Facts
The exception in s. 55(3)(a) would not be available where a new corporation was created in the series. Consider this example:
- Husband, Wife and (unrelated) Third Party each subscribe for 1/3 of the voting common shares of newly-incorporated Realtyco.
- They transfer equal portions of their current equal shareholdings of Opco to Realtyco under s. 85(1) in consideration for preferred shares of equivalent fair market value.
- Opco transfers realty to Realtyco under s. 85(1) in consideration for preferred shares of equivalent FMV.
- The cross-shareholdings between Opco and Realtyco are redeemed for notes, thereby giving rise to deemed dividends.
- The notes are set-off.
Questions
Does s. 55(2) not apply in light of s. 55(3.01)(g)(v)? Would this change if before Step 1 Husband and Wife incorporated Holdco and they and Third Party rolled all their Opco shares into Holdco before Holdco (rather than they) proceeds with Steps 1 to 5?
1st Scenario
In finding that the s. 55(3)(a) exception was not available for the deemed dividends arising in Step 4 under the first Scenario, CRA first indicated (TaxInterpretations translation):
Respecting the issuance of shares on an incorporation…prior to the first issuance…the incorporator controls [the corporation] and consequently…he will be considered as being related to that corporation before the first issuance of shares. …[T]he initial subscriptions by Husband and Wife (the incorporators) would not result in an increase in interest described by subparagraphs 55(3)(a)(iii) to (v).
CRA noted:
- The initial subscription for Realtyco shares by Third Party would result in a s. 55(3)(a)(ii) increase as Third Party was unrelated to the dividend recipients (Opco and Realtyco) as well as s. 55(3)(a)(v) increase of Third Party relevant to the deemed dividend paid by Realtyco to Opco.
- Third Party also would have a s. 55(3)(a)(ii increase of interest from its transfer of Opco shares to Realtyco for preferred shares (Step 2), as well as when the cross-shareholdings were redeemed (Step 4).
CRA then stated:
Furthermore, as regards the dividend deemed to be received by Opco, an increase in interest of Third Party described in subparagraph 55(3)(a)(v) would result from the transfer of the shares of Opco by Third Party to Realtyco in consideration for preferred shares in the capital of Realtyco, as well as on the redemption of the preferred shares in the capital of Realtyco held by Opco. Finally, on the purchase for cancellation of the shares in the capital of Opco held by Realtyco, Third Party increased its interest in Opco, which is a particular described in subparagraph 55(3)(a)(v) regarding the dividend deemed to be received by Realtyco.
Because paragraph 55(3.01)(g) does not exclude an increase in interest described in subparagraph 55(3)(a)(v), the dividend recipients, Opco and Realtyco, would be unable to utilize the exception…provided in paragraph 55(3)(a). ... [In any event] the condition provided in subpargraph 55(3.01)(g)(v) would not be satisfied as the shares of the recipients of the dividends, Opco and Realtyco, were held by individuals at the moment of receipt of the dividends.
2nd Scenario
Respecting the second Scenario, CRA assumed that Holdco and Realtyco were incorporated by Husband or Wife, so that Holdco was related to Realtyco and Opco, and Husband and Wife were related to Realtyco, and that the original investment of Third Party in Opco was not part of the same series of transactions as the receipt of the dividends in Step 4.
CRA then stated:
The disposition of the shares … of Opco by Husband, Wife and Third Party to Holdco would not result in a disposition described in subparagraph 55(3)(a)(i), (ii) or (v) as, immediately before the disposition, Holdco would be related to Opco and Realtyco, the dividend recipients.
However, the investment of Third Party in Holdco … would result in an increase in interest described in subparagraph 55(3)(a)(ii) as Third Party would be…unrelated to Opco and Realtyco, the dividend recipients.
Finally, the investment of Holdco in Opco…would not constitute an increase in interest described in subparagraph 55(3)(a)(ii) and (v) as … Holdco would be related to Opco and Realtyco immediately before the transfer of the shares.
…[T]he "particular corporation" [under s. 55(3.01)(g)] would be Holdco. …[T]he increase in interest of Third Party in Holdco described in subparagraph 55(3)(a)(ii) would be deemed not to be described in that subparagraph [by s. 55(3.01)(g)].
...[T]he other transactions of the series…would occur between persons related to the dividend recipients since Holdco would control both Opco and Realtyco.
Consequently, based on paragraph 55(3.01)(g)…it is possible that Opco and Realtyco could utilize the exception to the application of subsection 55(2) provided in paragraph 55(3)(a).
...[However] it would be important that the transactions respecting the formation of Holdco and Realtyco (the dividend recipients) be properly effected. …For example, the disposition of the shares of Opco by Husband, Wife and Third Party to Holdco could technically be described by subparagraphs 55(3)(a)(iii) and (v) respecting the dividend deemed to be received by Realtyco. In effect, immediately before the disposition, Holdco would be considered to not be related to Realtyco if the latter did not exist at that moment.