Situation (a)
The shares (of only one class) of Investco were owned 95% by Mr. X and 5% by his spouse, Ms. Y. Investco wholly owned Opco, and also held $100,000 in a non-income producing bank account, which was derived from a dividend out of Opco’s operating business profits. Ms. Y (in complete contrast to Mr. X) has had no involvement in that business. During its year ending December 31, 20X1, Opco disposed of all its assets to a third party, and then was wound up into Investco on December 31, 20X1 (which was Investco’s year end).
In 20X2, Investco pays a $10,000 dividend: $9,500 to Mr. X and $500 to Ms. Y. Given the absence in 20X2 of a source individual in respect of Ms. Y engaged in the operation of the business sold by Opco, does the dividend received by Ms. Y qualify as an excluded amount under s. (e)(i) of the definition of "excluded amount"?
Before responding affirmatively, CRA noted that s. (e)(i) of "excluded amount" excludes income of an over-17 individual for a taxation year that is not derived, directly or indirectly, from a related business in respect of the individual for the year, assuming that Investco did not carry on a business in the year 20X2, and then stated:
The dividend received by Ms. Y would be considered to arise directly or indirectly from a related business (the former Opco business) in respect of Ms. Y notwithstanding that the dividend was paid in a year subsequent to the year in which the Opco business was disposed of. However, the dividend would not be considered to arise, directly or indirectly, from a related business in respect of Ms. Y for the year 20X2 since the former Opco business was not carried on in that year. … Consequently, the dividend received by Ms. Y could qualify as an excluded amount pursuant to subparagraph (e)(i) … .
Situation (b)
In 20X3, Investco (which carries on an investment business in which Mr. X is actively involved, and Ms. Y not at all) invests $90,000 in ABC Stock Inc. Investco receives a $500 dividend (its only income for 20X3) on the ABC Inc. shares during the year and reinvests the entire amount by purchasing new shares in the capital of ABC Inc.
Before the end of 20X3, Investco sells shares of ABC Inc. (at no gain or loss) for $10,000 and pays a dividend of $10,000: $9,500 to Mr. X; and $500 to Ms. Y. Does the dividend received by Ms. Y qualify as an excluded amount under s. (e)(i) of the definition? CRA responded:
As noted above, Investco invested $90,000 in its business. Thus, when Investco sells a portion of the property used in the operation of that business in order to pay the dividend declared to its shareholders, it is the CRA's view that the dividend must be considered to have arisen, directly or indirectly, from Investco's business.
Consequently, the dividend received by Ms. Y would be considered to have arisen directly or indirectly from the business of Investco, a related corporation in respect of Ms. Y. Thus, the dividend received by Ms. Y cannot qualify as an excluded amount pursuant to subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).
On the other hand, if it were shown that Investco does not carry on a business, the dividend received by Ms. Y from Investco would not be considered to be derived directly or indirectly from a related business in respect of Ms. Y and could qualify as an excluded amount pursuant to subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).