Tax Interpretations Judicial and CRA interpretations of Canadian tax law and transactional implications

Income Tax Act - 81-100 - Section 83

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Subsection 83(2)

Cases

2529-1915 Québec Inc. and Faraggi v. The Queen, 2009 DTC 5012, 2009 FCA 398 [capital dividend elections for distributions of what should have been known to be income-account gains were shams]

Overview of facts.  The two individual taxpayers devised a scheme to: generate artificial capital gains of $110 million in some home-grown companies; pay the supposedly resulting capital dividend accounts (CDAs) of $55 million to another company (1915); generate artificial capital losses in the home-grown companies to offset their capital gains; effectively sell negotiated portions of the CDA to 3rd-party purchasers by having them subscribe for preferred shares at a 21% premium to their redemption amount with the shares’ redemption amounts effectively being flowed out to the 3rd parties as purported capital dividends; and then pocketing such subscription “premiums” as capital dividends paid out to them.  Readers who are satisfied with this overview may skip the next three paragraphs.

Artificial generation of $55M CDA in home-grown companies.  A stack of 13 wholly-owned corporations was formed (i.e., so that the 1st  to 12th subsidiary were direct or indirect subsidiaries of the 13th corporation), with the proceeds of a daylight loan to the first subsidiary being used by it to subscribe for $10 million of preferred shares of its immediate parent (the second subsidiary), and so on up the chain so that the 12th subsidiary subscribed for preferred shares of the 13th corporation.  The 2nd subsidiary the declared a stock dividend on the preferred shares held by the 1st subsidiary consisting of “gainmaking” preferred shares with a redemption amount of $10 million and a nominal adjusted cost base, and so on up the chain so that 12 of the 13 subsidiaries were holders of gainmaking shares.  The 2nd subsidiary then sold its gainmaking shares to the 1st subsidiary in consideration for a $10 million demand promissory note of the 1st subsidiary (realizing a capital gain of approximately $10 million), and so on up the chain so that 12 of the 13 subsidiaries realized total gains of approximately $110 million and an addition to their capital dividend accounts of approximately $55 million.  The 13th subsidiary paid a cash dividend of $10 million to the 1st subsidiary in order that it could repay its daylight loan. They then increased the par value of the gainmaking shares in their capital (now all held by the 1st subsidiary) resulting in s. 84(1) deemed dividends totalling approximately $55 million being received by the 1st subsidiary, and a purported addition to its CDA of the same amount.  After they had thus paid out their CDAs, the subsidiaries offset the gains they had realized on the gainmaking shares by selling their preferred shares to one of the individual taxpayers (Faraggi) for their nominal value.

Transfer of $55M CDA to 1915.  One of the corporate taxpayers (1915) subscribed for preferred shares of the 1st subsidiary and received a purported capital dividend of approximately $55 million thereon.

“Sale” by 1915 of CDA and pocketing of 21% “commission” by individual taxpayers.   At various subsequent junctures, 1915 effectively transferred negotiated portions of its CDA to 3rd-party corporations.  These corporations subscribed to different classes of preferred shares of 1915 at a premium of $210 per each $1,000 redemption amount of preferred share and received a dividend (designated to be a capital dividend) of approximately $1,000 per share on those shares (thereby reducing their redemption amounts to a nominal amount).  The two individual taxpayers effectively received these premiums from 1915 as capital dividends on preferred shares.

Gains generated on income account.  After finding that the daylight loan used in the transactions and the promissory notes issued in the transactions issued in the transactions generating capital gains were not shams, and finding that the share premiums generated by 1915 were business income, Noël JA found that the “gainmaking” shares which were acquired for the purpose of their immediate resale so as to give rise to such gains were acquired on income account, given that “property acquired for resale is held on account of revenue” (para. 73).

Elections were shams.  Given that these shares were acquired on income account, the subsidiaries in making capital capital dividend elections to flow out their CDAs to 1915 were making a misrepresentation which rendered such elections shams, and similarly the subsequent capital dividend elections by 1915 also were shams.

Dale v. The Queen, 97 DTC 5252, Docket: A-15-94 (FCA)

At the time of a purported capital dividend on preference shares, the authorized capital of the corporation had not yet been amended to include preference shares. However, in a subsequent taxation year, an order of the Nova Scotia Supreme Court was obtained that the authorized share capital and issued share capital of the corporation should be retroactively amended to reflect the issuance of the preference shares prior to the dividend. Accordingly, the capital dividend was valid.

Administrative Policy

2011 T.I. 2011-0414731E5 F: CRA does not plan to adopt an administrative position which would allow a private corporation to make a s. 83(2) election with respect to a dividend deemed to be paid by it under s. 84.1(1)(b) to a person who is not already a shareholder of the corporation.

26 September 2002 T.I. 2002012895: A dividend deemed to be paid by s. 84.1(1)(b) does not meet the requirement in s. 83(2) that the dividend become payable to shareholders of any class of shares of a corporation's capital stock. Accordingly, the s. 83(2) election may not be made in respect of the deemed dividend.

91 C.R. - Q.23: Where a corporation redeems shares owned by one shareholder, it may pay the balance of its capital dividend account to that one shareholder.

29 August 1991 T.I. (Tax Window, No. 8, p. 21, ¶1423): No provision permits a late election.

25 June 1990 Memorandum (November 1990 Access Letter, ¶1523): "There is no provision in sections 83 and 184 for amending an already filed election, for filing an amended election, for later substituting another election for an already-filed election, for apportioning or adjusting the amount of an excessive election made thereunder or for revoking an election already made thereunder". Furthermore, a resolution providing that the corporation's shareholders shall repay any amount by which a purported capital dividend exceeds the capital dividend account might nullify the s. 83(2) election.

IT-66R6 "Capital Dividends"

Subsection 83(2.1)

Cases

Groupe Honco Inc. v. The Queen, 2013 DTC 5105 [at 6069], 2013 FCA 128, aff'g 2013 DTC 1032 [at 149], 2012 TCC 305, infra [two or three main purposes]

Trudel JA stated (at para. 24) that:

[C]ounsel for the appellants is ignoring the purpose and spirit of subsection 83(2.1) of the Act in attempting to persuade us that the word “main” does not leave open the possibility of having two or three motivations that explain a transaction or series of transactions.

An argument that the exception in s. 83(2.1) applied was not raised with sufficient notice.

See Also

Groupe Honco Inc. v. The Queen, 2013 DTC 1032 [at 149], 2012 TCC 305, aff’d 2013 FCA 128, supra

On January 13, 1999, a newly-incorporated corporation ("New Supervac") was leased the assets of an unrelated corporation ("Old Supervac"), coupled with an option to acquire those assets and the right to also acquire all the shares of Old Supervac.  The business was restored to profitability in short order, and New Supervac then acquired the assets on October 7, 1999, acquired the Old Supervac shares on November 17, 1999 and amalgamated with it on January 1, 2001.  The amalgamated New Supervac paid a capital dividend in the fall of 2004 to one of the taxpayers (with such capital dividend being further distributed), and the Minister applied s. 83(2.1) to the capital dividends.

Boyle J accepted the taxpayers’ evidence that the reasons for acquiring Old Supervac included accessing its losses and avoiding the necessity to obtain a fresh safety certification for one of its assets.  However, he found that the taxpayer had not rebutted the reasonable inference that accessing Old Supervac’s capital dividend account was not also one of the main purposes of the series of transactions culminating in the purported capital dividend, noting that the taxpayer’s evidence that it and its professional advisors had been oblivious to the capital dividend account at the time of acquisition was “surprising” (para. 32), and also noting that neither Old Supervac's former advisors nor the taxpayers' lawyer who structured the transactions had been called to testify.  The taxpayer’s appeal was dismissed.

