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: 1) Can the CRA provide guidance on the application of the purpose test 2) What are the factors used when deciding whether a reduction of value is significant
Position: 1) Determination of purpose is based on facts particular to a situation, including, but not limited to, the actions taken by the parties to the dividend and their motivation 2) Whether a reduction of value is significant is a question of fact and could be measured in terms of an absolute dollar amount or on a percentage basis
Reasons: See response
2015 CTF Annual Conference
Question 6(a): Section 55 – Basic Concepts – Significant Reduction of Value Purpose Test
As one of the conditions that could trigger the application of subsection 55(2), proposed clause 55(2.1)(b)(ii)(A) refers to a dividend that is received on a share that is held as capital property by the dividend recipient and one of the purposes of the payment or receipt of the dividend is to effect a significant reduction in the fair market value of any share.
In the case of a large dividend, it is fair to say that the payment of such a dividend will in fact reduce the value of the shares of a corporation. If we assume that the reduction of value is significant, can the CRA provide guidance on the application of the purpose test above? In particular, what factors will the CRA consider when deciding whether the factual reduction of value was the purpose for declaring the dividend?
Continuing with proposed clause 55(2.1)(b)(ii)(A), can the CRA describe the factors or tests they would consider in deciding whether a reduction of value is significant?
The determination of purpose is based on facts that are particular to the situation, including, but not limited to, the actions taken by the parties to the dividend and their motivation. In Ludco (2001 SCC 62), the Court was of the view that “in the interpretation of the Act, as in other areas of law, where purpose or intention behind actions is to be ascertained, courts should objectively determine the nature of the purpose, guided by both subjective and objective manifestations of purpose.” Although a dividend on a share would normally result in a reduction of value of the share, it’s not the result that determines the application of proposed subsection 55(2.1). It’s the purpose and the motivation behind the purpose that could be established by finding the answer to questions such as “What does the taxpayer intend to accomplish with a reduction in value? How would such reduction in value be beneficial to the taxpayer? What actions did the taxpayer take in connection with the reduction in value?” Without limiting the application of the purpose test, a dividend that is directly or indirectly instrumental in the creation of an accrued loss on any share that may be used, or has the potential to be used, to shelter a gain on some other property provides an indication that the FMV reduction purpose exists (for example, one might consider transferring a property with an accrued income or capital gain to the corporation that issued shares that have an accrued loss.) Furthermore, it is also necessary to ascertain that the purpose of the dividend is not to increase the cost of property. For example, and without limiting the application of the purpose test, the use or possibility of using an increased cost amount of properties to shelter a gain is an indication that the purpose of the dividend is to increase cost.
The technical notes to the July 31, 2015 Legislative Proposals stated:
The “one of the purpose” tests in subparagraphs (b)(i) and (ii) are to be applied separately to each dividend. For example, subparagraph (b)(ii) could apply to a dividend one of the purposes of which is to increase significantly the cost of any property even if subparagraph (i) applies (or does not apply because one of the purposes was not to reduce significantly a gain on any share).
As such, the purpose tests in proposed subparagraph 55(2.1)(b)(ii) could apply even if the dividend does not satisfy the purpose in proposed subparagraph 55(2.1)(b)(i) (i.e., there is no gain on the shares).
Whether a reduction of value is significant is a question of fact and could be measured in terms of an absolute dollar amount or on a percentage basis.
November 24, 2015
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