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.
Principal Issues: 1) Whether the payment of discretionary dividends by Opco to each of its corporate shareholders, Holdco1, Holdco2 and Holdco3 will result in the application of subsection 56(2)? 2) Whether the series of transactions would be subject to subsection 245(2)?
Position: 1) No 2) We would need to review the pertinent facts to make a determination with respect to GAAR>
Reasons: Consistent with previous court decisions, subsection 56(2) will not apply to the payment of dividends provided that the applicable taxpayer does not have a pre-existing entitlement to dividends.
XXXXXXXXXX 2006-017560
Fiona Harrison
September 13, 2006
Dear XXXXXXXXXX:
This is in reply to your letter of March 10, 2006, wherein you requested a technical interpretation in respect of the following situation:
1. The shareholders of an operating corporation ("Opco") are three holding corporations, namely, Holdco1, Holdco2 and Holdco3.
2. Holdco1, Holdco2 and Holdco3 are not related persons within the meaning of subsection 251(2) of the Income Tax Act (the "Act").
3. The issued and outstanding capital stock of Opco includes Class A common shares, Class B common shares and Class C common shares.
4. Holdco1 holds 200 Class A common shares, Holdco2 holds 100 Class B common shares and Holdco3 holds 200 Class C common shares of the capital stock of Opco. Each of the Class A common shares, Class B common shares and Class C common shares was issued at the relevant time for an amount which was equal to the fair market value ("FMV") thereof and such consideration was paid in full by the subscriber to the issuer. Each of the different classes of common shares carries the right to one vote per share.
5. The share rights, restrictions, privileges and conditions of the different classes of common shares of Opco each contain a distinct right to a priority payment on dissolution.
6. The articles of incorporation for Opco provide that dividends that may be declared at the discretion of the board of directors on any one or more of the Class A common shares, Class B common shares and/or Class C common shares on a discretionary basis. It is intended that a holder of any one or more of the Class A common shares, Class B common shares or Class C common shares of the capital stock of Opco may receive at the discretion of the board of directors of Opco a dividend from Opco to the exclusion of the holders of the other classes of common shares.
7. Each of Holdco1, Holdco2 and Holdco 3 is and will remain connected to Opco for all applicable purposes under Part IV of the Act. It is not expected that the payment of any one dividend or series of payments of dividends in aggregate will be sufficient to affect the FMV so as to prevent any one or more of Holdco1, Holdco2 and Holdco3 from being connected with Opco for the purposes of Part IV of the Act.
8. No single shareholder has de jure control of Opco.
You enquire as to the applicability of subsection 56(2) or subsection 245(2) in respect of the above-described situation.
It is your view that the payment of discretionary dividends as described in the foregoing fact situation will not result in the application of either subsection 56(2) or subsection 245(2) as a result of the Supreme Court of Canada's decision in Neuman v. R. [1998] 3 CTC 177, ("Neuman") provided that a shareholder receiving a dividend on a class of shares does not do so where a pre-existing entitlement of such dividend amount lies with another shareholder of the corporation. You note that the foregoing fact situation is among arm's length parties that have chosen to govern their affairs pursuant to a comprehensive unanimous shareholders agreement. You state that such agreement does not provide for any pre-existing entitlement to dividends on any particular class of shares.
You also assert that the distinct share rights of the Class A common shares, Class B common shares and Class C common shares of Opco as described are sufficient for corporate law purposes to constitute separate classes of shares.
You conclude that as a result of none of the common shareholders having a pre-existing entitlement to a dividend payable by Opco, subsection 56(2) will not be applicable. You further conclude that subsection 245(2) should not apply because the foregoing situation does not constitute an avoidance transaction or series of transactions involving a misuse of a provision or an abuse of the Act read as a whole.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. The following comments are, therefore, of a general nature only and are not binding on the Canada Revenue Agency.
Consistent with the Supreme Court of Canada's decision in Neuman, we agree that, generally, subsection 56(2) will not apply to arrangements involving the payment of dividends by a corporation, provided that the applicable taxpayer does not have a pre-existing entitlement to the dividends, and provided that proper consideration was given for the shares when issued. While you have represented that each of the Class A common shares, Class B common shares and Class C common shares was issued at the relevant time for an amount equal to the FMV thereof, we suggest that it may be difficult to determine the FMV of shares which carry an entitlement to discretionary dividends.
In a phone conversation of August 3, 2006, you have advised that Opco has sufficient undistributed "income earned or realized after 1971" within the meaning of section 55 of the Act ("safe income on hand") to cover the dividends paid by Opco to each of its shareholders. Consequently, subsection 55(2) will not apply to the dividends received by each of Holdco1, Holdco2 and Holdco3.
We have not previously encountered the use of discretionary shares in this type of situation. Consequently, the determination of the application of subsection 245(2) to the above-described series of transactions would necessitate a review of all the pertinent facts and relevant documentation and would best be dealt with within the context of an advance income tax ruling request.
Yours truly,
Mark Symes
Manager
Corporate Reorganizations Section
Reorganizations and Resources Divison
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2006
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2006
Email this Content