4 July 1995 External T.I. 9516855 - 55(2) AND REDEMPTION OF SHARES

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.

Principal Issues:

	Whether subsection 55(2) of the Act would apply to 	a deemed dividend arising on the redemption of 	shares.

Position TAKEN:

	Unless there is safe income attributable to the 	shares or Part IV tax is paid on the dividend, the 	dividend will be subject to the application of 	subsection 55(2) of the Act.

Reasons FOR POSITION TAKEN:

	The deemed dividend has resulted in a significant 	reduction in the capital gain that would have been 	reported by the corporation on the disposition of 	the shares that were redeemed and the exception in  	55(3)(a) is not applicable.

		951685
XXXXXXXXXX	A. Seidel

Attention: XXXXXXXXXX

July 4, 1995

Dear Sirs:

This is in reply to your letter dated April 28, 1995, which was faxed to us on June 23, 1995, in which you requested our views with respect to the application of subsection 55(2) of the Income Tax Act (the "Act") to a redemption of shares.

It appears that the interpretation you seek relates to specific taxpayers and specific proposed transactions and, therefore, we bring to your attention Information Circular 70-6R2 dated September 28, 1990 and the Special Release thereto dated September 30, 1992, issued by Revenue Canada, Customs, Excise and Taxation. Confirmation with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. Nevertheless, we can offer the following general comments in response to your letter.

A father, through a holding company, controls a corporation (hereinafter referred to as "Opco") and his son, daughter and son-in-law, through holding companies, are minority shareholders of Opco. It is proposed that the son's holding company (hereinafter referred to as "Sonco") will acquire all of the shares of Opco held by his father's holding company and that Opco will redeem its shares held by the son-in-law's holding company (hereinafter referred to as "Holdco"). Holdco owns in excess of 20% of the common shares of Opco

In the situation where Opco redeems its shares such that the redemption price paid for such shares exceeds the paid-up capital of such shares, Holdco will, subject to the application of subsection 55(2) of the Act, be deemed to have received a taxable dividend equal to such excess pursuant to subsection 84(3) of the Act.

Unless one of the exceptions in subsection 55(3) of the Act is applicable, subsection 55(2) of the Act provides that where Holdco is entitled to a deduction under subsection 112(1) of the Act in respect of the subsection 84(3) deemed dividend and the dividend is received as part of a series of transactions or events, one of the results of which was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on the disposition at fair market value of any share of capital stock immediately before the dividend and that could reasonably be considered to be attributable to anything other than income earned or realized after 1971 and before the commencement of the series of transactions or events (referred to as "safe income"), the amount of the dividend is deemed not to be a dividend received by Holdco and, in the situation where Holdco has disposed of the shares, the amount of the taxable dividend is deemed to be proceeds of disposition of the share. Pursuant to subparagraph (b)(i) of the definition of "disposition" in section 54 of the Act and the provisions of subsection 84(9) of the Act, the redemption of the Opco shares is a disposition of those shares to Opco for purposes of the Act.

Pursuant to paragraph 55(3)(a) of the Act, subsection 55(2) of the Act does not apply to any dividend received by a corporation unless the dividend was received as part of a transaction or event or series of transactions or events that resulted in a disposition of property to a person to whom the corporation was not related or that resulted in a significant increase in the interest in any corporation of any person to whom the dividend recipient was not related.

Pursuant to subparagraph 55(5)(e)(i) of the Act, a person is deemed not to be related to another person if they are brothers or sisters of that person. The extended meaning of brother in paragraph 252(2)(b) of the Act includes a brother-in-law. Accordingly, in the situation described herein, the redemption of the Opco shares held by Holdco would result in both a significant increase in the interest in any corporation (ie. Opco) of a person (ie. Sonco) to whom the corporation that received the dividend (ie. Holdco) was not related and a disposition of property (ie. the Opco shares) to a person (ie. Opco) to whom the dividend recipient (ie. Holdco) is not related such that the exception to the application of subsection 55(2) of the Act in paragraph 55(3)(a) of the Act would not apply.

It is therefore our view that a series of transactions which results in Holdco receiving a deemed dividend on the redemption by Opco of its shares and which also results in a significant reduction in the capital gain that would have been realized by Holdco on the disposition of the Opco shares would be subject to the application of subsection 55(2) of the Act such that the dividend would be deemed not to be a dividend and the amount of the deemed dividend would be deemed to be proceeds of disposition of those shares if the amount of the taxable dividend exceeds the aggregate of:

(i)the safe income on hand attributable to the Opco shares owned by Holdco, and

(ii)4 times the amount of any Part IV tax payable by Holdco in respect of such dividends.

However, a designation may be filed by Holdco under paragraph 55(5)(f) of the Act to designate the amount of the dividend referred to in (i) above as a separate dividend. In such case subsection 55(2) of the Act will only apply to the amount by which the taxable dividend exceeds the aggregate of the amounts in (i) and (ii) above.

These comments are provided in accordance with the guidelines set out in paragraph 21 of Information Circular 70-6R2.

Yours truly,

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