pays all of its portfolio dividend income to Mrs. A, would the dividend income received by Mrs. A be considered income that is derived directly or indirectly from a related business for s. 120.4 purposes? CRA stated:
Dividends paid by Investco out of its after-tax income from its investments in publicly-traded corporations would not be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A. Therefore, if Investco does not have a related business in respect of Mrs. A, the dividends it pays to Mrs. A that are derived from income and gains earned from its investments in publicly-traded corporations would be an “excluded amount” in respect of Mrs. A under subparagraph (e)(i) of … “excluded amount” … .
CRA then addressed an example where, in Year 1, Opco pays a $1M dividend to Investco and Investco then invests that dividend in shares of publicly-traded corporations. In Year 2, Investco pays a dividend-in-kind to Mrs. A of its entire stock portfolio which, at that time, has an aggregate FMV of $1.1M (for an accrued gain of $0.1M).
Before concluding that only $1.0M of the $1.1M dividend-in-kind received by Mrs. A would be derived from the related business of Opco in respect of Mrs. A (so that if Investco did not have a related business in respect of Mrs. A, $0.1M of the amount would not be derived from such a business), CRA stated:
The portion of the FMV of the distributed stock portfolio that represents the initial investment of the dividends paid by Opco to Investco would be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A. However, gains earned by Investco as a result of the investment of those dividends would not be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A.