3 March 2003 Internal T.I. 2003-0183077 - DIVIDEND STRIPPING USING RCA

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Various questions pertaining to an RCA. However, the application of GAAR to the arrangement precludes having to determine the RCA issues.

Position: Arrangement would be considered an avoidance transaction.

Reasons:

Similar arrangements have been determined by the GAAR Committee to be avoidance transactions.

				March 3, 2003

	XXXXXXXXXX  TSO		HEADQUARTERS
				Income Tax Rulings
	Attention:  XXXXXXXXXX 			  Directorate
				Renée Shields
(613) 948-5273

				2003-018307

Transfer of Shares to a Retirement Compensation
Arrangement (RCA) by RCA Member and subsequent redemption of shares

This is in response to our conversation and your electronic correspondence of January 14, 2003 regarding certain transactions undertaken within an RCA.

Our understanding of the facts is as follows. The individual is an employee and a shareholder of OPCO. The individual is also a shareholder of #CO. The paid up capital (PUC) of the individual's #CO shares is $XXXXXXXXXX. In XXXXXXXXXX, OPCO established an RCA for the benefit of the individual. OPCO contributed $XXXXXXXXXX to the RCA. The individual transferred his shares in #CO to the RCA trust in return for a note payable for $XXXXXXXXXX, being the fair market value of the shares. #CO redeemed the shares for $XXXXXXXXXX , which amount it paid to the RCA trust. The RCA trust paid $XXXXXXXXXX to the individual to satisfy the note payable.

In your email and during our conversations, you posed several questions:

1. Was refundable tax due on the value of the shares transferred to the RCA by the individual?

2. Should the RCA have reported a deemed dividend upon redemption of the shares?

3. Is the RCA entitled to a capital loss on the redemption of the shares?

4. Does the arrangement qualify as an RCA?

Based on the discussion of GAAR, below, it will become apparent that these issues, in the context of the RCA, are no longer specific concerns.

GAAR

In a situation in which a corporation resident in Canada redeems the shares of any class of its capital stock, subsection 84(3) of the Income Tax Act (the "Act") provides that the corporation is deemed to have paid and the shareholder is deemed to have received a dividend equal to the amount by which the amount paid by the corporation on the redemption of a share exceeds the PUC in respect of the particular share. Accordingly, in the absence of the RCA arrangement described above, the following would have been the results had the individual retained ownership of the shares. When #CO redeemed the shares, the individual would have had a deemed dividend of:

$XXXXXXXXXX (redemption amount) - $XXXXXXXXXX (PUC) = $XXXXXXXXXX.

In addition, pursuant to paragraph 82(1)(b) of the Act, 1/4 of the deemed dividend, or $XXXXXXXXXX, would have been included in computing the individual's income. The included amounts would have been taxable at the individual's marginal rate. Section 121 of the Act would have allowed a dividend tax credit of 2/3 of the amount included pursuant to paragraph 82(1)(b) of the Act.

Instead, under the RCA arrangement described above, the individual realized a capital gain of $XXXXXXXXXX on the disposition of the shares to the RCA ($XXXXXXXXXX - $XXXXXXXXXX). The capital gain was taxable at 50%.

XXXXXXXXXX Additionally, a presentation on this type of scheme was made at the 2002 Canadian Tax Conference.

By way of summary, the tax benefit to the individual is the reduction in Part I tax that would be payable had the shares been redeemed when the individual was the shareholder. The avoidance transaction includes all of the transactions involving the creation of the RCA trust, the individual's sale of shares to the RCA trust for a promissory note, the redemption of the shares and the payment by the RCA to the individual in satisfaction of the promissory note. The misuse or abuse is the abuse of the scheme of the Act relating to distributions of corporate surplus, which the Act envisages as being taxed as a payment of dividends. There is also an abuse of the Act as a whole relating to non arm's-length sale of shares by using an accommodating buyer, essentially a non-arm's length entity (the RCA trust), to technically achieve the results of an arm's length sale.

It was the opinion of the GAAR Committee that the arrangements constituted avoidance transactions with no apparent bona fide purposes other than to obtain the tax benefit i.e. to shelter the deemed dividend arising on the share redemption from taxation in the individuals' hands. Consequently, the GAAR Committee concluded that GAAR would be applied to treat the share redemption as having occurred while the employee was the shareholder. You indicated during our conversation that in the case at hand, the year in question is statute-barred. As such, notwithstanding the application of GAAR, the CCRA may not initiate a reassessment.

We trust that these comments will be of assistance.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

Mickey Sarazin, C.A.

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch