Principal Issues: 1. Whether paragraph c) of the definition "excessive eligible dividend designation"("EEDD") in subsection 89(1) would apply in the particular situation? 2. Whether GAAR would apply in the particular situation?
Position: 1. No definitive position. However, paragraph c) of the definition would not apply to Cibleco solely because of the transactions described in the situation. 2. No position on GAAR.
Reasons: 1. Not enough information provided in this particular situation. Definition EEDD in subsection 89(1). 2. Not enough information provided in this particular situation.
FEDERAL INCOME TAX ROUNDTABLE 11 October 2013
2013 APFF CONFERENCE
Question 15
Extraction from the general rate income pool account in the context of a sale of shares with insufficient safe income
Facts
- Targetco is a "taxable Canadian corporation" ("TCC") as defined in subsection 89(1) and a "Canadian-Controlled private corporation" ("CCPC") as defined in subsection 125(7). It has a general rate income pool ("GRIP") account as defined in subsection 89(1) in the amount of $2.6 million.
- A corporation ("Sellco") holds all of the issued and outstanding shares of the capital stock of Targetco. Sellco is a TCC and a CCPC.
- Safe income on hand attributable to the shares of the capital stock of Targetco held by Sellco is $2 million.
- Sellco is in the process of selling all of the shares of the capital stock of Targetco to Thirdco. Targetco will retain its status as a CCPC.
Problem and objective
Prior to the sale of the shares of the share stock of Targetco, Sellco would like Targetco to declare a dividend in its favour in the total amount of its GRIP. However, the safe income on hand attributable to its shares of the capital stock of Targetco is insufficient to cover the entire amount.
Thus, any dividend (whether actual or deemed) that Targetco would pay on the shares of its capital stock to Sellco and which may be considered to be attributable to anything other than safe income on hand, would be subject to the application of the subsection 55(2). This dividend would then be deemed not to be a dividend received by Sellco on the shares, and would instead be treated as a capital gain. Thus, technically, even if it reduced Targetco’s GRIP, it could not increase Sellco's GRIP.
Proposed transactions
Step 1: Targetco will declare and pay a $2 million dividend to Sellco, up to the amount of its safe income on hand. Targetco will designate the dividend as a designated dividend in accordance with the requirements of subsection 89(14).
Step 2: Sellco will subscribe for preferred shares of the capital stock of Targetco for cash equal to Targetco’s available GRIP balance of $600,000. The shares subscribed for will have an adjusted cost base ("ACB"), a fair market value and a cash surrender value of $600,000. The paid-up capital (as defined in subsection 89(1)) of these shares will be $600,000 (unless it is possible under the applicable Corporations Act to provide a nominal paid-up capital upon the issuance of the shares, in which case Targetco will do so and step 3 will not be necessary).
Step 3: Targetco will reduce without consideration the paid-up capital of the newly issued preferred shares to a nominal amount of $0.01, and the amount of the reduction will be included by Tagetco in its contributed surplus.
Step 4: Targetco will purchase the preferred shares issued in Step 2 and designate the deemed dividend of approximately $600,000 as a designated dividend in accordance with the requirements of section 89(14). Since the ACB of the shares is $600,000, the deemed dividend on the redemption of the preferred shares would not be reclassified as a capital gain by virtue of subsection 55(2).
Targetco will retain its status as a CCPC during the execution of the contemplated transactions.
Result
Targetco’s GRIP will end up in Sellco.
There would be no artificial increase in GRIP as a result of the planning. There is merely the preservation of a tax account in the hands of the seller rather than leaving it to the buyer.
Questions to the CRA
(a) In the situation described above, would a corporation have made an "excessive eligible dividend designation"("EEDD") because of the application of paragraph (c) of the definition of EEDD provided in subsection 89(1), so that the amount of the specified dividend would be subject to Part III.1 tax of 30% by virtue of subsection 185.1(1)?
(b) Would the proposed transactions be subject to the general anti-avoidance provision ("GAAR") in section 245, given that the planning is to prevent an erosion of Targetco’s GRIP without an equivalent increase in Sellco’s GRIP if a $2.6 million dividend was paid by Targetco?
CRA response
The CRA is not prepared to make a final determination with respect to the application of the GAAR and paragraph (c) of the definition of EEDD provided in subsection 89(1) respecting the situation described above, on the basis only of the information available.
Whether the GAAR and the specific anti-avoidance provision in paragraph (c) of the EEDD definition would be applicable requires an analysis of all facts and circumstances relevant to a particular situation. This would include knowing why there is a difference between safe income on hand and the GRIP, reviewing Targetco’s financial statements, obtaining details of Targetco’s surplus and the history of Targetco and its shareholders.
In addition, the preamble and paragraph (c) of the definition of EEDD in subsection 89(1) states:
excessive eligible dividend designation, made by a corporation in respect of an eligible dividend paid by the corporation at any time in a taxation year, means…
(c) an amount equal to the amount of the eligible dividend, if it is reasonable to consider that the eligible dividend was paid in a transaction, or as part of a series of transactions, one of the main purposes of which was to artificially maintain or increase the corporation’s general rate income pool, or to artificially maintain or decrease the corporation’s low rate income pool.
Thus, in determining whether paragraph (c) of the definition of EEDD applies in respect of a particular situation, it is necessary to consider each specific dividend that is paid by a corporation.
In the situation described above, Targetco is the only corporation which will pay a dividend and whose GRIP will be reduced. The contemplated transactions will not, by themselves, have the effect of maintaining or increasing the GRIP of Targetco. Consequently, the contemplated transactions, by themselves, would not engage paragraph (c) of the EEDD definition.
However, on a subsequent payment (after the contemplated transactions) of an eligible dividend by Sellco, it would be necessary to examine whether paragraph (c) of the definition of EEDD and subsection 185.1(1) were applicable with respect to Sellco.
Taxpayers contemplating such transactions who wish to be certain of the potential application of the specific anti-avoidance provision in paragraph (c) of the EEDD definition and GAAR could request advance rulings from the Tax Rulings Directorate.
Robert Gagnon
(613) 957-2108
2013-049578