Example of hybrid sale using safe income and long-term capital gains deduction where certain assets (e.g., building) are to be retained (pp. 11:12-13)
- Target is a CCPC that qualifies as an SBC at all relevant times.
- Three arm’s-length holding corporations are the only shareholders of Target, and each Holdco owns one-third of the outstanding shares of Target.
- Each Holdco is owned by an individual shareholder. The Holdcos are themselves SBCs at all relevant times, but have assets that are to be excluded from the share sale, such as a building used and leased by Target for use in its active business carried on in Canada.
- Target has safe income on hand equal to the share purchase price, and this safe income is attributable equally to the common shares owned by the three Holdcos. ...
Target pays a taxable dividend to each of the Holdcos from its existing safe income on hand. The Holdcos use this dividend to increase the ACB and PUC of the common shares of Target. This can be accomplished by, for example, subscribing for additional common shares of Target with the dividend proceed…
[S]hareholders of the Holdcos acquire a number of preferred shares in the Holdcos, typically through a tax-deferred share exchange under subsection 51(1) or 86(1) or by payment of a high-low stock dividend. They then sell the preferred shares of the Holdcos to a newly incorporated corporation (Newco) on a taxable basis and, to the extent possible, shelter the resulting capital gains with their LCGDs. On this sale, the individual shareholders receive high ACB, low PUC shares of Newco.
Each Holdco redeems the preferred shares owned by Newco in consideration for the shares of Target. Subsection 55(2) should not apply to this redemption, or should apply with no consequence, because the deemed dividend does not reduce the capital gain realized on the shares of the Holdcos since the ACB and FMV of these shares are equal. The individual shareholders then sell the shares of Newco to the purchaser in consideration for cash. The result is that the shareholders can extract all of the proceeds that may have otherwise been deferred in their respective Holdco using a hybrid transaction….
Continuance of a CCPC to a foreign jurisdiction may create better protection for assets (p. 11:16)
[A] corporation that is incorporated outside Canada or that is continued to a jurisdiction outside Canada cannot be a “Canadian corporation” or a CCPC at the relevant time. However, if a corporation that is not a Canadian corporation and that also is not resident in Canada earns investment income, the income generally is treated as foreign accrual property income…
[M]any foreign jurisdictions have more robust asset protection laws than Canada, which can be an important reason for establishing a corporation in a foreign jurisdiction.
Additional tax on aggregate investment income for CCPCs (p. 11:17)
[A]ggregate investment income consists of all taxable capital gains realized by the CCPC, plus the CCPC’s passive income (rents, interest, royalties, and dividends from portfolio investments in foreign corporations), other than dividends paid by taxable Canadian corporations. The two provisions that implement the anti-deferral regime are section 123.3, which provides for an additional 10 3/3 percent tax on aggregate investment income, and the “full rate taxable income” definition in subsection 123.4(1), which denies the general rate reduction in subsection 123.4(2) in respect of aggregate investment income of a CCPC. Section 123.3 provides that the tax is applicable to a corporation that is a CCPC throughout the relevant year, while the exclusion of aggregate investment income in the definition of “full rate taxable income” in subsection 123.4(1) is also applicable only to corporations that are CCPCs throughout the relevant year.
GAAR considerations re avoidance of CCPC status so as to reduce taxability of aggregate investment income (pp. 11:18-19)
First, CCPCs alone are entitled to numerous favourable rules under the Act. Nevertheless, it does not seem particularly controversial to structure legal and de facto control of a corporation as a CCPC in order to benefit from the favourable rules; indeed, such planning is both longstanding and very common. It is not obvious why the converse should not also be true; that is, it is not obvious why taxpayers should not be entitled to organize their affairs to cause a corporation not to qualify as a CCPC, thereby avoiding both the favourable and unfavourable rules that apply to CCPCs.
Second, and very much related to the first point, the Act is designed to readily strip a corporation of its CCPC status. Since CCPC status may be lost in a myriad of circumstances as a result of entirely non-tax-motivated transactions, the implication is that CCPC status is not the default treatment but rather an aberration.
Third…the Department of Finance turned its mind to extending the refundable tax regime to non-CCPC private corporations in July 2017. To date, there has been no suggestion that the department intends to move forward with such a change… .
Use of s. 89(11) election to avoid deemed s. 249(3.1) year end (p. 11:18)
Subsection 249(3.1) applies to deem a CCPC’s year-end to occur when the CCPC undergoes a change in status to a non-CCPC. This provision should be considered by CCPC vendors and their shareholders when entering into any share sale transactions with foreign buyers or public corporations that could result in a change of control. The CRA’s position is that the deemed year-end in subsection 249(3.1) does not occur when a corporation undergoes a change in status if the corporation has made a subsection 89(11) election in the same taxation year [fn 50: … 2010-0377251E5 … 2014-055019117 … and … 2014-0523171E5] because subsection 89(11) applies from the beginning of the year in which the change in status occurs. The interaction between subsections 249(3.1) and 89(11) can provide an opportunity to avoid a deemed year-end under subsection 249(3.1) while permitting pre-closing transactions, such as asset dropdowns, which could be more efficient if the corporation is a non-CCPC.
Use of holding companies to create CDA and s. 84.1, to defer tax on a sale by individual shareholders (pp. 11:19-20)
- Opco is a CCPC.
- Opco has an individual shareholder owning 100 class A common shares with an FMV of $10 million and an ACB of $100.
- The purchaser is willing to pay the full purchase price for Opco shares in cash on closing.
The shareholder incorporates a holding corporation (Newco) and transfers 50 percent [fn 52: The optimal percentage of shares to roll to Newco may be slightly more or less than 50 percent, but 50 percent is used here for simplicity.] of his or her class A common shares with an FMV of $5 million to Newco on a rollover basis. Newco then exchanges its 50 class A common shares for 50 class B common shares (non-voting) on a taxable basis pursuant to subsection 85(1) by electing at an FMV of $5 million. As a result of this transaction, ignoring the nominal ACB, Newco realizes a capital gain in the amount of $5 million and a taxable capital gain of $2.5 million. This results in an increase to Newco’s CDA balance of $2.5 million and an increase to Newco’s RDTOH account of $766,666.67….
The shareholder then sells, in two equal tranches, his or her remaining shares to Newco in exchange for a shareholder loan in the amount of $5 million. [fn 53: To elect for a dividend to be a capital dividend and a dividend to be a taxable dividend, the sale to Newco must occur in two separate tranches so that two separate deemed dividends arise.] Because the requirements of section 84.1 are met on this transfer, Newco is deemed to have paid two dividends to the shareholder of $5 million in aggregate (again ignoring the nominal ACB). Newco then elects for the first dividend to be a capital dividend from Newco’s CDA and the second dividend to be a taxable dividend that is intended to recover Newco’s existing RDTOH balance….
Newco then sells its high ACB shares of Opco to the purchaser with no additional capital gain or loss being realized. The benefit of the application of section 84.1 is that it allows a shareholder to potentially recover the CDA and RDTOH balance through the application of section 84.1, while also increasing the intercorporate cost base of the shares sold to the purchaser.
GAAR analysis of use of s. 84.1 (p. 11:24)
[O]n initial consideration, reliance on a specific anti-avoidance rule to obtain a beneficial tax deferral seems to fall within the scope of abusive tax avoidance because “the outcome defeats the rationale of the provision relied upon.” [ Lipson, 2009 SCC 1, at para. 40]
Nonetheless, the apparent abuse is tempered by the fact that, potentially, marginally greater tax will be payable on the ultimate distribution from Newco than would otherwise be payable if the deferred proceeds are distributed as dividends. Furthermore, the Act contains many provisions that are intended to facilitate tax deferrals, particularly when funds continue to be retained in corporate solution….
Ability to use s. 84.1 deemed dividend as capital dividend (p. 11:22)
[l]n a 2002 technical interpretation, the CRA found that a purchaser corporation is unable to elect under subsection 83(2) with respect to a dividend that it is deemed to have been paid pursuant to paragraph 84.1(1)(b). [fn 54: … 2002-0128955]… In our view, [this] interpretation is incorrect when the transferor already owns shares of the corporation at the time of the transfer because subsection 84(7) would deem the dividend to be payable and, through such prior share ownership, the transferor would clearly be a shareholder of the corporation. …
[2006-0183851E5] found that such a deemed dividend may properly be the subject of an election under subsection 83(2), provided that the recipient of the deemed dividend under section 84.1 owns shares of any class of shares of the capital stock of the payer corporation immediately before the dividend is deemed to be paid or payable.
Potential generation of dividend refund with s. 84.1(1) dividend (p. 11:23)
[T] he 2002 technical interpretation discussed above … stated that the technical requirements for triggering a refund of RDTPH are not met when the dividend is deemed to have been paid pursuant to section 84.1…
It may be credibly argued that the only sensible result is that a deemed dividend arising under section 84.1 should give rise to the recovery of RDTOH because a dividend cannot be paid except on a class of shares, because the person receiving a dividend is a shareholder, and because the right to receive dividends is attached to a share….
The individual will own shares of Newco when the dividend arises, and therefore it could be argued that the deemed dividend under section 84.1 should be considered to be paid on these shares. …
In common parlance, a “dividend” is considered to be a distribution of corporate profits to its shareholders, and therefore it could be argued that in order for a deemed or fictitious dividend to arise, there must be deemed or fictitious shares on which the dividend is paid.
Narrow scope of abuse stated in Explanatory Notes (pp. 11:23-24)
The Department of Finance explanatory notes that accompanied the enactment of subsection 129(1.2) indicate that the perceived abuse that this section is intended to combat is the circumstance in which the corporation paying the taxable dividend receives a refund of RDTOH but the recipient is not subject to income tax at the shareholder level. This is not the case with the intentional triggering of section 84.1 because the individual shareholder pays personal tax on the deemed dividends that cause the refund of RDTOH. Thus, if the application of this provision is indeed limited to preventing the abuse identified in the explanatory notes, subsection 129(1.2) should not apply.