12 January 1990 External T.I. 59210 - Avoidance of Tax on Capital Gains - Intercorporate Dividends Deemed to be Capital Gain

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.

January 12, 1990

Dear Sirs:

Re: Subsection 55(2) of the Income Tax Act (the "Act")

We are writing in response to your letter of November 28, 1989 requesting our opinion on the application of subsection 55(2) of the Act where there is an asset sale, followed by the payment of a dividend.

You have asked us to consider the following situation.

"1. Opco and Holdco are corporations incorporated under the laws of Canada. Each is a "Canadian corporation" and a "public corporation" within the meanings of paragraphs 89(l) (a) and 89(1)(g), respectively of the Act.

2. All of the issued and outstanding shares of Opco are held by Holdco.

3. Opco is desirous of divesting itself of one of its divisions: (the "Sold Assets") and for this purpose has entered into an agreement of purchase and sale with an arms length party for the sale of such assets. Opco will realize a capital gain upon the disposition of the Sold Assets.

4. Subsequent to the sale, Opco proposes to pay a dividend to Holdco equal to the net sale proceeds remaining after payment of any expenses related to the disposition and any resulting tax liability."

You have also provided the following comments:

1. The dividend paid by Opco to Holdco will be received as part of a transaction or event or a series of transactions or events that resulted in a disposition of property to an arm's length party.

2. The sale of the Sold Assets by Opco was in contemplation of the subsequent payment of a dividend to Holdco within the parameters of subsection 248(10) of the Act.

3. Any income from Opco's sale of the Sold Assets would not constitute "safe income" and the payment of a dividend by Opco to Holdco would not constitute a "safe dividend".

4. The proposed transaction is not a butterfly transaction described in paragraph 55(3)(b) of the Act.

It is your view that the application of subsection 55(2) of the Act to the dividend paid to Holdco in the above situation may be unintended since income, otherwise be "safe income", becomes something otherwise safe income" because a series of transactions or events, as described in paragraph 55(3) (a) of the Act, is considered to have commenced.

It is also your belief that inequitable results occur if subsection 55(2) of the Act is applied in this situation since the dividend will be paid out of p of its on which taxes have been paid and the payment reflects a business decision rather than an attempt to extract capital surplus.

The provisions of subsection 55(2) of the Act are intended to tax any intercorporate dividend where one of the purposes of paying the dividend was to effect a significant reduction in the capital gain which would, but for the dividend, have been realized on the disposition of any share of the capital stock of a corporation if such share had been disposed of at fair market value prior to the dividend. Whether or not one of the purposes of the above dividend is to reduce the gain on the shares of Opco is a question of fact. In the limited-fact situation presented we would not expect that purpose to be present.

However, if the dividend resulted from the application of subsection 84(3) of the Act, the provisions of subsection 55(2) of the Act are applied based on the results, not the purpose, of the dividend.

The opinions expressed are not rulings and are not considered binding on the Department in accordance with paragraph 24 of Information Circular 70-6R dated December 18, 1978.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch