Section 186

A Canadian resident personal trust receives a dividend from ACo, and distributes the dividend to B Co (a beneficiary) to which A Co is connected – but they cease to be connected corporations by December 31 of that year. Does Part IV tax apply? CRA responded:

[A] taxable dividend designated in favour of a particular beneficiary pursuant to subsection 104(19) will be deemed to have been received by the beneficiary at the time that is the end of the particular taxation year of the trust in which the trust received the dividend … [given that] the designation under subsection 104(19) could only occur at the end of the taxation year of a trust, since … paragraphs 104(19)(a) and (d) require that the designation is made in the [trust] income tax return … [and] it is only at the end of its taxation year that a trust will know its income for the year… .

Accordingly … B Co. would be deemed to have received the taxable dividend on the shares of A Co. on December 31 … and …[a]t that date, A Co. and BCo. are not connected. Therefore, B Co. would be subject to Part IV tax … .

A discretionary family trust ("Trust") receives a cash taxable dividend on June 20, 2017 on its non-voting common shares of Opco (whose voting shares are held by Mr. A) and immediately distributes that amount to Holdco (a family corporation controlled by Mr. A, and with a June 30 year end) in its capacity of beneficiary. Three days later, the control of Opco is acquired by a third party, resulting in (i) a deemed taxation year end for Opco (but with December 31 being retained as its year end) and (ii) it no longer being connected to Holdco. By virtue of a s. 104(19) designation by Trust in its return for its year ended December 31, 2017, the amount is deemed to be a taxable dividend received by Holdco.

Headquarters indicated that such dividend was subject to Part IV tax in the hands of Holdco because the time at which it was considered to have received the s. 104(19) dividend (the calendar year end of the Trust) was in the taxation year of Holdco (commencing on July 1, 2017) throughout which Opco was no longer connected to Holdco. In reaching this conclusion, it stated:

[T]he CRA's position is to consider that the amount designated to the beneficiary by a trust in accordance with subsection 104(19) is deemed to be received as a dividend by the beneficiary of the trust at the end of the taxation year of the trust in which the trust received the dividend. This position is based inter alia on the fact that the trust cannot make the designation under subsection 104(19) before the end of its taxation year. In addition, it is only at the end of its taxation year that a trust will be able to determine whether all the conditions set out in that provision are satisfied. ...

[T]he taxation year in which the amount received by Holdco from Trust will be deemed to be a taxable dividend for Holdco is the year ending on June 30, 2018. It is also in that year that Holdco may claim the dividend deduction in subsection 112(1). It is therefore in that taxation year that Holdco will be subject to Part IV tax on the dividend paid by Opco to Trust on June 20, 2017.

A dividend is received by a family trust from a Canadian-controlled private corporation with only operating assets (Opco) and immediately distributed to a corporate beneficiary (Holdco) that is connected at that time with Opco - but ceases to be connected by the end of that calendar year due to an in intervening sale of Opco by the trust. CRA considers that the trust will not enjoy the (s. 186(1)(a)) connected-corporation exemption from Part IV tax even if a timely s. 104(19) designation is made by the trust. The reason is that it considers the s. 104(19) designation to not be effective until the end of the year, at which time Holdco no longer is connected.

Two related corporations (Holdco A and B, with calendar years) held 51% and 49% of the single class of shares (common shares) of Opco (which had a June 30 year end). On June 30, Opco declared a dividend to its shareholders, on July 1, Holdco A disposed of its Opco shares to an arm's length party, and on November 30, the dividend was paid. Was Holdco A required to pay Pt. IV tax pursuant to s. 186(1)(a)? CRA responded:

Holdco A would be liable to pay Part IV tax pursuant to paragraph 186(1)(a) on the Dividend that it received on November 30 of the Particular Year. This is because, upon receipt of the Dividend, Opco was not connected to Holdco A. Again, it appears to us that the fact that Opco is connected with Holdco A under subsection 186(4) at some time in the particular year other than the time of receipt of the Dividend would be irrelevant for purposes of Part IV tax.

Opco, which was held as to 51% of its shares (being common shares) by Holdco A (with a calendar year) and 49% by Holdco B (which dealt at arm’s length with Holdco A). One day after Opco declared a dividend (on June 30) on its common shares, Holdco A disposed of all of its shares to an arm’s length third party. The declared dividend was not actually paid, and received by Holdco A and Holdco B, until November 30 of the same year. Is it at the time of receipt of the dividend that the recipient corporation must be connected with the payer in order to be exempted from tax under s. 186(1)(a) - or simply at any time in its taxation year? CRA responded:

[I]t is at the time the dividend is received by a particular corporation that it must be determined whether the payer corporation is connected with the particular corporation for purposes of Part IV tax.

… Holdco A should pay Part IV tax pursuant to paragraph 186(1)(a) on the dividend it received from Opco on November 30 … since at that time Opco was not connected with Holdco A. … [T[he fact that Opco was connected with Holdco A at any other time during Holdco A's taxation year would be irrelevant.

On a butterfly transaction, Pt. IV tax circularity issues are avoided by having a year end for the transferee corporation (Newco) occur between Newco’s purchase for cancellation of its preferred shares held by the distributing corporation (DC) in consideration for a demand note, and DC’s purchase for cancellation its shares held by TC for a demand note (so that TC is subject to Pt. IV tax on the second transaction).

In its closing comments on a proposed one-wing split-up butterfly in which a portion of the farm business of the “Transferor” was transferred to the new “Transferee” formed by one of the farming brothers, CRA indicated that the transactions may give rise to circular Part IV tax issues and that the Transferor and Transferee should consult their local TSO to determine which corporation should receive the dividend refund and which corporation would be subject to Part IV tax.

CRA ruled on a butterfly split-up of a rental property company (which was considered to carry on an active business because it had more than five full-time employees) between transferee companies (TCs) formed by its two shareholders, being holding companies for the families of two brothers (one of them, deceased).

Except for preliminary transactions to transfer registered title to the properties to new nominees, the proposed transactions were essentially to commence with DC increasing the PUC of its common shares by the lesser of (a) the safe income on hand attributable to the common shares at that time and (b) the aggregate of (i) its pre-1972 CSOH and (ii) an amount sufficient to trigger a refund of its RDTOH balance at that time, if any. The stated principal purpose of this step was to increase the ACB of the DC common shares, so as to eliminate the capital gain that would otherwise arise as a result of s. 88(2)(b)(ii) deeming the pre-1972 CSOH amount to be proceeds of disposition rather than a deemed dividend on the winding-up of DC at the completion of the transactions.

The ruling letter also indicates that if there is any significant dividend refund on this step, DC likely will submit a request to the relevant TSO to have a change of taxation year end (i.e., to avoid dividend circularity issues).

CRA ruled on a simple butterfly for the split-up of a CCPC distributing corporation (DC) with cash, and investment assets, between the respective newly-incorporated transferee corporations (the TCs) for three siblings and their respective family trusts. DC has ERDTOH and NERDTOH balances.

After the creation of cross-shareholdings between DC and the three TCs using the usual plumbing, and the redemption for notes of the prefs held by DC in each TC, the shares held by the TCs in DC are not redeemed, as this would result in Part IV tax circularity issues. Instead, the TCs close off their first taxation years and then, on the following day or so, the TC notes are distributed by DC to the respective TCs on a s. 88(2) winding up of DC.

DC is not to be dissolved until it has received and distributed, on a pro rata basis, the dividend refund.

A butterfly split-up of a DC holding rental property between two transferee corporations (the TCs) for two unrelated families, with undivided interests in the real estate being transferred to each TC in consideration for the assumption of liabilities (in such proportions as to ensure satisfaction of the pro rata distribution requirement) and for voting preferred shares (presumably with somewhat less than 50% of the votes of each TC), which were promptly redeemed for notes.

DC was then to be wound-up into its two shareholders (the TCs) and its sole assets at that time – the two redemption notes owing by the two TCs – distributed to that TC so that the note was extinguished. Apparently, in order to avoid circularity issues, the winding-up dividend (effected through such note distribution) was to occur in a subsequent calendar year (i.e., at the beginning of 2020?).

A DC which holds a rental property and an investment portfolio and is owned by Parent and his four children will spin off its investment portfolio in reliance on the s. 55(3)(a) exception to four TCs mostly owned by each of the four children.

Each TC will redeem the preferred shares issued by it to DC in connection with the spin-off, the first taxation year end of each TC will end on the following day so as to prevent circularity in the calculation of the refund of RDTOH and Part IV tax of the TCs and DC. Thereafter, DC will redeem its preferred shares held by the four TCs.

In the context of a group of corporations undertaking a reorganization involving share redemptions between multiple corporations, with one or more of the corporations having an existing RDTOH balance, the correspondent indicated that “the impact of circular RDTOH calculations can make it virtually impossible to do a detailed RDTOH calculation for each specific corporation.”

CRA first confirmed its position in 2003-0030085 that a circular calculation was required, and then stated:

We note that when the Part IV tax and the dividend refund are determined by successive circular calculations, the amounts of the Part IV tax and of the dividend refund of each connected corporation increase proportionally with each calculation. We also note that, since a corporation’s dividend refund is applied against its Part IV tax payable, generally, one corporation’s net Part IV tax payable will equal the other’s net dividend refund.

In other words, even though computing a corporation’s Part IV tax and dividend refund by successive circular calculations inflate these amounts and that these calculations are tedious, they are not financially injurious to the connected corporations as the net amount of Part IV tax payable by one corporation (Part IV tax payable minus its dividend refund) will equal the net amount of the dividend refund (dividend refund minus Part IV tax payable) of the other.

Mother along with an arm’s length business associate (“Investor”) wanted to use some of the assets of the family business corporation (“Amalco”) to engage in some sort of development project, whereas her daughter did not want any part of this. Accordingly, it was agreed that one of the two businesses would be spun off to the Daughter’s Newco under s. 55(3)(a). It was also contemplated that thereafter the business retained by Amalco would be sold by Amalco at fair market value to a recently formed development company (XCo) which was controlled by Mother but in which Investor had made a significant equity investment.

Respecting the cross-redemption transactions that concluded the spin-off transactions referred to above, Newco redeemed the Newco Class B Special Shares held by Amalco (which, going into the transactions, had no RDTOH balance), caused its first taxation year to end at the end of that day, and the redemption by Amalco of its Amalco Class B Voting Comon Shares held by Newco occurred on the following day. The disclosed Purposes state:

The reason for Newco causing its first Taxation Year to end at the end of the day on which the Newco Class B Special Shares are redeemed ... is to avoid a possible Part IV tax “circularity” issue.

CRA ruled on a combined pipeline and split-up butterfly transaction respecting DC, which invested in marketable securities, and the shares in which passed to the estate with their adjusted cost based having been stepped-up under s. 70(5). DC then transferred its marketable securities to three transferee corporations (TCs) for the three beneficiaries in consideration for “butterfly shares” – but with DC holding onto the notes that it received on the immediate redemption of the butterfly shares for a redacted period of time. After this peirod, DC was wound-up into the TCs, thereby resulting in deemed winding-up dividends and in the notes being extinguished on their being assigned to the TCs.

DC had refundable dividend tax on hand. This sequencing of the two deemed dividends (coupled with the appropriate choice by the TCs of their first year end) avoided Part IV tax circularity issues.

2017-0724071C6 indicated that where Holdco receives a dividend of $400,000 that was subject to Part IV tax of $153,333 (38.33% of $400,000) equalling the connected payer’s dividend refund and, in turn, pays a dividend to its individual shareholders resulting in a dividend refund (DR) of the Part IV tax – so that the dividend received by Holdco was subject to s. 55(2) there should be two returns filed by Holdco – one reporting the Part IV tax, and a second one reporting the capital gain under s. 55(2), thereby giving rise to refundable tax and an addition to Holdco’s RDTOH account which could only be used prospectively. CRA now provided six numerical examples going through variants on this scenario.

Respecting scenarios where Holdco did not pay a full dividend to its individual shareholder, CRA stated:

[A]ny future payment of a taxable dividend by Holdco that resulted in a refund of Part IV tax could result in the potential application of subsection 55(2) to the extent that this payment was part of the same series of transactions. The CRA would consider any future DR as a result of the payment of a dividend by a corporation, where the payment was part of the same series of transactions, as coming first from the Part IV tax paid on the taxable dividend.

