Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: Whether the paragraph 55(3)(a) exemption applies in two scenarios
Position: In the first scenario, no. Possibly in the second scenario.
Reasons: See below.
FEDERAL TAXATION ROUND TABLE 10 OCTOBER 2014
2014 APFF CONFERENCE
Question 16.
Application of paragraph 55(3.01)(g) ITA
In the course of certain internal corporate reorganizations between related persons, subsection 55(2) applied and the exception provided in paragraph 55(3)(a) was not applicable where a new corporation was created as part of the series of transactions. In particular, as the initial share issue to the shareholder resulted in a significant increase in the interest in the new corporation and that shareholder was not related to it immediately prior to that time (since the corporation did not exist at that time), subparagraph 55(3)(a)(ii) applied.
Consider the following example:
(a) Husband, Wife and Third Party incorporate Realtyco and each subscribes for 1/3 of the voting particpating shares of Realtyco;
(b) Husband, Wife and Third Party each transfers under subsection 85(1) an equal share of their Opco shares to Realtyco in consideration for the issuance by the latter of preferred shares having a value equalling that of the realty to be transferred;
(c) Opco transfers realty to Realtyco under subsection 85(1) in consideration for preferred shares having a value equal to the value of the realty;
(d) Opco purchases for cancellation the shares in its capital held by Realtyco in consideration for the issuance of a note with an amount equal to the value of the purchased shares;
(e) Realtyco redeems the shares in its capital held by Opco in consideration for the issuance of a note with an amount equal to the value of the redeemed shares;
(f) The notes are set-off.
(g) The redemption of the preferred shares of Realtyco and the purchase for cancellation of the Opco shares give rise to deemed dividends received by Opco and Realtyco respectively. Opco and Realtyco deduct the deemed dividends under subsection 112(1);
(h) As a result of the foregoing transactions, Husband, Wife and Third Party each hold 1/3 of the total participating and voting shares of each of Opco and Realtyco directly.
Questions to the CRA
(a) Following the adoption of paragraph 55(3.01)(g), does the CRA believe that subsection 55(2) does not apply to the example described above? Would the answer be different if the acquisition by Husband, Wife and Third Party of Realtyco took place in connection with the transfer of their shares of Opco rather than by by the initial subscription for shares?
(b) Would the answer be different if, prior to the transactions in the above example, Husband, Wife and Third Party created a holdding corporation (Holdco) to which they trnasferred all of their interests in Opco shares, and it was Holdco that carried out the transactions provided for in steps (a) and (b) above instead of Husband, Wife andThird-Party?
CRA Response
Overview
Paragraph 55(3)(a) essentially provides that subsection 55(2) does not apply to any dividend received by a corporation (referred to as the "dividend recipient") to the extent that none of the events referred to in subparagraphs 55(3)(a)(i) to (v) has occurred as part of a transaction or event or a series of transactions or events as a part of which the dividend was received.
The two dividend recipients in the series of transactions described above are Opco and Realtyco. Opco and Realtyco are also dividend payers.
Respecting the issuance of shares on an incorporation, our long-standing position is to consider that even prior to the first issuance of shares in the capital stock of the new corporation, the incorporator controls it and, consequently, will be considered as being related to that corporation before the first issuance of shares. We therefore assume that the transaction would be structured so that the initial subscriptions to Realtyco's share capital by Husband and Wife (the incorporators of Realtyco) would not result in an increase in interest described by subparagraphs 55(3)(a)(iii) to (v).
Paragraph 55(3.01)(g) excludes any disposition of property that would, but for paragraph 55(3.01)(g)(i), be described in subparagraph 55(3)(a)(i), or any significant increase in the total direct interest in a corporation that would, but for paragraph 55(3.01)(g), be described in subparagraph 55(3)(a)(ii), to the extent that certain conditions are met. It should be noted, however, that paragraph 55(3.01)(g) does not exclude the property disposition and interest increase provisions described in subparagraphs 55(3)(a)(iii) to (v).
Furthermore, for the purposes of paragraph 55(3)(a), we assume that the only transactions that are part of the series of transactions in which the dividends were received are those described in this question. We also assume that Husband and Wife would control Opco, Realtyco and Holdco in the scenarios described in this question.
CRA Response to Question 16(a)
The initial subscription for shares in the capital stock of Realtyco by Third Party would result in an increase in the ownership interest described under subparagraph 55(3)(a)(ii) since Third Party is a person not related to Opco and Realtyco, the dividend recipients. This share subscription would also result in an increase in Third Party's ownership described in subparagraph 55(3)(a)(v) in respect of the dividend deemed to be received by Opco.
Increases in the interest of Third Parties described under subparagraph 55(3)(a)(ii) would also result from the transfer of shares of Opco by Third Party to Realtyco in consideration for preferred shares in the capital stock of Realtyco, as well from cross-share redemptions of shares between Opco and Realtyco.
