Possible need for a specific anti-avoidance purpose (p. 6-5)
[C]ertain practitioners have suggested that in the absence of a specific tax-avoidance motive behind a dividend, neither an FMV-reduction purpose nor a cost-increase purpose should be found to exist (fn 20: See Eoin Brady and Gwendolyn Watson, "The 'Purpose' of Subsection 55(2)," in 2015 Ontario Tax Conference (Toronto: Canadian Tax Foundation, 2015), 8:1-16]…
Creditor-proofing transaction: Opco pays dividend to Holdco who makes secured loan to Opco (pp. 6:15-16)
[I]n CPL Holdings…a dividend was paid followed by a loanback of the proceeds of the dividend to the operating corporation. The transactions had the effect of significantly reducing the capital gain that would have been realized on the disposition of shares. The court held that the purpose test in former subsection 55(2) was not satisfied. …
[T]he court did analyze the reduction in the FMV of the shares (which is essentially the new FMV-reduction purpose test) and concluded that such a reduction, in a creditor-proofing transaction, was one of the effects of the transaction, but not one of its purposes…
…However, the CRA could theoretically argue that the cost-increase purpose test is applicable with respect to creditor-proofing transactions. As a result of the creditor-proofing dividend, Holdco has realized a significant increase in the aggregate tax cost of all of its properties because of the secured loan… . However, the same analysis used by the court in CPL Holdings to determine that the FMV-reduction purpose test was not met is applicable in the context of the cost-increase purpose test….
[T]he CRA clearly stated [in 2015-0623551C6] that creditor-proofing transactions offend the new purpose tests… .
[T]he CRA's position that the FMV-reduction purpose test applies to creditor-proofing dividends by default can legitimately be questioned. A creditor-proofing dividend is typically paid solely to create (or enhance) internal security over Opco's assets….
CRA requirement for reversal of basis increase in loss-transfer transaction (p. 6:20)
[I]n a loss-consolidation transaction, the effect of the payment of a dividend on a share may be to increase the aggregate ACB of the dividend recipient's property; however, the CRA does not consider this to be a purpose of the payment or receipt of the dividend because any ACB created is eliminated in the unwinding of the transaction.
Purification of Opco for SBC purposes through dividending excess assets to Holdco: issues (p. 6:21)
[U]nder the current rules the safe income exception may not readily apply. A one-time purification dividend may be substantial and thus may exceed both the FMV and the accrued gain (if any) of the Opco shares held by Holdco. This may be especially problematic if Holdco owns only dividend-sprinkling shares that are redeemable for a nominal amount and have a limited liquidation entitlement (since the FMV of the shares may be nominal).
Furthermore, restructuring a purification dividend as a share redemption or repurchase to gain access to the related-party exception may not be possible. Distributing non-active business assets shortly before a divestiture would likely negate the application of the exception (given the risk of an unrelated party acquiring an interest in the dividend payer as part of the same series of transactions)….
In many circumstances, Holdco would likely be able to convincingly argue that the sole purpose of the purification dividend was to provide the individual shareholders access to their LCGE. and thus no offensive purpose existed….
Targeted mischief of scaling back Pt IV tax refund (p. 6:10)
[T]he part IV tax exception no longer applies when, as part of a series of transactions, a refund of part IV tax is received as a consequence of a payment of a dividend by a corporation to any shareholder, including an individual….
Although the department has yet to disclose the mischief that it sought to address with this amendment, we understand that it was troubled by the part IV tax exception to subsection 55(2) applying when part IV tax was initially paid or payable but then refunded (as part of the same series), regardless of who received the dividend. In effect, the concern was that no corporate-level tax was paid, and yet subsection 55(2) still did not apply.
Difficulties in utilizing the delayed CDA addition/absence of integration (pp. 6:24-26
[A]lthough the application of subsection 55(2) results in a deemed capital gain and an increase in the CDA, the proceeds of the share redemption may already have been fully distributed by Holdco. Accordingly, Holdco may not have enough cash available to pay the permanent tax on the deemed capital gain or to fully use its CDA. ...
[T]he new part IV tax exception distorts the integration principle, resulting in either overintegration (when the taxpayer has insufficient funds to fully use the CDA) or underintegration (when the taxpayer can fully use the CDA). The effective tax rate is increased from the non-eligible dividend rate for Alberta residents in the top tax bracket of 40.24 percent to a combined tax of 50.24 percent simply because a Holdco is interposed in the structure. This result appears to be punitive. When subsection 55(2) applies to recharacterize the dividend and Holdco has sufficient cash on hand to fully use the CDA, the effective integrated tax rate is 33.49 percent, rather than 40.24 percent (if the shareholder had received the deemed dividend directly from Investco or received the dividend under the old part IV tax exception). We understand that the Department of Finance is aware of this distortion and the compliance issues associated with its amendment to the part IV tax exception but currently has no intention of making any further amendments to address these issues.
Avoidance of exclusion if Pt. IV refund not received as part of the series (pp. 6:27-29)
[A]ny dividend paid from Holdco to the shareholder needs to form part of the series of transactions in which the dividend is received by Holdco that resulted in a significant reduction in the capital gain that, but for the dividend, would have been realized on a disposition at FMV of the Investco shares. …
[M]any tax practitioners are concerned that any dividend that would entitle the corporation to recover the part IV tax could be included in the series of transactions because the jurisprudence has generally ascribed a very broad interpretation to the phrase "series of transactions." In our view, this is an extreme interpretation because the part IV tax exception would be rendered meaningless if every dividend that would entitle the corporation to recover the part IV tax would result in the application pf subsection 55(2) on the receipt of a refund of part IV tax….
In Industries SLM [[1996] 2 CTC 2572 at 2588], the Tax Court specifically held that in the context of subsection 55(2) the phrase "series of transactions" should be interpreted as narrowly possible… .
...Canada Trustco suggests that each transaction in a "series" must have "been separately undertaken to produce the final result. In the context of subsection 55(2), the courts have held that the result that subsection 55(2) is designed specifically to address is a significant reduction in the portion of the capital gain through the use of an intercorporate dividend. On this basis, for a transaction to be included as part" of a "series of transactions" arguably it is necessary for the transaction to either directly or indirectly contribute to the significant reduction in the amount of the capital gain of a disposition of the Investco shares at FMV.
[I]f the payment of the dividend by Holdco does not contribute, directly or indirectly, to a significant reduction in the capital gain on the disposition of the Investco shares, then that payment is arguably outside the series and therefore does not trigger recharacterization pursuant to subsection 55(2).
Arguably, a similar analysis may apply to the deeming provision in subsection 248(10) because the dividend paid by Holdco is not completed in contemplation of a significant reduction in the capital gain on the disposition of the Investco shares. The dividend paid by Holdco does not achieve the objective of reducing the capital gain of the Investco shares.
PUC-streaming under s. 84(1)(c) (pp. 6:45-46)
…CRA has not made any specific comments regarding the potential application of new section 55 to PUC-streaming transactions. …
Fundamentally, since PUC is primarily a class concept this planning requires the use of separate share classes. In its simplest form, PUC of the class of shares to be redeemed can be reduced with a correlating increase in the PUC of another class. On a technical application, paragraph 84(l)(c) would prevent such a migration of PUC from giving rise to a deemed dividend.
Although the strategy is technically defensible, GAAR needs to be considered….
If no other strategy is feasible, consideration should be given to minimizing the risk that a "series of transactions" will be found….
One alternative is for the dividend recipient to delay paying a subsequent dividend for as long as possible. However, in the wasting freeze situation, for example, the subsequent dividend paid in year 5 could be associated with the share redemption in the same year (assuming that the subsequent dividend paid in year 5 is otherwise outside the series of the year 1 share redemption), even though arguably the subsequent dividend paid in year 5 recovered the part IV tax on the share redemption in year 1. Since the RDTOH account is fungible, it might be difficult to argue that the portion of the refunded part IV tax relates to the first dividend and not the dividends received thereafter….
Failure of s. 55(2.3) to explicitly split the deemed dividend into 2 separate dividends (p. 6:12)
[P]aragraph 55(2.3)(a) deems the amount as determined in subsection 55(2.2) that does not exceed the safe income to be a separate taxable dividend for the purposes of subsection 55(2). Paragraph 55(2.3)(b) generally provides that the separate dividend paid from safe income to which paragraph 55(2.3)(a) applies reduces the safe income of the share on which the dividend is received. However, unlike paragraph 55(5)(f) … , subsection 55(2.3) does not explicitly split the dividend into two separate dividends. Instead, paragraph 55(2.3)(a) carves out a separate dividend equal to the safe income from the amount of the stock dividend. We have raised this issue with the Department of Finance and understand that it is considering whether an amendment may be necessary to make the rules in subsection 55(2.3) more consistent with paragraph 55(5)(f) (although the explanatory notes suggest that the amount in excess of safe income is subject to the application of subsection 55(2)).
Risk of CRA calculating safe income where taxpayer has applied s. 55(2) (pp. 6:13-14)
If a taxpayer has not calculated its safe income on hand and accepts the application of subsection 55(2) to an intercorporate dividend, query whether the CRA would go to the effort of calculating safe income for the taxpayer to ensure that the safe-income dividend is not recharacterized to be a capital gain. When a dividend is recharacterized as a capital gain and it is later determined that all or a portion of the recharacterized dividend is considered to be paid out of safe income, the recharacterized capital gain would revert to being a dividend. As a result, practitioners should take care when distributing capital dividends arising from subsection 55(2) gains because they could be retroactively determined to be taxable dividends and result in the payment of excessive capital dividends.
Potential unavailability of the safe-income exception for normal-course dividends (pp. 6:18-19)
Dividends are … frequently paid to finance or support a corporation's parent company or a larger corporate group. Examples include dividends paid
- pursuant to an internal policy of cash pooling—for example, when cash is centralized for lender security, administration, or credit-rating purposes;
- for internal redistribution—for example, when payment is made to a moneylending corporation that lends the receipted funds to another entity within the same corporate group; or
- to cover general corporate expenses. …
[T]he safe-income exception may not be available for several reasons, including …:
- the safe income is less than the profits distributed (for example, as a result of accelerated CCA claims or accrued but unpaid dividends associated with other shares);
- there is no inherent gain in the shares of Opco on which the dividend is paid (as a result of an unrelated decline in the aggregate value of Opco's assets, for example); or
- in the case of periodic dividends, the safe-income determination time concept is strictly applied (although, as discussed above, this should not be the case).
These issues are exacerbated if a chain of corporations exists. For example, suppose Parentco owns Subco 1, which owns both Subco 2 and Subco 3. Although a dividend from Subco 2 to Subco 1 might be covered by the safe-income exception, any further dividend paid from Subco 1 to Parentco might not be so protected. This would be the case, for example, if there is a decline in the value of Subco 3 and therefore there is no accrued gain inherent in the shares of Subco 1, even if the Subco 2 shares are in a gain position.
Safe-income planning on sale produces only a deferral (p. 6:35)
[B]efore the sale, a safe-income dividend was paid (or deemed to be paid), thus reducing the gain on the subsequent sale. This planning could result in a significant deferral of tax on the portion of the value related to the safe-income dividend, provided that this portion of the value was retained in a corporation. The benefit of this planning is effectively unwound when the safe income is ultimately distributed as a dividend to the shareholders. Given current tax rates, this planning is generally beneficial only in situations in which the plan is to defer the dividend distribution for a significant period because the current tax rate on dividends paid on the distribution to individuals significantly exceeds the rate of tax that would be paid on the realization of a capital gain….
Streaming of safe income where discretionary common shares (pp. 6:37-38)
[T]he CRA has suggested recently that all income earned or realized by a corporation during the holding period may reasonably contribute to the gain on the class of discretionary common shares on which a discretionary dividend is paid (to the exclusion of other participating share classes). [fn 102: 2015-0593941E5] This global approach to safe income seems to result in the ability to stream safe income to specific shareholders receiving dividends first. Safe income effectively becomes a pool that can be allocated to any participating shareholder by virtue of receiving a discretionary dividend before other shareholders. This approach appears to represent a marked departure from the CRA's historical position regarding the allocation of safe income. Our understanding is that the CRA may have purposefully adopted a more lenient approach toward safe income to balance the perceived inequities associated with the amendments to section 55. This approach also potentially results in the allocation of safe income to more than one person when considering the consolidated lookthrough approach whereby the safe income on a share of a particular corporation can include income earned or realized by any corporation with which the corporation has a direct or indirect interest….
