5 October 2018 APFF Roundtable Q. 4, 2018-0768891C6 F - Stock Dividend and Safe Income

Unedited CRA Tags

55(2) à (2.4), 107(2)

View modes

Translation

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: How does the safe income of a corporation contribute to gains on the stock dividend shares and the shares upon which the stock dividend is paid?

Position: For corporations that are "dividend recipients", the rules in subsections 55(2.2) to (2.4) and paragraph 52(3)(a) are relevant. For individuals, a corporation's safe income contributes to the stock dividend shares and the shares upon which the stock dividend is paid based on the relative gains inherent in the shares, as determined immediately after the stock dividend is paid.

Reasons: Wording of the Act and previous positions.

FEDERAL TAX ROUNDTABLE 5 OCTOBER 2018
2018 APFF CONFERENCE

Question 4

Allocation of safe income on the payment of a high-low dividend

Scenario

An operating company "OPCO" was owned by four shareholders in equal shares (25% each):
o two discretionary family trusts, namely, Trust A and Trust B;
o two holding corporations, namely, Holdco A and Holdco B.
All shareholders subscribed at the same time, and in the same amount of $25, for 25 treasury common shares of the corporation at the time of its incorporation.
Mr. A. held 100% of the shares of Holdco A.
Holdco A and Mr. A were beneficiaries of Trust A. Other members of Mr. A's family were also beneficiaries. The trustees of Trust A were Mr. A's parents and a third party.
Mr. B. held 100% of the shares of Holdco B.
Holdco B and Mr. B were beneficiaries of Trust B. Other members of Mr. B's family were also beneficiaries. The trustees of Trust B were Mr. B's parents and a third party.
OPCO was a corporation connected with Holdco A and Holdco B within the meaning of paragraph 186(4)(b).
OPCO, all shareholders and all trustees were Canadian residents.
Mr. A and Mr. B were dealing with each other at arm’s length.
The fair market value ("FMV") of all participating shares [i.e., common shares] was $1,000,000 (or $250,000 each).
The aggregate safe income of the participating shares was $400,000 (or $100,000 each). [Translator’s note: the French original refers in various places to “revenu gagné” (earned income) but also to “revenu protégé” (safe income). Both have been rendered in English as “safe income.”]

OPCO paid a dividend of $400,000 in high-low preferred shares to the holders of the participating shares. Each shareholder received 100 high-low preferred shares with an aggregate paid-up capital of $100 and an aggregate redemption value of $100,000.

As we understand it, Holdco A and Holdco B will each receive 100 high-low preferred shares which, by virtue of subsections 55(2) et seq., will reduce the aggregate safe income on the common shares from $400,000 to $200,000.

For Holdco A and Holdco B, the paid-up capital of the high-low preferred shares received would remain at $100 and the adjusted cost base ("ACB") and the redemption value of the shares would be $100,000. Subsection 55(2) would not have any effect on the redemption, since the ACB would be equal to the redemption value.

At the same time, Trust A and Trust B will each receive 100 high-low preferred shares with a total paid-up capital of $100 and a total redemption value of $100,000.

Questions to the CRA

(a) How is the safe income allocated in light of the subsection 55(2) amendments, especially subsections 55(2.2) to (2.4), Technical Interpretation 2016-0668341E5 and the current position?

b) Where Trust A is taxable on the $100 high-low preferred share dividend and makes an immediate capital distribution of those high-low preferred shares to Holdco A immediately after their receipt, what safe income will be attributable to the preferred shares received by Holdco A?

CRA Response to question 4(a)

We have assumed that one or more of the purpose tests in subsection 55(2.1) is satisfied with respect to the stock dividend declared and paid by Opco to its corporate shareholders, namely Holdco A and Holdco B.

Subsections 55(2.2) to (2.4) apply in respect of a stock dividend received by a dividend recipient. A "dividend recipient" is defined in subsection 55(2.1) (inter alia for the purposes of subsections 55(2.2) and (2.4)) as a corporation resident in Canada and, accordingly, those rules do not apply to Trust A and Trust B.

For the purposes of inter alia subsections 55(2), (2.1), (2.3) and (2.4), subsection 55(2.2) deems the amount of the stock dividend received by Holdco A and Holdco B and the amount deductible by them under subsection 112(1) to be equivalent to $100,000. This amount is the greater of (i) the amount of the increase, resulting from the payment of the stock dividend, of the paid-up capital of the corporation paying the dividend and (ii) the FMV of the 100 shares issued as a stock dividend at the time of payment.

