1 September 1998 CTF Roundtable, 9822610 - NEUMAN V. THE QUEEN

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.

Recent Cases
Revenue Canada Review
Canadian Tax Foundation Conference
October, 1998

Melville Neuman v. The Queen

Supreme Court of Canada
May 21, 1998

This case dealt with the application of 56(2) to an income-splitting transaction between Mr. Neuman and his spouse (“Mrs. Neuman”). In brief, the facts were as follows.

Mr. Neuman owned shares of a corporation (“Newmac”) which held an income producing asset. In April of 1981, Mr Neuman transferred his Newmac shares to a new corporation (“Melru”) in return for Melru Class G voting shares. Melru also issued 99 Class F shares to Mrs. Neuman which were non-voting but were entitled to receive, at the discretion of the directors, a dividend in preference to the Class G shares. In 1982, Mrs. Neuman was elected as sole director of Melru. Subsequently, in 1982, Newmac paid a dividend of $20,000 on its shares held by Melru. Mrs. Neuman caused Melru to pay a dividend on its Class F shares of $14,800 and on its Class G shares of $5,000. Mrs. Neuman immediately loaned $14,800 to Mr. Neuman in return for a promissory note. The loan was never repaid.

The Minister reassessed Mr. Neuman under subsection 56(2) to include $14,800 in his income. On appeal, the Supreme Court found that, in order for subsection 56(2) to be applicable, the person directing a payment must have a preexisting entitlement to that payment. Accordingly, subsection 56(2) was inapplicable to the Neuman arrangement because the dividends, if not declared and paid to Mrs. Neuman, were not required to be paid elsewhere.

The Department accepts the Supreme Court’s conclusions and will not generally seek to apply subsection 56(2) to income-splitting arrangements involving the payment of dividends by a corporation. Subsection 56(2) may be applicable, however, where dividends are paid to shareholders who, having regard to the dividend entitlements of their shares as set out in the articles of incorporation, receive dividends to which they are not entitled. In this case, to the extent that the person directing the payment of such dividends owns shares which entitle him or her to the dividends which were paid elsewhere, subsection 56(2) may be applicable.

Subsection 74.4(2) may be applicable to income splitting arrangements similar to those in Neuman. To the extent subsection 74.4(2) is not applicable, the Department would not generally seek to apply GAAR to these types of arrangements.

The Supreme Court also commented that, in general, taxpayers are entitled to arrange their affairs for the sole purpose of achieving a favourable position regarding taxation. The Department does not dispute this view. However, any transaction(s) to this end may be subject to the application of the anti-avoidance provisions of the Act including the GAAR.

Objections or appeals involving situations similar or identical to that in Neuman, which had been held in abeyance pending the outcome in Neuman, have been allowed.

However, with respect to taxpayers who had been assessed under subsection 56(2) with respect to discretionary dividends before the Supreme Court’s judgment and who had not objected to such assessments within the prescribed time, the Department will follow its usual policy and will not issue a reassessment for the purpose of allowing a refund to such a taxpayer.

File: 982261
Date: September 1998