Principal Issues: The sole shareholder of a corporation receives a stock dividend. The fair market value of the shares received as the stock dividend is equal to 9/10 of the value of the common shares held by the shareholder. After the stock dividend, the common shares (with a reduced value) are exchanged pursuant to section 51 for preferred shares having a value equal to the value of the common shares. After the exchange, new common shares are issued for a nominal amount to a family trust. The stock dividend and the exchange of the common shares are done for the purpose of implementing an estate freeze.
1- Whether subsection 15(1.1) would apply with respect to the stock dividend;
2- Whether the shares issued as a result of the stock dividend would be issued as part of an arrangement the main purpose of which was to permit any increase in the value of the property of the corporation to accrue to other shares that would, at the time of their issue, be prescribed shares;
3- Whether subsection 74.4(2) would apply with respect to the shares issued as a result of the stock dividend;
4- What would be the safe income attributable to shares issued as a result of the stock dividend?
5- As an alternative, if the shares of the corporation are held equally by three shareholders and the steps implemented to freeze the value of the corporation are the same except that the new common shares are issued to three family trusts, whether subsection 15(1.1) would apply with respect to the stock dividend.
Position: 1. Generally no.
2. An arrangement may include more than one transaction. If the transactions are planned together for the purpose of achieving an estate freeze, the transactions may be considered to be part of the arrangement. The main purpose of an arrangement is a question of fact. The question of whether the new shares issued are prescribed shares is a question of fact.
3. No.
4. In the case of stock dividend consisting of shares having a high redemption amount and nominal paid-up capital, an allocation should be made of the safe income and safe income on hand formerly attributable to the common shares on which the dividend was paid, on the basis of the relative amounts of the gains inherent in the original shares and in the shares constituting the dividend.
5. If the stock dividend is paid to all shareholders of the payor pro rata in proportion to their shareholdings, generally no.
Reasons: 1. and 5. It may not reasonably be considered that one of the purposes of the payment was to significantly alter the value of the interest of a specified shareholder of the corporation.
2. Meaning of arrangement and question of fact.
3. The stock dividend does not constitute a transfer by an individual, either directly or indirectly, by means of a trust or by any other means, to a corporation for the purpose of subsection 74.4(2).
4. Longstanding position.
FEDERAL TAXATION ROUNDTABLE 10 OCTOBER 2014
2014 APFF CONFERENCE
Question 19
Stock Dividend
In the following hypothetical situation:
- Mr. X holds all Opco shares, which are 100 Class A shares with voting and participation rights.
- The value of the 100 Opco Class A shares is $1,000,000, and their paid-up capital ("PUC") and adjusted cost base ("ACB") are $1.
- Mr. X wishes to effect an estate freeze in favour of a trust for the benefit of his children and his spouse.
- To accomplish the freeze, the following transactions will be carried out:
- A stock dividend of Opco Class B shares having a redemption value of $900,000 and a total PUC of $1.
- The exchange of the 100 Class A Shares, now valued at $100,000, for Class C freeze preferred shares. Subsection 51(1) will apply to this exchange.
- The subscription for Opco Class A voting and participating shares by the family trust for a nominal amount ($10).
Questions to the CRA
a) Can you confirm that subsection 15(1.1) would not apply in such a situation, and that Mr. X should, therefore, only include in his income tax return the increase in the PUC, in this case, $1?
b) Can you confirm that the stock dividend, which was part of the freeze, complies with subparagraph 6205(2)(a)(i) of the Income Tax Regulations ("ITR"), namely that it is part of an “arrangement,” the main purpose of which was to permit any increase in the value to accrue to other shares? Thus, both the Class B Shares and the Opco Class C Shares would constitute prescribed shares for the purposes of subsection 110.6(8)?
c) Can you confirm that subsection 74.4(2) will not apply to the Class B Shares issued by way of the stock dividend, consistently with Technical Interpretation 2003-0004125 "Freeze by paying a stock dividend"?
d) Can you confirm that the safe income attributable to the Class B Shares corresponds to that on the Class A Shares based on the proportion of the unrealized gain on the Class B Shares to the unrealized gain on Class A shares prior to the issuance of the stock dividend?
e) If Opco Shares were held by three shareholders and a similar transaction to that described in the hypothetical situation took place (a stock dividend followed by an exchange and then a subscription by three family trusts), can you confirm that subsection 15(1.1) would not apply in such a situation since the stock dividend was paid in proportion to the holdings of each of the three shareholders?
