Deliberately generating a s. 84.1 dividend on a sale of a CCPC can produce lower tax if this planning works

An individual shareholder holding shares of a Canadian controlled private corporation (Opco) with a nominal adjusted cost base and a fair market value of say $10M potentially could use s. 84.1 on a sale of his shares to a third-party for cash in order to generate and receive a capital dividend as well as generating a dividend refund. For example, he could:

1. do a drop-down of half of his Opco shares to a wholly-owned Newco on a s. 85(1) rollover basis
2. have Newco do a dirty s. 85(1) exchange of its Opco shares with Opco for new Opco shares, thereby realizing a $5M capital gain and additions to its capital dividend account and refundable dividend tax on hand account
3. sell in two equal tranches his remaining Opco shares to Newco in consideration for two $2.5M notes, thereby generating, under s. 84.1:
   
   1. a $2.5M capital dividend; and
   2. a $2.5M taxable dividend (generating a dividend refund)

Since he and Newco have high basis in the Opco shares, the sale to the purchaser can now close without further gain being realized.

Issues to be addressed in this planning include:

• It would appear that CRA now accepts that a s. 83(2) election can be made on a s. 84.1 dividend.
• However, CRA might challenge the proposition that a s. 84.1 dividend can generate a dividend refund.
• S. 129(1.2) could apply to deny the dividend refund if one of the main reasons for step 3(b) was to obtain a dividend refund
• Re GAAR, what arguably is the Lipson doctrine, that a specific anti-avoidance provision should not be used to generate a tax benefit, is bothersome (see also Satoma)

Speaking of GAAR, it would appear that continuing a CCPC under foreign corporate law in order to avoid the high corporate rate on investment income is not abusive given inter alia that the scheme of the Act is to make it hard to be a CCPC rather than going in the opposite direction – and furthermore, the Department of Finance turned its mind to extending the refundable tax regime to non-CCPC private corporations in July 2017, but so far has not moved on this.

Neal Armstrong. Summaries of Anthony Strawson and Timothy P. Kirby, “Vendor Planning for Private Corporations: Select Issues,” 2017 Conference Report, (Canadian Tax Foundation), 11:1-28 under s. 110.6(2.1), s. 123.3, s. 84.1(1), s. 83(2), s. 129(1) and s. 129(1.2).