30 September 2003 Internal T.I. 2003-0033397 - Part IV Tax and Subsection 55(2)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Application of subsection 55(2). Is the particular dividend subject to tax under Part IV.

Position: No.

Reasons: The law.

		September 30, 2003

	Nicolas Colarusso	HEADQUARTERS
	Tax Avoidance	Reorganizations and
	Laval TSO	  Resources Division
		Michael Cooke
(613) 957-2126

		2003-003339

Part IV Tax and Subsection 55(2)

This is in reply to your memorandum to us dated September 12, 2003 wherein you requested our comments with respect to the above provisions of the Income Tax Act (the "Act") as they apply to the fact situation described in your memorandum.

Based on the information in your memorandum, we understand the following.

Holdco1 and Holdco2 each owned 50% of the voting shares of Opco. Holdco1, Holdco2 and Opco are taxable Canadian corporations. Holdco1 and Holdco2's taxation year ends on XXXXXXXXXX while Opco's taxation year ends on XXXXXXXXXX.

On XXXXXXXXXX, an arm's length third-party ("Purchaser") acquired all the voting shares of Opco owned by each of Holdco1 and Holdco2. As a result, Purchaser acquired control of Opco at that time such that, in accordance with subsection 249(4), Opco had a deemed taxation year ending on XXXXXXXXXX . However, immediately before that time Opco paid a taxable dividend to each of Holdco1 and Holdco2. You indicate that subsection 55(2) would apply to the dividend received by Holdco1 and Holdco2, subject to Part IV tax being paid by Holdco1 and Holdco2 on the dividend (or a portion thereof) it received from Opco.

Since Opco was connected with Holdco1 and Holdco2 at that time Holdco1 and Holdco2 would only be required to pay Part IV tax on the dividend it received from Opco (or a portion thereof) to the extent that Opco received a dividend refund as a result of such payment. At the time Opco filed its income tax return for its taxation year in which it paid the dividends (i.e. XXXXXXXXXX), Opco had a balance of RDTOH at the end of that year and requested a dividend refund. However, in its subsequent taxation year (i.e. ending XXXXXXXXXX) Opco incurred a non-capital loss and requested that this loss be carried back and deducted against Opco's taxable income for its XXXXXXXXXX taxation year.¹

You indicate that as a result of the above loss carry back, Opco's RDTOH balance at the end of XXXXXXXXXX was reduced to nil and as such, Opco was not entitled to receive any dividend refund in respect of the dividend it paid to each of Holdco1 and Holdco2. Moreover, neither Holdco1 nor Holdco2 remitted any Part IV tax in respect of the taxable dividend that each corporation received from Opco since each corporation knew that Opco was not entitled to a dividend refund as a result of the loss carry back.

Accordingly, it is your view that subsection 55(2) would apply to the dividend received by Holdco1 and Holdco2.

Notwithstanding the above, you indicate that Holdco1 and Holdco2 have argued that subsection 55(2) does not apply due to the fact that the dividends in question were subject to Part IV tax at the time the dividend from Opco was received by each of them.

You have asked us to confirm whether subsection 55(2) should apply or not.

Our Comments:

Since the particular dividends paid by Opco are not deemed dividends that arose as a result of a redemption of its shares (pursuant to subsection 84(3)), we have assumed for the purpose of the discussion that follows that the payment of such dividends by Opco was for the purpose of reducing the amount of capital gain that would arise on the sale of the Opco shares to the Purchaser by each Holdco.² Accordingly, subject to each Holdco having a sufficient amount of safe income on hand attributable to their particular shares of Opco at that time, subsection 55(2) would apply to each such dividend (or a portion thereof) that is not otherwise subject to Part IV tax that is not refunded as a consequence of the payment of a dividend to a corporation where the payment is part of the series.

Based on our understanding of the facts, Opco (being the "payer corporation") was connected with each of Holdco1 and Holdco2 pursuant to paragraph 186(4)(b) at the time Opco paid the dividends (i.e. the dividends were paid on XXXXXXXXXX and that time falls in the taxation year of each Holdco ending XXXXXXXXXX). Accordingly, as noted above, Holdco1 and Holdco2 would only be required to pay Part IV tax on the dividend (or portion thereof) it received if Opco was entitled to and received a dividend refund under subsection 129(1) for that year.

Pursuant to subsection 129(1), a private corporation's dividend refund is based on the lesser of 1/3rd of its taxable dividends paid in the year and the amount of its RDTOH at the end of the particular year as determined by subsection 129(3). Because Opco deducted its non-capital loss for its taxation year ending XXXXXXXXXX from its taxable income for its taxation year ending XXXXXXXXXX, Opco's RDTOH within the meaning of subsection 129(3) is nil at the end of its taxation year in which it paid the dividends.

Based on theses facts, neither Holdco1 nor Holdco2 is subject to tax under Part IV on any portion of the assessable dividend it received from Opco. Accordingly, subject to the above noted assumptions, subsection 55(2) would apply to the full amount of the taxable dividend received by each of Holdco1 and Holdco2.

If you have any questions concerning this matter please feel free to contact Michael Cooke.

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch

ENDNOTES

¹ We have assumed that the deduction of Opco's post-acquisition of control non-capital loss from its pre-acquisition of control taxable income is in accordance with paragraphs 111(5)(b) and 111(1)(a).

² The carry back of non-capital losses incurred by the payer corporation should not have any impact on determining whether the purpose of a particular dividend was to reduce the capital gain on a share or not.