A corporation resident in Canada ("Parent") owning 100% of "Target" accepts an offer from an unrelated third party ("Purchaser") to purchase all of the Target shares for $3 million, with the sale agreement specifying that assets which Purchaser does not wish to acquire ("Excluded Assets") are assigned a value of zero. The ACB of the Target shares is $3 million and the safe income attributable to them is nil.
Immediately prior to its sale to Purchaser, Target pays a dividend in kind of $250,000 (the "Dividend") to Parent by transferring an Excluded Asset to Parent.
CRA rejected a suggestion that since, whether or not the Dividend was paid, the value of the Target shares would be $3 million, and the capital gain would be nil, s. 55 could not apply. It stated:
Considering that the FMV of shares in the capital stock of Target would be reduced as a result of the payment of the Dividend, it is necessary to determine whether one of the purposes for which the Dividend was paid was to significantly decrease the FMV of a share in the capital stock of Target, in light of, among other things, the answers that would be given to the following questions:
- What does Parent intend to accomplish by decreasing the value of shares in the capital stock of Target?
- How does the reduction in the value of the shares of the capital stock of Target benefit Parent?
- What actions has Parent taken in connection with the reduction in value of the shares of the capital stock of Target?
In addition, the CRA generally considers that the Purpose Tests [in ss. 55(2.1)(b)(i) and (ii)] could apply to a dividend paid by an operating company to its corporate shareholder in order to dispose of surplus assets for the purpose of the purification and subsequent sale of [its] shares … 2017-0724021C6 … .
… [T]he payment of the Dividend and the Sale are part of the same series … . In light of the parameters established by the CRA and the applicable approach for purposes of applying the Purpose Tests, it seems difficult to argue that none of the purposes of the payment or receipt of the Dividend is to significantly decrease the FMV of the shares of the capital stock of Target.
Consequently, subsection 55(2) should likely apply … .