Barclays Mercantile Industrial Finance Ltd. v. Melluish, [1990] BTC 209 (Ch. D.) [main purpose was to make a profit, not take deduction]

The taxpayer ("BMI") acquired a film from a non-resident corporation ("WBI"), leased it to another corporation at a return that yielded 2.16% per annum on its expenditure, and claimed a 100% first-year capital allowance for the amount of the expenditure (on the basis that the film qualified as "plant"). S.3(1)(c) of Schedule 8 to the Finance Act 1971 denied the deduction of the allowance if it appeared with respect to the purchase of the plant "that the sole or main benefit which ... might have been expected to accrue to the parties ... was the obtaining of an allowance". In finding that this anti-avoidance provision did not apply, Vinelott J. accepted (at pp. 239-240) a submission that:

"The main object of WBI in selling the film to BMI was to recover the cost of making the film while ensuring that the film be distributed by the WBI organisation. The main object of BMI was to make profit by acquiring and leasing the plant. It is probable that BMI would not have been able to offer a leaseback to a company in the WBI organization at an acceptable rent unless it could obtain a capital allowance and unless it had spare capacity in the group sufficient to absorb it. But it does not follow that BMI's object was to obtain an allowance; BMI's object and purpose was to make a profit on a purchase and lease of the plant.

and stated (at p. 240) that the provisions was "aimed at artificial transactions designed wholly or primarily at creating a tax allowance".

Administrative Policy

11 January 1994 T.I. 933423 (C.T.O. "CDA Anti-Avoidance Rules"): Where the shares of a corporation ("Opco") having a capital dividend account are transferred by a related individual to a newly-incorporated holding corporation (which then receives a capital dividend from Opco), RC generally will look to the main purpose for the original acquisition by the individual of the Opco shares in making the determination under s. 83(2.1).

IT-66R6 "Capital Dividends"

Articles

Nathan Boidman, "One of the Main Purposes Test", Canadian Tax Highlights, Vol. 22, No. 5, May 2014, p. 9.

Prevalence of “one of the main purposes” test (p. 9)

The phrase "one of the main purposes" (or "one of the main reasons," "one of the main objectives," or "one of the principal purposes") appears in the Act at least 79 times, in the 2014 budget's proposed anti-treaty-shopping rules, and more and more often in Canada's tax treaties.

Groupe Honco finding of multiple “main” purposes (pp. 9-10)

In Groupe Honco (…2013 FCA 128)…[t]he FCA said, "The phrase 'one of the main purposes' is unambiguous and implies that a taxpayer may have more than one main motive in acquiring shares."

U.K. reading out of “one of” (p.10)

Jonathan Schwarz, the author of Schwarz on Tax Treaties, 3d ed. (Wolters Kluwer), described the phrase, which appeared in 1992 in UK tax treaties and earlier in domestic UK tax law, as a phrase of uncertain meaning that the UK courts have effectively sidestepped by reading out the words "one of." …

(The UK decisions referred to are Prudential Plc v. Revenue & Customs, [2007] UKSPC 636; IRC v. Trustees of the SEMA Group Pensions Scheme, [2002] STC 276 (Ch. D); IRC v. Kleinwort Benson Ltd. [1969] 2 Ch. 221; and AH Field (Holdings) Ltd. v. Revenue & Customs, [2012] UKFTT 104 (TC).)

U.K. approach is better (p.10)

The approach of the UK courts (to perhaps omit the words "one of" and turn the phrase into a simple "main purpose" test) and of the Canadian courts, as in Honco (to effectively drop the word "main" and make the phrase into a "one of the purposes" test), both attest to the uncertainty of the language. The better interpretation appears to be the one adopted by the UK courts: a search for the transaction's driving purpose or reason that represents the single "main" purpose or reason.

Subsection 83(2.4)

Administrative Policy

11 January 1994 T.I. 933423 (C.T.O. "CDA Anti-Avoidance Rules"): Where an individual transfers shares in a related corporation having a capital dividend account to a newly-incorporated holding corporation in exchange for shares of the holding corporation, and the corporation pays a capital dividend to the new holding corporation, it would appear that the capital dividend would not be exempted by s. 83(2.4)(b) because the corporation's capital dividend account would have arisen before it became related to the holding corporation.