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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: In the hypothetical situations described, whether subparagraph 55(3)(a)(ii) would apply.
Position: In the situation described, there is a possibility that subparagraph 55(3)(a)(ii) would apply. We do not have sufficient information to reach a definitive conclusion.
Reasons: It may be argued that the two redemptions of shares are part of the same series of transactions or events. There may be an increase of interest resulting from the second redemption of shares by persons who are not related to the dividend recipients. If that increase is significant, subparagraph 55(3)(a)(ii) would apply. Subparagraph 55(3)(a)(v) could also apply with respect to the dividend resulting from the second redemption.
XXXXXXXXXX
2014-052801
Sylvie Labarre, CPA, CA
April 25, 2014
Dear Madam,
Subject: Subparagraph 55(3)(a)(ii) of the Income Tax Act
This is in response to your e-mail of April 15, 2014, in which you requested our opinion on the application of subparagraph 55(3)(a)(ii) of the Income Tax Act (hereinafter the "Act") in the following hypothetical situation.
Unless otherwise indicated, all legislative references in this letter are to provisions of the Act.
Hypothetical Situation
Holdco 1 and Holdco 2 respectively hold 50% of the participating and voting shares in the capital stock of the Opco corporation. Holdco 1 and Holdco 2 respectively hold 50% of the participating and voting shares in the capital stock of Quebeco 1.
A holds 100% of the shares in the capital stock of Holdco 1.
B holds 100% of the shares in the capital stock of Holdco 2.
A and B respectively hold 50% of the participating and voting shares in the capital stock of Quebeco 2. Quebeco 1 holds 1,000,000 preferred shares in the capital stock of Quebeco 2. The adjusted cost base and the paid-up capital of such preferred shares is $100. The redemption value for the preferred shares in the capital stock of Quebeco 2 is equal to $1,000,000, or $1 each.
Opco incorporates Québec Inc. #3. Opco holds all of the participating and voting shares of Québec Inc. #3. Quebeco 2 transfers to Quebec Inc. #3, a realty property with a fair market value of $100,000 and a cost amount of $1,000. Quebeco 2 and Québec Inc. #3 make an election under subsection 85(1) in respect of the transfer of the property. Quebeco 2 receives 100,000 preferred shares in the capital stock of Québec Inc. #3. The adjusted cost base and the paid-up capital of such preferred shares is $1,000. The redemption value of the preferred shares in the capital stock of Québec Inc. #3 is equal to their fair market value of $100,000.
Following the transfer of the property, Quebeco 3 redeems the preferred shares of its capital stock held by Quebeco 2 ("Redemption 1"). The consideration received by Quebeco 2 in respect of this redemption has a fair market value of $100,000. A deemed dividend of $99,000 results from Redemption 1 under subsection 84(3). Quebeco 2 deducts this dividend under subsection 112(1) in computing its taxable income.
Following Redemption 1, Quebeco 2 redeems the preferred shares of its capital stock held by Quebeco 1 (hereinafter "Redemption 2"). The consideration received by Quebeco 1 in respect of this redemption is equal to $1,000,000. A deemed dividend of $999,900 results from Redemption 2 under subsection 84(3). Quebeco 1 deducts this dividend under subsection 112(1) in computing its taxable income.
Questions
You wish to know whether subparagraph 55(3)(a)(ii) would apply in the context of Redemption 1.
You also wish to know whether subparagraph 55(3)(a)(ii) would apply in the context of Redemption 2.
This technical interpretation provides general comments on the provisions of the Act and related legislation, where referenced. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R5, Advance Income Tax Rulings and Technical Interpretations.
For the purposes of this letter, we assume that A and B are not related for the purposes of section 55.
Redemption 1
In determining whether subparagraph 55(3)(a)(ii) applies in connection with Redemption 1, it would be necessary, among other things, to determine which transactions form part of the series of transactions or events as part of which the dividend resulting from Redemption 1 was received.
Next, consideration should be given as to whether an increase described in subparagraph 55(3)(a)(ii) occurred as part of the series of transactions or events.
In our view, subparagraph 55(3)(a)(ii) does not apply in respect of any increase in the total direct ownership interest of Opco in Québec Inc. #3 that results from Redemption 1, if there is such an increase, as Opco is a person related to Quebec Inc. #2, the recipient of the dividend.
We are also of the view that in this situation it could be argued that Redemption 2 is part of the same series of transactions or events as part of which the dividend resulting from Redemption 1 was received. However, we cannot give you a definitive conclusion in this regard in a technical interpretation and in the absence of a review of all the surrounding facts.
If Redemption 2 was in the same series as Redemption 1, it would be necessary to determine whether any increase in the total direct interest in Quebec Inc. #2 of A and B would come within subparagraph 55(3)(a)(ii) where this subparagraph is considered in respect of Redemption 1. Under the assumptions we have made for the purposes of this letter, A or B, as the case may be, would not be related to the recipient of the dividend, Québec Inc. #2. Furthermore, any increase in the direct interest of A or B in Quebeco 2 would result from the disposition of shares in the capital stock of Quebeco 2 by Quebeco 1 for proceeds of disposition that were less than their fair market value by virtue of the application of paragraph (j) of the definition of "proceeds of disposition" in section 54 (which excludes a deemed dividend under subsection 84(3) from proceeds of disposition of shares.) Therefore the question becomes whether the total direct interest of A and B in Quebeco 2 increases significantly as part of the series of transactions or events that includes Redemption 2.
In general, a significant increase in the total direct interest in a corporation of a person or persons who were unrelated to the recipient of the dividend can be determined by reference to the value of the investment in the corporation or as a function of the percentage of equity held in the corporation. In Technical Interpretation 9725615, our Directorate addressed in these terms the calibration of a significant increase of a person in the circumstances in which no person acquires shares of a corporation:
“In circumstances where no person has acquired any shares of the corporation in question, it is our view that for the purposes of determining whether there has been "a significant increase in the total direct interest" of an unrelated person in the corporation for the purposes of the proposed amendments to subparagraph 55(3)(a)(ii) and (iv) of the Act that one must compare the value of a person's interest in the corporation as a percentage of the value of all interests in the corporation immediately before the share redemption to the value of that person's interest in the corporation as a percentage of the value of all interests in the corporation immediately after the share redemption.”
In order to determine if there is an increase in interest, it is necessary to compare (i) the percentage obtained by comparing the value of the shares held by A and B in the capital stock of Quebeco 2 with the total value of all interests, immediately before Redemption 2, with (ii) the percentage obtained by comparing the value of the shares held by A and B in the capital stock of Quebeco 2 with the total value of all interests immediately after Redemption 2. Following such comparison, we could conclude that there is a significant increase described in subparagraph 55(3)(a)(ii). We do not have sufficient information to provide you with more specific comments on the presented situation.
Thus, if the conditions described under subparagraph 55(3)(a)(ii) were satisfied in the hypothetical situation presented, the recipient of the deemed dividend resulting from Redemption 1 would not be able to utilize the exception to the application of subsection 55(2), provided for in paragraph 55(3)(a).
Redemption 2
In determining whether subparagraph 55(3)(a)(ii) applies in connection with Redemption 2, it is necessary, among other things, to determine which transactions form part of the series of transactions or events in which the dividend resulting from Redemption 2 has been received.
Next, consideration should be given to whether an increase described in subparagraph 55(3)(a)(ii) has occurred as part of the series of transactions or events.
We are of the view that in this situation it could be argued that Redemption 1 forms part of the same series of transactions or events in which the dividend resulting from Redemption 2 has been received.
However, subparagraph 55(3)(a)(ii) would not apply in respect of any increase in the total direct interest of Opco in Quebeco 3 resulting from Redemption 1, if there is such an increase, as Opco is a person related to Quebeco 1, the recipient of the dividend. Furthermore, it would be necessary to determine whether any increase in the total direct interest in Quebeco 2 of A and B would come within subparagraph 55(3)(a)(ii) when that subparagraph is considered in respect of Redemption 2. Under the assumptions made for the purposes of this letter, A or B, as the case may be, would not be related to the recipient of the dividend, Quebeco 1. In addition, any increase in the direct interest of A and B in Quebeco 2 would result from the disposition of shares in the capital stock of Quebeco 2 by Quebeco 1 for proceeds of disposition less than their fair market value by virtue of the application of paragraph (j) of the definition "proceeds of disposition" in section 54 (which excludes the deemed dividend under subsection 84(3) from proceeds of disposition of shares). The question would then be whether the total direct interest of A and B in Quebeco 2 increased significantly as part of the series of transactions or events that includes Redemption 2.
The three penultimate paragraphs of the comments set out above under "Redemption 1" section apply when determining whether a significant increase has occurred as a result of Redemption 2.
Furthermore, subparagraph 55(3)(a)(v) could also apply in the context of Redemption 2 by Quebeco 2 in the event of a significant increase in the total direct interest of A and B in Quebeco 2, the dividend payer in respect of Redemption 2.
Thus, if the conditions described under subparagraph 55(3)(a)(ii) or subparagraph 55(3)(a)(v) were satisfied in the hypothetical situation presented, the recipient of the deemed dividend resulting from Redemption 2 could not utilize the exception to subsection 55(2) under paragraph 55(3)(a).
We hope that our comments are of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch
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