23 June 1989 Administrative Letter 58226 F - Refundable Divided Tax on Hand of a Canadian-controlled Private Corporation

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.

June 23, 1989

Dear Sirs:

Re:  Subsection 129(1) and 186(1) of the Income Tax Act (the "Act")

We refer to your letter of November 10, 1988 in which you requested a technical interpretation of the provisions of subsection 129(1) of the Act as it interacts with the provisions of subsection 186(1) of the Act in the situation described below. We apologize for the delay in responding to your letter, which, as you are aware, was occasioned partly by the need to obtain the views of our Audit Application Division on the assessing practice of the Department on the type of situation described by you and partly by the workloads of that Division and of this Directorate.

The factual situation addressed in your letter pertains to a husband and wife who are in the process of separating and who will ultimately obtain a divorce. The husband is the sole shareholder of a Canadian-controlled private corporation ("CCPC") which has refundable dividend tax on hand ("RDTOH") of approximately (19(1)) CCPC and RDTOH have the meanings assigned by paragraph 125(7)(b) and subsection 129(3) of the Act, respectively.  Pursuant to the separation agreement, the husband has agreed to transfer shares of his holding company in exchange for shares of that company. As a result of the acquisition of the shares of the CCPC by the wife's holding company, the CCPC would be "connected" to that company by virtue of the provisions of paragraph 186(4)(a) and subsection 186(2) of the Act, or alternatively, pursuant to the provisions of paragraph 186(4)(b) of the Act.

It is intended that the CCPC will then redeem its shares held by the holding company at a redemption price equal to their fair market value, with the result that the CCPC would be entitled to a dividend refund pursuant to the provisions of subsection 129(1) of the Act, and the holding company will be subject to Part IV tax by virtue of the provisions of paragraph 186(1)(b) of the Act. You indicate that both husband and wife wish to avoid the tax consequences described herein, and suggest that if the CCPC agrees to forego the dividend refund, then the holding company would not be subject to Part IV tax. In view of the wording adopted in paragraph 129(1)(a) of the Act, you believe that the act of making a dividend refund is a discretionary and you seek confirmation of this from us.

You also requested our opinion on an alternative arrangement.  Under this second alternative, immediately after the redemption by the CCPC of its shares held by the wife's holding company, the CCPC would obtain a daylight loan, and use the funds therefrom to subscribe for retractable and redeemable preferred shares of the holding company having a high redemption amount and a low paid-up capital, within the meaning of paragraph 89(1)(c) of the Act.  The redemption amount of the preferred shares would be equal in value to the redemption price paid by the CCPC to the holding company as set out above.

The holding company would then use the proceeds of the subscription price to redeem its preferred shares from the CCPC, which would then repay the daylight loan. In this manner, the holding company would create a dividend refund, and the CCPC would be subject to Part IV tax pursuant to paragraph 186(1)(b) of the Act in equal and offsetting amounts to the dividend refund due to the CCPC and the Part IV tax payable by the holding company that would arise in the situation described above.

Opinions

Your request appears to relate to a specific proposed transaction. Confirmation of the tax consequences of a specific proposed transaction will only be provided in response to a request for an advance income tax ruling. The procedures for requesting an advance ruling are set out in Information Circular 70-6R. Although we are unable to provide any opinion in response to the specific transactions described in your letter, we do provide the following general observations.

Paragraph 129(1)(a) of the Act states that:

     Where a corporation was, at the end of any taxation year, a private corporation and a return of its income for the year has been made within 3 years from the end of the year, the Minister

(a)     may, upon mailing the notice of assessment for the year, refund without application therefor an amount (in this Act referred to as its "dividend refund" for the year) equal to the lesser of

(i)     1/4 of all taxable dividends paid by it in the year on shares of its capital stock; and

(ii)     its refundable dividend tax on hand at the end of the year.

We agree that the above provision does not impose upon the Minister the requirement to pay a dividend refund as defined under paragraph 129(1)(a) of the Act.  However, it is our view that by definition, a dividend refund arises when a private corporation (as defined by paragraph 89(1)(f) of the Act) has paid a taxable dividend in a taxation year, and at the end of that year, has RDTOH.  Consequently, whether or not the Minister refunds the lesser of the two amounts referred to in paragraph 129(1)(a) of the Act, the holding company referred to in your letter would, in our view, be subject to Part IV tax pursuant to paragraph 186(1)(b) of the Act on the amount of the dividend it would be deemed by paragraph 84(3)(b) of the Act to have received from the CCPC as a result of the redemption by the CCPC of its shares, as described above.

In response to the alternative arrangement described in your letter, it is our opinion that the provisions of subsection 129(1.2) of the Act would apply thereto, with the result that the dividend arising as a consequence of the redemption of the preferred shares of the holding company would, for the purposes of subsection 129(1) of the Act, be deemed not to be a taxable dividend.

Yours truly,

for Director Reorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch