26 November 2013 CTF Roundtable, 2013-0507981C6 - Stock dividend by a foreign corporation 15(1.1)

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: Whether subsection 15(1.1) could apply to a foreign corporation receiving a stock dividend from another foreign corporation.

Position: Generally, yes.

Reasons: It is reasonable to consider subsection 15(1.1) whenever a stock dividend has been paid by a corporation, subject to the additional purpose test and exclusions contained within that provision.

Canadian Tax Foundation ("CTF") Annual Conference
Canada Revenue Agency Roundtable
November 26, 2013

Background

In 2012, the Income Tax Rulings Directorate ("Rulings") was asked to provide a ruling that subsection 15(1.1) would not apply to a stock dividend that was proposed to be paid by a non-resident corporation ("ForOpco") resident in one jurisdiction ("Country A") to another non-resident corporation ("ForHoldco") that was resident in another jurisdiction ("Country B"). Briefly, the transactions surrounding the proposed stock dividend were as follows:

1. At the commencement of the transactions, a corporation resident in Canada ("Canco") would directly own approximately 99.99% of all of the issued common shares of ForOpco (with the other .01% held by another foreign affiliate of Canco in order to meet certain corporate law requirements in Country A).

2. Canco would incorporate ForHoldco in Country B.

3. ForOpco would modify its organizing documents to reduce the amount of shares outstanding by a factor of 100,000 (i.e. after the modification, 100,000 previously outstanding shares would be represented by 1 share).

4. ForOpco would return capital to Canco, which funds would be used to subscribe for additional common shares in ForHoldco, which, in turn, would use those proceeds to invest in preferred shares of ForOpco.

5. ForOpco would then pay the proposed stock dividend, consisting of common shares, to ForHoldco.

After the stock dividend, ForHoldco would hold approximately 99.8% of the outstanding common shares of ForOpco, while Canco would hold approximately 0.2% of the common shares.

Representatives of the taxpayers stated that the purpose of the proposed transactions was to ultimately allow for a tax efficient transfer of ForOpco and its subsidiaries from being held directly under Canco to underneath Canco's existing holding company structure in Country B. We were informed that the taxpayer did not want to utilize subsection 85.1(3) to transfer the ForOpco shares to ForHoldco, as although the transfer would then be tax-deferred for Canadian tax purposes, a transaction of that nature would result in a gain and attract significant income tax in Country A. We were further informed that the provisions of the tax convention between Canada and Country A would not provide any relief in respect of the gain.

Question

What factors does IT Rulings consider in determining whether subsection 15(1.1) applies to a corporation receiving a stock dividend from a non-resident corporation?

Comments

Subsection 15(1.1) of the Act applies to the payment by a corporation of a stock dividend where one of the purposes of the payment was to significantly alter the value of the interest of any specified shareholder of the corporation. Where applicable, the fair market value of the stock dividend is to be included in the income of the recipient shareholder, except to the extent it has otherwise been included in the recipient's income as a taxable dividend under paragraphs 82(1)(a), (a.2) and (c) to (e).

As non-resident corporations are not otherwise excluded from the application of subsection 15(1.1), whenever a corporation has paid a stock dividend, regardless of whether that corporation is a resident or non-resident of Canada, subsection 15(1.1) must be considered. For example, where the subsection is applied in a situation in which one non-resident corporation has paid a stock dividend to another non-resident corporation that is a controlled foreign affiliate of a corporation resident in Canada, the income imputed to the foreign affiliate by subsection 15(1.1) would be included in the computation of that affiliate's FAPI for the year and, consequently, in the Canadian corporation's income for the year under subsection 91(1).

In the situation described in the above-noted ruling request, the stated purpose of the proposed transactions, and in particular the stock dividend, was to transfer over 99% of the equity in ForOpco from Canco to ForHoldco. Both Canco and ForHoldco were considered specified shareholders of ForOpco, and as a result, it was reasonable to conclude that the purpose of the stock dividend was to significantly alter the interest of a specified shareholder of the corporation.

Although suggested by the taxpayer's representatives, it was not clear from their representations that the intended result of the transactions could have been accomplished through the utilization of subsection 85.1(3). In particular, while not specifically proposed, a subsequent disposition of the ForOpco shares appeared to be contemplated in the ruling request, which may have attracted the application of the anti-avoidance rule in subsection 85.1(4). Regardless, it was not necessary for Rulings to make a determination on this particular aspect, as for purposes of considering the application of subsection 15(1.1), it is not relevant whether the Canadian income tax effects of a stock dividend paid by a corporation would be similar to the effects of a transfer of shares under subsection 85.1(3), or under any other "rollover" provision contained in the Act. In this regard, the Canada Revenue Agency is of the view that each of the rollover provisions of the Act is intended only to provide relief in respect of situations where its specific requirements are met.

Overall, in respect of this ruling request, concerns were raised regarding the taxpayer's inability to furnish relevant information in relation to other related proposed transactions. Similarly, concerns were also raised by the fact that the ultimate purpose of the shift of ForOpco's value may have been to avoid application of the Canada-Country A tax convention in respect of a future disposition of ForOpco's shares, and instead to qualify for the relief provided under the tax convention between Country A and Country B.

Jeffrey Johns
2013-050798