Principal Issues: Whether the issuance by an operating corporation of discretionary dividend shares of its capital stock to a holding corporation for nominal consideration, as part of an asset protection plan, would be subject to any anti-avoidance provisions of the Act or would be acceptable in terms of tax policy?
Position: General comments provided.
Reasons: Question of fact.
FEDERAL TAX ROUNDTABLE 5 OCTOBER 2012
2012 APFF CONFERENCE
Question 13
Discretionary dividend shares
An operating corporation, Opco, is 100% owned by Mr. X. The only shares issued by Opco were 100 Class A shares, which are voting and participating. The FMV of the Class A shares of the capital stock of Opco is $5,000,000. Their adjusted cost base ("ACB") to Mr. X, and their paid-up capital ("PUC"), is $100. Each year, approximately $500,000 of cash is added to Opco's balance sheet.
Mr. X incorporated a holding corporation ("Holdco") and subscribed for 100 common shares of the capital stock of Holdco for consideration of $100.
As a second step, Mr. X exchanged, under subsection 51(1), his 100 Class A shares of the capital stock of Opco in consideration for 5,000,000 freeze preferred shares of the capital stock of Opco having a total FMV of $5,000,000 and a PUC, and an ACB to Mr. X, of $100.
Opco issued 100 new Class A shares of its capital stock to Mr. X, for consideration of $1.00 per share, as well as issuing of 100 discretionary dividend shares of its capital stock to Holdco for a consideration of $1 per share.
In order to protect its future liquidity (estimated at approximately $500,000 per year), Opco would like to be able to pay a dividend on the discretionary dividend shares of its capital stock held by Holdco. Such a dividend declaration would not have the effect of depreciating the redemption value of the 5,000,000 freeze shares of the capital stock of Opco held by Mr. X.
Question to the CRA
Insofar as discretionary dividend shares were issued by an operating corporation to a holding corporation, as part of a plan (including the steps described above) aimed at protecting certain assets of the operating corporation, would the tax authorities consider that such planning would be subject to the application of an anti-avoidance rule or would they consider that such planning is acceptable from a tax policy standpoint?
CRA Response
It must first be emphasized that the potential application of any anti-avoidance rule provided for in the Act requires an analysis of all the facts and circumstances pertaining to a particular situation. Given that the statement in this question only briefly describes a particular hypothetical situation, it is not possible to provide a precise or definitive statement as to the potential application of any anti-avoidance rule. The following general comments nonetheless can be made.
The tax consequences of subscribing for discretionary dividend shares in the capital stock of Holdco would depend on, inter alia, the FMV of those shares at the time of their subscription. An analysis of certain factors such as the agreements between the parties, the purpose of the implementation of the planning, and the intention as to the payments of dividends to the holder of the discretionary dividend shares may lead us to believe that an economic benefit was conferred on Holdco.
Among the anti-avoidance rules that could apply in a situation similar to that set out in the question, we would refer inter alia to the following.
We are of the view that subsection 15(1) could apply to the extent that Holdco acquired the discretionary dividend shares of Opco for consideration less than their FMV. Indeed, Opco could be considered to have conferred a benefit on Holdco under section 15(1) when the shares were issued.
In light of the statement in this question, whether subsection 110.6(7) could apply also seems relevant to us. In summary, Mr. X may not be entitled to the capital gains deduction provided in subsection 110.6(2.1) in computing his taxable income for a taxation year by virtue of paragraph 110.6(7)(b), if the gain from a disposition by Mr. X of the new Class A shares of the capital stock of Opco was part of a series of transactions or events under which Holdco acquired discretionary dividend shares of capital stock of Opco for consideration well below their FMV at the time of acquisition.
In closing, the use of discretionary dividend shares could result in the application of subsection 245(2), depending on the facts and circumstances surrounding a particular situation. In the context of the analysis as to whether it is reasonable to consider under subsection 245(4) that an avoidance transaction would result in an abuse of the provisions of the Act read as a whole, the Income Tax Rulings Directorate would take into account, inter alia, paragraph 85(1)(e.2), which does not permit a taxpayer to accord a benefit upon a corporation unless it is a wholly-owned subsidiary of the taxpayer.
Jean Lafrenière
(613) 941-2956
2012-045418