5 April 2005 External T.I. 2004-0099071E5 - Part IV tax circularity

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.

Principal Issues: In a circular calculation of Part IV tax where the amount of dividends is equal and exceeds 3 times the opening RDTOH which causes the circular problem, which corporation will have the RDTOH balance at the end of the circularity

Position: Generally, provided that no other dividend is paid by either corporation, they should be in the same position as before the payment of the dividends.

Reasons: In such circumstances, the amount of Part IV tax payable by each corporation and the amount of its dividend refund should be equal and offset

2004-009907
XXXXXXXXXX T. Harris
(613) 957-2114
April 5, 2005

Dear XXXXXXXXXX:

Re: Refundable Dividend Tax on Hand

We are writing in response to your facsimile of October 15, 2004, wherein you requested our opinion concerning which of the two corporations would have a balance of refundable dividend tax on hand ("RDTOH"), within the meaning of subsection 129(3) of the Income Tax Act (the "Act"), at the end of its taxation year in the situation described below.

Situation

In the course of a divisive reorganization, an operating company ("Opco") transfers certain assets to one of its shareholder corporations ("Holdco") on a tax-deferred basis under subsection 85(1) of the Act for consideration including preferred shares of Holdco. Following this transfer, the shares of Opco held by Holdco are redeemed or purchased for cancellation. Then, the preferred shares of Holdco acquired by Opco on the transfer are redeemed. As a result of these redemptions and purchases for cancellation, each of Holdco and Opco is deemed, pursuant to subsection 84(3) of the Act, to have paid a dividend and to have received a dividend from each other. Immediately before this series of transactions Opco has a balance of $50,000 in its RDTOH account, whereas Holdco does not have any RDTOH balance. Also, immediately prior to the redemptions and/or purchases for cancellation described above, Opco will be connected to Holdco and Holdco will be connected to Opco for the purposes of Part IV of the Act. Furthermore, these dividends are deemed to have been paid and received by each of Opco and Holdco in its same taxation year, the amount of the two dividends is the same (assume $500,000) and exceeds 3 times Opco's original RDTOH balance. Finally, no other dividends have been paid or received by either of Opco or Holdco in the relevant taxation year.

During our telephone conversation (XXXXXXXXXX/Harris), you also enquired whether the amount that Opco should record as its opening RDTOH balance at field 460 of its T2 corporate tax return should be its actual opening balance or an amount equal to one-third of the taxable dividend that Opco is deemed to have paid.

Our Comments

The particular situation outlined above appears to relate to a factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Where the particular transactions have been completed, any enquiry should be addressed to the relevant tax services office. Although we cannot comment on a specific situation involving a particular taxpayer, the following comments may be of assistance.

In the situation described above, it is our view that the Part IV circularity will continue until each of Opco and Holdco has a Part IV tax liability for the year equal to one-third of the taxable dividend paid by it of $500,000 (i.e. $166,666.67). For the particular taxation year, Holdco will have a Part IV tax payable under subsection 186(1) of the Act in the amount of $166,666.67 and will be entitled to a dividend refund under subsection 129(1) of the Act in that same amount. Consequently, in determining Holdco's tax liability for the year such amounts will offset each other. Provided that no amount will be included in Holdco's RDTOH for the year under paragraph 129(3)(a) of the Act, Holdco's RDTOH balance at the end of its taxation year will be equal to $166,666.67, an amount equal to its opening RDTOH balance of nil plus its Part IV tax liability for the taxation year. The amount of Holdco's dividend refund for the taxation year will reduce its RDTOH balance during its subsequent taxation year. In the case of Opco, it will also have a Part IV tax payable under subsection 186(1) of the Act in the amount of $166,666.67 and be entitled to a dividend refund under subsection 129(1) of the Act in that same amount, such that these amounts will also offset each other in determining Opco's tax liability for the year. Similarly, provided that no amount will be included in Opco's RDTOH for the year under paragraph 129(3)(a) of the Act, Opco's RDTOH balance at the end of its taxation year will be equal to $216,666.67, an amount equal to its opening RDTOH balance of $50,000 plus its Part IV tax liability for the taxation year. The amount of Opco's dividend refund for the taxation year will reduce its RDTOH balance during its subsequent taxation year.

With respect to your enquiry concerning the amount that Opco should record as its opening RDTOH balance at field 460 of its T2 corporate tax return, it is our view that this amount should be its actual opening RDTOH balance. Opco should also complete Schedule 3 detailing all of the applicable transactions. Assuming a Part IV tax liability of $166,666.67 for the year the amount reported at field 485 of Opco's T2 return would be $216,666.67.

We trust that these comments will be of assistance. Please note that these comments may not be valid if any of the assumptions on which they are based, as described in the Situation above, are changed. As stated in paragraph 22 of Information Circular 70-6R5, this opinion is not a ruling and, consequently, is not binding on the Canada Revenue Agency in respect of any particular situation.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch

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