Subsection 55(2.4) sets out three conditions that must be satisfied in order for subsection 55(2.3) to apply to a stock dividend. In this scenario, those three conditions would be met with respect to Holdco A and Holdco B.

Subsection 55(2.3) provides that where it applies to a stock dividend:

“(a) the amount of the stock dividend is deemed for the purpose of subsection (2) to be a separate taxable dividend to the extent of the portion of the amount that does not exceed the amount of the income earned or realized by any corporation — after 1971 and before the safe-income determination time for the transaction, event or series — that could reasonably be considered to contribute to the capital gain that could be realized on a disposition at fair market value, immediately before the dividend, of the share on which the dividend is received; and

(b) the amount of the separate taxable dividend referred to in paragraph (a) is deemed to reduce the amount of the income earned or realized by any corporation — after 1971 and before the safe-income determination time for the transaction, event or series — that could reasonably be considered to contribute to the capital gain that could be realized on a disposition at fair market value, immediately before the dividend, of the share on which the dividend is received.”

For the 25 common shares of the capital stock of OPCO held by Holdco A and Holdco B, respectively, the capital gain that could be realized on a disposition at the FMV of those shares, immediately before the stock dividend, is $249,975 (FMV of $250,000 minus ACB of $25). The amount of the dividend as indicated above would be $100,000 and this amount does not exceed the amount of income earned or realized that could reasonably be considered to contribute to the capital gain that could be realized on the 25 common shares immediately before the stock dividend (i.e., the $100,000 of safe income, as noted above).

Consequently, by virtue of paragraph 55(2.3)(a), the amount of the $100,000 stock dividend received by Holdco A and Holdco B will be deemed to be a separate dividend for the purposes of subsection 55(2). By virtue of paragraph 55(2.3)(b), the amount of $100,000 will be deemed to reduce OPCO's safe income that contributed to the capital gain on the 25 common shares of the capital stock of OPCO held respectively by Holdco A and Holdco B.

By virtue of subparagraph 52(3)(a)(ii), immediately after the stock dividend is paid, Holdco A and Holdco B will hold 100 high-low preferred shares with a FMV of $100,000 and an ACB of $100,000, and 25 common shares with an FMV of $150,000 and an ACB of $25, resulting in an unrealized gain of $149,975 for those 25 common shares of the capital stock of OPCO. Immediately following the payment of the stock dividend, the 25 common shares of the capital stock of OPCO held by Holdco A and Holdco B respectively would no longer have any safe income. By virtue of subsection 52(3), the safe income of $100,000 contributing to the capital gain on the 25 common shares of the capital stock of OPCO held respectively by Holdco A and Holdco B before the payment of the stock dividend is now reflected in the ACB of the 100 high-low preferred shares received as a stock dividend by Holdco A and Holdco B.

Subsection 55(2) should not apply to any future redemption of these 100 high-low preferred shares held by Holdco A or Holdco B. On the one hand, subparagraph 55(2.1)(b)(ii) does not apply to a dividend received on a redemption of shares and to which subsection 84(3) applies. On the other hand, subparagraph 55(2.1)(b)(i) should not apply since in a situation where the redeemed preferred shares would have a redemption amount equal to their adjusted cost base, the dividend referred to in subsection 84(3) would not have the effect of substantially reducing the portion of the capital gain that, absent the dividend, would have been realized on a disposition of a share of the capital stock at its FMV immediately before the dividend.

Regarding Trust A and Trust B, immediately after the stock dividend, each of them will hold 100 high-low preferred shares having a redemption amount of $100,000 and, by virtue of subparagraph 52(3)(a)(i) and paragraph (c) of the definition of "amount" in subsection 248(1), an ACB of $100. As a result, there would be an unrealized capital gain of $99,900 on those 100 high-low preferred shares. In addition, Trust A and Trust B will each hold 25 common shares with a FMV of $150,000 and an ACB of $25 resulting in an unrealized gain of $149,975.

OPCO's safe income contributing to the capital gain on the 25 common shares held by Trust A and Trust B, respectively, will be reduced by only $100, being the stock dividend received by Trust A and Trust B. The safe income contributing to the combined shareholdings held by Trust A or Trust B will therefore be $99,900. That amount of safe income will, however, be split between the two classes of shares held by Trust A and Trust B based on the unrealized gain on each class.

