10 November 1995 CTF Roundtable, 9529570 - 55(2) CASES - NASSAU WALNUT - CPL HOLDINGS

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:

Position with respect to recent 55(2) cases

Position:

see document

Reasons:

1995 Canadian Tax Foundation
Revenue Canada Forum

Subsection 55(2) - Recent Cases

We have been asked to comment on the recent decisions of the Tax Court of Canada in Nassau Walnut Investments Inc. 95 DTC 367 and the Federal Court - Trial Division in C.P.L. Holdings Ltd. 95 DTC 5253.

In Nassau Walnut, the appellant corporation owned 70,000 of the common shares of Westminster Transport Ltd. ("Westminster"). These shares had a fair market value of $700,000, paid-up capital of $1,000 and income earned or realized after 1971 ("safe income") attributable to them of $270,000. The shares were redeemed for $700,000 in a series of ten consecutive repurchase transactions. No designation was filed by the Appellant under paragraph 55(5)(f) in respect of any portion of the resulting $699,000 deemed dividend. The Minister, pursuant to subsection 55(2), reassessed the entire deemed dividend as proceeds of disposition. At trial, the Minister argued that the $270,000 of safe income was required to be allocated among the 70,000 shares pro rata. As a result, in the absence of a designation under paragraph 55(5)(f), the entire amount of the deemed dividend arising on the redemption of the Appellant's 70,000 Westminster shares was subject to being recharacterized as proceeds of disposition pursuant to subsection 55(2). The Appellant's position, which was accepted by the Court, was that it could allocate the $270,000 of safe income exclusively to the first 27,000 shares redeemed with the result that the Appellant would receive a $270,000 dividend tax-free.

This case has been appealed to the Federal Court of Appeal. Until the appeal is decided the Department intends to maintain its long-standing position¹ that each share of a corporation is entitled only to its proportionate share of the safe income of the corporation during the relevant holding period of that share. It should be noted that the Nassau Walnut decision was not followed in the recent Tax Court of Canada decision in Gestion Jean-Paul Champagne Inc. (Judgment dated October 6, 1995, as yet unreported).

In C.P.L. Holdings, the plaintiff owned 99 of the 100 issued and outstanding shares of Clem Industrial Machine Ltd. ("Clem Industrial"). On January 1, 1987 Clem Industrial declared a $415,000 dividend to the plaintiff. The proceeds of the dividend were immediately loaned back to Clem Industrial and secured by a demand debenture in favour of the plaintiff against the assets of Clem Industrial. One month later, the plaintiff sold 49 of its Clem Industrial shares to an arm's-length party for one dollar a share. In deciding that subsection 55(2) had no application to the transactions, the Court relied on the evidence of the witnesses called by the plaintiff who testified that the payment of the dividend was unrelated to the subsequent sale by the plaintiff of its shares in Clem Industrial.

The Department considers that the decision in C.P.L. Holdings is based on its own unique facts. In considering whether one of the purposes of a dividend was to significantly reduce the capital gain on the disposition of a share, the Department will examine all of the surrounding circumstances including the time elapsed between the payment of the dividend and the arm's-length sale. Ordinarily, if an arm's-length sale of shares occurs within a short time after a dividend was received on the shares, the Department will consider this to be strongly indicative that one of the purposes of the dividend was to reduce the capital gain that would otherwise have been realized on the share sale.

David Palamar
File 952957
November 10, 1995

ENDNOTES

¹ See, for example, John R. Robertson, Capital Gains Strips: A Revenue Canada Perspective on the Provisions of Section 55, in Report of Proceedings of the Thirty-Third Tax Conference, 1981 Conference Report (Toronto: Canadian Tax Foundation, 1982) p. 81 at 85.