21 November 2017 CTF Roundtable Q. 3, 2017-0724021C6 - Meaning of purpose

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: A. Does a purification dividend have a purpose described in 55(2.1)(b)? B. Is the Ludco test the proper test to use to determine purpose?

Position: A. For 55(2) not to apply, none of the purpose described in 55(2.1)(b) can be present. For example, such purpose could be present if the dividend is paid with assets other than surplus assets or in contemplation of a possible disposition of the shares. B. The Ludco test is the correct test to use. Purpose has to be determined based on subjective and objective manifestations of purpose.

Reasons: A. Purpose test in 55(2.1)(b) B. Proper interpretation of case law.

2017 CTF Annual Conference
CRA Roundtable

Question 3: Meaning of purpose

A. A technical interpretation released in April 2017 (2016-0658841E5) notes that paying a dividend with the goal of purifying the corporation by distributing surplus assets so that the shares in the capital stock of that corporation are “qualified small business corporation shares” within the meaning of subsection 110.6(1) (“QSBCS”) would certainly be a relevant factor that should be taken into account. The TI says, however, that it also should be ensured that the dividend has no other purpose described in paragraph 55(2.1)(b). The TI says that if, for example, the dividend paid to the corporation exceeds the amount that would be required to transfer the surplus assets, this could be a sign that the dividend has another purpose, which was one of those referred to in paragraph 55(2.1)(b).

If the dividend’s only purpose is to maintain the QSBCS status of the shares, the dividend should not have a purpose (but might have the result) of reducing the FMV or the gain on the shares. In this situation, would CRA agree that the purpose tests are not met?

B. Is the test under Ludco Enterprises Ltd et al v. The Queen, 2001 DTC 5505 (SCC) (“Ludco”), the right test to use to determine “purpose” in the context of subsection 55(2) as opposed to the test under The Queen v. Placer Dome, 96 DTC 6562 (FCA) (“Placer Dome”), which was a decision under subsection 55(2)? Note that Ludco is a decision under paragraph 20(1)(c) which does not have both a purpose and a result test and recent jurisprudence on subsection 55(2), including Placer Dome, does not apply the principle established in Ludco that the objective manifestation of purpose is critical to ascertain the purpose or intention behind actions under former subsection 55(2) because of the particular language therein that distinguishes between purpose and result. Placer Dome held that the purpose test in subsection 55(2) requires a subjective understanding whereas an objective approach is required for the result test. Also, it is understood that the determination of “purpose” in Placer Dome does not require the taxpayer to adduce corroborative or additional evidence when a taxpayer’s explanation of purpose is neither improbable nor unreasonable.

CRA Response

A. Subsection 55(2) could apply where any one of the purposes described in paragraph 55(2.1)(b) is present and, therefore, it is important to demonstrate that the payment or receipt of the dividend has no purpose described in paragraph 55(2.1)(b).

Whether a purpose of maintaining QSBCS status cannot be divorced from other purposes such that a payment of a dividend can be viewed as having only the purpose of maintaining QSBCS status but has no purpose of reducing the accrued gain or value of the shares or increasing the cost of property of the dividend recipient can only be made in light of all the relevant facts and circumstances.

As indicated in the above-mentioned interpretation, where the dividend is paid with assets other than surplus assets, this might be a sign that the payment of the dividend could have a purpose referred to in paragraph 55(2.1)(b). Or, if the removal of the surplus assets from the corporation through the payment of a dividend is made in contemplation of a possible disposition of the shares of the corporation, it may also indicate that there is a purpose referred to in paragraph 55(2.1)(b).

The above are only examples of questions that could be asked to help determine whether a purpose referred to in paragraph 55(2.1)(b) could be present in respect of a dividend paid to qualify as QSBCS. They do not represent the only guidelines to use to determine such purpose in that context.

We also question why the payment of a dividend to remove surplus assets is not covered by safe income since the generation of surplus assets or a disposition of such assets would generally result in a realization of income.

B. As indicated in document 2015-0610651C6, the correct test to use to determine purpose in respect of subsection 55(2) is the Supreme Court’s test in Ludco which is as follows:

“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.”