CRA response to question 19(a)
The position of the CRA is that subsection 15(1.1) generally does not apply where a corporation pays a stock dividend solely to a person who holds all of the issued and outstanding shares in the capital stock of the corporation. Accordingly, pursuant to paragraph (c) of the definition of "amount" in subsection 248(1), Mr. X would only be required to include in his income tax return the increase in the PUC, in this case, of $1.
CRA response to question 19(b)
The term "arrangement" in subparagraph 6205(2 (a)(i) ITR has a broad meaning. An arrangement could encompass more than one transaction. Thus, if several transactions are effected in the context of a freeze in favour of persons contemplated by ITR subparagraph 6205(2)(a)(ii), the CRA could consider that the arrangement includes these transactions if it appears to it that they were planned together to achieve the targeted purpose, being the freeze. For example, the payment of a stock dividend of Class B shares in the capital stock of the Corporation to reduce the value of the Class A (participating) shares in such capital stock followed by an exchange of all such Class A shares in order to receive Class C shares in the capital stock of the Corporation, being transactions effected so as to be followed by the issuance of new participating shares to the family trust, could form part of the same arrangement in the circumstances. In such a case, the Class B and C Shares in the capital of Opco would be issued by the Corporation as part of the arrangement.
The question of whether the main purpose of the arrangement is to permit any increase in the value of property of a corporation to accrue to other shares that would, at the time of their issue, be prescribed shares, is a question of fact. An arrangement could have been put in place mainly for purposes other than those described in ITR subparagraph 6205(2)(a), such as realizing certain financial, structural or other objectives, or for obtaining certain tax advantages.
If the principal purpose test is satisfied, it would be necessary in the current situation to determine whether the test provided for in ITR subparagraph 6205(2)(a)(ii) is satisfied at the completion of the arrangement, being when the Class A shares in the capital stock of the Corporation are issued (assuming that such shares were prescribed shares at the date of their issue) to the family trust.
CRA response to question 19(c)
For the purposes of subsection 74.4(2), the CRA's position is that, in general, a stock dividend paid by a corporation does not in itself constitute a transfer made directly or indirectly (by means of a trust or otherwise) to a corporation by an individual. Thus, the provisions of subsection 74.4(2) would not apply so as to compute deemed income on the value of the Class B shares received in satisfaction of the stock dividend.
In contrast, the exchange of the 100 Class A shares of Opco for Class C freeze preferred shares would constitute a transfer made directly or indirectly (by means of a trust or otherwise) to a corporation by an individual for purposes of subsection 74.4(2).
CRA response to question 19(d)
Where there is a stock dividend of a class having a redemption amount higher than its nominal paid-up capital, it will be necessary to apportion the safe income and the safe income on hand which is attributable to the shares on which the dividend was paid, being the Class A shares, between such shares and the shares received as a stock dividend, being the Class B shares. The apportionment of this safe income and safe income on hand which will thereupon be attributable to the Class B shares will be effected in accordance with the proportion of the gain inherent in the Class B shares as compared to the gain inherent in the Class A shares prior to the stock dividend. The amount of safe income and safe income on hand which would be attributable to the Class B shares would reduce the safe income and safe income on hand which was attributable to the Class A shares prior to the payment of the stock dividend.
CRA response to question 19(e)
Subsection 15(1.1) applies where it can reasonably be considered that one of the reasons for the payment of a stock dividend is to significantly alter the value of a particular shareholder's interest in the corporation. An increase or reduction in the value of the interest of a shareholder does not generally occur if the stock dividend is payable to all the shareholders in proportion to their interest in the corporation, as would appear to be the case in the hypothetical situation in question (e).
Sylvie Labarre
(613) 946-5357
October 10, 2014
2014-053804