CRA contemplates that all of the business income earned by a corporation following a subscription for a separate class of discretionary dividend shares could be allocated to those shares

Opco has three holding-company shareholders, each holding a separate class of discretionary dividend common shares. Whereas the first two shareholders only invested a nominal amount for their shares on Opco’s incorporation, the third shareholder (HA) subscribed $50,000 for its shares at a time that the global safe income of Opco was $70,000. Two years later, when the global safe income had increased to $90,000, Opco paid a $35,000 dividend to HA.

CRA indicated that if the safe income generated in the two years up to the dividend was business income (rather than, for instance, being from the realization of gains that had already accrued at the time of HA’s share subscription), and making some surmises on the contribution of this safe income to the accrued capital gain on the shares of HA, “the amount of $20,000 would represent a separate taxable dividend pursuant to paragraph 55(5)(f) and would not be subject to subsection 55(2),” whereas if the purpose test in s. 55(2.1)(b) was satisfied, the balance of the dividend could be subject to s. 55(2).

Before referring to various conferral-of-benefit provisions, GAAR and the difficulties posed by discretionary dividend shares in a butterfly, CRA stated that it was “not intended to give our general approval for the use of discretionary dividend shares.”

Neal Armstrong. Summary of 7 October 2016 APFF Roundtable, Q. 13 under s. 55(2.1)(c).