8 June 2016 CTF Technical Seminar: Update on s. 55(2)

Comments of Yves Moreno and Annie Mailhot-Gamelin (both with the Income Tax Rulings Directorate) on the proposed s. 55(2) rules included:

• The integration principle is key to CRA’s thinking about safe income and s. 55(2), (so that the role of s. 55(2) is “is to ensure that corporate tax is paid, but that at the same time that there is no duplication of corporate taxes”) and, conversely, “the concept of safe income is one of the pillars of integration.”
• The changes to s. 55(2) were meant to address the type of planning raised by D & D Livestock, where ACB is created (without being caught by existing s. 55(2) because there was no gain on the shares in question). In particular, new s. 55(2) “now would address circumstances where the purpose of the dividend is to either reduce the value of a share…or to increase the cost of the property in the hands of the dividend recipient…” (with both elements being present in the D&D-style planning).
• For the new rules to apply, there is no requirement that a sale occur as part of the same series of transactions. In this regard, the policy is similar to the boot rules, where excess boot will produce an immediate gain even if there is no plan to use the additional basis.
• CRA previously provided comfort (in 2015-0613821C6) on the non-application of s. 55(2.1)(b) to dividends paid as part of a corporation’s standard practice of paying regular quarterly or annual dividends. CRA now indicated that the rationale is that “it is doubtful that the dividend would significantly reduce the fair market value or the gain on shares,” and that, in any event, “it is difficult to imagine that one of the purposes of the dividends would be to achieve that.” CRA rejected calling this position a “safe harbour,” stating that “the analysis of every dividend will involve its own set of facts and circumstances.” Similarly, there can be no automatic exemptions for other common dividend transactions such as funding general current expenses of a parent or settling intragroup debt resulting from cash pooling arrangements.

CRA considers it to be appropriate from a policy perspective for safe income to be correspondingly lower where incentive deductions have lowered a corporation’s income for ITA purposes.

CRA indicated that it cannot confirm in the context of a butterfly that the pro-rata requirement in s. 55(1) is met where the shares issued are discretionary, and might ask that the terms of those shares be changed in order to be able to issue a favourable ruling under s. 55(3)(b).

After noting that "even if there is no accrued gain on the share that is reduced by a dividend, the significant reduction in fair market value test might still apply" under s. 55(2.1)(b), CRA stated:

The new rule in s. 55(2.5) is clear that even if a share has nominal fair market value and potentially no accrued gain, a dividend might significantly reduce its fair market value since the value of the share must be adjusted to take into account the value of the dividend.