| Author: | Simon Leung |
| File: | 921135 |
April 28, 1992
PRAIRIE TAX CONFERENCE
DRAFT/EBAUCHE
May 19 & 20, 1992
Question 24
Mr. X owns 70% of all of the common shares of Opco. His son, Y, owns 20% and an arm's length key employee, E, owns the remaining 10%. Mr. X wishes to partially freeze his interest in favour of his son by reducing his common share interest in Opco from 70% to 50% and increasing his son's interest from 20% to 40%. To accomplish this, each shareholder of Opco first transfers his common shares of Opco to his holding company (i.e. Xco, Yco and Eco, as the case may be). Each of Xco, Yco, and Eco then exchanges the common shares of Opco that it held for redeemable and retractable preference shares of Opco having an aggregate redemption amount and fair market value equal to the fair market value of the common shares of Opco so exchanged. The holding companies then subscribe for new common shares of Opco in the following ratio: 50% by Xco, 40% by Yco and 10% by Eco.
Would subsection 55(2) of the Income Tax Act (the "Act") apply to the deemed dividends arising as a result of the retraction of any of the preference shares of Opco by either Xco or Yco?
Department's Position
If the series of transactions outlined above results in a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on the disposition at fair market value of the preference shares of Opco held by Xco or Yco immediately before the dividend and such reduction could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the commencement of the series of transactions, subsection 55(2) of the Act would apply to the taxable dividend (other than to any portion thereof which is subject to tax under Part IV).
The exemption contained in paragraph 55(3)(a) of the Act would not apply to this series of transactions because the deemed dividend would be received by Xco or Yco, as part of a series of transactions or events, that resulted in
(i) a disposition of property (i.e. the common shares of Opco) to Eco with which both Xco and Yco deal at arm's length; and
(ii) a significant increase in the interest in Opco by Eco and in Eco by E who deal at arm's length with Xco and Yco.