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Principal Issues: Whether subsection 55(2) would apply to an extraordinary dividend paid in the context of a permanent disability insurance payment received by the corporation.
Position: General response.
Reasons: See below.
FINANCIAL STRATEGIES AND INSTRUMENTS ROUNDTABLE 5 OCTOBER 2018
2018 APFF CONFERENCE
Redemption of shares in the event of disability of a shareholder by using buy-sell disability insurance, and subsection 55(2)
Mr. A and Mr. B hold respectively all the shares of the capital stock of their holding corporation ("Holdco A" and "Holdco B"). Holdco A and Holdco B hold, in equal shares, Class B shares in the capital stock of an operating corporation (Opco) with a respective FMV of $500,000. In addition, Mr. A and Mr. B hold, in equal shares, Class A shares in the capital stock of Opco with a respective FMV of $1,000,000.
Opco has taken out $1,500,000 buy-sell disability insurance on each of the shareholders, Mr. A and Mr.B. The insurance proceeds received by Opco do not constitute taxable income to the corporation.
In the event of disability of either, Opco will receive the disability insurance proceeds and then pay it by way of a special dividend of $1,000,000 to the holding company of the active shareholder in order for that such shareholder to buy the shares held personally by the disabled shareholder. Subsequently, Opco will proceed with the redemption of the shares held by the holding corporation of the disabled shareholder for an amount of $500,000.
Question to the CRA
Would the rules in subsection 55(2) apply since a special dividend has been paid to the holding corporation of the active shareholder?
The question as stated did not specify how the distribution of the value of the insurance policy received by Opco among the shareholders would occur and did not describe the attributes of the issued shares in the capital stock of Opco. In addition, it was not specified by what mechanism the special dividend could be paid solely to the holding corporation of the active shareholder. Consequently, we have not commented on those elements.
With respect to the special taxable dividend paid by Opco to the holding corporation of the active shareholder, it must be determined whether one of the purposes of payment or receipt of the dividend is one referred to in subparagraphs 55(2.1)(b)(i) and (ii). In Technical Interpretation 2015-0613821C6 (footnote 1), with respect to the application of the purpose test under the above subparagraphs, the CRA indicated that, subject to certain conditions, the payment of a dividend under of a well-established policy of paying regular dividends would not be considered to have one of the purposes referred to in subparagraphs 55(2.1)(b)(i) and (ii). In addition, the CRA indicated that in other circumstances, the determination of the presence or absence of any of the purposes in subparagraphs 55(2.1)(b)(i) and (ii) could only be made through a review of all the particular facts of a situation and that this could not be done in the context of a Roundtable question or a simple statement of purpose. Finally, the CRA indicated that despite paragraph 19(h) of Information Circular IC70-6R7 (footnote 2), "Advance Income Tax Rulings and Technical Interpretations", it could issue a favourable advance ruling on such a determination where all manifestations of purpose and corroborating circumstances support the absence of one of the purposes described in subparagraph 55(2.1)(b)(ii) and (ii). This determination, in an advance ruling request, would, however, be conditional on the representation made by the taxpayer that the purposes for which the dividend was paid do not include one of the purposes described in proposed paragraph 55(2.1)(b)(i) and (ii) and that the description of the facts represents a complete description of all the manifestations of such purpose and all the relevant facts.
Clarification has also been provided, inter alia, in the context of Technical Interpretations 2016-0627571E5 (footnote 3) and 2017-0724021C6 (footnote 4) on the issue of applying the purpose test for the purposes of paragraph 55(2.1)(b).
Although in certain circumstances the dividend paid by Opco to the holding corporation of the active shareholder may not be considered to have any of the purposes described in paragraph 55(2.1)(b), that determination can only be made after a review of all the facts of a particular situation.
As for the redemption of shares of the capital stock of Opco held by the holding corporation of the disabled shareholder, a result test would apply so that subsection 55(2) could, to the extent that all other conditions of application of this provision were satisfied, apply to the deemed dividend received by the holding corporation of the disabled shareholder.
It should be noted that any dividend or portion of the dividend that is attributable to income earned or realized by Opco would be exempt from the application of subsection 55(2).
In conclusion, this answer is limited solely to the analysis of the application of subsection 55(2) and nothing herein should be construed as acquiescence by the CRA that another provision of the Income Tax Act would not apply to the situation described in the question. The application of one or more provisions of the Income Tax Act generally requires the analysis of all facts and circumstances pertaining to a particular situation.
5 October 2018
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Technical Interpretation 2015-0613821C6, 17 November 2015.
2 CANADA REVENUE AGENCY, Information Circular IC70-6R7, “Advance Income Tax Rulings and Technical Interpretations”, 22 April 2016 (online: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/ic70-6r7.html
3 CANADA REVENUE AGENCY, Technical Interpretation 2016-0627571E5, 23 June 2016.
4 CANADA REVENUE AGENCY, Technical Interpretation 2017-0724021C6, 21 November 2017.
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