CRA confirms that amounts derived from a related business do not include capital gains from the passive investment of the dividends therefrom

S. 120.4(1.1)(d) provides that an amount derived directly or indirectly from a business includes an amount that:

• is derived from the provision of property or services to, or in support of, the business, or
• arises in connection with the ownership or disposition of an interest in the person or partnership carrying on the business, or
• is derived from an amount described [above]

Notably, it does not reference an amount arising from the disposition of property whose acquisition was funded with dividends from the business.

CRA confirmed that this is so in a simple example. In Year 1, Opco pays a $1M dividend to its wholly-owning Holdco (Investco, which is owned equally by Mr. and Mrs. A, but with Mrs. A not involved in the Opco business). Investco invests in shares of publicly-traded corporations; then in Year 2, Investco pays a dividend-in-kind to Mrs. A of its entire stock portfolio which, at that time, has an aggregate FMV of $1.1M (for an accrued gain of $0.1M).

Before concluding that only $1.0M of the $1.1M dividend-in-kind received by Mrs. A would be derived from the related business of Opco in respect of Mrs. A (so that if Investco did not have a related business in respect of Mrs. A, $0.1M of the amount would not be derived from such a business), CRA stated:

The portion of the FMV of the distributed stock portfolio that represents the initial investment of the dividends paid by Opco to Investco would be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A. However, gains earned by Investco as a result of the investment of those dividends would not be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A.

Neal Armstrong, Summaries of 2 November 2018 External T.I. 2018-0771861E5 under s. 120.4(1.1)(d) and s. 120.4(1) – excluded amount – (e)(i).