Principal Issues: Whether one of the purpose tests provided for in subparagraph 55(2.1)(b)(ii) of the Legislative Proposals relating to the Income Tax Act and Regulations of July 31, 2015 would apply in a situation of creditor proofing by way of the payment of a dividend equal to the value of the operating corporation and the lending of the amount of the dividend to the operating corporation.
Position: Yes. It appears that one of the purposes of the payment of the dividend would be to effect a significant reduction in the fair market value of the shares of the capital stock of the operating corporation.
Reasons: Wording of the Legislative Proposals relating to the Income Tax Act and Regulations of July 31, 2015.
XXXXXXXXXX 2015-061773
Sylvie Labarre, CPA, CA
December 21, 2015
Dear Sir,
Subject: Purpose test of Subparagraph 55(2.1)(b)(ii) and creditor proofing the assets of a corporation
This is in response to your email of November 11, 2015 in which you inquired whether the purpose test provided in subparagraph 55(2.1)(b)(ii) is satisfied in the following hypothetical situation.
Unless otherwise stated, all statutory references herein are references to the July 31, 2015 income tax legislative proposals respecting the Act and the Regulations (hereinafter, the “Legislative Proposals").
Hypothetical Situation
1. Holdco holds 100% of the shares in the capital stock of Opco. The shares in the capital stock of Opco are held as capital property by Holdco.
2. The fair market value ("FMV") of the shares in the capital stock of Opco is $1 million and the adjusted cost base ("ACB") is $100.
3. Opco carries on a construction business.
4. Opco has retained earnings of $1 million.
5. No safe income is attributable to shares held by Holdco in the capital stock of Opco.
6. With the sole purpose of securing its assets from the risks inherent in the construction sector, Opco pays a dividend of $1 million to Holdco. The dividend paid by Opco did not result from a redemption, acquisition or cancellation of any shares. The dividend is subject to Part IV tax. Holdco deducts the dividend amount pursuant to subsection 112(1).
7. Holdco then lends the sum of $1 million to Opco.
8. Holdco has no intention to sell its shares in the capital stock of Opco.
Question
You wish to know if, in the hypothetical situation mentioned above, subsection 55(2) and subparagraph 55(2.1)(b)(ii) of the Legislative Proposals would apply so as to deem the dividend paid by Opco to Holdco to be a capital gain from the disposition of capital property.
Our Comments
This technical interpretation provides general comments on certain of the July 31, 2015 income tax legislative proposals respecting the Act and the Income Tax Regulations (the "Legislative Proposals") and on the provisions of the Act, as the case may be. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.
Subparagraph 55(2.1)(b)(ii) reads as follows:
(ii) the dividend (other than a dividend that is received on a redemption, acquisition or cancellation of a share, by the corporation that issued the share, to which subsection 84(2) or (3) applies) is received on a share that is held as capital property by the dividend recipient and one of the purposes of the payment or receipt of the dividend is to effect:
(A) a significant reduction in the fair market value of any share, or
(B) a significant increase in the cost of property, such that the amount that is the total of the cost amounts of all properties of the dividend recipient immediately after the dividend is significantly greater than the amount that is the total cost amounts of all properties of the dividend recipient immediately before the dividend.
It appears to us that one of the purposes of the dividend payment was to effect a significant reduction in the FMV of a share in the capital of the operating company where 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, as in the hypothetical situation described above.
Moreover, it is possible that the dividend comes within one of the other purpose tests provided in paragraph 55(2.1)(b).
You indicated that the amount of the dividend is deductible under subsection 112(1) and is not subject to Part IV tax. In such a situation, it is necessary to determine what is the safe income on hand which could reasonably be regarded as contributing to the capital gain that has been realized on a disposition at FMV, immediately before the dividend, of the share in respect of which the dividend was paid.
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 have an ACB of $100, an FMV of $1 million and the retained earnings of $1 million. 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 the 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. In the hypothetical situation, this amount would be deemed to be a capital gain from the disposition of capital property by virtue of subsection 55(2)(c).
We trust that our comments will be of assistance.
Stéphane Charette, CPA, CMA, MBA
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and
Regulatory Affairs Branch