Principal Issues: In a particular situation, Mr. A is one of the shareholders of OPCO. Approximately 25% of the fair market value of these shares is attributable to anything other than safe income on hand. Mr. A wishes to extract OPCO’s surpluses otherwise than as taxable dividends. The following series of transactions is undertaken: 1) Mr. A transfers shares of the capital stock of OPCO to a new corporation (“GESTION A”) in return for shares of the capital stock of GESTION A on a rollover basis pursuant to subsection 85(1); 2) OPCO redeems its shares held by GESTION A. Because the amount of the deemed dividend is higher than the safe income on hand attributable to the redeemed shares and due to the fact that GESTION A does not make the designation under paragraph 55(5)(f), the entire amount of the deemed dividend is recharacterized as proceeds of disposition. Consequently, the non-taxable portion of the capital gain is added to GESTION A’s CDA; and 3) GESTION A pays a capital dividend to Mr. A equal to its CDA balance. The overall result of this series of transactions is that the amount of tax payable by Mr. A, OPCO and GESTION A, with respect to OPCO’s surpluses distributed first to GESTION A then to Mr. A, is significantly less than the amount of tax payable if OPCO would distribute its surpluses to Mr. A as taxable dividends. Whether the CRA is of the opinion that GAAR would apply in this particular situation taking into consideration the recent Tax Court of Canada decisions with respect to surplus stripping cases?
Position: A file with a similar series of transactions was recently referred to the GAAR Committee. The GAAR Committee recommended that GAAR not be applied in this particular file considering the current state of the case law. However, the CRA is concerned about this type of tax planning which defeats the integration principle. We have expressed our concerns to the Department of Finance.
Reasons: According to the jurisprudence.
9 OCTOBER 2015 FEDERAL TAX ROUNDTABLE
2015 APFF CONFERENCE
Question 15
Surplus Stripping and General Anti-avoidance Rule (“GAAR”)
Consider the following situation:
An individual ("A") is one of the shareholders of a company ("Opco"). Approximately 25% of the fair market value of the shares in the capital stock of Opco held by A is attributable to something other than the safe income on hand ("SIOH").
A wishes to extract OPCO surplus other than in the form of taxable dividends.
In this regard, the following series of transactions is implemented:
1. A transfers shares the shares held by A in the capital stock of Opco to a newly-incorporated corporation (“Holdco A”) in consideration for Holdco A shares. A and Holdco A make an election under subsection 85(1). In this regard, the agreed sum is equal to the adjusted cost base to A of the transferred shares.
2. Opco redeems the shares in its capital stock held by Holdco A, resulting in a deemed dividend under subsection 84(3). Since the amount of the deemed dividend is greater than the SIOH and given that Holdco A did not make a designation under paragraph 55(5)(f), the entire deemed dividend is recharacterized as proceeds of disposition under paragraph 55(2)(b). As a result, the non-taxable portion of the capital gain resulting from the redemption of the shares is included in the Holdco A capital dividend account ("CDA").
3. Holdco A pays to A a capital dividend in an amount equal to the balance of its CDA.
As a result, it appears that the tax payable by A, Opco and Holdco A in respect of the Opco surplus distributed, first to Holdco A and then to A, is lower than the tax payable if Opco distributed its surplus to A in the form of taxable dividends.
Question to CRA
Is the CRA of the view that the GAAR applies as a consequence of, and because of, the series of transactions described above, taking into account, inter alia, Evans v. The Queen (footnote 1), Gwartz v. The Queen (footnote 2) and Descarries v. The Queen (footnote 3), and in particular the following comments from the Tax Court of Canada in the latter case:
As stated by the appellants in their written submissions, I noted in Gwartz v. The Queen that the Act does not contain any general prohibition stating that any distribution by a company must be done in the form of a dividend. However, I also specified in that case that, although the taxpayers may arrange to distribute surpluses in the form of dividends or of capital gains, that option is not limitless. Any tax planning done for that purpose must comply with the specific anti-avoidance provisions found in sections 84.1 and 212.1 of the Act. (footnote 4). [References omitted]
CRA Response
A file similar to that described above was recently submitted to the GAAR committee and it recommended that the GAAR not be applied having regard to the current state of the jurisprudence.
Nonetheless, the CRA is concerned by this type of tax planning which, in particular, is contrary to the integration principle.
Accordingly, we have brought our concerns respecting this type of tax planning to the attention of the Department of Finance.
Jean Lafrenière
(613) 670-9013
October 9, 2015
2015-059564
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 2005 TCC 684.
2 2013 TCC 86.
3 2014 TCC 75.
4 Idem, paragraph 43.