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: Whether the Canada Revenue Agency ("CRA") would comment on the particular circumstances under which subsection 84(2) could apply in the context of a particular series of transactions designed to implement a post-mortem estate planning strategy?
Position: Comments provided.
Reasons: In accordance with the provisions of the ITA and our previous positions.
Society of Trust and Estate Practitioners Conference Roundtable ("STEP") 2011
Canada Revenue Agency ("CRA") Roundtable
June 2-3, 2011
Unless otherwise stated, every reference herein to a part, section, subsection, paragraph or a subparagraph is a reference to the relevant provision of the Income Tax Act ("Act").
Question 5 Post-Mortem Estate Planning Deemed Dividend
In post-mortem estate planning, an important objective is to avoid double taxation. The Act allows three main methods whereby double taxation can be avoided, which are the loss carryback mechanism under subsection 164(6), the step-up approach using a wind-up (paragraph 88(1)(d) and the amalgamation equivalent); and the so-called "pipeline method". Our question concerns the pipeline method, which can be illustrated by the following sequence of transactions:
a) A taxpayer, Mr. A, dies holding shares of a corporation, "ACo", which have appreciated in value. The shares have cost of $100 and a fair market value of, say, $600,000. A capital gain of $599,900 results at death (assume no spousal rollover).
b) The estate, holding the shares of ACo, with an adjusted cost base of $600,000, transfers the shares of ACo to a holding company, AHoldco, taking back a promissory note of $600,000 (assume that in the intervening period, ACo has not appreciated in value).
c) A dividend of $600,000 is paid by ACo to AHoldco, which is received tax-free by AHoldco (the dividend is deducted in arriving at the taxable income of AHoldco under subsection 112(1)).
d) A Holdco repays the promissory note of $600,000 with a cash payment to the Estate.
Our question concerns whether, in a sequence of transactions such as this, the promissory note issued by AHoldco to the Estate, which represents the adjusted cost base of the shares of ACo to the Estate, is a tax-free transaction. At the 2010 Canadian Tax Foundation CRA Roundtable (and we acknowledge other recent technical interpretations on point as well), the CRA stated that in certain circumstances this transaction could result in a dividend from AHoldco to the Estate as a result of subsection 84(2). This would seem to be an unfair and inappropriate result, leading to double taxation, which the sequence of transactions seeks to avoid. The basis of this position seems to be the particular wording of subsection 84(2).
We wish to ask the CRA of the particular circumstances under which, in their view, the provisions of subsection 84(2) could apply.
As discussed in previously published CRA statements, the potential application of subsection 84(2) requires a thorough review of all of the facts and circumstances relating to a particular situation. In light of the limited facts provided to us, we are not able to confirm that subsection 84(2) would not apply in the context of the series of transactions described above.
Notwithstanding the above, we are prepared to offer the following comments on the matters raised in the foregoing question.
Post-mortem planning is an expression generally used to describe any planning that is undertaken principally to mitigate a form of double taxation exposure that can result when a person owns shares of the capital stock of a private corporation with an accrued gain at the time of death. In general terms, this double tax exposure would arise at the shareholder level where the deceased would be liable for tax on the capital gain triggered on the application of the subsection 70(5) "deemed disposition rules", and subsequently, the same value would be subject to tax when the corporation either distributes assets, or sells the assets and distributes the after-tax proceeds, to its shareholders (which may include the estate) by means of a winding-up or a share redemption, and the resulting capital loss is unavailable to offset the capital gain of the deceased.
Generally, there are two traditional post-mortem planning techniques to avoid this form of double taxation at the shareholder level. The first method is known as the "subsection 164(6) capital loss carryback strategy". Subsection 164(6) effectively provides the taxpayer's legal representative with the possibility of carrying back the estate's capital loss resulting from the winding-up or redemption of the shares of the capital stock of the private corporation to offset the deemed capital gain realized by the deceased. This strategy, which must be implemented within the first taxation year of the particular estate, essentially eliminates the capital gain of the deceased and allows the estate to be taxed once, as a deemed dividend on the winding-up or share redemption.
The second post-mortem strategy, which is illustrated in the hypothetical series of transactions described above, is commonly referred to as the "pipeline strategy." When correctly implemented, the result of the pipeline strategy is that the extraction of the corporation's surplus is subject to taxation as a capital gain as a consequence of the deemed disposition rules on death.
It is our understanding that the choice of post-mortem planning technique would generally depend upon, amongst other things, the applicable capital gains and eligible and ineligible dividend tax rates in the particular situation, in addition to the existence of certain beneficial corporate tax assets, such as the general rate income pool ("GRIP"), the refundable dividend tax on hand ("RDTOH") account and the capital dividend account ("CDA"). Accordingly, where a corporation would not have any of the aforementioned beneficial tax accounts, and where the corporation would be in a jurisdiction in which capital gains are afforded more favourable tax treatment than dividends, the pipeline strategy may be the preferred method as previously described.
However, in undertaking a pipeline strategy, we would note that the anti-avoidance provisions of section 84.1 and subsection 84(2) must be examined. It is our view that these provisions, which have different requirements for application, target certain transactions that result in the extraction of corporate surplus otherwise than by way of a dividend treatment (otherwise known as "surplus stripping"). Furthermore, we believe that section 84.1 and subsection 84(2) are not in conflict and that the potential application of both provisions must be considered in the context of pipeline transactions.
To that end, we note that subsection 84(2) would apply where funds or property of a corporation resident in Canada have at any time after March 31, 1977 been distributed or otherwise appropriated in any manner whatever to or for the benefit of the shareholders of any class of shares in its capital stock, on the winding-up, discontinuance or reorganization of its business. The result of the application of subsection 84(2) is that the corporation shall be deemed to have paid at that time a dividend on the shares of that class equal to the amount described in the remainder of the provision.
Consequently, in the context of the pipeline strategy described above, some of the additional facts and circumstances that in our view could lead to the application of subsection 84(2) and warrant dividend treatment could include the following:
- The funds or property of ACo would be distributed to the estate in a short time frame following the death of Mr. A.
- The nature of the underlying assets of ACo would be cash and ACo would have no activities or business ("cash corporation").
Where such circumstances exist, resulting in the application of subsection 84(2) and dividend treatment on the distribution to the estate, we believe that double taxation at the shareholder level could still be avoided with the implementation of the subsection 164(6) capital loss carryback strategy, provided the conditions of that provision would apply in the particular facts and circumstances.
Finally, we note that we have issued several favourable rulings wherein we have concluded that subsection 84(2) would not apply to the proposed full or partial pipeline strategies. (footnote 1) These situations, in contrast to the examples noted above, did not involve cash corporations. Furthermore, in each case the taxpayers' proposed transactions contemplated, among other things, the continuation of the business for a period of at least one year, followed by a progressive distribution of the corporation's assets over an additional period of time. Consequently, one or more of the conditions of subsection 84(2) were not met in each case and the pipeline strategy was effectively implemented.
June 2, 2011
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 See, for example, Documents F 2002-0154223, F 2005-0142111R3, F 2007-0237511R3, F 2009-0346351R3, F 2010-0377601R3, F 2010-0388591R3 and E 2011-0403031R3 (publication pending).
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