Under the scenario presented in Question 4(a), safe income that could reasonably be considered to contribute to the capital gain on the 25 common shares of the capital stock of OPCO held by Trust A and Trust B is $59,940 (149,975 / 249,875 X 99,900) and the safe income that could reasonably be expected to contribute to the capital gain on the 100 high-low preferred shares of the capital stock of OPCO held by Trust A and Trust B is $39,960 (99,900/249 875 X 99,900).

CRA Response to question 4(b)

By virtue of the definition of "amount" provided in subsection 248(1), Trust A would include in the calculation of its income an amount of $100 as a stock dividend paid by OPCO. As for the high-low preferred shares distributed by Trust A to Holdco A as a capital distribution, and assuming that Trust A was able to make such a distribution with no tax consequences by virtue of subsection 107(2), the safe income contributing to the capital gain of those shares would be the same as that determined in Question 4(a), namely $39,960.

It should be noted that the special rules regarding the amount of stock dividends that were added to the Income Tax Act by Parliament, including to subsections 55(2.2) to (2.4), were intended to address tax policy concerns associated with the use of this type of dividend in order to circumvent subsection 55(2) or to limit its application.

In that context, the type of transaction described in Question 4(b) could, depending on the facts and circumstances of a particular situation, constitute an avoidance transaction, which would lead the CRA to consider the potential application of the general anti-avoidance rule in subsection 245(2). In a particular actual situation, an analysis of the tax benefit, the avoidance transaction and the abuse of the Income Tax Act should be conducted as a part of a review of the potential application of subsection 245(2).

Marc Séguin
(514) 620-8562
5 October 2018
2018-076889

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

Text of Severed Letter

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.

Principales Questions: How does the safe income of a corporation contribute to gains on the stock dividend shares and the shares upon which the stock dividend is paid?

Position Adoptée: For corporations that are "dividend recipients", the rules in subsections 55(2.2) to (2.4) and paragraph 52(3)(a) are relevant. For individuals, a corporation's safe income contributes to the stock dividend shares and the shares upon which the stock dividend is paid based on the relative gains inherent in the shares, as determined immediately after the stock dividend is paid.

Raisons: Wording of the Act and previous positions.

TABLE RONDE SUR LA FISCALITÉ FÉDÉRALE DU 5 OCTOBRE 2018

APFF - CONGRÈS 2018

Question 4

Répartition du revenu gagné lors du versement d’un dividende en action « high-low »

Scénario

Une société en exploitation « OPCO » serait détenue par quatre actionnaires en parts égales (25 % chacun) :
- deux fiducies familiales discrétionnaires, soit Fiducie A et Fiducie B;
- deux sociétés de gestion, soit Gestion A et Gestion B.
Tous les actionnaires auraient souscrit au même moment, et pour un même montant de 25 $, à 25 actions « ordinaires » du trésor de la société au moment de la constitution.
M. A. détiendrait 100 % des actions de Gestion A.
Gestion A et M. A seraient bénéficiaires de Fiducie A. D’autres membres de la famille de M. A seraient également bénéficiaires. Les fiduciaires de Fiducie A seraient les parents de M. A et un tiers.
M. B. détiendrait 100 % des actions de Gestion B.
Gestion B et M. B seraient bénéficiaires de Fiducie B. D’autres membres de la famille de M. B seraient également bénéficiaires. Les fiduciaires de Fiducie B seraient les parents de M. B et un tiers.
OPCO serait une société rattachée à Gestion A et Gestion B au sens de l’alinéa 186(4)b) L.I.R.
OPCO, tous les actionnaires et tous les fiduciaires seraient résidents canadiens.
M. A et M. B n’auraient pas de lien de dépendance entre eux.
La juste valeur marchande (« JVM ») de la totalité des actions avec droit de participation serait de 1 000 000 $ (ou 250 000 $ chacun).
Le revenu gagné global des actions avec droit de participation serait de 400 000 $ (ou 100 000 $ chacun).

OPCO verserait un dividende d’une valeur de 400 000 $ en actions privilégiées high-low aux détenteurs des actions avec droit de participation. Chaque actionnaire recevrait 100 actions privilégiées high-low ayant un capital versé total de 100 $ et une valeur de rachat totale de 100 000 $.

Selon notre compréhension, Gestion A et Gestion B recevront chacun 100 actions privilégiées high-low qui, en vertu des paragraphes 55(2) et suivants L.I.R., réduiront le revenu gagné global sur les actions « ordinaires » de 400 000 $ à 200 000 $.

Pour Gestion A et Gestion B, le capital versé des actions privilégiées high-low reçues demeurerait à 100 $ et le prix de base rajusté (« PBR ») ainsi que la valeur de rachat des actions seraient de 100 000 $. Le paragraphe 55(2) L.I.R. n’aurait pas d’effet au rachat, car le PBR serait égal à la valeur de rachat.

Simultanément, Fiducie A et Fiducie B recevront chacune 100 actions privilégiées high-low ayant un capital versé total de 100 $ et une valeur de rachat totale de 100 000 $.

Questions à l’ARC

a) Comment le revenu gagné sera-t-il réparti si l’on considère les modifications à l’article 55 L.I.R., plus particulièrement aux paragraphes 55(2.2) à 55(2.4) L.I.R., l’interprétation technique 2016-0668341E5 et la position actuelle ?

b) Dans le scénario où Fiducie A s’imposerait sur le dividende en actions privilégiées high-low de 100 $ et attribuerait, à titre de capital, les actions privilégiées high-low à Gestion A immédiatement après les avoir reçues, quel sera le revenu gagné attribuable aux actions privilégiées high-low reçues par Gestion A?

Réponse de l’ARC à la question 4a)

Nous prenons comme hypothèse qu’un, ou plusieurs, des tests d’objet prévus au paragraphe 55(2.1) L.I.R. est respecté à l’égard du dividende en actions déclaré et versé par Opco en faveur de ses actionnaires corporatifs, soit Gestion A et Gestion B.

Les paragraphes 55(2.2) à 55(2.4) L.I.R. s’appliquent à l’égard d’un dividende en actions reçu par un bénéficiaire de dividende. Un « bénéficiaire de dividende » est défini au paragraphe 55(2.1) L.I.R. (entre autres, aux fins des paragraphes 55(2.2) et 55(2.4) L.I.R.) comme une société résidant au Canada et, par conséquent, ces règles ne s’appliquent pas à Fiducie A et Fiducie B.

Pour l’application notamment des paragraphes 55(2), 55(2.1), 55(2.3) et 55(2.4) L.I.R., le paragraphe 55(2.2) L.I.R. répute le montant du dividende en actions reçu par Gestion A et Gestion B et leur droit à la déduction en vertu du paragraphe 112(1) L.I.R. être équivalent à 100 000 $. En effet, ce montant serait le plus élevé entre i) le montant de l’augmentation, découlant du versement du dividende en actions, du capital versé de la société qui a versé le dividende et ii) la JVM des 100 actions émises à titre de dividende en actions au moment du versement.

Le paragraphe 55(2.4) L.I.R. énonce trois conditions qui doivent être respectées afin que le paragraphe 55(2.3) L.I.R. s’applique à un dividende en actions. Dans le présent scénario, ces trois conditions seraient respectées à l’égard de Gestion A et Gestion B.

Lorsqu’il est applicable à un dividende en actions, le paragraphe 55(2.3) L.I.R. prévoit ceci :

« a) le montant du dividende en actions est réputé, pour l'application du paragraphe (2), être un dividende imposable distinct jusqu'à concurrence de la partie du montant qui n'excède pas le montant du revenu gagné ou réalisé par une société – après 1971 et avant le moment de détermination du revenu protégé quant à l'opération, à l'événement ou à la série d'opérations ou d'événements – qu'il serait raisonnable de considérer comme contribuant au gain en capital qui aurait été réalisé lors d'une disposition à la juste valeur marchande, effectuée immédiatement avant le dividende, de l'action sur laquelle le dividende a été reçu;
b) le montant du dividende imposable distinct visé à l'alinéa a) est réputé réduire le montant du revenu gagné ou réalisé par une société – après 1971 et avant le moment de détermination du revenu protégé quant à l'opération, à l'événement ou à la série d'opérations ou d'événements – qu'il serait raisonnable de considérer comme contribuant au gain en capital qui aurait été réalisé lors d'une disposition à la juste valeur marchande, effectuée immédiatement avant le dividende, de l'action sur laquelle le dividende a été reçu. »

Pour les 25 actions ordinaires du capital-actions d’OPCO détenues respectivement par Gestion A et Gestion B, le gain en capital qui pourrait être réalisé lors d’une disposition à la JVM de ces actions, immédiatement avant le dividende en actions, serait de 249 975 $ (JVM de 250 000 $ moins PBR de 25 $). Le montant du dividende indiqué ci-dessus serait de 100 000 $ et il n’excéderait pas le montant du revenu gagné ou réalisé qu’il serait raisonnable de considérer comme contribuant au gain en capital qui pourrait être réalisé sur les 25 actions ordinaires immédiatement avant le dividende en actions (soit le revenu protégé de 100 000 $, indiqué ci-dessus).

Par conséquent, en vertu de l’alinéa 55(2.3)a) L.I.R., le montant du dividende en actions de 100 000 $ reçu par Gestion A et Gestion B sera réputé être un dividende distinct aux fins du paragraphe 55(2) L.I.R. En vertu de l’alinéa 55(2.3)b) L.I.R., ce montant de 100 000 $ sera réputé réduire le revenu gagné d’OPCO qui contribue au gain en capital des 25 actions ordinaires du capital-actions d’OPCO détenues respectivement par Gestion A et Gestion B.

En vertu du sous-alinéa 52(3)a)(ii) L.I.R., immédiatement après que le dividende en actions aura été versé, Gestion A et Gestion B détiendront 100 actions privilégiées high-low avec une JVM de 100 000 $ et un PBR de 100 000 $ ainsi que 25 actions ordinaires avec une JVM de 150 000 $ et un PBR de 25 $, entraînant ainsi un gain latent de 149 975 $ pour ces 25 actions ordinaires du capital-actions d’OPCO. Immédiatement après le versement du dividende en actions, les 25 actions ordinaires du capital-actions d’OPCO détenues respectivement par Gestion A et Gestion B n’auraient plus de revenu gagné. En vertu du paragraphe 52(3) L.I.R., le revenu gagné de 100 000 $ contribuant au gain en capital sur les 25 actions ordinaires du capital-actions d’OPCO détenues respectivement par Gestion A et Gestion B avant le versement du dividende en actions se retrouve maintenant reflété dans le PBR des 100 actions privilégiées high-low reçues à titre de dividende en actions par Gestion A et Gestion B.

Le paragraphe 55(2) L.I.R. ne devrait pas s’appliquer lors d’un rachat éventuel futur de ces 100 actions privilégiées high-low détenues par Gestion A ou Gestion B. D’une part, le sous-alinéa 55(2.1)b)(ii) L.I.R. ne s’applique pas à un dividende reçu lors d’un rachat d’actions et auquel le paragraphe 84(3) L.I.R. s’applique. D’autre part, le sous-alinéa 55(2.1)b)(i) L.I.R. ne devrait pas s’appliquer étant donné que, dans une situation où les actions privilégiées rachetées auraient une valeur de rachat égale à leur prix de base rajusté, le dividende visé par le paragraphe 84(3) L.I.R. n’aurait pas pour résultat de diminuer sensiblement la partie du gain en capital qui, sans le dividende, aurait été réalisée lors d’une disposition d’une action du capital-actions à la JVM effectuée immédiatement avant le dividende.

À l’égard de Fiducie A et Fiducie B, immédiatement après le dividende en actions, elles détiendront chacune 100 actions privilégiées high-low ayant une valeur de rachat de 100 000 $ et, en vertu du sous-alinéa 52(3)a)(i) L.I.R. et de l’alinéa c) de la définition du terme « montant » prévue au paragraphe 248(1) L.I.R., un PBR de 100 $. Il y aurait donc un gain en capital latent de 99 900 $ sur ces 100 actions privilégiées high-low. De plus, Fiducie A et Fiducie B détiendront chacune 25 actions ordinaires ayant une JVM de 150 000 $ et un PBR de 25 $, entraînant ainsi un gain latent de 149 975 $.

Le revenu gagné d’OPCO contribuant au gain en capital de 25 actions ordinaires détenues respectivement par Fiducie A et Fiducie B ne sera réduit que de 100 $, soit le dividende en actions reçu par Fiducie A et Fiducie B. Le revenu gagné contribuant à l’ensemble des actions détenues par Fiducie A ou Fiducie B sera donc de 99 900 $. Ce montant de revenu gagné sera toutefois réparti entre les deux catégories d’actions détenues par Fiducie A et Fiducie B en fonction du gain latent sur chacune des catégories.

Selon le scénario présenté à la question 4a), le revenu gagné pouvant raisonnablement être considéré comme contribuant au gain en capital sur les 25 actions ordinaires du capital-actions d’OPCO détenues par Fiducie A et Fiducie B serait de 59 940 $ (149 975 / 249 875 x 99 900) et le revenu gagné pouvant raisonnablement être considéré comme contribuant au gain en capital sur les 100 actions privilégiées high-low du capital-actions d’OPCO détenues par Fiducie A et Fiducie B serait de 39 960 $ (99 900 / 249 875 x 99 900).

Réponse de l’ARC à la question 4b)

En raison de la définition du terme « montant » prévue au paragraphe 248(1) L.I.R., Fiducie A inclurait dans le calcul de son revenu 100 $ à titre de dividende en actions versé par OPCO. Quant aux actions privilégiées high-low attribuées par Fiducie A à Gestion A à titre de capital, et en présumant que Fiducie A a pu effectuer une telle distribution sans conséquence fiscale en vertu du paragraphe 107(2) L.I.R., le revenu gagné contribuant au gain en capital de ces actions serait le même que celui déterminé à la question 4a), soit 39 960 $.

Il convient de noter que les règles spéciales concernant le montant des dividendes en actions qui ont été ajoutées à la Loi de l’impôt sur le revenu par le législateur, entre autres aux paragraphes 55(2.2) à 55(2.4) L.I.R., visaient des préoccupations de politique fiscale associées à l’utilisation de ce type de dividendes dans le but de contourner le paragraphe 55(2) L.I.R. ou d’en limiter son application.

Dans cette optique, le type d’opération décrit dans la question 4b) pourrait, en fonction des faits et des circonstances d’une situation réelle donnée, constituer une opération d’évitement, ce qui amènerait l’ARC à considérer l’application potentielle de la règle générale anti-évitement prévue au paragraphe 245(2) L.I.R. Dans une situation réelle donnée, il faudrait procéder à une analyse relative à l’avantage fiscal, à l’opération d’évitement et à l’abus de la Loi de l’impôt sur le revenu dans le cadre de l’examen de l’application potentielle du paragraphe 245(2) L.I.R.

Marc Séguin
(514) 620-8562
Le 5 octobre 2018
2018-076889

Summaries

Summary Under

Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.3)

shift in safe income to high-low prefs paid as stock dividend

Summary Under

Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.3)

different effect of stock dividend of high-low preferred shares paid to Holdco and trust shareholders

The 100 common shares of Opco, having an aggregate fair market value (FMV) of $1,000,000 and an aggregate paid-up capital (PUC), and aggregate adjusted cost base (ACB) to their holders, of $100 are held as to 25% and 25% by two unrelated holding companies (Holdco A and Holdco B) each wholly-owned by Mr. A and Mr. B and as to a further 25% and 25% by two discretionary family trusts for the families of A and B (Trust A and Trust B). The common shares (being all of the issued and outstanding shares) have an aggregate safe income of $400,000 ($100,000 each).

Opco now pays a $400 stock dividend (valued at $400,000) of high-low preferred shares so that each shareholder receives 100 preferred shares with a PUC of $100 and a redemption amount of $100,000.

How is the safe income allocated; and where Trust A is taxable on the $100 stock dividend and makes an immediate capital distribution of those preferred shares to Holdco A, what safe income will be attributable to those preferred shares received by Holdco A?

CRA first noted that for the purposes of inter alia ss. 55(2) to (2.4), s. 55(2.2) deems the amount of the stock dividend received by Holdco A and Holdco B and their s. 112(1) deductible amount to be $100,000. CRA then noted that since the accrued capital gain on the 25 common shares of OPCO held by Holdco A and B immediately before the stock dividend exceeded the $100,000 stock dividend amount and this $100,000 amount, in turn, did not exceed the amount of income earned or realized that could reasonably be considered to contribute to the capital gain that could be realized on the 25 common shares immediately before the stock dividend, then by virtue of s. 55(2.3)(a), the amount of the $100,000 stock dividend received by Holdco A and Holdco B would will be deemed to be a separate dividend for the purposes of subsection 55(2), and by virtue of s. 55(2.3)(b), OPCO's safe income that contributed to the capital gain on the 25 common shares of the capital stock of OPCO held respectively by Holdco A and Holdco B would be reduced by $100,000.

By virtue of s. 52(3)(a)(ii), the 100 high-low preferred shares of each of Holdco A and B (with a FMV of $100,000) will have an ACB of $100,000, their 25 common shares (with an FMV of $150,000) will have an ACB of $25; and those 25 shares would no longer have any safe income. By virtue of s. 52(3), the safe income of $100,000 contributing to the capital gain on the 25 common shares of the capital stock of OPCO held respectively by Holdco A and Holdco B before the payment of the stock dividend is now reflected in the ACB of the 100 high-low preferred shares received as a stock dividend by Holdco A and Holdco B.

As for Trust A and Trust B, immediately after the stock dividend, each of them will hold 100 high-low preferred shares having a redemption amount of $100,000 and, by virtue of s. 52(3)(a)(i) and para. (c) of s. 248(1) –amount, an ACB of $100. OPCO's safe income contributing to the capital gain on the 25 common shares held by Trust A and Trust B, respectively, will be reduced by only $100, being the stock dividend received by Trust A and Trust B. However, that amount of safe income will be split between the two classes of shares held by Trust A and Trust B based on the unrealized gain on each class.

The safe income reasonably contributing to the capital gain on the 25 common shares of the capital stock of OPCO held by Trust A and Trust B is $59,940 (149,975 / 249,875 X 99,900) and the safe income reasonably contributing to the capital gain on the 100 preferred shares held by Trust A and Trust B is $39,960 (99,900 / 249 875 X 99,900).

CRA then stated:

As for the high-low preferred shares distributed by Trust A to Holdco A as a capital distribution, and assuming that Trust A was able to make such a distribution with no tax consequences by virtue of subsection 107(2), the safe income contributing to the capital gain of those shares would be the same as that determined in Question 4(a), namely $39,960.

Summary Under

Tax Topics - Income Tax Act - Section 52 - Subsection 52(3) - Paragraph 52(3)(a)

different effect of stock dividend of high-low preferred shares paid to trust and corporate shareholders

The 100 common shares of Opco, having an aggregate FMV of $1,000,000 and an aggregate PUC and aggregate ACB to their holders, of $100, are held as to 25% and 25% by two unrelated holding companies (Holdco A and Holdco B) each wholly-owned by Mr. A and Mr. B and as to a further 25% and 25% by two discretionary family trusts for the families of A and B (Trust A and Trust B). The Opco common shares have an aggregate safe income of $400,000 ($100,000 to each shareholder).

Opco now pays a $400 stock dividend (valued at $400,000) of high-low preferred shares so that each shareholder receives 100 preferred shares with a PUC of $100 and a redemption amount of $100,000.

Consequences included the following:

By virtue of s. 55(2.3)(b), Opco's safe income that contributed to the capital gain on the 25 common shares of the capital stock of Opco held respectively by Holdco A and Holdco B would be reduced by $100,000.
By virtue of s. 52(3)(a)(ii), the 100 high-low preferred shares of each of Holdco A and B (with a FMV of $100,000) will have an ACB of $100,000.
Each Holdco’s 25 common shares (with an FMV of $150,000) will have an ACB of $25 and those 25 shares no longer have any safe income.
By virtue of s. 52(3), the safe income of $100,000 contributing to the capital gain on the 25 common shares of the capital stock of Opco held respectively by Holdco A and Holdco B before the payment of the stock dividend is now reflected in the ACB of the 100 high-low preferred shares received as a stock dividend by Holdco A and Holdco B.
As for Trust A and Trust B, immediately after the stock dividend, each of them will hold 100 high-low preferred shares having a redemption amount of $100,000 and, by virtue of s. 52(3)(a)(i) and para. (c) of s. 248(1) –amount, an ACB of $100.
Opco’s safe income contributing to the capital gain on the 25 common shares held by Trust A and Trust B, respectively, will be reduced by only $100, being the stock dividend received by Trust A and Trust B. However, that safe income amount will be split between the two classes of shares held by Trust A and Trust B based on the unrealized gain on each class – and, as noted, there now is significant unrealized gain on the preferred shares.

You are here

5 October 2018 APFF Roundtable Q. 4, 2018-0768891C6 F - Stock Dividend and Safe Income

View modes

Translation disclaimer