Ludco followed the purpose test in respect of paragraph 18(1)(a) established by the Supreme Court in Elizabeth C. Symes v. The Queen, 1994 DTC 6001 (“Symes”):

“74 As in other areas of law where purpose or intention behind actions is to be ascertained, it must not be supposed that in responding to this question, courts will be guided only by a taxpayer's statements, ex post facto or otherwise, as to the subjective purpose of a particular expenditure. Courts will, instead, look for objective manifestations of purpose, and purpose is ultimately a question of fact to be decided with due regard for all of the circumstances. For these reasons, it is not possible to set forth a fixed list of circumstances which will tend to prove objectively an income gaining or producing purpose.”

The test provided in Symes and Ludco constitutes the benchmark test to determine purpose or intent. The test was followed by a long line of cases on various subjects including, but not restricted to:

• Petro-Canada v. The Queen, 2004 DTC 6329 (FCA): qualifying of expenses as CEE.
• Makuz v. The Queen, 2006 DTC 3201 (TCC): existence of a partnership.
• McPherson v. The Queen, 2007 DTC 326 (TCC): whether a gift is a genuine gift.
• Canada Safeway Ltd. v. The Queen, 2008 DTC 6074 (FCA): secondary intention (income vs. capital gain).
• Groupe Honco Inc. v. The Queen, 2013 DTC 1032 (TCC): application of subsection 83(2.1).
• Perera v. The Queen, 2014 DTC 1172 (TCC): expenses incurred for the purpose of earning employment income.
• Standard Life Assurance Co of Canada v. The Queen, 2015 DTC 1113 (TCC): designated insurance properties.
• Lyn Kew v. The Queen, 2015 DTC 1172 (TCC): purpose of a relocation expense.
• Mariano v. The Queen, 2015 DTC 1209 (TCC): intent of donation.
• 3488063 Canada Inc. v. The Queen, 2016 DTC 5099 (FCA): application of section 94.1.
• Edison Transportation LLC v. The Queen, 2016 DTC 1063 (TCC): section 9 and paragraph 18(1)(a).
• MacDonald v. The Queen, 2017 TCC 157 (TCC): capital gain vs. income determination.

The decision of the Federal Court of Appeal in Placer Dome was in response to the Crown’s argument that “purpose” in subsection 55(2), based on some Australian case law, does not embrace the motivation of each of the participants and that term is to be understood in an objective, not a subjective sense, especially when a dividend and a disposition of a share are inextricably linked where the transaction has the effect of reducing substantially a capital gain. The Crown lost the argument and the Court reaffirmed that the “purpose” test in subsection 55(2) is a subjective test. This has to be differentiated from the standard established by Ludco and Symes on the determination of purpose.

At paragraph 20 of the FCA decision in Placer Dome, the Court made the following comment: “it is not necessary that the taxpayer adduce corroborative or additional evidence which shows or tends to show that his or her testimony is true.” Such comment was derived from McAllister Drilling, 95 DTC 5001 (FCTD), where the Court made the following comment at paragraph 8 of the decision:

“In the somewhat unusual circumstances of this case where credibility is conceded, if I agree that the taxpayers' evidence is credible, it will not require the bolstering or corroboration afforded by external facts”. [Our emphasis]

In both Placer Dome and McAllister Drilling, the court determined the “purpose” of the taxpayers by not only listening to their testimony but also by examining all the facts and corroborating their testimony with the objective facts and the evidence. The comments made by the courts and quoted above only meant that a court does not need to probe further if the facts and evidence in front of them are sufficient to establish the credibility of the testimony.

The court in Placer Dome and McAllister Drilling did not contradict Ludco and Symes. They followed the standard established in Ludco and Symes that “courts should objectively determine the nature of the purpose, guided by both subjective and objective manifestations of purpose” (see above).

Where a dispute under subsection 55(2) arises, the Crown and the CRA will ensure that all relevant facts and evidence are brought to the court to help it to establish the objective manifestations of purpose and the credibility of the testimony of the taxpayers.

M. Ton-That
2017-072402
November 21, 2017