27 January 2000 External T.I. 1999-0009375 - DIVIDENDS SUBJECT TO 55(2)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether subsection 55(2) will apply to a series of transactions?

Position: Yes.

Reasons: The purpose test appears to be met. Further, the exemption in paragraph 55(3)(a) is not met.

XXXXXXXXXX 						1999-000937
F. Francis
Attention: XXXXXXXXXX 

January 27, 2000

Dear Sirs:

Re: Subsection 55(2) of the Income Tax Act (the "Act")

This is in reply to your letters of October 4, 1999, and January 18, 2000, and further to our conversation of October 27, 1999, wherein you requested our comments with respect to the applicability of subsection 55(2) of the Act to the following situation:

Unless otherwise noted, all references herein are to the Act.

1. Holdco A and Holdco B are wholly-owned by Brother A and Brother B, respectively.

2. Holdco A and Holdco B each own 50% of Holdco C.

3. Holdco C owns 100% of Opco.

4. Opco pays a dividend out of its "safe income" to Holdco C. Holdco C pays a dividend to each of Holdco A and Holdco B.

5. An "unrelated person" within the meaning of section 55 acquires a significant interest in Opco.

6. As part of an estate freeze, common shares of Holdco C are issued to the following companies:

• 25% to Holdco A
• 25% to Holdco B
• 25% to Holdco D which is owned by A's daughter
• 25% to Holdco E which is owned by B's daughter

You enquire as to whether subsection 55(2) would apply to the dividends paid to Holdco A and Holdco B.

OUR COMMENTS

Subsection 55(2) is an anti-avoidance provision designed to prevent the use of the inter-corporate dividend exemption to unduly reduce a capital gain on a sale of shares. The test in subsection 55(2) (the "purpose test") is whether one of the purposes of the dividend is to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of the shares of the corporation immediately before the dividend and that could reasonably be considered to be attributable to anything other than safe income earned by any corporation after 1971 and before the "safe-income determination time" for the transaction.

You have advised that the dividends paid to Holdco A and Holdco B do not come out of the safe income of Holdco C. Consequently, since the purpose test appears to be met, subsection 55(2) will apply to the dividends unless the exemption in paragraph 55(3)(a) applies. Paragraph 55(3)(a) provides an exemption from the application of subsection 55(2) for dividends received in certain related party transactions. In particular, subparagraph 55(3)(a)(ii) provides that the exemption in paragraph 55(3)(a) will not apply to dividends received by a corporation if, as part of a transaction or event or series of transactions or events in which the dividend was received, there was at any particular time an increase in the total direct interest in any corporation of one or more persons who were "unrelated persons" immediately before the particular time, unless the increase resulted from a disposition of shares of a corporation for proceeds of disposition that are not less than the fair market value of those shares at the time of the increase.

In this respect, we note that:

(i) brothers and sisters are deemed not to be related to each other pursuant to subparagraph 55(5)(e)(i);

(ii) by virtue of paragraph 55(3.01)(a), each of Holdco A, Holdco B, Holdco D and Holdco E is an "unrelated person";

and

(iii) there will be a significant increase in the total direct interest in any corporation within the meaning of subparagraph 55(3)(a)(ii) where an unrelated person subscribes for shares of a corporation. Therefore, the estate freeze will result in a significant interest in the total direct interest in Holdco C of the unrelated persons, Holdco D and Holdco E.

Consequently, paragraph 55(3)(a) will not apply to exempt the above series of transactions from the application of subsection 55(2) of the Act.

We trust the above comments are of assistance to you. However, as noted in Information Circular 70-6R3 issued on December 30, 1996, the above comments are not binding on the Canada Customs and Revenue Agency.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch