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 55(2) applies to the share redemptions noted in a series of transactions on the basis that clauses 55(3)(a)(iii)(B) and/or 55(3)(a)(iv)(B) apply.
Position: Yes – based on assumed facts.
Reasons: Meets technical requirements. Assuming that the disposition of the shares of Holdco A and Holdco B by Holdco C occurs as part of the same series as the share redemptions, clauses 55(3)(a)(iii)(B) and 55(3)(a)(iv)(B) will technically apply to the deemed dividends. Deemed dividends subject to subsection 84(3), requires the results test to be applied.
XXXXXXXXXX 2018-077250
Allison Thomas
September 10, 2018
Dear XXXXXXXXXX:
Re: Application of Clause 55(3)(a)(iii)(B) and Clause 55(3)(a)(iv)(B)
This is in response to your letter dated August 2, 2018, where you requested our view on the hypothetical fact situation described in your letter (unless otherwise stated, all statutory references herein are to the Income Tax Act (Canada)).
Our Understanding of the Basic Facts
- Holdco A owns 100% of the shares of Opco;
- Opco and Holdco A own real estate that is used in Opco’s active business;
- Holdco B owns 40% of the shares of Holdco A;
- Holdco C owns 11% of the shares of Holdco A and 12.5% of the shares of Holdco B. The remaining 49% of shares of Holdco A are owned by unrelated individuals while the remaining 87.5% of the shares of Holdco B are directly or indirectly owned by various other unrelated holding companies;
- Husband and wife own 100% of the shares of Holdco C;
- Husband and wife are not related to any other direct or indirect shareholder of Holdco A or Holdco B;
- There is no one person or group of persons that control Holdco A or Holdco B; and
Each of the corporations described above is a Canadian-controlled private corporation.
Our Understanding of the Basic Transactions
The real estate assets of Opco and Holdco A will be transferred to a new wholly-owned subsidiary of Holdco A on a tax-deferred basis for asset protection purposes as follows:
1. Holdco A will incorporate a new wholly-owned subsidiary corporation, Realco.
2. Holdco A will transfer its real estate asset to Realco on a tax-deferred basis under subsection 85(1). As consideration for the transfer, Realco will issue non-voting, non-participating, fixed-value preferred shares to Holdco A having a fair market value equal to the fair market value of the transferred real estate.
3. Opco will transfer its real estate asset to Realco on a tax-deferred basis under subsection 85(1). As consideration for the transfer, Realco will issue non-voting, non-participating, fixed-value preferred shares to Opco having a fair market value equal to the fair market value of the transferred real estate.
4. Holdco A will transfer a portion of the shares of Opco it owns to Realco on a tax-deferred basis under subsection 85(1). As consideration for the transfer, Holdco A will receive non-voting, non-participating, fixed-value preferred shares of Realco. The fair market value of the Opco shares to be transferred by Holdco A will equal the fair market value of the preferred shares issued by Realco to Opco in step 3.
5. Realco will redeem the preferred shares it issued to Opco in step 3 triggering a deemed dividend under subsection 84(3). As consideration for the share redemptions, Realco will issue a demand promissory note to Opco.
6. Opco will redeem the shares transferred by Holdco A to Realco in step 4 triggering a deemed dividend under subsection 84(3). As consideration for the share redemptions, Opco will issue a demand promissory note to Realco.
7. The promissory notes described in steps 5 and 6 will be settled by offset.
8. Holdco C will sell its shares of Holdco B and Holdco A to one or more of the other shareholders of Holdco A and Holdco B for their fair market value, triggering a capital gain to Holdco C. The negotiation of the sale of Holdco C’s interest in Holdco A and Holdco B took place during the course of steps 1 through 7.
