2019-0819431E5 concerned a medical practice corporation (PC1) (which had reinvested its earnings in a significant investment portfolio) whose voting shares were owned by Dr. A and non-voting shares were held 50-50 by Dr. A and Dr. A’s spouse (Spouse A). On December 30 of Year 1, PC1 ceased carrying on its medical practice, on December 31, Spouse A acquired 50% of Dr. A’s voting shares for their fair market value, and on January 1 of Year 2, Dr. A incorporated PC2, which carried on the medical practice formerly carried on by PC1. PC2 does not contribute any capital towards the investment activities in PC1.
2019-0819431E5 considered (and still considers) that the TOSI rules applied in Years 1 and 2 to dividends paid to Spouse A. However, CRA now re-addressed Year 3 where, respecting the application of para. (c), it had stated that because “…any dividend paid by PC1 to Spouse A would be considered to be derived directly or indirectly from a 'related business' carried on by PC2 (and not PC1) in Year 2 and subsequent years ,” the shares of PC1 held by Spouse A would not qualify as “excluded shares.”
CRA now stated:
In the event that the income of PC1 for Year 2 and any subsequent year is income earned solely from its investment business, such income would not be considered to be derived directly or indirectly from the medical services business now carried on by PC2. This would be the case even though the historical retained earnings of PC1 that are used in PC1’s investment business were originally derived from its former medical services business. Accordingly, in those circumstances, we would consider all the conditions of the “excluded share” definition to be technically met for those years.
CRA went on to indicate that the transactions “appeared to be undertaken primarily to ensure that the shares of PC1 held by Spouse A would meet the definition of ‘excluded shares’,” and that GAAR could be engaged.