Translation disclaimer
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: A Canadian-controlled private corporation ("Holdco") owns all of the voting and participating shares of the capital stock of another Canadian-controlled private corporation ("Subco"). At one point in time, Holdco also owned more than 50% of the voting shares of the capital stock of a public corporation ("Pubco"). Pubco owns preferred shares of the capital stock of Subco (the "Subco Preferred Shares"). The Subco Preferred Shares were issued as consideration for the transfer of assets by Pubco in favour of Subco on a rollover basis. The Subco Preferred Shares are retractable for an amount equal to the fair market value ("FMV") of the consideration received by Subco upon the issuance of the shares, plus a premium to be established in function of various parameters (the "Premium"). The purchase agreement between Pubco and Subco contains a price adjustment clause. Initially, Subco and Pubco determine the FMV of the transferred assets to be $2 M. Afterwards, the price adjustment clause operates and the FMV of the transferred assets and the Subco Preferred Shares is reduced by $1 M. As a result of various transactions, Holdco ends up losing control of Pubco. After this loss of control of Pubco, the Subco Preferred Shares are redeemed. Question a): Whether the Part IV.1 tax or the Part VI.1 tax would apply with respect to the redemption of the Subco Preferred Shares. Question b): If Part VI.1 tax applies, whether subsection 191(4) would apply in order to deem an amount of $1 M to be an "excluded dividend." Question c): Whether subsection 191(4) would also apply in order to deem an amount equal to the Premium to be an "excluded dividend." Question d): Whether Part VI.1 would apply to any dividends that could be paid on the Subco Preferred Shares. Question e): Whether subsection 55(2) would apply in the circumstances. Question f): What would be the impact of the application of subsection 55(2) with respect to the Part IV.1 and VI.1 taxes.
Position: Answer to Question a): The dividend resulting from the redemption of the Subco Preferred Shares would be an "excepted dividend" as described in paragraph 187.1 (d), provided that such dividend is received on a short term preferred share and is not described in paragraph (b) or (c) of the definition of "excluded dividend" in subsection 191(1). However, assuming that this is the case, Part VI.1 tax would apply to the dividend payer in the circumstances. Answer to Question b): Subsection 191(4) would not apply. The CRA's position is that for the purposes of subsection 191(4), the amount must be expressed in dollars and cannot be subject to a price adjustment clause. Answer to Question c): No. Answer to Question d): Yes. Answer to Question e): Yes. Answer to Question f): Where subsection 55(2) applies, the dividend is deemed not to be a dividend received by the corporation. Subsection 55(2) applies "notwithstanding any other section" of the Act. However, the dividend will still be a dividend from the perspective of the dividend payer. Consequently, Part IV.1, which normally applies with respect to dividends received by a corporation, cannot apply to the amount of the dividend deemed by subsection 55(2) not to be a dividend. However, the provisions of subsection 55(2) have no impact on the potential application of Part VI.1, which applies with respect to dividends paid by a corporation.
Reasons: Wording of the Act and previous positions.
2007-025083
XXXXXXXXXX S. Prud'Homme
(613) 957-8975
January 28, 2008
Dear Sir,
Subject: Request for Technical Interpretation - Subsection 55(2) and taxes of Parts IV.1 and VI.1 of the Income Tax Act.
This is in response to your email of July 2, 2007, in which you requested our opinion regarding the application of subsection 55(2) and the taxes under Parts IV.1 and VI.1 of the Income Tax Act (the "Act") in a particular situation.
Unless otherwise stated, all statutory references herein are to provisions of the Act.
It appears to us that the situation described in your letter and summarized below may be an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more completed transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their opinion. However, we are able to offer the following general comments that may be helpful. It should be noted that the application of one or more provisions of the Act generally requires an analysis of all the facts relating to a particular situation. Accordingly, and given that your letter only briefly describes a hypothetical situation, the comments we provide below may not be fully applicable in a particular situation.
(1) Particular Situation
You have presented us with the situation described below (the "Particular Situation") as part of your request for a technical interpretation.
A Canadian-controlled private corporation ("Holdco") holds all of the voting and participating shares of a second Canadian-controlled private corporation ("Subco"). During a particular taxation year, Holdco also held shares, representing more than fifty percent (50%) of the votes to elect the majority of the directors, of a public corporation ("Pubco") whose shares are traded on a stock exchange recognized by the Income Tax Regulations. Subco and Pubco are therefore related during this period as they are controlled by the same person, Holdco.