In your letter, you have indicated that subsection 55(2) would apply to the deemed dividends described in steps 5 and 6 on the basis that clauses 55(3)(a)(iii)(B) and/or 55(3)(a)(iv)(B) would apply, if the sale of shares by Holdco C described in step 8 takes place as part of the same series of transactions as the deemed dividends. However, you are concerned that this result is not appropriate from a tax policy perspective since the deemed dividends do not affect the accrued capital gains that would otherwise arise on the Holdco A and Holdco B share sales by Holdco C.
This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.
Notwithstanding the above, we are prepared to offer the following comments.
Generally speaking, paragraph 55(3)(a) of the Act provides an exemption from the application of subsection 55(2) for certain dividends received in the course of related-party transactions. More specifically, paragraph (a) exempts a dividend to which subsection 84(2) or (3) applies, if, as part of a transaction or event or a series of transactions or events that includes the receipt of the dividend, there was not, at any particular time, a disposition of property or a significant increase in the total direct interest in a corporation in the circumstances described in subparagraphs (a)(i) to (v).
It appears from your question that the sale of the shares of Holdco B and Holdco A by Holdco C takes place as part of the same series of transactions as the share redemptions described in steps 5 and 6. The ultimate determination of whether the sale of these shares would be considered part of the “series of transactions or events” in which the deemed dividends were received would inevitably be a determination of fact. However, we will proceed on the basis that the above-described transactions take place as part of the same series for purposes of our analysis on the application of subsection 55(2).
While it might be reasonable to conclude that the deemed dividends described in steps 5 and 6 do not affect the fair market value of the Holdco A and Holdco B shares (and consequently any capital gain realized by Holdco C on its disposition of such shares), such dividends would reduce a portion of the capital gain that, but for such dividend, would have been realized on a disposition at fair market value of any shares (i.e., the shares of Realco and Opco). Further, since the dividends paid by Realco and Opco are deemed dividends under subsection 84(3), the results test in subparagraph 55(2.1)(b)(i) is the relevant test that must be considered in this situation, not the purpose tests in paragraph 55(2.1)(b). Therefore, if the effect of these deemed dividends is to significantly reduce a portion of the capital gain that would otherwise have been realized on a fair market value sale of any share, then subsection 55(2) will apply unless a particular exception applies.
As you noted in your letter, clause 55(3)(a)(iii)(B) prohibits a disposition, to a person or partnership who was an unrelated person immediately before the particular time, of property (other than shares of the capital stock of the dividend recipient) more than 10% of the fair market value of which was, at any time during the series, derived from any combination of shares of the capital stock and debt of the dividend payer. You also noted that clause 55(3)(a)(iv)(B) prohibits a disposition, after the time the dividend was received, to a person or partnership that was an unrelated person immediately before the particular time, of property more than 10% of the fair market value of which was, at any time during the series, derived from any combination of shares of the capital stock and debt of the dividend recipient.
Holdco A’s value is derived, at least in part, from the value of the shares of Opco and Realco it owns. Similarly, Holdco B’s value is derived, at least in part, from the shares of Holdco A that it owns, which in turn is derived from the value of the shares of Opco and Realco owned by Holdco A. If the shares of Opco and Realco represent more than 10% of the value of Holdco A and Holdco B, and if the disposition of the shares of Holdco A and Holdco B by Holdco C occurs as part of the same series as the deemed dividends, then we agree with your analysis that clause 55(3)(a)(iii)(B) and clause 55(3)(a)(iv)(B) will technically apply.
In respect of your tax policy concern, as noted above, paragraph 55(3)(a) is intended to provide an exemption from the application of subsection 55(2) for certain dividends received in the course of related-party transactions. Based on our understanding of the facts in your situation, since the other direct or indirect shareholders of Holdco A are not related persons, and the transactions, which include a sale of Holdco A shares as part of the same series as the deemed dividends, it is our view that the application of subsection 55(2) is operating as intended.
We trust that these comments will be of assistance.
Yours truly,
Michael Cooke, CPA, CA
Manager
Corporate Reorganizations Section II
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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