6 December 1995 Roundtable Q. 19, 9530410 - 55(2) and adjustment to acb

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 Department.

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

Principal Issues:

Increase in stated capital-effect on acb where 55(2) applies to the deemed dividend- possibility of double taxation

Position:

double taxation only where the share not disposed of in the same year

Reasons:

wording of the Act

Tax Executives Institute
December 6, 1995

QUESTION 19 - INCREASE IN PAID-UP CAPITAL -INCREASE IN ACB AS WELL

When a taxable Canadian corporation increases its stated capital, its shareholders may, pursuant to subsection 84(1), be deemed to have received a taxable dividend. The amount of the deemed dividend is subsequently added to the shareholder's adjusted cost base for the shares pursuant to paragraph 53(1)(b). On a subsequent sale of the shares, the increased adjusted cost base would be used to determine the shareholder's gain or loss on disposition.

In the situation where the increase in stated capital was intended to equal, but is subsequently found to exceed, the safe income amount attributable to the shareholder's shares and the increase was part of a series of transactions that were intended, in part, to reduce the amount of the capital gain realized on a subsequent sale of the shares, paragraph 55(2)(a) will deem the dividend not to be a dividend.

1.Does paragraph 55(2)(a) mean that the increase in stated capital does not result in a deemed dividend under subsection 84(1), and that there is, therefore, no addition to the shareholder's adjusted cost base of the property under paragraph 53(1)(b)?

2.If so, would the amount deemed by paragraph 55(2)(b) or (c) to be proceeds of disposition or a gain, respectively, be added to the adjusted cost base of the shares by subsection 52(1)?

3.If the error in the amount of the increase in stated capital is detected before the shareholder files its return of income for the year in which the increase took place, is the shareholder entitled to make a designation (or series of designations) under paragraph 55(5)(f)? Would the shareholder be entitled to make a late-filed designation if the error is not discovered until after the return for the year has been filed?

4.Where the shares are disposed of to a third party before the end of the shareholder's taxation year, would Revenue Canada confirm that the portion of the increase in stated capital that is deemed not to be a dividend is considered to have been otherwise included in computing the proceeds of disposition of the shares for purposes of paragraph 55(2)(b)? In other words, would such amount not be deemed by that paragraph to be proceeds received from the third party?

In the event that questions 1 and 2 are answered in the negative, would Revenue Canada support a request to the Department of Finance to amend paragraph 53(1)(b) to include an amount that, but for paragraph 55(2)(a), would have been deemed to be a dividend by subsection 84(1)?

Department's Position

1.To the extent that the increase in stated capital is deemed not to be a dividend by virtue of paragraph 55(2)(a), there would be no addition to the shareholder's adjusted cost base by virtue of paragraph 53(1)(b).

2.There is no addition to the cost of the shares by virtue of subsection 52(1), since there is no property acquired on the increase in stated capital.

3.If the error is detected before the shareholder files its return of income for the year in which the increase took place, the shareholder is still entitled to make a designation or series of designations under paragraph 55(5)(f).

It is also the Department's practice to accept an amended return which includes a designation which is filed before the time has expired for filing a notice of objection in respect of the initial assessment for the year in which the dividend is received.

Our administrative position regarding paragraph 55(5)(f) designations was stated at the 1992 Canadian Tax Foundation, and is found on page 7:8 of the 1992 Conference Report. When, as a result of an audit, it is found that the "safe income" is less than the dividend and no designation has been made, the full amount of the dividend will not be assessed as proceeds if the following conditions are present:

-the corporation made a reasonable effort to calculate the "safe income";

-the transactions have been reported;

-the residual amount (the excess of the proceeds over the taxpayer's calculated safe income) has, where significant, been reported as a capital gain in the corporation's return of income when filed; and

-the corporation requests the department in writing to reassess only the excess.

Although not specifically stated in the 1992 Conference Report, it is the Department's practice that the taxpayer must also provide a written confirmation that it will not file an objection or appeal to the application of subsection 55(2). (See page 1150 of the APFF Congrès 92).

4.We agree that where the shares are disposed of before the end of the taxation year, then the amount deemed not to be a dividend would not be deemed to be proceeds of disposition of the share, since it is otherwise included in computing such proceeds. In effect, the potential for double taxation arises only in the situation where the shares are not disposed of in the year, since there will be an amount deemed to be a gain of the corporation for the year by virtue of paragraph 55(2)(c) and there is no adjustment to cost base as discussed above. Therefore when the shares are ultimately disposed of, there is potential double taxation.

We would support a request to the Department of Finance to modify subsection 53(1).

Author: V. Plant
File: 953041
Date: November 23, 1995