Furthermore, Pubco holds shares in the capital stock of Subco. Those shares are retractable preferred shares ("Rollover Preferred Shares") and were issued as part of an asset transfer made a few years earlier. At the time of that asset transfer, Subco and Pubco were related.
The Rollover Preferred Shares issued on the transfer of assets are short-term preferred shares by virtue of paragraph (a) of the definition of "short-term preferred share" in subsection 248(1). The Rollover Preferred Shares would also, by the same token, constitute taxable preferred shares by virtue of paragraph (a) of the definition of "taxable preferred share" in subsection 248(1).
The terms and conditions of the asset sale agreement contained a price adjustment clause in relation to the Rollover Preferred Shares. On the transfer of assets, the rollover forms were duly filed in the prescribed time and form.
The rights, privileges, conditions and restrictions provided for the Rollover Preferred Shares contain a premium clause (the "Premium"). That Premium is in addition to any consideration paid for the Rollover Preference Shares. It is payable and becomes due upon the purchase, cancellation or redemption of the Rollover Preferred Shares.
No fixed dollar amount is set out in the rights, privileges, conditions and restrictions for the Rollover Preferred Shares, in respect of the redemption value of such shares. However, a reference to the fair market value of the consideration received on issue of the shares is included in the rights, privileges, conditions and restrictions of the Rollover Preference Shares.
Upon issuance of the Rollover Preferred Shares, the redemption value of such shares was established by Pubco and Subco at an amount equal to the fair market value of the assets transferred, as determined at that time.
As a result of various transactions, Holdco lost control of Pubco. Consequently, Holdco and Pubco ceased to be related persons. Following that loss of control, no other person has control of Pubco. As Pubco is no longer related to Holdco, Pubco and Subco also ceased to be related persons at that time. On the loss of control of Pubco by Holdco, Pubco therefore no longer had a significant interest in Subco within the meaning of subsection 191(2).
After the loss of such related person status, the fair market value of the Rollover Preferred Shares was adjusted downwards following the application of the price adjustment clause provided for in the asset sale agreement. Thus, the original issue value of the Rollover Preferred Shares was set at an amount of $2,000,000. However, following the application of the price adjustment clause, the taxpayer and the tax authorities agreed to establish the fair market value of the assets transferred by Pubco to Subco at an amount of $1,000,000.
Subsequent to the application of that price adjustment clause, Subco begins to redeem the Rollover Preferred Shares held by Pubco. The Rollover Preferred Shares are redeemable at the fair market value of the consideration received on the rollover plus the Premium. As a result of the application of the adjustment clause, the Rollover Preferred Shares are therefore redeemable at a price lower than their original issue value, i.e., for an amount of $1,000,000, in addition to the Premium calculated according to various parameters.
The paid-up capital and adjusted cost base of the Rollover Preferred Shares are nominal.
You are of the view that, on redemption of the Rollover Preferred Shares, Subco would be deemed to have paid and Pubco would be deemed to have received a dividend pursuant to subsection 84(3) in an amount equal to the aggregate of the redemption value of the Rollover Preferred Shares and the Premium (the paid-up capital of the Rollover Preferred Shares being nominal). That dividend is a taxable dividend within the meaning of the definition in subsection 89(1). Pubco would deduct this taxable dividend received from Subco in computing its taxable income by virtue of subsection 112(1).
Question (a)
First, you wish to know whether the Canada Revenue Agency ("CRA") considers that, in the Particular Situation, Part IV.1 and Part VI.1 taxes would be applicable on the redemption of the Rollover Preferred Shares at a time when Subco and Pubco are not related persons.
In your view, Part IV.1 tax would not be applicable because the Rollover Preferred Shares would be short-term taxable preferred shares and any dividend on those shares would be an "excluded dividend" under paragraph 187.1(d). In your view, however, Part VI.1 tax would apply.
Question (b)
In the event that Part VI.1 tax would potentially apply to the dividend paid by Subco on the redemption of the Rollover Preferred Shares, you wish to know whether the CRA considers that subsection 191(4) would apply to deem an amount of $1,000,000 to be an "excluded dividend" for purposes of Part VI.1.
In that regard, you are of the view that subsection 191(4) would apply to deem an amount of $1,000,000 to be an "excluded dividend" for purposes of Part VI.1 since, in your view, a fixed amount for the cash redemption value was agreed to in the asset transfer agreement and pursuant to the application of the adjustment clause. On that basis, you are of the view that an amount of $1,000,000, payable on the redemption of the Rollover Preferred Shares, would not be subject to Part VI.1 tax.
Question (c)
You wish to know whether the CRA considers that subsection 191(4) would apply to deem the amount of the Premium to be an "excluded dividend" for Part VI.1 purposes.
In your view, the Premium would be subject to Part VI.1 tax as it would be an amount in excess of the fair market value of the original consideration for which the Rollover Preferred Shares were issued.
Question (d)
You wish to know whether the CRA considers that dividends that may be paid on the Rollover Preferred Shares would be subject to Part VI.1 tax.
In your opinion, such dividends would be subject to Part VI.1 tax.
Question (e)
You wish to know whether the CRA considers that the provisions of subsection 55(2) would apply to the dividend that would be deemed to be received by Pubco as a result of the redemption of the Rollover Preferred Shares.
Question (f)
If subsection 55(2) were to apply to the dividend that would be deemed to be received by Pubco as a result of the redemption of the Rollover Preferred Shares, you wish to know whether or not that statutory provision would override the taxes in Parts IV.1 and VI.1, and if so, to what extent.
Response to Question (a)
Generally, section 187.2 provides that a corporation is liable to tax under Part IV.1 at the rate of 10% on the total of all amounts each of which is a dividend, other than an "excluded dividend", received by it in the year on a taxable preferred share to the extent that any amount in respect of that dividend is deductible in computing its taxable income for the year under inter alia section 112.
Since the Rollover Preferred Shares would be short-term preferred shares, the dividend that would be received by Pubco as a result of the redemption of those shares would be an "excluded dividend" under paragraph 187.1(d) to the extent that the dividend would not be described in paragraph (b) or (c) of the definition of "excluded dividend" in subsection 191(1). Given that your email only briefly describes a hypothetical situation, we cannot confirm that the dividend received by Pubco as a result of the redemption of the Rollover Preferred Shares would not fall within paragraph (b) or (c) of the definition of "excluded dividend" in subsection 191(1). However, for the purposes hereof, we will assume that such dividend received by Pubco would not fall within paragraph (b) or (c) of the definition of "excluded dividend" in subsection 191(1), and therefore that such dividend would not be subject to Part IV.1 tax.
In general terms, and taking into account the proposed amendments, paragraph 191.1(1)(a) provides that a taxable Canadian corporation is liable to pay a tax under Part VI.1 equal to 50% of the amount, if any, by which the total of all taxable dividends, other than "excluded dividends", paid by the corporation in the year on short-term preferred shares exceeds the corporation's dividend allowance for the year.
Based on our understanding of the Particular Situation, the dividend that would be deemed to be paid by Subco on the redemption of the Rollover Preferred Shares would not be an "excluded dividend" within the meaning of the definition in subsection 191(1). Among other things, at the time such dividend would be paid by Subco, Pubco would not have a significant interest in Subco within the meaning of subsection 191(2). Accordingly, we are of the view that the portion of the dividend that would be deemed to be paid by Subco on the redemption of the Rollover Preferred Shares that would exceed the dividend allowance applicable to Subco for the year would be subject to Part VI.1 tax.
Response to Question (b)
Generally, for subsection 191(4) to apply and deem a dividend paid on the redemption of a share to be an "excluded dividend" for the purposes of Part VI.1, it is necessary for the terms or conditions of the share or the agreement in respect of the share specify an amount in respect of the share, including an amount for which the share is to be redeemed. In addition, for subsection 191(4) to apply, the specified amount must not exceed the fair market value of the consideration for which the share was issued or the fair market value of the share immediately before the particular time.
In that regard, the CRA's long-standing position is that, in order for an amount to be effectively and validly specified as an amount in respect of a share for purposes of subsection 191(4), that amount must, inter alia, be expressed in dollars, not be determined by formula, and not be subject to subsequent change. Specifically, the CRA has indicated in the past that it will generally not accept that the amount shown is subject to adjustment under a price adjustment clause.
Based on the foregoing and the fact that, in the particular situation, the price adjustment clause would have applied to reduce the redemption value of the Rollover Preferred Shares from $2,000,000 to $1,000,000, the CRA's position is that subsection 191(4) would not apply in this case, on the basis that no amount was actually and validly designated in respect of each of the Rollover Preferred Shares on the transfer of assets by Pubco to Subco, or on the basis that the amount originally designated in respect of each of those shares would exceed the fair market value of the assets transferred by Pubco to Subco.
Note that by virtue of subparagraph 191(4)(d)(ii), it would not be possible to claim that the dividend paid on the redemption of a Rollover Preferred Share would be deemed to be an "excluded dividend" for the purposes of Part VI.1 by virtue of the fact that the agreement for the redemption of such a share specified an amount in respect of the share. Indeed, the Rollover Preferred Shares would be "taxable preferred shares" immediately prior to the concluding of the redemption agreement.
