Principal Issues: [TaxInterpretation translation] Does the CRA consider that subsection 83(2.1) could apply in two scenarios involving the reclassification of the capital stock of a private corporation followed by the payment of a capital dividend to certain shareholders of the corporation?
Position: Scenario 1: Improbable; Scenario 2: Improbable
Reasons: Scenario 1: It cannot be established that CCO and DCO acquired their Class A common shares of ACO primarily to receive a capital dividend. In that regard, we find it determinative that ACO's articles of incorporation provide that a capital dividend may be paid to shareholders of only one class of its shares. Scenario 2:
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2020
APFF CONFERENCE 2020
8. Capital dividend routing
Subsection 83(2.1) is an anti-avoidance measure. It applies where a dividend that would otherwise be a capital dividend has been paid on a share (or a share therefor) acquired by the shareholder in a transaction, or in a series of transactions, one of the main purposes of which was to receive the capital dividend.
In certain situations, a corporation's CDA may be more valuable to some shareholders of the corporation than to others. For example, a capital dividend paid to a non-resident shareholder is subject to Part XIII tax in the same manner as any other dividend. Also, a capital dividend paid to a shareholder who is otherwise exempt from tax under part I of the ITA has no added value to the shareholder compared to a taxable dividend.
In those circumstances, it may be more efficient to channel a corporation's capital dividends to certain shareholders rather than others in order to take full advantage of the CDA.
Questions to the CRA
In each of the two scenarios below, does the CRA consider subsection 83(2.1) to apply?
a) ACO is a CCPC. ACO has three corporate shareholders: BCO, CCO and DCO. The share capital of ACO consists of 30 Class A common shares. Each shareholder holds 10 Class A common shares in the capital stock of ACO. BCO is a Canadian corporation exempt from Part I tax under subsection 149(1). CCO and DCO are taxable CCPCs.
At time X, ACO disposes of a portion of its assets to a third party and realizes a capital gain. As a result of this disposition, ACO's CDA balance is $100.
At time X+1, BCO exchanges its 10 Class A common shares in the capital stock of ACO for 10 Class B common shares in the capital stock of ACO. The exchange is made pursuant to section 51. Under ACO's articles, dividends may be declared and paid on either Class A or Class B shares without having to declare and pay proportionate dividends on the other class of shares.
At time X+2, ACO pays a capital dividend pursuant to subsection 83(2) in the amount of $100 on the Class A common shares of its capital stock held by CCO and DCO.
b) CCO is a CCPC. ACO has three corporate shareholders: BCO, CCO and DCO. The share capital of ACO consists of 30 Class A common shares. Each shareholder holds 10 Class A common shares of ACO's share capital.
BCO is a Canadian corporation exempt from Part I tax by virtue of subsection 149(1). CCO is a non-resident corporation for purposes of the Income Tax Act. DCO is a taxable CCPC.
At time X, ACO disposes of a portion of its assets to a third party and realizes a capital gain. As a result of this disposition, ACO's CDA balance is $100.
At time X+1, DCO exchanges its 10 Class A common shares of the capital stock of ACO for 10 Class B common shares of the capital stock of ACO. The exchange is made pursuant to section 51. Under ACO's articles, dividends may be declared and paid on either Class A or Class B shares without having to declare and pay proportionate dividends on the other class of shares.
At time X+2, ACO pays a capital dividend pursuant to subsection 83(2) in the amount of $100 on the Class B common shares of its capital stock held by DCO.
CRA Responses
General comments
The CRA considers that the flow-through of all or part of a private corporation's CDA balance to certain of its shareholders is generally not abusive to the extent that the specific anti-avoidance rule in subsection 83(2.1) does not apply.
For the purposes of applying subsection 83(2.1), the CRA has traditionally considered that it is the main purpose of the original acquisition of the shares that must be taken into account when they are exchanged for shares of another class upon reclassification of the capital stock of the corporation (footnote 1) . In addition, the CRA is generally of the view that subsection 83(2.1) does not apply to transactions that result in the payment of a capital dividend to certain original shareholders of the corporation. Such positions are largely based on the legislative intent of subsection 83(2.1), which is to prevent a corporation from transferring the balance of its CDA to another corporation or person by selling shares of its capital stock.
With respect to transactions other than those described in Interpretation Bulletin IT-146R4, it remains important to determine whether one of the main purposes of acquiring a share - or a share substituted for it - through a transaction or series of transactions is to receive a capital dividend. In Honco Group Inc. et al. v. The Queen (footnote 2), the Court confirmed that an objective assessment of the purpose test in subsection 83(2.1) is required, which can only be done by considering all the relevant circumstances of a particular situation. In such cases, subsection 83(2.1) could apply where a review of all the circumstances surrounding a transaction or series of transactions demonstrates that one of the main purposes of the acquisition of a share - or a share substituted for it - is to receive a capital dividend.
CRA Response to Question 8(a)
In our view, subsection 83(2.1) could only be applied in such a scenario if it can be established that CCO and DCO respectively acquired their Class A common shares in the capital stock of ACO in a transaction or series of transactions one of the main purposes of which was to receive the capital dividend on such shares.
In that regard, it is relevant to note that the CRA is of the view that subsection 83(2.1) generally does not apply to transactions that result in the payment of a capital dividend to the original shareholders of the corporation because of the legislative intent behind such a provision.
CRA Response to Question 8(b)
In accordance with the above-noted CRA administrative position applicable to shares acquired on the reclassification of the capital stock of a corporation, it is necessary to assess the purpose of DCO when it initially acquired the Class A common shares of the capital stock of ACO.
In our view, subsection 83(2.1) could only be applied in that scenario if it can be established that DCO acquired its Class A common shares in the capital stock of ACO in a transaction or as part of a series of transactions, one of the main purposes of which was to receive the capital dividend.
In that regard, it is relevant to note that the CRA is of the view that subsection 83(2.1) generally does not apply to transactions that result in the payment of a capital dividend to the original shareholders of the corporation because of the legislative intent behind such a provision.
François Mathieu
October 7, 2020
2020-085220
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Interpretation Bulletin IT-146R4 (archived), "Shares Entitling Shareholders to Choose Taxable or Capital Dividends", September 6, 1991.
2 2012 DTC 1257 (TCC), confirmed on appeal 2013 FCA 128.
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