29 November 2016 CTF Roundtable Q. 4, 2016-0671491C6 - 55(2) and Part IV Tax

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.

Principal Issues: Where a Canadian corporation (Holdco) has been subject to Part IV tax on a dividend received from Opco and the Part IV is refunded as a result of a payment of dividend to an individual shareholder such that subsection 55(2) applies to the dividend received from Opco, could Holdco elect under subsection 83(2) for a portion of the dividend paid to the individual shareholder to be a capital dividend?

Position: No. Subsection 55(2) only applies after the application of section 186 and subsection 129(1). The 83(2) election can only be made on a subsequent dividend but not on the dividend paid by Holdco that triggered the refund of the Part IV tax, otherwise it would impair on the application of subsection 55(2) to the dividend received by Holdco.

Reasons: See document.

2016 CTF Annual Conference
CRA Roundtable

Question 4: 55(2) and Part IV tax

Assume the following facts:

1. Holdco owns all the shares of Opco. Opco is therefore connected with Holdco by virtue of subsection 186(4).

2. Holdco and Opco have the same taxation year.

3. All the transactions described below occur in the same taxation year of Holdco and Opco beginning after 2015.

4. Opco’s refundable dividend tax on hand, as defined in subsection 129(3) (“RDTOH”), is approximately $383,333.

5. Taking its RDTOH into account, Opco will pay a taxable dividend of $1,000,000 to Holdco. Opco expects to receive a dividend refund under subsection 129(1) of $383,333 (based on the lesser of 38 1/3% of the taxable dividend paid and the RDTOH at the end of its taxation year).

6. Holdco will then pay a taxable dividend of the same amount to a shareholder who is an individual.

7. Consequently, Holdco will pay Part IV tax of $383,333 but will be eligible for an offsetting dividend refund.

8. Assume also the following:

* all transactions are part of the same series,
* no safe income can be considered to contribute to the gain, if any, on the shares of Opco held by Holdco, and
* paragraph 55(2.1)(b) applies to the dividend received by Holdco.

Question:

In Holdco’s tax return for the year in which it receives the $1,000,000 of dividend from Opco, by virtue of the application of subsection 55(2), the dividend would be reported as a capital gain of $1,000,000 of which $500,000 is taxable. Thus, Holdco would report no Part IV tax on the dividend and Holdco would add to its RDTOH account an amount equal to the lesser of $153,333 (30 2/3% of $500,000) and its Part I tax otherwise payable. Holdco would only need to pay a taxable dividend of $400,000 to the individual shareholder in order to get a full refund of its RDTOH. Therefore, instead of paying a taxable dividend of $1,000,000 to the individual shareholder, could Holdco instead elect under subsection 83(2) to pay a capital dividend of $500,000 and the balance of the $500,000 available cash as a taxable dividend to the individual shareholder?

CRA Response:

Although one should be able to self-assess under subsection 55(2) if one of the purposes under subparagraph 55(2.1)(b)(ii) is met, the application of subsection 55(2) in this situation is predicated on the actual payment of the Part IV tax and the actual receipt of the refund of such Part IV tax. In the situation described above, although paragraph 55(2)(c) deems the dividend received by Holdco to be a capital gain, the deeming has no incidence on the application of section 186 to the dividend received and, consequently, on the application of section 129 to the dividend paid by Holdco. Concluding otherwise would make the Part IV tax condition of application of subsection 55(2) redundant.

In Ottawa Air Cargo Centre Ltd v. The Queen (TCC affirmed by FCA) (2007 D.T.C. 661), the Court stated that:

“In terms of the “textual” operation of subsection 55(2), the dividend amount is deemed not to be a dividend, but rather proceeds of disposition on the sale of shares. The portion of the provision in parentheses enunciates an exception to the operation of subsection 55(2), and that exception is with regard to non-refunded Part IV tax. The portion of a dividend for which a refund of Part IV tax is not received is not subject to recharacterization. This seems to be all the more true as the phrase “subject to tax under Part IV that is not refunded” does not sound either hypothetical or analytical. It appears to require that a procedure be followed to the letter, which leads me to believe that the requirement of an actual refund of Part IV tax is mandatory for the dividend to be recharacterized as a capital gain under subsection 55(2).”

This means that Holdco would have to produce an original return and an amended return for the taxation year in which the dividend is received from Opco. The first return would report the amount of Part IV tax owing and the refund of such Part IV tax resulting from the payment of a dividend by Holdco to the individual shareholder. For the Part IV tax to be fully refunded, the taxable dividend paid to the individual shareholder has to be $1,000,000. The second return would provide adjustments resulting from the application of subsection 55(2) to the dividend received by Holdco. However, the amount of taxable dividend paid by Holdco to the individual shareholder would not change since a reduction of such amount would result in a reduction of the refund of the Part IV tax established in the original return and the application of subsection 55(2) would become applicable to a declining amount resulting from a circular calculation.

A textual, contextual and purposive interpretation of subsections 55(2) and 129(1) leads to the conclusion that Holdco’s election under subsection 83(2) in respect of the dividend paid to the individual shareholder that results in a refund of Part IV tax paid on the dividend received from Opco would not be valid as it would reduce the amount of the refund of Part IV tax resulting from the payment of a taxable dividend by Holdco and retroactively impair the application of subsection 55(2) to the dividend received from Opco.

The $500,000 increase of Holdco’s CDA resulting from the application of subsection 55(2) to the dividend of $1,000,000 received from Opco will be available to Holdco only for an election under subsection 83(2) on future dividends.

Marc Ton-That
2016-067149
November 29, 2016