8 December 1995 External T.I. 9415515 - PAID-UP CAPITAL REDUCTIONS- DELAWARE CORPORATIONS

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

	 					5-941551
XXXXXXXXXX					A. Godin
(613) 957-8953

Attention: XXXXXXXXXX

November 12, 2002

Dear Sirs:

Re: Subsection 89(1) of the Income Tax Act (Canada) (the "Act")

This is in reply to your letter dated June 7, 1994 in which you requested our views as to whether a cash distribution by a Delaware corporation to its Canadian shareholder would be regarded as a tax-free return of capital or whether it would be regarded as a dividend for Canadian tax purposes. You present the following situation.

Canco is a taxable Canadian corporation and a private corporation. FA1 is a wholly-owned subsidiary of Canco that was incorporated in the state of Delaware in the United States. On incorporation, FA1 issued common shares to Canco for a consideration of $100. Canco subsequently made various contributions to the capital of FA1 totalling $1,000. However no additional shares were received by Canco as consideration. The additional contributions increased the fair market value of the outstanding shares of FA1 by the amount of the contributions and their adjusted cost base pursuant to paragraph 53(1)(c) of the Act.

We understand from your letter that under Delaware corporate law, such additional contributions could have been added either to the capital or to the surplus account and that it was elected to add them to the capital account for corporate law purposes.

FA1 wishes to make a cash distribution of $500 to Canco by reducing its capital. However, it is your understanding that under Delaware corporate law a cash distribution to shareholders can only be made from a "surplus" account. In order to distribute any cash from the capital contributed to the corporation by the shareholders, FA1 must first transfer the amount from its capital account to its surplus account. In this regard, you summarized your understanding of the Delaware corporate law and attached a copy of section 244 on the question of capital contributions and distributions. Moreover, you state that under Delaware corporate law, any distribution of cash from surplus is considered to be a dividend. However, such distributions are clearly distinguishable from a dividend from retained earnings or earned surplus. For instance, only distributions from retained earnings are reported for financial statement purposes as a dividend.

Opinion requested

You ask the following questions.

1. In the fact situation described above, would the Department treat the distribution to Canco as a return of capital or as a dividend for Canadian tax purposes?

2. Would the Department's answer to question 1 change if the contributions had been made originally to surplus rather than to capital?

Our comments

The situation outlined in your letter appears to relate to a specific taxpayer and involve actual contemplated transactions. As explained in Information Circular 70-6R2 dated September 28, 1990 ("IC-70-6R2"), assurance as to the tax consequences of contemplated transactions can only be obtained in the context of an advance income tax ruling. The procedure for requesting an advance ruling is outlined in IC-70-6R2. Nevertheless, we can offer the following general comments.

A distribution of property by a corporation to its shareholders can be either a dividend or represent a non taxable return of capital, for the purpose of computing a taxpayer's income for a taxation year. Whether a cash distribution is a dividend or a return of capital in any particular situation is a question of fact to be determined with regard to the relevant corporate law.

Subsection 248(1) generally defines a dividend as including a stock dividend, but does not define the word beyond that; consequently, we must look to the accepted ordinary meaning of the term for the purposes of the Act. Generally, it is our view that a dividend can include any distribution of property by a corporation to its shareholders that is not a return of the paid-up capital of a class of shares of a corporation. For this purpose, it does not matter whether the corporation making the distribution is a Canadian resident or not. We find support for this position in Cangro Resources Limited (In Liquidation) v. Minister of National Revenue, 67 DTC 582.

In some jurisdictions, a corporation can return capital to its shareholders by reducing its capital account as determined under corporate law. A reduction in the stated capital account of a class of shares of a corporation produces a corresponding decrease in the "paid-up capital" of that class of shares since paid-up capital, as defined in subsection 89(1) of the Act generally reflects, subject to some exceptions, the stated capital of a corporation. A reduction in the paid-up capital of a class of shares does not constitute a dividend for the purposes of the Act, but instead gives rise to a reduction in the adjusted cost base of the shares of the corporation pursuant to subparagraphs 53(2)(a)(ii) or (b)(ii), depending on the circumstances.

As mentioned in paragraph 2 of Interpretation Bulletin IT-463R dated July 12, 1991 ("IT-463R"), the paid-up capital of a class of shares of a corporation is determined, pursuant to clause 89(1)(c)(ii)(C), without reference to the Income Tax Act. The calculation is therefore based on the relevant corporate law rather than tax law. The paid-up capital is frequently referred to as stated capital under corporate law and is usually identified as such in the corporation's financial statements. Paragraph 3 of the Bulletin states that the stated capital account reflects the par value of shares issued with a par value and the amount ascribed by the directors for shares issued without par value. Paragraph 4 of the Bulletin states that neither amounts contributed by shareholders that are not represented by issued shares (contributed surplus for example) nor premiums received for a particular share issue constitute part of paid-up capital under clause 89(1)(c)(ii)(C) unless it forms part of stated capital under the applicable corporate law.

We understand, from the information provided in your letter, that under Delaware corporate law, it is not possible for a corporation to make any asset distribution by reducing its capital. Instead, cash distributions must be made from the surplus account and constitute dividends under Delaware law. You point out that these payments are not distributions of corporate profits. This does not appear to have any bearing on the matter as such distributions are still regarded as dividends in Delaware. In our view, a distribution of the type envisaged in your letter would not lead to a reduction in the adjusted cost base of the shares pursuant to subparagraph 53(2)(b)(ii) since it would not be an amount received by a taxpayer on a reduction of the paid-up capital of the corporation; the amount would instead be received on a reduction of the surplus of the corporation. The reduction in the paid-up capital of the corporation does not give rise to any payment, but rather to an increase in the surplus account.

In conclusion, it seems to us that a distribution as described above would be regarded as a dividend and not as a return of capital, regardless of whether the initial contribution was made to capital or to surplus, and that this tax result is attributable to the fact that Delaware corporate law does not permit any return of capital except from a surplus account. While we have not explored this question further, it seems conceivable that a similar result could be found in other jurisdictions as well, including possibly some Canadian jurisdictions.

We regret that our answer could not be more favourable. We would like to apologize for the lengthy delay in responding, which was attributable to a number of reasons.

The foregoing represents our general views with respect to the subject matter of your letter. The foregoing opinions are not rulings and in accordance with the guidelines set out in Information Circular 70-6R2 dated September 28, 1990 are not binding on Revenue Canada, Customs, Excise and Taxation.

Yours truly,

for Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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