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: Where there is no plan to sell the shares of Opco, does the purpose test in proposed paragraph 55(2.1)(b) apply to a creditor-proofing dividend that exceeds safe income and that significantly reduces the value of (and the accrued gain) on the shares?
Position: The apparent purpose of such creditor-proofing dividend is to reduce the value of the shares. Subsection 55(2) applies where the purpose is present. The application of subsection 55(2) to this situation is in accordance with the scheme of the Act, considering that: 1) the purpose of subsection 112(1) is to avoid double-taxation on income that was already subject to tax, 2) an exchange of shares of a corporation by a shareholder for non-share consideration issued by the corporation in excess of ACB is subject to tax, 3) a dividend in excess of after-tax income of a corporation for the purpose of significantly reducing the value of the shares by converting such value into full ACB debt that could be sold or repaid without tax implication ought to be subject to tax under the scheme of the Act, 4) the fact that the purpose of the dividend is also to achieve creditor-proofing does not change the conclusion.
Reasons: See below.
2015 CTF Annual Conference
Question 6(e): Creditor proofing
One very common transaction that has been drawn into question is using a holding company for asset protection purposes. Assume that a corporation is worth $10 million and has safe income of $2 million. The owners of Opco (an individual and his spouse) want to protect the value that they have accumulated. Their advisors determine that a dividend of $8 million could be paid to a newly formed holding company without causing commercial and corporate law issues (they will transfer their Opco shares to Holdco under section 85 and then declare the dividend). Once the dividend is received, Holdco will loan the funds back to Opco. Some of the loan will be secured against assets.
The owners have no plans to sell Opco, and even if they do sell, the sale could be structured as a sale of Holdco since it should qualify for the capital gains exemption. As there has factually been a significant reduction of value of Opco’s shares, can the CRA comment on whether proposed subsection 55(2) will apply? Will the securitization dividend and loan back have to be limited to safe income despite the apparent lack of intention to sell Opco from Holdco?
We understand that a creditor-proofing transaction could be achieved by having Holdco lend money to Opco either before or after the payment of the dividend. When Opco pays a “lumpy” dividend such as in this creditor-proofing transaction in order to significantly reduce the value on the Opco shares, the apparent purpose of the payment of the dividend for the application of subsection 55(2) is to reduce the value on the Opco shares. When such purpose is present, subsection 55(2) applies to the dividend. We would like to further elaborate on our response as follows:
- The deduction under subsection 112(1) on inter-corporate dividends has the purpose of avoiding double-taxation on income earned by a corporation that has already been subject to tax. In addition to other restrictions established elsewhere, subsection 55(2) essentially establishes limits to that deduction. Hence, one cannot presume that the scheme of the Act is to exempt all payments made between corporations that could be considered to be a dividend under corporate law.
- The scheme of the Act restricts the increase in tax-free amounts that a shareholder may derive from a corporation without any payment of tax. For example, any exchange of shares of a corporation by a shareholder is subject to tax when non-share consideration is received in excess of the ACB of the shares disposed of on the exchange.
- The payment of a dividend that is in excess of the amount of the after-tax income of a corporation for the purpose of significantly reducing the value of the shares by essentially converting a significant amount of accrued value on a share of a corporation into full ACB debt that could be sold or repaid without any tax implication should be subject to tax under the scheme of the Act, as supported by proposed subsection 55(2).
- The fact that the purpose of the dividend is also to achieve creditor proofing would not alter that conclusion.
November 24, 2015
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