Principal Issues: 1. Where subsection 55(2) applies with respect to the increase of the stated capital of shares, would CRA take a position to eliminate the double taxation that could arise in such a case?
2. Where subsection 55(2) applies with respect to the stock dividend, would CRA take a position to eliminate the double taxation that could arise in such a case?
Position: 1. In a situation where the conditions to apply paragraph 55(2)b) are met, subsection 55(2)(c) would not apply. In computing the amount added to the proceeds of disposition pursuant to subsection 55(2)(b), amounts included otherwise as the proceeds of disposition would be excluded from the proceeds included pursuant to subsection 55(2)(b). Therefore, no double taxation would arise in that case. However, in circumstances where subsection 55(2)(c) applies instead of paragraph 55(2)(b), the amount deemed not to be a dividend could be taxed as a capital gain twice. In such a case, we would apply 55(2)(c) in the year of the increase of the stated capital of the shares and when the shares would be sold, the capital gain would be reduced by the amount already included in the income pursuant to paragraph 55(2)(c).
2. CRA would take a position similar to the one taken in document 9830665.
Reasons: 1. Where paragraph 55(2)(b) applies, no administrative position is required. Where paragraph 55(2)(c) applies, a position is necessary to eliminate the inclusion as a capital gain of the same amount resulting from the fact that even if the amount is taxed as a capital gain pursuant to paragraph 55(2)(c), the ACB of the shares is not increased by that amount.
2. Previous position.
XXXXXXXXXX 2011-041589 Sylvie Labarre, CA
August 31, 2011
Dear Sir,
Subject: Increase in paid-up capital and stock dividend
This is in response to your email of August 2, 2011 in which you asked us what the position is of the Canada Revenue Agency ("CRA") to avoid possible "double taxation" where either an increase in paid-up capital of a given class or a stock dividend occurs in the context of potential application of subsection 55(2) of the Income Tax Act (the "Act").
Unless otherwise stated, all statutory references are provisions of the Act.
The situations on which you have questions are:
- a situation where a corporation resident in Canada proceeds with an increase in the paid-up capital of shares of a class held by another corporation resident in Canada (in this type of transaction, your questions relate to two possibilities, namely, the application of paragraph 55(2)(b) or of paragraph 55(2)(c));
- a situation where preferred shares are received by a corporation resident in Canada as a stock dividend paid on common shares of the capital stock of another corporation resident in Canada.
In those situations, we have assumed that the corporation resident in Canada would receive a taxable dividend in respect of which it would be entitled to a deduction under subsection 112(1).
You referred to the problems or positions taken, related to "double taxation" in similar situations, which have been raised in certain documents of our Directorate. Those documents referred to situations where it was determined that subsection 55(2) applied to a deemed dividend received upon an increase in paid-up capital or with the stock dividend, as the case may be, which did not lead, in accordance with the legislation in force at that time, to an increase in the adjusted cost base ("ACB") of the particular class of shares or preferred shares received as a stock dividend for the portion that was deemed not to be a dividend received by the corporation by virtue of paragraph 55(2)(a). We then noted that, if no position was taken in order to avoid "double taxation" in some cases, the same amount could be taxed twice as a capital gain.
You wish to know if the problems raised with regard to "double taxation" still exist in the situations described previously. In addition, you wish to know what our position would be to prevent an amount from being taxed twice as a capital gain on an increase in paid-up capital of a particular class or on a stock dividend in the context of the potential application of subsection 55(2).
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the CRA not to issue a written opinion regarding proposed transactions otherwise than through advance rulings. Furthermore, when it comes to determining whether a completed transaction has received adequate 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 we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
Proposed legislative changes
On July 16, 2010, the Department of Finance issued legislative proposals to implement technical measures regarding income tax. Some of those technical measures relate to paragraphs 52(3)(a) and 53(1)(b), which are relevant for a stock dividend or an increase in paid-up capital. Under the legislative proposals of July 16, 2010, paragraphs 52(3)(a) and 53(1)(b) would read as follows:
Paragraph 52(3)(a)
(a) where the stock dividend is a dividend, the amount, if any, by which
(i) the amount of the stock dividend
exceeds
(ii) the amount of the dividend that the shareholder may deduct under subsection 112(1) in computing the shareholder’s taxable income, except any portion of the dividend that, if paid as a separate dividend, would not be subject to subsection 55(2) because the capital gain referred to in that subsection could reasonably be considered not to be attributable to anything other than income earned or realized by any corporation after 1971 and before the safe-income determination time for the transaction or event or series of transactions or events as part of which the dividend was received.
Paragraph 53(1)(b)
(b) where the property is a share of the capital stock of a corporation resident in Canada, the amount, if any, by which
(i) the total of all amounts each of which is the amount of a dividend on the share deemed by subsection 84(1) to have been received by the taxpayer before that time
exceeds
(ii) the portion of the total determined under subparagraph (i) that relates to dividends in respect of which the taxpayer was permitted a deduction under subsection 112(1) in computing the taxpayer’s taxable income, except any portion of the dividend that, if paid as a separate dividend, would not be subject to subsection 55(2) because the capital gain referred to in that subsection could reasonably be considered not to be attributable to anything other than income earned or realized by any corporation after 1971 and before the safe-income determination time for the transaction or event or series of transactions or events as part of which the dividend was received;
Subject to an election in respect of the coming into force of the measures under paragraph 53(1)(b), the proposed amendments to those paragraphs would apply to the amounts or dividends (as the case may be) received after the November 8, 2006.
On the other hand, the wording of the proposed amendment to paragraph 53(1)(b), as set out above, would not be the one used by a taxpayer if the taxpayer opted to use the following transitional wording in respect of a dividend received before July 16, 2010:
(b) where the property is a share of the capital stock of a corporation resident in Canada, the amount, if any, by which
(i) the total of all amounts each of which is the amount of a dividend on the share deemed by subsection 84(1) to have been received by the taxpayer before that time
exceeds
(ii) the portion of the total determined under subparagraph (i) that relates to dividends
(A) in respect of which the taxpayer was permitted a deduction under subsection 112(1) in computing the taxpayer’s taxable income, and
(B) that arose directly or indirectly as a result of a conversion of contributed surplus into paid-up capital;
Increase in Paid-Up Capital
If the proposed amendment to paragraph 53(1)(b) were adopted as described above, a corporation resident in Canada could not increase the ACB of the shares of a particular class that it held beyond a certain amount where that corporation is deemed to have received a taxable dividend on shares of that class by virtue of subsection 84(1) by reason of an increase in the paid-up capital in respect of those shares, where it receives a deduction under subsection 112(1). In such circumstances, and if we do not consider the transitional language, the increase in the ACB may not exceed the amount that would reasonably be attributable to the income earned or realized by the corporation issuing the shares of the particular class, after 1971 and before the safe income determination time (as to the transaction, event or series of transactions or events in which the dividend was received) ("safe income on hand”).
With respect to the potential application of subsection 55(2) in a particular situation, it must be determined whether one of the purposes of the deemed dividend received as a result of the increase in paid-up capital would be to substantially reduce the portion of a capital gain that, without the dividend, would have been realized on a disposition of a share at fair market value and that it would be reasonable to consider to be attributable to something other than safe income on hand. We cannot make a final determination as to whether or not that purpose test and the application of subsection 55(2) are satisfied as part of a general request for technical interpretation. In fact, to decide definitively, we should consider all the facts and circumstances surrounding that increase in paid-up capital, and not just the proposed amendment to paragraph 53(1)(b).
To the extent that it is determined that subsection 55(2) does not apply to an increase in paid-up capital giving rise to a deemed dividend to a corporation resident in Canada for which it has obtained a deduction by virtue of subsection 112(1) (and subject to an election to apply the transitional wording for paragraph 53(1)(b)), the excess of the increase in paid-up capital respecting the shares held over the safe income on hand respecting those shares would not be taxed twice as a capital gain. Consequently, we consider that the problem of "double taxation" does not exist. It would therefore not be necessary to adopt a position in that respect.
To the extent that the purpose test in subsection 55(2) is satisfied and the situation is not covered by the exceptions in subsection 55(3), paragraph 55(2)(a) would apply. In certain situations, it may be that an amount is likely to taxed twice as a capital gain since the ACB of the shares would not be increased by the amount referred to in paragraph 55(2)(a). At that point, we would take a position to avoid double taxation. In a situation where a corporation disposed of shares in the same series of transactions or events as the increase in paid-up capital, the CRA would apply paragraph 55(2)(b) and disregard 55(2)(c). As paragraph 55(2)(b) provides that the amount referred to in paragraph 55(2)(a) will be deemed to be proceeds of disposition of the share except to the extent that it is otherwise included in computing such proceeds, the amount would be taxed only once as a capital gain.
By contrast, a position should be taken to avoid "double taxation" if we take as an example a situation where the amount referred to in paragraph 55(2)(a) should be included as a capital gain by virtue of paragraph 55(2)(c), where such amount should also be included as a capital gain on a potential disposition of the shares to a third party (since the amount referred to in paragraph 55(2)(a) would not be part of the ACB of the shares even if we applied paragraph 55(2)(c)). Our position in this example could be to apply paragraph 55(2)(c) but not to tax that amount as a capital gain on a potential disposition of the shares.
Furthermore, we did not attempt to review all the other tax consequences of an increase in paid-up capital. It is important, however, that you note that the amendments proposed on July 16, 2010 to the definition of "capital dividend account" in subsection 89(1) could, in certain circumstances, have adverse tax consequences where an amount has been calculated under subparagraph 53(1)(b)(ii).
Dividend of Preferred Shares
If the proposed amendment to paragraph 52(3)(a) were adopted as described above, a corporation resident in Canada would not be able to include in the ACB of the shares received as a dividend, an amount greater than the safe income regarding the shares in respect of which the dividend was paid.
If the shares received as a dividend were of the same class as the shares in respect of which the dividend was paid, it would be necessary to determine whether one of the purposes of the preferred stock dividend was the significant reduction in the portion of the capital gain on common shares that was attributable to anything other than safe income on hand. We cannot take a definitive position on this issue of testing the purpose as part of a request for a general technical interpretation. Before deciding definitively, it would be necessary to consider all the facts and circumstances surrounding the payment of that stock dividend, and not just the proposed amendment to paragraph 53(2)(a).
Similarly, if a corporation resident in Canada receives preferred shares as a dividend on common shares, the same review should be conducted in determining the purposes of the dividend. As part of that review, it should be taken into account that even if paragraph 52(3)(a) ensures that the ACB of the preferred shares cannot be greater than the safe income on hand in respect of the common shares, one of the purposes of the preferred share dividend could be a significant decrease in the portion of the capital gain on the common shares attributable to anything other than safe income on hand.
After a full analysis of the facts of a particular situation, it may be determined that the purpose test set out in subsection 55(2) is not satisfied or that one of the exceptions in paragraph 55(3) applies. In such a case, we would consider that there is no "double taxation". It would therefore not be necessary to adopt a position in that regard.
If it were determined that the purpose test of the stock dividend is satisfied and the conditions in subsection 55(3) were not satisfied, then paragraph 55(2)(a) would apply, which could result in "double taxation" in certain situations. In such a case, we would take a position to avoid "double taxation" which would be similar to that taken in document 9830665 which read as follows: [TaxInterpretations translation]
Where in a situation such as the situation described above, there is a payment by a corporation on common shares of a preferred stock dividend that is subject to the provisions of subsection 55(2) and a subsequent sale of the common shares in the same taxation year, the application of paragraph 55(2)(b) to increase the proceeds of disposition of the common shares by the amount of the dividend and the realization of a capital gain on the sale of preferred shares would result in double taxation. Such result would be contrary to paragraph 248(28)(a).
In that situation, the Minister would typically apply paragraph 55(2)(b), but would not include a taxable capital gain in computing the taxpayer's income in respect of the disposition of the preferred shares in order to avoid the double taxation. A taxpayer may alternatively not apply paragraph 55(2)(b) in respect of the stock dividend and include in computing the taxpayer’s income a taxable capital gain on the sale of the preferred shares.
If the disposition of the preferred shares occurs in a taxation year subsequent to the year of the payment of the stock dividend and the sale of the common shares, the taxpayer must apply paragraph 55(2)(b) in respect of the stock dividend and not include a taxable capital gain on the sale of the preferred shares in the subsequent taxation year.
In closing, we did not attempt to review all the other tax consequences of a stock dividend. However, we refer once again to the amendments proposed on July 16, 2010 to the definition of "capital dividend account" in subsection 89(1) which could, in certain circumstances, have adverse tax consequences where an amount has been calculated under subparagraph 52(3)(a)(ii).
These comments are not advance income tax rulings and are not binding on the CRA with respect to a particular situation.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
for the Director
Corporate Reorganizations and Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch