21 May 1996 External T.I. 9526115 - IF DIVIDENDS PROHIBITED UNDER CORPORATE LAW?

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 the Department would apply subsection 110.6(8) in a situation where the payment of dividends was prohibited by corporate law tests of liquidity and solvency.

Position TAKEN:

The above-noted corporate law tests are facts which must be considered in determining whether subsection 110.6(8) would apply; however, they are not, in and by themselves, sufficient to conclude that subsection 110.6(8) would not apply.

Reasons FOR POSITION TAKEN:

Position taken in other files. The Department will rule on the application of subsection 110.6(8) when all the facts can be determined at the time of the ruling request.

			5-952611
XXXXXXXXXX		M. Azzi

Attention: XXXXXXXXXX

May 21, 1996

Dear Sirs:

Re: Subsection 110.6(8) of the Income Tax Act (the "Act")

This is in reply to your letter of October 4, 1995, wherein you enquired whether the Department would apply subsection 110.6(8) of the Act in a situation where the payment of dividends on shares, that are not prescribed shares within the meaning of section 6205 of the Income Tax Regulations, was prohibited by corporate law tests of liquidity and solvency. We apologize for the delay in responding to your request.

Our Comments

The scenario outlined in your letter appears to relate to actual proposed transactions involving identifiable taxpayers which, as reflected in paragraph 3 of Information Circular 70-6R2, should be the subject of an advance income tax ruling request. The Department will rule on the application of subsection 110.6(8) of the Act when all the facts can be determined at the time of the request. We are, however, prepared to offer the following general comments.

Subsection 110.6(8) of the Act is an anti-avoidance rule enacted to prevent the conversion of dividend income into exempt capital gains. Subsection 110.6(8) of the Act will apply if it may reasonably be concluded, having regard to all the circumstances, that a significant part of a capital gain is attributable to the fact that dividends were not paid on a share (other than a prescribed share) of a corporation or, if paid, were less than a required amount.

In interpreting the phrase "a significant part of the capital gain", 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.

As for the above-noted corporate law tests, in our view, they are facts which must be considered in determining whether subsection 110.6(8) of the Act would apply in a particular situation. However, these tests are not, in and by themselves, sufficient to conclude that subsection 110.6(8) of the Act would not apply.

We trust that these comments will be of assistance.

Yours truly,
R. Albert
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch