| 5-910958 | |
| D.R. Sommerfeldt | |
| (613) 957-2110 | |
| July 11, 1991 | |
| Dear Sirs: | |
| Re: Subsection 110.6(8) |
We acknowledge receipt of your letter dated March 28, 1991, which raises several questions as to our interpretation of subsection 110.6(8) of the Income Tax Act (Canada) (the "Act"). All statutory references in this letter are references to the Act.
It is our understanding that the issues which are of concern to you may be restated as follows:
1. What is the Department's interpretation of the phrase "a significant part of the capital gain," as it appears in subsection 110.6(8)?
2. How does the Department interpret the phrase "the fact that dividends were not paid on a share (other than a prescribed share) of a corporation or that dividends paid on such a share in the year or in any preceding taxation year were less than 90% of the average annual rate of return thereon for that year, as it appears in subsection 110.6(8)?
3. Where inadequate dividends are paid on a non-prescribed share in one or more years, what is the effect, for the purpose of subsection 110.6(8), of a "catch-up" dividend in a subsequent year?
Issue I
In interpreting the phrase "a significant part of the capital gain," as it appears in subsection 110.6(8), it is our view that the determination of what constitutes a significant part of the capital gain in a question of fact which must be decided in each particular case having regard, as the subsection states, to all the circumstances. Accordingly, the Department has not developed detailed or specific guidelines in respect of this issue. While we are of the view that in many cases this question is appropriately answered by ascertaining the proportion or percentage of the capital gain that is attributable to the non-payment of adequate dividends, we are also of the view that there may be circumstances where it is appropriate to consider the amount or magnitude, expressed in dollars, of the capital gain that is so attributable.
Issue 2
It in our view that the phrase "the fact that dividends were not paid on a share (other than a prescribed share) of a corporation or that dividends paid on such a share in the year or in any preceding taxation year were less than 90% of the average annual rate of return thereon for that year, " as it appears in subsection 110.6(8), requires that the stipulated quantum of dividends must be paid on any relevant share (other than a prescribed share) in each and every year during the applicable period (generally the period throughout which the particular individual or a related person owns the property that is the subject of the disposition).
In your letter you suggested an interpretation (that was amplified in a previous telephone conversation) to the effect that:
(a) if a corporation has paid a dividend on a non-prescribed share in a particular year, the "dividend were not paid test" cannot apply to any other year in which a dividend was not paid; and
(b) the reference in subsection 110.6(8) to "dividends paid" means that the "average annual rate of return test applies only to those taxation years in which a dividend was actually paid and not to a year in which a dividend was not paid.
We believe that such an interpretation produces an unreasonable result. For instance, if a corporation were to pay a dividend in the second taxation year that a particular non-prescribed share in outstanding (subsection 110.6(9) makes special provision for the first such year), and if such dividend were to satisfy the "average annual rate of return test," the corporation could, pursuant to your interpretation, avoid the application of subsection 110.6(8) without ever paying another dividend on the share. In our view, such a result is unreasonable and contrary to the intention of Parliament in enacting subsection 110.6(8).
In construing subsection 110.6(8), it is appropriate to apply the modern rule of statutory interpretation, as expressed in Stubart v. The Queen [1984] CTC 294 at 316-317, 84 DTC 6305 at 6323-6324 (SCC) (see also B.C. v. Henfrey Samson Belair Ltd. et al. (1989) 75 CBR (NS) 1 at 17 (SCC)). Hence, when the phrase "the fact that dividends were not paid on a share (other than a prescribed share) of a corporation or that dividends paid on such a share in the year or in any preceding taxation year were less than 90% of the average annual rate of return thereon for that year" is read in the entire context of section 110.6, particularly subsections 110.6(8) and (9), it appears that the "object and spirit" of the phrase is that the adequacy of dividends is to be determined on a year-by-year basis.
Thus, to summarize, in a situation where an individual has a capital gain for a taxation year and where a dividend was not paid on a relevant non-prescribed share either in that year or in one or more preceding years, it becomes necessary to ascertain whether a significant part of the capital gain is attributable to such fact (i.e., the non-payment of a dividend), notwithstanding that the '"average annual rate of return test" is satisfied in all taxation years but those in which a dividend in not paid.
Issue 3
It is our position, as stated above, that the phrase which in the subject of Issue 2 requires that a dividend, in the requisite amount, must be paid in each and every year. If this is not done, it is not possible, after the end of a particular year, to pay a "catch-up" dividend so as to comply retroactively with this particular requirement.
However, the fact that no dividend or an inadequate dividend is paid in a particular year does not, in and of itself, mean that subsection 110.6(8) will automatically apply to deny the capital gains deduction. Rather, it is necessary to ascertain whether it may reasonably be concluded, having regard to all the circumstances, that a significant part of the capital gain is attributable to such fact. It is possible that, where a "catch-up" dividend of sufficient magnitude is paid, it would not be reasonable to conclude that a subsequent capital gain is attributable to the fact that no dividend or an inadequate dividend was paid in a year prior to the "catch-up" dividend. In other words, while a "catch-up" dividend cannot remedy a failure to comply with the "dividends were not paid test" and the "average annual rate of return test, " the "catch-up" dividend may, depending on all the circumstances, avoid an adverse result when applying the reasonably attributable test."
We are unable to provide you with any specific comments as to the circumstances in which a "catch-up" dividend may have the above effect. In this regard, we refer you to Question 60 at the 1987 Round Table (87 CR 47:35):
Whether the gain to be realized on a disposition is attributable to the fact that dividends were not paid on a share or that the dividends paid on such a share were less than 90 percent of the average annual rate of return as defined subsection 110.6(9) is a determination that involves a significant finding of fact.
Conclusion
The foregoing comments represent our general views in respect of the issues raised by your letter. These views may require qualification when applied to a specific transaction. As explained in paragraph 21 of Information Circular 70-6R2, the above comments are not advance rulings and are not binding on the Department.
Yours truly,
for DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch