18 September 2025 Roundtable, 2025-1067941C6 - CLHIA 2025 - Q.3 - Capital Dividend Account Anti-Avoidance Rule in Subsection 83(2.1)

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: Whether subsection 83(2.1) will be applicable in a particular fact scenario.

Position: No, but Part III tax will apply.

Reasons: see reasons below.

CLHIA Roundtable – September 2025

Question 3 - Capital Dividend Account Anti-Avoidance Rule in Subsection 83(2.1)

Background

Subsection 83(2) (endnote 1) generally provides that where a private corporation pays, at any particular time, a dividend on any class of shares of its capital stock and the corporation so elects in respect of the full amount of the dividend, in prescribed manner and prescribed form, the dividend will be deemed to be a capital dividend to the extent of the corporation’s capital dividend account immediately before the particular time. (endnote 2) In addition, no part of the dividend will be included in computing the income of any shareholder of the corporation.

However, subsection 83(2.1) contains an anti-avoidance rule which generally provides that where a capital dividend is paid on a share of a corporation and the share (or another share for which the share was substituted) was acquired by its holder in a transaction or as part of a series of transactions one of the main purposes of which was to receive the dividend, the dividend shall, inter alia, be deemed to be received by the shareholder and paid by the corporation as a taxable dividend and not as a capital dividend.

Subsections 83(2.2) to (2.4) contain certain exceptions to subsection 83(2.1). In particular, subsections 83(2.2) and (2.3) may be relevant where the addition to a corporation’s capital dividend account was the result of the receipt of the proceeds of a life insurance policy as described in paragraph (d) of the definition of capital dividend account.

We are seeking the CRA’s views on the application of the exceptions to subsection 83(2.1) in the following fact situation.

Fact Situation

Mr. A was the controlling shareholder of Opco A, a Canadian-controlled private corporation. Opco B was indirectly controlled by Mr. B, through Holdco B, a Canadian-controlled private corporation.

In 20X1, Opco A and Opco B entered into a partnership agreement relating to a specific business opportunity in respect of which Opco A and Opco B were jointly responsible for the related funding. However, Opco A ran into financial difficulty and Opco B had to lend $100,000 to Opco A (the “Opco A Loan”) to permit it to fund its investment. Opco A acquired a $100,000 life insurance policy on Mr. A’s life as collateral security for the Opco A Loan.

Shortly thereafter, Mr. A passed away. The proceeds of the life insurance policy received by Opco A were fully used by it to repay the Opco A Loan. Opco A’s accountants credited the total amount of the life insurance proceeds of $100,000 to Opco A’s capital dividend account by reason of paragraph (d) of the definition of capital dividend account (the adjusted cost basis of the policy was nil).

Subsequently, the spouse of Mr. A agreed to sell the shares of Opco A to Opco B for $10,000. Once this sale was concluded, Holdco B arranged for Opco A and Opco B to be amalgamated to form Amalco AB. Immediately before the amalgamation, Opco A had a capital dividend account of $100,000, corresponding to the life insurance proceeds received by Opco A, and Opco B had a capital dividend account of nil.

After several years, Amalco AB became profitable and had sufficient earnings to pay dividends to Holdco B. Since the amalgamation, no amount was added to Amalco AB’s capital dividend account. Amalco AB paid a dividend of $100,000 to Holdco B and elected that the full amount of the dividend be treated as a capital dividend.

For the purposes of this question, it can be assumed that one of the main purposes of the acquisition of the shares of Opco A by Opco B was to acquire Opco A’s capital dividend account, and that, prior to the sale of the shares of Opco A to Opco B, Opco A was never related to Opco B.

Question

Can the CRA confirm that due to the exceptions in subsections 83(2.2) to (2.4), subsection 83(2.1) will not apply to the capital dividend paid by Amalco AB to Holdco B.

CRA Response

For the reasons set out below, it is the CRA’s view that subsection 83(2.1) will not apply to the dividend paid by Amalco AB to Holdco B, but that Part III tax will apply in respect of the full amount of the dividend. This is because it is reasonable to conclude that Amalco AB’s capital dividend account was nil at the time it paid the dividend to Holdco B by virtue of the application of paragraph 87(2)(z.1) on the amalgamation of Opco A and Opco B (the “Amalgamation”).

Specifically, upon an amalgamation of two or more corporations, paragraph 87(2)(z.1) provides that, for purposes of computing the new corporation’s capital dividend account, the new corporation will be deemed to be the same corporation as, and a continuation of, each predecessor corporation, other than a predecessor corporation to which subsection 83(2.1) would, if a capital dividend were paid immediately before the amalgamation, apply to deem any portion of the dividend to be a taxable dividend.

Therefore, for purposes of computing Amalco AB’s capital dividend account as a result of the Amalgamation, Amalco AB will not be deemed to be a continuation of Opco A, such that Opco A’s capital dividend account of $100,000 will not be included in computing Amalco AB’s capital dividend account, if subsection 83(2.1) would apply to a capital dividend paid by Opco A to Opco B immediately before the Amalgamation (the “Hypothetical Capital Dividend”). In the present case, it can reasonably be considered that subsection 83(2.1) would apply to the Hypothetical Capital Dividend. This is because, one of the main purposes of the acquisition of the shares of Opco A by Opco B was to acquire Opco A’s capital dividend account (and hence to receive the Hypothetical Capital Dividend), and, as will be explained below, none of the exceptions in subsections 83(2.2) to (2.4) would apply in respect of the Hypothetical Capital Dividend.

Subsection 83(2.2) provides an exception to subsection 83(2.1) for certain capital dividends paid to an individual. This exception would not be applicable in the circumstances since the Hypothetical Capital Dividend is paid by Opco A to Opco B, a corporation.

Subsection 83(2.3) generally provides that subsection 83(2.1) will not apply to a capital dividend paid by a corporation where it is reasonable to consider that the purpose of paying the dividend was to distribute the proceeds of a life insurance policy that were received by the corporation and included in computing its capital dividend account as a consequence of the death of a person. In the current fact situation, it would not be reasonable to consider that the purpose of the payment of the Hypothetical Capital Dividend immediately before the Amalgamation is to distribute the life insurance proceeds. This is because such proceeds were fully used by Opco A to repay the Opco A Loan prior to the Amalgamation. Consequently, subsection 83(2.3) would not apply to exclude the Hypothetical Capital Dividend from the application of subsection 83(2.1).

Finally, subsection 83(2.4) generally provides that subsection 83(2.1) will not apply to a capital dividend paid by a particular corporation to a corporation related to it (the “related corporation”) where it is reasonable to consider that all or substantially all of the capital dividend account of the particular corporation immediately before the dividend became payable consisted of amounts other than any amount described in paragraphs 83(2.4)(a) to (e). In particular, pursuant to paragraph 83(2.4)(b), the exception in subsection 83(2.4) will not apply where all or substantially all of the capital dividend account of the particular corporation consisted of amounts that represented the capital dividend account of a corporation before it became related to the related corporation. In the present case, immediately before the payment of the Hypothetical Capital Dividend, all of Opco A’s capital dividend account consisted of amounts that represented Opco A’s capital dividend account before it became related to Opco B. As such, subsection 83(2.4) would not apply to exclude the Hypothetical Capital Dividend from the application of subsection 83(2.1).

Based on the foregoing, it is the CRA’s view that subsection 83(2.1) would apply to the Hypothetical Capital Dividend, and, as a result, Opco A’s capital dividend account of $100,000 before the Amalgamation will not be included in computing Amalco AB’s capital dividend account by virtue of paragraph 87(2)(z.1). It therefore follows that, at the time of the actual payment of the dividend by Amalco AB to Holdco B, Amalco AB’s capital dividend account was nil. As such, the full amount of the dividend paid by Amalco AB does not constitute a capital dividend as defined in subsection 83(2) because paragraph 83(2)(a) only deems a dividend to be a capital dividend to the extent of the corporation’s capital dividend account immediately before the dividend became payable. Therefore, since the dividend paid by Amalco AB to Holdco B is not a capital dividend, subsection 83(2.1) will not be applicable in the circumstances and, subject to the filing of an election under subsection 184(3), Part III tax will apply in respect of the full amount of the dividend so paid.

Laurence Gagné
2025-106794
September 18, 2025

ENDNOTES

1 “Unless otherwise stated, all references to a statute are to the relevant provision of the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, (the Act), or, where appropriate, the Income Tax Regulations, C.R.C., c.945, as amended, (the Regulations)”.

2 The definition of “capital dividend account” is found in subsection 89(1).