23 March 1990 Internal T.I. 59599 F - Issue of Special Shares by Opco to Holdco

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.

March 23, 1990

Dear Sirs:

We refer to your letter of February 14, 1990, which was written in response to our letter to you of January 29, 1990.

In your letter, you questioned why we considered that the provisions of subsection 55(2) of the Income Tax Act (the "Act") could apply to an issue of special shares by an Opco to a Holdco in the manner described in our letter under reference.  You point out that the issue of the shares would not arise as a result of a transfer of assets, and that in the hypothetical situation you have in mind, the shares would not only be issued for nominal consideration, but would also be redeemable for a nominal value. However, the shares would carry the right to a large dividend in order to effect the transfer of retained earnings from Opco to Holdco to ensure that investment income generated by Opco is kept separate from operating income and operating capital.  As indicated in our earlier letter, the shareholders of Opco and Holdco would be the same.

Comments

The provisions of subsection 55(2) of the Act are always of concern in cases where a class of shares attracts an inordinately large dividend, whether that dividend is paid periodically or arises on the redemption of the shares.  Any dividend that would effect a significant reduction in the portion of a capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of the capital stock of either Opco or Holdco immediately before the dividend and that could reasonably be considered to be attributable to anything other than "...income earned or realized by any corporation..." would be subject to the purpose test of subsection 55(2) of the Act.  Here, we would point out that the provisions of subsection 55(2) would also apply to a dividend paid on a share or a class of shares which reduced a capital gain on any other share and which was part of a transaction or event or a series of transactions or events that resulted in any one of the two events referred to in paragraph 55(3)(a) of the Act. It should be noted that subsection 248(10) of the Act contains an extended definition of the term "series of transactions or events".

A class of shares that is entitled to receive a disproportionately large dividend in priority to other issued shares of a corporation would, in most cases, come under the scrutiny of subsection 56(2) of the Act.  In such cases, it is again a question of fact if the payment of a dividend results in the conferral of a benefit on a taxpayer who concurs to the payment or in a benefit that the taxpayer desires to have conferred on some person, and on this we make no comment in respect of your situation.  Also, depending on the circumstances, the provisions of subsection 245(2) of the Act could be considered.

We hope these comments will be of assistance.

Yours truly,

T. Harrisfor DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch