Holdco holds all the shares of Opco, which have a fair market value (“FMV”) of $1M and an adjusted cost base (“ACB”) of $100. Opco (which carries on a construction business) has retained earnings of $1M and no safe income is attributable to Holdco’s shares of Opco.
“With the sole purpose of protecting its assets from the risks inherent in the construction sector,” Opco paid a $1M dividend to Holdco, which was not subject to Part IV tax and for which Holdco took a $1M s. 112(1) deduction, with Holdco lending the sum back to Opco. Holdco had no intention of selling the Opco shares, and the Opco shares were not redeemed etc. on the dividend payment.
Would s. 55(2) and draft s. 55(2.1)(b)(ii) apply to deem the dividend to be a gain from the disposition of capital property? CRA responded (TaxInterpretations translation):
It appears to us that one of the purposes of the payment of the dividend was to effect a significant reduction in the FMV of a share in the capital of the operating company when the purpose of the transaction was to shelter from creditors the assets of a corporation carrying on a business or to secure those assets by diminishing the total value of the operating corporation and augmenting the value of its shareholder (the holding company)… .
In the facts indicated by you, there was no safe income attributable to the shares in the capital of Opco, held by the holding company, even though the shares in the capital of Opco held by Holdco had an ACB of $100, an FMV of $1M and the retained earnings were $1M. We would have thought that on these assumptions, there would be an amount of safe income on hand which it was reasonable to consider as contributing to a capital gain which would have been realized on a disposition at FMV, made immediately before the dividend, of the shares held by Holdco on which the dividend was received.
However, on the assumption indicated by you respecting safe income, subsection 55(2) would apply to the amount of the dividend. This amount would be deemed not to be a dividend…[and] would be deemed to be a capital gain from the disposition of capital property by virtue of paragraph 55(2)(c).