Furthermore, as regards the dividend deemed to be received by Opco, an increase in interest of Third Party described in subparagraph 55(3)(a)(v) would result from the transfer of the shares of Opco by Third Party to Realtyco in consideration for preferred shares in the capital of Realtyco, as well as on the redemption of the preferred shares in the capital of Realtyco held by Opco.
Finally, on the purchase for cancellation of the shares in the capital of Opco held by Realtyco, Third Party increased its interest in Opco, which is an event described in subparagraph 55(3)(a)(v), in respect of the dividend deemed to be received by Realtyco.
Because paragraph 55(3.01)(g) does not exclude an increase in interest described in subparagraph 55(3)(a)(v), the dividend recipients, Opco and Realtyco, would be unable to utilize the exception from the application of subsection 55(2) provided in paragraph 55(3)(a).
It therefore becomes academic to determine whether paragraph 55(3.01)(g) could deem an increase in ownership interest or disposition of property described in subparagraphs 55(3)(a)(i) and (ii) to not come within those subparagraphs. It should be noted, however, that the condition provided in subparagraph 55(3.01)(g)(v) would not be satisfied as the shares of the recipients of the dividends, Opco and Realtyco, were held by individuals at the moment of receipt of the dividends.
CRA Response to Question 16(b)
We assume that there would be no initial subscription of shares to set up Holdco but that the holdings of Husband, Wife and Third Party in Holdco would result from the transfer of their shares in the capital stock of Opco to Holdco. In this regard, we assume that prior to this transfer of shares, Holdco and Realtyco would be incorporated and would have as their founders Husband and/or Wife. Holdco would therefore be considered to be related to Opco and Realtyco. Husband and Wife would be considered to be related to Realtyco. Finally, we assume that the Third Party’s original investment in Opco did not occur as part of the series of transactions in which the dividends were received by Opco and Realtyco.
The disposition of shares of Opco's capital stock by Husband, Wife and Third Party to Holdco would not result in a disposition described in subparagraphs 55(3)(a)(i), (iii) or (v) as, immediately prior to the disposition, Holdco would be related to Opco and Realtyco, the dividend recipients.
However, the investment of Third Party in Holdco in connection with this transfer of shares would result in an increase in interest described in subparagraph 55(3)(a)(ii) as Third Party would be a person unrelated to Opco and Realtyco, the dividend recipients.
Finally, the investment of Holdco in Opco in connection with this transfer would not constitute an increase in interest described in subparagraph 55(3)(a)(ii) and (v) as on the basis of the assumptions above, Holdco would be related to Opco and Realtyco immediately before the transfer of the shares.
It therefore becomes relevant to determine whether the increase in Third Party's interest in Holdco described in subparagraph 55(3)(a)(ii) could be excluded by virtue of 55(3.01)(g).
For the purposes of paragraph 55(3.01)(g), the "particular corporation" would be Holdco. The conditions set out in subparagraphs 55(3.01)(g)(i) to (v) would be respected. Accordingly, the increase in interest of Third Party in Holdco described in subparagraph 55(3)(a)(ii) would be deemed not to be described in that subparagraph.
In respect of the other transactions of the series in which Holdco would subscribe for shares in the capital stock of Realtyco to undertake the remaining transactions in the series, all such transactions would occur between persons related to the dividend recipients since Holdco would control both Opco and Realtyco.
Consequently, based on paragraph 55(3.01)(g) and on the assumptions made, it is possible that Opco and Realtyco could utilize the exception to the application of subsection 55(2) provided in paragraph 55(3)(a).
In this scenario, it would be important that the transactions respecting the formation of Holdco and Realtyco (the dividend recipients) be properly effected; otherwise, triggering events described in paragraph 55(3)(a) could be generated. For example, the disposition of the shares of Opco by Husband, Wife and Third Party to Holdco could technically be described by subparagraphs 55(3)(a)(iii) and (v) respecting the dividend deemed to be received by Realtyco. Indeed, immediately before the disposition, Holdco would be considered to not be related to Realtyco if the latter did not exist at that moment.
It should be noted that to the extent that it was determined that the acquisition of a Third Party interest in Opco was part of the series of transactions in the course of which the dividends were received by Opco and Realtyco, this would in particular be a fact described in subparagraph 55(3)(a)(v) in respect of the deemed dividend received by Realtyco. Paragraph 55(3.01)(g) does not apply in respect of an increase in ownership interest described in subparagraph 55(3)(a)(v). Accordingly, Realtyco could not use the exception to the application of subsection 55(2) provided for in paragraph 55(3)(a).
Marc Séguin
(514) 620-8562
October 10, 2014
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