In conclusion, we are of the view that the portion of the dividend that was deemed to be paid by Subco upon redemption of the Rollover Preferred Shares and that exceeded the dividend allowance applicable to Subco for the year would be subject to Part VI.1 tax.
Response to Question (c)
In response to Question (b), we indicated that subsection 191(4) would not be applicable in the Particular Situation to deem the amount of the dividend arising from the redemption of the Rollover Preferred Shares to be an "excluded dividend" for the purposes of Part VI.1. Consequently, we are of the view that the portion of the dividend that would be deemed to be paid by Subco on the redemption of the Rollover Preferred Shares that would exceed Subco's dividend allowance for the year would be subject to Part VI.1 tax.
Response to Question (d)
Given that the Rollover Preferred Shares are short-term preferred shares and that dividends that may be paid on such shares would not be "excluded dividends" within the meaning of subsection 191(1) (or deemed to be so), we are of the view that the portion of such dividends that is paid by Subco and that exceeds Subco's dividend allowance for the year would be subject to tax under Part VI.1
Response to Question (e)
In the Particular Situation and as a result of the redemption of the Rollover Preferred Shares, Pubco, a corporation resident in Canada, received a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1). Furthermore, we understand that that dividend was received by Pubco as part of a transaction or event or a series of transactions or events, that would effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any Rollover Preferred Share immediately before the dividend and that could reasonably be considered to be attributable to something other than "safe income" earned or realized by any corporation after 1971 and before the safe-income determination time for the transaction, event or series.
In addition, it appears that paragraph 55(3)(a) would not apply in the Particular Situation to ensure that subsection 55(2) does not apply to the dividend received by Pubco as a result of the redemption of the Rollover Preferred Shares.
Indeed, the redemption of the Rollover Preferred Shares would be caught by subparagraphs 55(3)(a)(ii) and (v) as it would result in a significant increase in the total direct interest in Subco (the "dividend payer") of Holdco, a person unrelated to Pubco (the "dividend recipient") immediately before the redemption. In addition, the exception for a disposition of shares for proceeds of disposition at least equal to fair market value in subparagraph 55(3)(a)(ii) would not apply in the circumstances (see, in particular, paragraph (j) of the definition of "proceeds of disposition" in section 54, and paragraph 55(3.01)(d)).
The redemption of the Rollover Preferred Shares would also be caught by subparagraphs 55(3)(a)(i) and (iii) since this transaction would result in a disposition of property (shares of the capital stock of Subco, the dividend payer) to Subco (see subsection 84(9) on this point) which would be a person unrelated to Pubco (the "dividend recipient") immediately before the redemption. The exception for a disposition of property for proceeds that are not less than fair market value in subparagraph 55(3)(a)(i) would not apply in the circumstances (see, for example, paragraph (j) of the definition of "proceeds of disposition" in section 54, and paragraph 55(3.01)(d)).
In view of the above, we are of the view that the provisions of section 55(2) would apply to the dividend that would be deemed to be received by Pubco arising on the redemption of the Rollover Preferred Shares.
Response to Question (f)
Where the conditions for the application of subsection 55(2) are satisfied, the amount of the dividend is deemed not to be a dividend received by the corporation under paragraph 55(2)(a). It should be noted that the provisions of subsection 55(2) apply "notwithstanding any other section" of the Act.
However, it is the CRA's view that a dividend to which subsection 55(2) applies remains a dividend from the perspective of the payer of that dividend. In other words, subsection 55(2) has no effect on the payer of the dividend. Indeed, that statutory provision does not provide that the dividend is deemed not to be a dividend paid by the dividend payer.
In very general terms, a corporation is liable to pay Part IV.1 tax in respect of dividends, other than "excluded dividends", received by it in the year on a taxable preferred share, to the extent that an amount in respect of those dividends is deductible in computing its taxable income for the year under, inter alia, section 112. Section 187.2 would therefore not apply to a dividend amount that would be deemed not to be a dividend received by the corporation by virtue of subsection 55(2).
In very general terms, a taxable Canadian corporation is liable for Part VI.1 tax in respect of the portion of dividends, other than "excluded dividends", paid by it on short-term preferred shares or taxable preferred shares that exceeds the dividend allowance applicable to that corporation for the year. Since subsection 55(2) does not affect the dividend payer, the application of this statutory provision in a particular situation would not affect the amount of Part VI.1 tax payable by a particular corporation.
We apologize for the delay in responding to your request. We hope that our comments will be of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
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