Principal Issues: Whether a deemed capital gain resulting from the application of paragraphs 55(2)(b) or 55(2)(c) could be considered to be a gain from the disposition of an active asset for purposes of subsection 125(5.1) and the definition of "adjusted aggregate investment income" provided in subsection 125(7).
Position: Yes.
Reasons: See below.
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2020
APFF CONFERENCE 2020
13. Interaction between subsection 55(2) and the definition of "adjusted aggregate investment income" in subsection 125(7).
For taxation years commencing after 2018, a corporation’s business limit is reduced in subsection 125(5.1) by the greater of (a) a reduction based on taxable capital and (b) a reduction based on "adjusted aggregate investment income.”
The definition "adjusted aggregate investment income" in subsection 125(7) provides that this amount will be the corporation's aggregate investment income (as defined in subsection 129(4)) for the year if paragraph (a) of that definition were worded to exclude the taxable (allowable) capital gain (loss) from the disposition of a property that is, at the time of its disposition, an active asset of the corporation.
Second, in the definition of "active asset" in subsection 125(7), it can be seen that a share of the capital stock of another corporation will qualify as an "active asset" if the other corporation is connected to the particular corporation and the share would be a qualified small business corporation share under certain assumptions described in that definition of "active asset".
On the other hand, paragraph 55(2)(c) deems the dividend in certain circumstances to be a gain of the dividend recipient from the disposition of a capital property. As for the redemption of a share, paragraph 55(2)(b) deems the dividend received on a redemption to be included in the proceeds of disposition of the share that is redeemed.
Questions to the CRA
a) Can it be concluded that a deemed capital gain under paragraph 55(2)(c) will never be an "active asset" since the dividend recipient's gain will be deemed to arise from the disposition of capital property and not from the disposition of a share?
(b) Can it be concluded that a deemed capital gain under paragraph 55(2)(b) could arise from "active asset" if paragraph (b) of the definition of "active asset" is satisfied, i.e., the other corporation is connected with the particular corporation and the share is a qualified small business corporation share?
CRA Response to Question 13(a)
Taxable capital gains from the disposition of property that is, at the time of disposition, an active asset of the corporation are excluded from the definition of "adjusted aggregate investment income" under paragraph (a) of that definition in subsection 125(7). Consequently, such gains are not taken into account in the reduction in the business limit provided in paragraph 125(5.1)(b).
Paragraph (b) of the definition "active asset" in subsection 125(7) provides that a share of the capital stock of another corporation is an active asset of a particular corporation at any time if, at that time, the share meets certain conditions set out in that definition.
Paragraph 55(2)(c) provides that where subsection 55(2) applies to a taxable dividend received by a dividend recipient, if paragraph 55(2)(b) does not apply to the dividend, that amount is deemed to be a gain of the dividend recipient, for the year in which the dividend was received, from the disposition of a capital property.
The term "capital property" is defined in section 54 and includes, inter alia, any property the disposition of which would result in a capital gain or loss to the taxpayer. In addition, based on the wording of subsection 55(2.1), only a taxable dividend received by a dividend recipient on a share that is held as capital property may be subject to the application of subsection 55(2).
The CRA is of the view that the term "capital property" in paragraph 55(2)(c) includes a share and that a deemed gain under paragraph 55(2)(c) could represent a capital gain from the disposition of property that would, at the time of payment of the dividend (footnote 1), be an active asset of the corporation receiving the dividend for the purposes of the definition of "adjusted aggregate investment income" and paragraph (b) of the definition of "active asset" in subsection 125(7), if all of the conditions in paragraph (b) of the definition "active asset" in subsection 125(7) are otherwise satisfied in respect of the share on which the taxable dividend subject to subsection 55(2) was paid.
CRA Response to Question 13(b)
Paragraph 55(2)(b) provides that, where subsection 55(2) applies to a taxable dividend received by a dividend recipient, if the dividend is received on a redemption, acquisition or cancellation of a share by the corporation that issued the share to which subsection 84(2) or 84(3 applies, that amount is deemed to be included in the proceeds of disposition of the share that is redeemed, acquired or cancelled, except to the extent that the dividend is otherwise included in computing those proceeds.
In the event that the share that is redeemed, acquired or cancelled satisfies all of the conditions set out in paragraph (b) of the definition of "active asset" in subsection 125(7), the taxable capital gain from the disposition of the share, computed after taking into account the application of paragraph 55(2)(b), can not be considered in reducing the business limit under paragraph 125(5.1)(b) under paragraph (a) of the definition of "adjusted aggregate investment income" in subsection 125(7).
Marc Séguin
(514) 620-8562
October 7, 2020
2020-085225
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Technical Interpretation 2017-0724051C6, November 21, 2017. It is the CRA's view that, for purposes of inclusion in a taxpayer's income, the amount of the dividend is deemed by paragraph 55(2)(c) to be a gain of the dividend recipient from the disposition of capital property at the time of payment of the dividend.
UNCLASSIFIED