Respecting when the amended return of Holdco should be filed, CRA indicated a preference for Holdco to wait until its original return was assessed. If Holdco wanted to avoid interest charges by paying at the time of the first return an amount that took into account its s. 55(2) liability to be reported in the second return, CRA described the procedures for avoiding having this overpayment refunded in the interim.

Holdco receives a dividend of $400,000 that is subject to Part IV tax of $153,333 (38.33% of $400,000) equalling the connected payer’s dividend refund and, in turn, pays a dividend to its shareholders resulting in a refund of the Part IV tax – so that the dividend received by Holdco is subject to s. 55(2). However, such application of s. 55(2) converts the dividend into a capital gain, thereby (it was suggested) reducing the Part IV tax under a circular calculation.

CRA considered such a circular calculation to be contrary to the scheme of s. 55(2), that for a dividend to be subject to s. 55(2), based on a Part IV tax refund, such refund must be a real refund of real tax (as per Ottawa Air Cargo) and that the right approach is for Holdco to declare $153,333 of Part IV tax in its initial return and, in a second return, show the Part IV tax paid for the taxation year as unchanged, even though the amount of the dividend received has been reduced by the application of s. 55(2).

CRA ruled on a s. 55(3)(a) split-up of a real estate rental corporation (Canco) whose common shares were held by Son Holdco and Daughter Holdco and whose prefs were held by a Holdco for the father and mother of Son and Daughter (Holdco 1). The transfer of the real estate to Newco 1 (whose common shares and prefs were acquired on the spin-off by Son Holdco and Holdco 1, respectively) and to Newco 2 (whose common shares and prefs were acquired on the spin-off by Daughter Holdco and Holdco 1, respectively) was stated to occur within the range permitted by s. 85, and the facts included a statement that “Canco does not have a material balance of CDA or RDTOH.”

CRA commented that to the extent that Canco has a balance in its RDTOH at its year-end immediately following the redemptions and purchases for cancellation of its shares held by Newco 1 and Newco 2, this could give rise to a “circular” calculation of RDTOH, resulting in each of Newco 1, Newco 2 and Canco being subject to Part IV tax, and stated:

Since the problem will affect the assessment of the income tax returns of Canco, Newco 1 and Newco 2, the district taxation office at which each of the corporations files its T2 income tax return will have to be consulted in order to determine which corporation will receive the dividend refund and which corporation will be subject to the Part IV tax liability under paragraph 186(1)(b) described in these comments.

The proposed transactions contemplate (in para. 24) respecting a spin-off of real estate by Opco to newly-incorporated Realtyco that Opco (with CRA consent) will close off its year end immediately before the real estate spin-off (and immediately after the payment of a deemed dividend by it to Realtyco) in order to claim capital cost allowance for the current fiscal period. Thereafter, Realtyco will pay a deemed dividend to Opco. Per para. 17:

The fiscal period of Realtyo will be fixed at a date which will permit the avoidance of Part IV tax circularity.

Will CRA require a dividend recipient to pay Part IV tax if it receives a dividend from a connected dividend payer that had RDTOH at the end of a particular taxation year even if the dividend payer is denied a dividend refund because its income tax return was not filed within that period? CRA responded:

[T]he CRA will consider that a dividend recipient’s Part IV tax liability with respect to a dividend received from a connected dividend payer will be determined according to the dividend refund actually received by the dividend payer.

On a cross-share redemption between two connected Canadian-controlled private corporations, neither of which has a refundable dividend tax on hand account account immediately before the redemption, each corporation is deemed to receive a dividend from the other. Does the application of s. 55(2) to the deemed dividend received by each corporation, which generates an addition to its RDTOH account and, therefore, generates a dividend refund to it and associated Part IV tax on the deemed dividend paid by it to the other corporation, engage the exclusion from s. 55(2) for dividends which are subject to Part IV tax – or does the Part IV tax exclusion not apply so that s. 55(2) applies to the full amount of the deemed dividend received by each corporation? CRA stated (TaxInterpretations translation):

[I]n accordance with sections 129 and 186, it is provided that the dividend refund, the RDTOH account and thus the Part IV tax of a given corporation are calculated as a function of all relevant amounts in this regard for the whole taxation year.

Furthermore…in…943963 Ontario Inc. …the parties…and the Court accepted that there was a given amount subject to Part IV tax by the appellant, the dividend recipient, notwithstanding that a part of the deemed dividend…was deemed to not be a dividend received, by virtue of subsection 55(2)(a). In other words, the part of the dividend giving rise to a capital gain by virtue of subsection 55(2) did not affect the amount of the "assessable dividend" taken into account for calculating the Part IV tax payable… . The application of subsection 55(2) in that case did not engage any circular calculation. …

Moreover, the fact of calculating the RDTOH account at the end of a taxation year of each corporation in such a situation…involving cross redemptions and thus cross dividends, entails circular calculations by them of their respective RDTOH, dividend refunds and Part IV tax. In policy terms, it does not appear acceptable to us that circular calculations could result in a complete reimbursement of the total RDTOH of each corporation in such a situation.

The trust designates a taxable dividend it received on June 30, 2013 from Opco to its beneficiary, Holdco, whose year-end is June 30. 2013. A trust cannot make an s. 104(19) designation until its year end (December 31) since it is only then that it can be determined that it has been resident in Canada throughout the year. Accordingly, Holdco should include the amount of the taxable dividend in its return for June 30, 2014 year and pay the applicable Part IV tax.

CRA confirmed its position in 9711005 and indicated that its position in 9906255 was no longer valid because of the 943963 Ontario decision. Accordingly, the portion of the dividend representing safe income on hand was subject to Part IV tax and the Part IV tax applied irrespective of a portion of the dividend being deemed not to be a dividend received by virtue of s. 55(2)(a).

CCRA indicated that it is not prepared to accept the waiver of a dividend refund ("DR") by a corporation in order to avoid the circularity problem regarding the calculation of Part IV tax, for the following reasons.

• First, it did not believe that the fact of a circular calculation having to be made by two corporations caused them any harm in general, stating in this regard that “although a corporation's Part IV tax and DR amounts are inflated in a situation where a circular calculation must be made, and a circular calculation is burdensome; no prejudice is suffered in general by either of the corporations that are subject to the circular type calculation to determine their Part IV tax and DR, as the net tax payment to be made by one corporation (Part IV Tax minus DR) will be equivalent to the net amount refunded to the other corporation (DR minus Part IV Tax).”
• Second, a corporation that receives an eligible dividend from a payer corporation is subject to Part IV tax whether or not the payer corporation receives the DR – so that if CCRA allowed a corporation to waive a DR, this would have no effect on the Part IV tax payable by the other corporation.

During its the taxation year ending September 30, 2000 ("2000 TY”), Bco paid its CCPC parent (Aco) a taxable dividend of $223,500, entitling it to a dividend refund ("DR") of $74,500, which reduced its total taxes payable for the year (otherwise $100,000 of Part I tax, payable on taxable capital gains) to $25,500. Aco received such dividend from Bco during its taxation year ended July 31, 2001 and, before giving effect to the loss carryback escribed below, was required to pay Part IV tax equal to the DR.

For its taxation year ended September 30, 2001 ("2001 TY"), Bco had a net capital loss of $280,000, and obtained a refund of its federal tax paid for its 2000 TY by carrying back that loss.

CCRA stated:

Aco may not be required to pay Part IV tax, for the taxation year ended July 31, 2001, if it was able to establish before October 31, 2001, i.e., the latest date before which it would be required to pay Part IV tax under subsection 186(1), that Bco's DR for the 2000 TY had been cancelled by reassessment pursuant to subsections 152(4) and 187(3).

Otherwise, Aco would have to pay the Part IV tax within the time limit set out in subsection 186(1). However, the CCRA could, under subparagraph 152(4)(b)(ii) and subsection 187(3), if Aco so requested in writing after Bco's DR has been cancelled by reassessment under subsection 152(4), reassess to cancel the Part IV tax payable by Aco for its taxation year ended July 31, 2001, and refund to it the Part IV tax paid. In addition, the CCRA could pay Aco interest on the amount refunded at the prescribed rate … for a particular period determined under subsections 164(3) and 187(3) ...