Principal Issues: Holdco owns all of the issued and outstanding shares of the capital stock of Opco. Holdco considers selling all its shares of the capital stock of Opco to an arm's length party. In the taxation year preceding the year during which the shares are sold, Opco pays a taxable dividend to Holdco. The amount of the taxable dividend is in excess of Opco's safe income. As such, subsection 55(2) would apply to the taxable dividend. In the event that Holdco wants to pay a capital dividend from its capital dividend account, when will the deemed capital gain triggered pursuant to subsection 55(2) be credited to its capital dividend account?
Position: In the particular situation, the capital gain triggered pursuant to subsection 55(2) will generally be added to Holdco's capital dividend account when it will dispose of the Opco shares, pursuant to paragraph 55(2)(b). However, in the event of the application of paragraph 55(2)(c) to a dividend, the capital gain would be deemed to be a gain of the corporation for the year in which the dividend was received from the disposition of a capital property and as such, could be distributed as a capital dividend only in the following years. Finally, where, in a particular situation, part of a taxable dividend would be attributable to safe income and the dividend recipient would try to apply subsection 55(2) without making a paragraph 55(5)(f) designation, probably in order to obtain a tax benefit as part of a surplus stripping arrangement, we are of the opinion that GAAR would apply in the particular situation.
Reasons: According to the Law and previous positions.
FEDERAL TAX ROUNDTABLE 7 OCTOBER 2011
APFF CONFERENCE 2011
Question 29
Capital dividend account following the application of subsection 55(2)
A Canadian corporation ("Holdco") holds all of the shares of an operating corporation resident in Canada ("Opco"). Holdco plans to sell all of Opco's shares to a third party and, before the sale, Opco would pay a dividend to its parent corporation. This dividend is a dividend that exceeds the income earned by the corporation after 1971, so that the presumptions in subsection 55(2) would apply. The dividend would be deemed not to be a dividend received by Holdco, and if Holdco has not yet disposed of the shares of Opco, that dividend would be deemed to be a capital gain realized by Holdco for the year in which the dividend was received.
Questions to the CRA
A) In the event that Holdco subsequently wishes to declare a dividend from its capital dividend account ("CDA") to its shareholder out of the CDA created under the presumption in subsection 55(2), at what point can the deemed capital gain be considered to be credited to the CDA of Holdco?
B) Will the addition to the Holdco CDA be on the date of the payment of the dividend in excess of the income earned?
C) Will it be credited only at the end of the year in which the dividend exceeding the earned income has been paid?
D) Will that dividend affect the calculation of the Holdco CDA only in the year following the year in which the Holdco dividend was paid having regard to the wording of paragraph 55(2)(c)?
CRA Response
The interpretation and application of subsection 55(2) requires consideration of all facts and circumstances relevant to a particular situation. Given that the statement in this question contains very little information, we will limit ourselves to making the following general comments.
Jurisprudence and doctrine inform us that subsection 55(2) is an anti-avoidance provision designed to thwart capital gains stripping while avoiding double taxation of corporate income. Subsection 55(2), read together with paragraph 55(5)(f), allows the payment of a tax-free dividend between corporations to reduce the capital gain that would have resulted from a notional sale of a share at fair market value to the extent that it could reasonably be considered to be attributable to income earned or realized by any corporation after 1971.
First, we are of the view that in the particular situation, the taxable dividend received by Holdco and the sale by it of the shares of the capital stock of Opco to a third party would necessarily be part of the same series of transactions or events.
In general, we are of the view that where it is possible to link various events within a single series of transactions or events, for example the payment of a taxable dividend to a corporation on a share in respect of which it is entitled to a deduction under subsection 112(1) and the subsequent disposition of such share by that corporation, the dividend, even if paid in a previous taxation year, would be deemed to be proceeds of disposition of the share as provided in paragraph 55(2)(b).
Consequently, in the particular situation, the capital gain resulting from the application of subsection 55(2) would generally be included in the calculation of the Holdco CDA at the time of the disposition by Holdco of the shares of the capital stock of Opco to the third party.
Furthermore, in a situation where it was paragraph 55(2)(c) that applied, rather than paragraph 55(2)(b), we are of the view that the deemed capital gain realized by the corporation for the taxation year in which the dividend was received from the disposition of a capital property could be distributed by it as a capital dividend only in subsequent taxation years.
Finally, in the particular situation, it appears that the safe income attributable to the shares that were disposed of was ignored in determining the effects of the application of subsection 55(2). We are of the view that the safe income on hand attributable to shares must always be taken into account by a corporation in determining a gain pursuant to subsection 55(2). If not, we are of the view that subsection 245(2) could be applicable.
Jean Lafrenière
(613) 941-2956
2011-041213