Annual cash dividends generally not a series (p. 6:17)
One issue to consider is whether annual dividends may be part of the same series of transactions or events that may commence with the first dividend, with the safe income determination time occurring immediately before the first dividend is paid. The better view is that each annual dividend should be viewed as being part of a separate series because the dividends are not inter-related and are subject to independent determinations by the directors… [citing 2016-0672321C6]
Avoidance of exclusion if Pt. IV refund not received as part of the series (pp. 6:27-29)
[A]ny dividend paid from Holdco to the shareholder needs to form part of the series of transactions in which the dividend is received by Holdco that resulted in a significant reduction in the capital gain that, but for the dividend, would have been realized on a disposition at FMV of the Investco shares. …
[M]any tax practitioners are concerned that any dividend that would entitle the corporation to recover the part IV tax could be included in the series of transactions because the jurisprudence has generally ascribed a very broad interpretation to the phrase "series of transactions." In our view, this is an extreme interpretation because the part IV tax exception would be rendered meaningless if every dividend that would entitle the corporation to recover the part IV tax would result in the application pf subsection 55(2) on the receipt of a refund of part IV tax….
In Industries SLM [[1996] 2 CTC 2572 at 2588], the Tax Court specifically held that in the context of subsection 55(2) the phrase "series of transactions" should be interpreted as narrowly possible… .
...Canada Trustco suggests that each transaction in a "series" must have "been separately undertaken to produce the final result. In the context of subsection 55(2), the courts have held that the result that subsection 55(2) is designed specifically to address is a significant reduction in the portion of the capital gain through the use of an intercorporate dividend. On this basis, for a transaction to be included as part" of a "series of transactions" arguably it is necessary for the transaction to either directly or indirectly contribute to the significant reduction in the amount of the capital gain of a disposition of the Investco shares at FMV.
[I]f the payment of the dividend by Holdco does not contribute, directly or indirectly, to a significant reduction in the capital gain on the disposition of the Investco shares, then that payment is arguably outside the series and therefore does not trigger recharacterization pursuant to subsection 55(2).
Arguably, a similar analysis may apply to the deeming provision in subsection 248(10) because the dividend paid by Holdco is not completed in contemplation of a significant reduction in the capital gain on the disposition of the Investco shares. The dividend paid by Holdco does not achieve the objective of reducing the capital gain of the Investco shares.
Avoidance of s. 55(2) through accessing related party exemption (p. 6:31)
[O]ne strategy to avoid subsection 55(2) is to restructure a dividend as a share redemption or repurchase… .
[A]ssume that Opco is a wholly owned subsidiary of Holdco, which owns 100 common shares of Opco worth $ 1 million (with nil ACB and PUC). Opco wishes to pay a dividend of $100,000 to Holdco….
The optimal approach to restructuring the dividend to satisfy the related-party exception is through an initial share-for-share exchange effected pursuant to subsection 86(1). Holdco first exchanges all of its Opco common shares for (1) preferred shares with a fixed redemption value of $100,000, and (2) common shares with a value equal to the balance ($900,000). The preferred shares are thereafter redeemed.
Provided that the Opco common shares (before the exchange) are worth considerably more than the amount of cash to be distributed to Holdco, no concerns regarding valuation should exist….
Appropriateness of preliminary transactions to stream ACB to non-redeemed shares (pp. 6:32-33)
[I]t appears [having cited 2015-0610681C6] that the CRA would challenge a preliminary transaction segregating pre-existing ACB from shares to be subsequently redeemed … .
[S]uppose that Holdco had pre-existing ACB of $100,000 and undertook a preliminary share-for-share exchange … under subsection 85(1). Under paragraph 85(l)(g), the ACB would be streamed to the newly issued preferred shares. Accordingly, the subsequent redemption of these shares would result in Holdco losing its pre-existing ACB. Arguably, however, the correct result is that only $10,000 (10 percent) of the pre-existing ACB is lost. It is unclear whether the CRA would sanction a preliminary cost base consolidation transaction to ensure that result.
PUC-streaming under s. 84(1)(c) (pp. 6:45-46)
…CRA has not made any specific comments regarding the potential application of new section 55 to PUC-streaming transactions. …
Fundamentally, since PUC is primarily a class concept this planning requires the use of separate share classes. In its simplest form, PUC of the class of shares to be redeemed can be reduced with a correlating increase in the PUC of another class. On a technical application, paragraph 84(l)(c) would prevent such a migration of PUC from giving rise to a deemed dividend.
Although the strategy is technically defensible, GAAR needs to be considered….
If no other strategy is feasible, consideration should be given to minimizing the risk that a "series of transactions" will be found….
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