5-9685
S. Leung
(613) 957-2116
19(1)April 6, 1990
Dear Sirs:
Re: Subsections 55(2), 56(2) and 245(2) of the Income Tax Act (the "Act")
We are writing in response to your letter of February 28, 1990 wherein you requested our views as to the application of subsections 56(2) and 245(2) of the Act to the following hypothetical fact situation which was outlined in your letter.
Situation
I. An individual ("Mr. X") owns l00% of the common shares of a corporation ("Opco"). The adjusted cost base to Mr. X and the paid-up capital of the common shares of Opco are nominal. "Adjusted cost base" and "paid-up capital" have the meanings assigned by paragraphs 54(a) and 89(l)('c) of the Act, respectively.
2. Opco has a significant cash balance of $500,000 that Mr. X would like to protect from the risks of Opco's business.
3. Mr. X also owns 100% of the common shares of another corporation ("Holdco").
4. Holdco will subscribe for one redeemable and retractable non-voting preferred share of Opco for $100. The amount and the timing of dividends to be declared on this share will be at the discretion of the directors of Opco.
5. Opco will declare and pay a cash dividend of $500,000 on the preferred share held by Holdco without paying any dividend on its common shares. By so doing Mr. X will achieve his objective of protecting the cash balance of $500,000 from the risks of Opco's operating business.
6. You have asked us to assume that the above transactions are not part of a series of transactions or events described in either of subparagraphs 55(3)(a)(i) or (ii). Therefore, in your view, subsection 55(2) of the Act would not apply by virtue of paragraph 55(3) (a) of the Act.
Your Request
You requested our views on the following:
i) whether subsection 56(2) of the Act would apply to any of the above-noted transactions and if so, how would it apply;
(ii) whether subsection 245(2) of the Act would apply to any of the above-noted transactions and if so, how would it apply;
(iii) whether our views on the above would be different if the adjusted cost base to Mr. X, or the paid-up capital, of the common shares of Opco was substantial; and
(iv) whether our answer would be different if the main purpose of the dividend was to attempt to cause the shares of Opco to be "qualified small business corporation shares" within the meaning assigned by subsection 110.6(l) of the Act.
Our Comments
The questions which you have asked are quite specific. However, since we do not have all of the relevant facts which would be necessary to respond to all of your specific enquiries, our comments must be general in nature. For purpose of our comments we have assumed that Opco and Koldco in the hypothetical situation outlined in your letter are taxable Canadian corporations within the meaning assigned by paragraph 89(l)(i) of the Act.
It is our view that a class of shares of a corporation that is entitled, at the discretion of the directors, to receive a disproportionately large dividend in relation to the other issued shares of the corporation would, in most cases, come under the scrutiny of subsection 56(2) of the Act. In such cases, it is a question of fact if the payment of a dividend results in the conferral of a benefit on a taxpayer who concurs to the payment or in a benefit that the taxpayer desires to have conferred on some other person, and on this we make no comment in respect of your situation. Also, depending on the circumstances, the provisions of subsection 245(2) of the Act could be considered.
Our views on the above would not be different if the adjusted cost base to Mr. X, or the paid-up capital, of the common shares of Opco was substantial.
If the main purpose of the dividend was to cause the shares of Opco to be qualified small business corporation shares, it is presumed that Mr. X will implement the above-mentioned transactions in contemplation of both the sale of his shares of Opco and the subsequent claim by him for a capital gains deduction pursuant to subsection 110.6(2.1) of the Act. It is, therefore, our view that subsection 55(2) of the Act could apply to the dividend because the subsequent sale of the shares of Opco by Mr. X will constitute part of a series of transactions or events one of the purposes of which is to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on the disposition of the shares of Opco immediately before the dividend. In this regard, we would like to point out that
(i) subsection 248(10) of the Act contains an extended definition of the term "series of transactions or events", and
(ii) it is our view that a preliminary transaction will form part of a series of transactions referred to in subsection 248(10) of the Act if, at the time the preliminary transaction is carried out, the taxpayer has the intention to implement the subsequent transactions constituting the series and the subsequent transactions will be part of a series although at the time of the completion of the preliminary transaction the taxpayer either had not determined all of the important elements of the subsequent transactions including, possibly, the identity of other taxpayers involved, or had lacked the ability to implement the subsequent transactions.
We trust the above will be of assistance.
Yours truly, for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch