30 May 2001 External T.I. 2001-0080815 - Part IV tax controlled corporations

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:

In a given fact situation whether

(1)the two corporations are connected ?

(2) the dividend recipient is liable to pay Part IV tax if the dividend payor is connected and has or not received a dividend refund ?

(3) a deemed dividend is to be treated the same way as an ordinary dividend for the purposes of Part IV and of dividend refund ?

(4) the individual shareholder ultimately could be the only person to pay tax on a dividend ?

Position:

(1) Yes.

(2) Yes, if the dividend payor is entitled to a dividend refund unless the dividend recipient can claim losses to offset the Part IV tax - No, if the dividend recipient is not entitled to a dividend refund.

(3) Yes.

(4) Generally, yes.

Reasons:

(1) The law - Ss. 186(2) and (4).

(2) The law.

(3) See case Placements Serco Ltée 88 DTC 6125.

(4) Provided that no Part IV tax is payable by the particular corporation.

XXXXXXXXXX 2001-008081
Marc LeBlond
May 30, 2001

Dear XXXXXXXXXX:

Re: Part IV of the Income Tax Act

This is in response to your facsimile letter dated April 14, 2001, wherein you requested our opinion on the application of Part IV of the Income Tax Act (the "Act") in the following situation.

The Situation

In summary, the situation under consideration, as we understand it, is as follows:

XXXXXXXXXX (OPCO I) and XXXXXXXXXX (OPCO II) are private corporations and Canadian-controlled private corporations, as defined under subsections 89(1) and 125(7) of the Act, respectively. XXXXXXXXXX (Mr. A), a resident of Canada, owns all the shares of OPCO I and of OPCO II except for OPCO II preferred shares (the "Shares") which are owned by OPCO I. The Shares are redeemable for an amount (the "redemption amount") equal to the fair market value (FMV) of the property received by OPCO II in exchange for the issuance of the Shares. The holder of the Shares is entitled to a XXXXXXXXXX% dividend computed on their redemption amount. The redemption amount of the Shares is greater than OPCO I's adjusted cost base (ACB) of the Shares, as provided under section 54 of the Act. We assume that the Shares' paid-up capital (PUC), as defined under section 89(1) of the Act, is the same as their ACB.

Your Questions

1 - Is OPCO II connected with OPCO I, pursuant to 186(4) of the Act, for the purposes of Part IV tax of the Act ?

2 - You ask us to confirm that:

(i) OPCO I would not have to pay any Part IV tax, pursuant to subsection 186(1) of the Act, in respect to a taxable dividend received from OPCO II, if OPCO II is connected with OPCO I and is not entitled to a dividend refund, pursuant to subsection 129(1) of the Act; and,

(ii) OPCO I would have to pay Part IV tax, pursuant to subsection 186(1) of the Act, in respect to a taxable dividend received from OPCO II, whether OPCO II is not connected with OPCO I or OPCO II is connected with OPCO I and is entitled to a dividend refund, pursuant to subsection 129(1) of the Act; and

3 - If OPCO II redeems the Shares, OPCO II will be deemed to have paid a dividend, pursuant to paragraph 84(3)(a) of the Act, and OPCO I will be deemed to have received a dividend, pursuant to paragraph 84(3)(b) of the Act. You ask whether:

(i) The subsection 84(3) deemed dividend should be treated the same way as an ordinary dividend for the purposes of Part IV of the Act and of the dividend refund, at subsection 129(1) of the Act;

(ii) OPCO I would have to pay Part I tax or Part IV tax, pursuant to subsections 2(1) and 186(1) of the Act, respectively, in respect to a dividend OPCO I would be deemed to have received as a result of the redemption of the Shares, pursuant to paragraph 84(3)(b) of the Act, if OPCO II is not entitled to a dividend refund, pursuant to subsection 129(1) of the Act; and

(iii) In fact, the dividend deemed to have been paid by OPCO II, pursuant to subsection 84(3) of the Act, will be taxed only when Mr. A is required to include a dividend in computing his income, pursuant to paragraph 12(1)(j) and subsection 82(1) of the Act, because OPCO I either paid him a dividend or OPCO I is deemed to have paid a dividend to him on the winding-up of its business, pursuant to subsection 84(2) of the Act.

Our Comments

The particular circumstances in your letter on which you have asked for our views appears to be a factual situation involving specific taxpayers. As explained in Information Circular 70-6R4 dated January 29, 2001, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. However, we are prepared to offer the following general comments which may be of assistance.

In general, Part IV tax is a special refundable tax imposed by section 186 of the Act on dividends received by a private corporation or a subject corporation, as defined under subsections 89(1) and 186(3) of the Act, respectively. Such a corporation pays a tax equal to the amount, by which 1/3 of the assessable dividends it received in the year from unconnected corporations, together with its pro-rata share of the dividend refund received by any connected corporation, as defined under 186(4) of the Act, that paid it an assessable dividend in the year, exceeds 1/3 of any non-capital losses or farm losses it chooses to claim for Part IV purposes. The tax paid under Part IV is credited to the corporation's refundable dividend tax on hand (RDTOH), as defined under subsection 129(3) of the Act, a notional account used to compute the tax refund available to the corporation when it pays its own dividends, referred to as a dividend refund under subsection 129(1) of the Act. This refundable tax mechanism is one of the features of what is generally referred to as "integration" of investment income which seeks to ensure that the total tax paid on investment income and capital gains earned through a Canadian-controlled private corporation and distributed to an individual shareholder approximates the tax that would, but for the capital gains exemption, have been payable if that income were earned directly by the individual.

Paragraph 186(4)(a) of the Act provides that, generally, a payer corporation is connected with a particular corporation at any time in a taxation year if the corporation paying the dividend is controlled by the corporation in receipt of the dividend, the particular corporation. A special definition of control is provided for the purposes of Part IV in subsection 186(2) of the Act. Under this definition, one corporation is controlled by another corporation if more than 50% of its issued share capital (having full voting rights under all circumstances) belongs, among other persons, to persons with whom the other corporation does not deal at arm's length.

In the situation you described, Mr. A owns more than 50% of OPCO II's issued share capital (having full voting rights under all circumstances) and is deemed not to deal at arm's length with OPCO I, pursuant to paragraph 251(1)(a) of the Act, because he is related to OPCO I, pursuant to subparagraph 251(2)(b)(i) of the Act, as he controls OPCO I. Therefore, OPCO II is controlled by OPCO I, for the purposes of subsections 186(2) and (4) of the Act, and OPCO II is connected with OPCO I, within the meaning of paragraph 186(4)(a) of the Act for the purposes of Part IV of the Act.

In respect to a taxable dividend received from OPCO II, we confirm that OPCO I would have to pay Part IV tax, pursuant to subsection 186(1) of the Act, only if OPCO II is entitled to a dividend refund. In that case, OPCO I would have to pay Part IV tax on the dividend received from OPCO II, pursuant to subsection 186(1) of the Act, to the extent of the Part IV tax remaining after deducting non-capital losses or farm losses that OPCO I chooses to claim to off-set the Part IV tax payable otherwise, pursuant to paragraphs 186(1)(c) and (d) of the Act.

The computation of a dividend refund under subsection 129(1) of the Act requires that a taxable dividend be paid, and the computation of Part IV tax, under subsection 186(1) of the Act, requires generally that a taxable dividend be received. In the Act, the expression "taxable dividend" is given the meaning in subsection 89(1) of the Act, pursuant to subsection 248(1) of the Act, which is, generally, a dividend other than a dividend in respect of which the corporation paying the dividend has elected to pay as a tax-free capital dividend, pursuant to subsection 83(2) of the Act. The Act does not provide an all-inclusive definition of the word dividend. However, in the case Placements Serco Ltée v. Her Majesty The Queen, 88 DTC 6125, Judge Hugessen, for the Court, said that, at page 6126:

The fact that the definitions of "dividend" in s. 248(1) and of "taxable dividend" in s. 89(1)(j) do not mention a "deemed" dividend is of no assistance to the appellant since the deeming provision has precisely this effect, of extending the meaning of the word "dividend" to payments which it would otherwise not cover.

Therefore, a deemed dividend pursuant to subsection 84(3) of the Act should be treated the same way as an ordinary dividend for the purposes of Part IV of the Act and of the dividend refund, at subsection 129(1) of the Act.

Generally, OPCO I would not have to pay Part I tax, pursuant to subsection 2(1) of the Act, in respect to amounts received by OPCO I from OPCO II as, on account of, in lieu of payment of or in satisfaction of, taxable dividends, since OPCO I would be entitled to deduct an amount equal to the dividend, in the computation of its taxable income for the year OPCO I received or is deemed to have received a taxable dividend from OPCO II, pursuant to subsection 112(1) of the Act.

As regards your last question ((3) (iii)), we agree, in principle, with your conclusion that generally, provided that no Part IV tax is payable by OPCO I, taxable dividends paid by OPCO II to OPCO I would only be taxed when Mr. A receives dividends from OPCO I. The reasons for this, as mentioned previously, is that generally corporations are permitted to deduct dividend income in computing taxable income for Part I tax purposes.

We trust that our comments will be of assistance.

Yours truly,

Maurice Bisson, CGA
for Director
Reorganization and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch