7 October 2016 APFF Roundtable Q. 14, 2016-0655921C6 F - Safe income on hand - Preferred shares -- translation

PRINCIPAL ISSUES: In a particular situation, there is a class of preferred shares that are non-voting, non-participating, with a redemption value equal to the adjusted cost base and having the right to discretionary dividends. In that particular situation, there is an assumption that the declaration of any discretionary dividend on the preferred shares do not result in an increase of the capital gain on the preferred shares immediately before the dividend. The question is whether subsection 55(2) would apply in that particular situation.

POSITION: Paragraph 55(2.1)(c) would apply because there would be no safe income that would contribute to a capital gain computed under paragraph 55(2.1)(c) assumptions (there is no hypothetical capital gain). The question would be whether the other conditions to apply subsection 55(2) would be met. One of those conditions would be the purpose tests provided for in paragraph 55(2.1)(b) which require the review of all the pertinent facts.

REASONS: Wording of the Act and question of fact.

7 OCTOBER 2016 APFF FEDERAL ROUNDTABLE - 2016 CONFERENCE

QUESTION 14

APPLICATION OF SECTION 55(2) WHEN PAYING A DIVIDEND ON PREFERRED SHARES WITHOUT ACCRUED GAIN

Holdco holds all of the "A" common shares and "B" preferred shares of Opco.

The "A" common shares have voting rights and are fully participating. The "A" common shares have a certain level of safe income.

The "B" preferred shares are non-voting and non-participating, but are entitled to a discretionary dividend and are redeemable at the option of the corporation for their paid-up capital ("PUC"). The PUC and the ACB of "B" preferred Shares are $100.

The “B” preferred shares do not have accumulated safe income or accrued gain. The "right to dividends" is distinct from the share, so that the declaration of a dividend does not result in an increase in the value of the "B" preferred shares.

We understand that in the event that a common share dividend is paid, it would reduce the safe income of the common shares.

Question to the CRA:

Does the CRA consider that each dividend paid on the "B" discretionary dividend preferred shares would trigger the application of subsection 55(2)?

CRA response

According to our understanding of your indicated facts for this hypothetical situation, the FMV which could be attributed to the class "B" preferred shares in the capital stock of Opco held by Holdco A would be equal to the PUC of such shares. The question of determining the FMV of participating or non-participating shares that are entitled to discretionary dividends immediately before a dividend is paid is a valuation question on which the CRA cannot pronounce respecting a hypothetical situation.

Taking into account your FMV assumption, the hypothetical capital gain that would have been realized on a FMV disposition of class "B" preferred shares immediately before the dividend, taking into account the rules referred to in paragraph 55(2.1)(c), would be nil. Therefore, the discretionary dividend would exceed the amount of income earned or realized by any corporation - after 1971 and before the safe-income determination time for the transaction or event, or series of transactions or events – that could reasonably be considered to contribute to the capital gain that could be realized on a disposition at FMV, immediately before the dividend, of the share on which the dividend is received.

If paragraph 55(2.1)(c) applies, it is necessary to examine whether the conditions described in paragraphs 55(2.1)(a) and (b) are satisfied before concluding that the dividend triggers the application of subsection 55(2).

The question of whether any of the purposes of the payment or receipt of the dividend is one referred to in paragraph 55(2.1)(b) is a question of fact that would require an assessment of all the relevant facts in a given situation.

Subject to the exclusion of a dividend that is subject to tax under Part IV of the Act which is not refunded as a consequence of the payment of a dividend by a corporation, subsection 55(2) would apply in the present situation if all the conditions of paragraphs 55(2.1)(a) to (c) were established.

If subsection 55(2) applied with respect to the discretionary dividend paid on the class "B" preferred shares, the CRA would accept that the amount of the dividend would not reduce the SIOH of the corporation. If to the contrary, subsection 55(2) was not applicable to dividends on the class "B" preferred shares, the dividend would reduce the SIOH of the corporation.

Sylvie Labarre (613) 670-9014
October 7, 2016
2016-065592