1st Situation. Mr. X instigates an estate freeze for his corporation (Opco), which is a small business corporation (“SBC”) and all of whose common shares end up being held by the “X Trust” (whose beneficiaries are his grown children, spouse and a newly-incorporated corporation (“Holdco”) which is never an SBC and is held by X Trust). In order that Opco can continue qualifying as an SBC, Opco annually pays dividends to X Trust out of its earnings, which allocates and distributes them to Holdco, making a s. 104(19) designation. Would s. 74.4(2) apply? CRA responded (TaxInterpretations translation):
[T]he provisions of subsection 74.4(2) would not apply to the transfer of property by Mr. X to Opco in the course of an estate freeze so long as Opco remained an SBC.
...[A]lthough the payment of a dividend by Opco to Holdco equal to the surplus funds generated in carrying on the business of Opco could be considered a transfer of property, subsection 74.4(2) generally would not apply where it is a corporation, rather than an individual, which transfers or lends property to a corporation. This legislative provision could however apply if it is demonstrated that an individual indirectly, by means of a trust or otherwise, transferred or lent property to a corporation or if subsection 74.5(6) applied. ...[W]e refer you to ...2002-0147325... . Mr. X would not be considered, for purposes of subsection 74.4(2), to have indirectly transferred property to Holdco.
2nd Situation. Mr. X transfers his business under s. 85(1) to a new corporation (“Opco”) for treasury shares. The other Opco shareholders are his spouse, minor children - and Holdco (which never is an SBC) holding a separate class of shares which are entitled to a discretionary dividend. Mr. and Ms, X, and the children, subscribe for common shares. In order that Opco can continue qualifying as an SBC, Opco annually pays dividends to Holdco out of the surplus funds generated from its operations. CRA stated:
[F]or so long as Opco remains an SBC, [subsection 74.4(2)] would not apply to the transfer of property (the business assets) effected by Mr. X to Opco in the course of incorporating his business, nor ... to the consideration paid by Mrs. X for the acquisition of shares in the capital of Opco. Furthermore, ... Mr. X would not be considered, for purposes of subsection 74.4(2), to have indirectly transferred property to Holdco.
...[T]he consideration paid by Mr. or Mrs. X for the acquisition of shares in the capital of Holdco, which is not an SBC, would technically constitute a transfer of property by an individual (Mr. or Mrs. X) to a corporation other than an SBC (Holdco). Thus, subsection 74.4(2) could technically apply, depending on the other facts and circumstances, to such transfers.