21 November 1991 Ministerial Correspondence 912954 F - Capital Gains Deduction

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.

Dear Sirs:

Re: Capital Gains Deduction

This is in reply to your letter dated October 9, 1991 wherein you requested our views regarding the application of subsection 110.6(8) of the Income Tax Act (the "Act") to the following hypothetical situation:

1.     Corporation A is a taxable Canadian corporation and a Canadian controlled private corporation within the meanings assigned by paragraphs 89(1)(i) and 125(7)(b) of the Act, respectively.

2.     Corporation A has both common and preferred shares outstanding.

3.     Dividends have never been paid on the preferred shares and Corporation A's common shareholders have concluded that a significant part of any capital gain that would result on the disposition of their common shares would be attributable to  such non-payment of dividends on the preferred shares.,

4.         It is proposed that a "catch-up" dividend be paid by Corporation A on its preferred shares equal to the sum of all dividends that would have been paid in every prior year that the preferred shares were outstanding had dividends been paid at the "average annual rate of return" (as defined in subsection 110.6(9) of the Act) for that prior year.

Issue

Where inadequate dividends are paid on a non-prescribed share (for the purpose of this letter "prescribed share" has the meaning assigned by section 6205 of the Income Tax Regulations) in one or more years, what is the effect, for the purposes of subsection 110.6(8) of the Act of a "catch-up" dividend in a subsequent year?

Our Comments

In interpreting the phrase "a significant part of the capital gain", as it appears in subsection 110.6(8) of the Act, it is our view that the determination of what constitutes a significant part of the capital gain is a question of fact which must be decided in each particular case having regard, as the subsection states, to all the circumstances. Accordingly, the Department has not developed detailed or specific guidelines in respect of this issue. While we are of the view that in many cases this question is appropriately answered by ascertaining the proportion or percentage of the capital gain that is attributable to the non-payment of adequate dividends, we are also of the view that there may be circumstances where it is appropriate to consider the amount or magnitude, expressed in dollars, of the capital gain that is so attributable.

It is our view that the phrase "the fact that dividends were not paid on a share (other than a prescribed share) of a corporation or that dividends paid on such a share in the year or in any preceding taxation year were less than 90% of the average annual rate of return thereon for that year", as it appears in subsection 110.6(8) of the Act, requires that the stipulated quantum of dividends must be paid on any relevant share (other than a prescribed share) in each and every year during the applicable period (generally the period throughout which the particular individual or a related person owns the property that is the subject of the disposition). If this is not done, it is not possible, after the end of a particular year, to pay a "catch-up" dividend so as to comply retroactively with this particular requirement.

However, the fact that no dividend or an inadequate dividend is paid in a particular year does not, in and of itself, mean that subsection 110.6(8) will automatically apply to deny the capital gains deduction. Rather, it is necessary to ascertain whether it may reasonably be concluded, having regard to all the circumstances, that a significant part of the capital gain is attributable to such fact. It is possible that, where a "catch-up" dividend of sufficient magnitude is paid, it would not be reasonable to conclude that a subsequent capital gain is attributable to the fact that no dividend or an inadequate dividend was paid in a year prior to the "catch-up" dividend. In other words, while a "catch-up" dividend cannot remedy a failure to comply with the "dividends were not paid" test and the "average annual rate of return" test, the "catch-up" dividend may, depending on all the circumstances, avoid an adverse result when applying the "reasonably attributable" test.

We are unable to provide you with any specific comments as to the circumstances in which a "catch-up" dividend may have the above effect. In this regard, we refer you to Question 60 at the 1987 Round Table (87 CR 47:35):

Whether the gain to be realized on a disposition is attributable to the fact that dividends were not paid on a share or that the dividends paid on such a share were less than 90 percent of the average annual rate of return as defined in subsection 110.6(9) is a determination that involves a significant finding of fact.

We are also unable to provide you with any specific comments regarding the quantum (absolute or relative) of a "catch-up" dividend; however, it is our view that funds available to a company as a result of the nonpayment of dividends on non-prescribed shares will increase the value of the company and that this increase in value may compound over time.

These comments represent our general views with respect to the subject matter of your letter.  The facts of a particular situation may yield a different result.  The foregoing comments are not rulings and, in accordance with the guidelines set out in Information Circular IC 70-6R2 dated September 28, 1990, are not binding on the Department.

We trust these comments will be of assistance to you.

Yours truly,

G. Thornley for DirectorBusiness and General DivisionRuling DirectorateLegislative and Intergovernmental Affairs Branch