Subsection 55(3.01)

A and B, who have been cohabiting in a conjugal relationship for 10 years and who each owned 50% of the common shares of Opco, commenced on January 1 of Year 11 to start living apart as a result of a breakdown of their conjugal relationship.

They then implemented a divisive reorganization of Opco under which B disposed of her Opco common shares to Newco (newly-incorporated by her) in consideration for Newco common shares, Opco disposed of a portion of its business property to Newco in consideration for Newco preferred shares and the two shareholdings were cross-redeemed for notes that were then set off. Any tainting events described in ss. 55(3)(a)(i) to (v) occurred on March 26 of Year 11(i.e., less than 90 days after they started to live separate and apart).

For purposes of s. 55(3)(a), were A and B related immediately before the tainting events, and would the application of the s. 55(3)(a) exception be compromised if A and B remained separate and apart for more than 90 days?

After noting that individuals connected by common-law partnership are related to each other pursuant to s. 251(2)(a) and that the determination of there being, a common-law partnership determination is to be made immediately before the time of occurrence of the potential tainting events (the “Determination Time”) and further referencing the deeming rule in the “common-law partner” definition in s. 248(1) that once a conjugal relationship established, it was deemed to continue until the couple were living separate and apart for more than 90 days because of a breakdown of their conjugal relationship, CRA went on to state:

Because A and B had ceased cohabiting for less than 90 days on the occurrence of any of the Tainting Events, they will be common-law partners prior to the completion of the Reorganization. Accordingly, the dividends received by the Newco and Opco will not be subject to subsection 55(2) because A will be related to B pursuant to paragraph 251(2)(a) … .

The application of paragraph 55(3)(a) will not be retroactively changed if A and B remain separate and apart for more than 90 days after they ceased cohabiting because of the breakdown of their conjugal relationship.

The children shareholders of two corporations (S1 and S2) that have been controlled for a number of years by their parents, transfer a portion of their S1 common shares to S2 under s. 85(1) for preferred shares, S1 transfers a portion of its assets under s. 85(1) to S2 for preferred shares, and the two cross- shareholdings are cross-redeemed for notes, which are set-off. Some of the child shareholders of S1 then acquired shares of S1 from other child shareholders.

CRA indicated that, assuming that s. 55(4) did not apply, the s. 55(3)(a) exception applied, stating:

S1 and S2 are not "unrelated persons" as defined in paragraph 55(3.01)(a) because each of them is a person to whom the dividend recipient is related pursuant to subparagraph 251(2)(c)(i), both corporations being controlled by the same group of persons, namely the parents.

Each of the children and each of the dividend recipients are not "unrelated persons" as defined in paragraph 55(3.01)(a) because each of the children is a person to whom each of S1 and S2 (the dividend recipients) is related, pursuant to subparagraph 251(2)(b)(iii).

Note that the fact that the children were deemed not to be related to each other pursuant to subparagraph 55(5)(e)(i) would not change the above to the extent that each of the children would still be related to each of the dividend recipients at all relevant times in the series.

Background

Prior to the preliminary transactions, Opco’s issued and outstanding shares were held by three unrelated individuals: Messrs. A and B held the Class A voting common shares; and Mr. C held the non-voting Class B common shares.

Preliminary transactions

Advances owing by Opco to two subsidiaries (Opco 2 and 3) are eliminated or reduced by those subsidiaries paying dividends-in-kind out of their safe income through the issuance of notes (including to employee minority shareholders), and then setting those notes off, to the extent owing to Opco, against all or a portion of the respective advance.

Estate freezing transactions are implemented (in which Mr. C participated in form) as a result of which:

• the following will each hold non-voting Class B common shares of Opco: (i) Trust A (settled by Mr. B for the benefit of Mr. A’s family and with Mr. and Mrs. A, and Mr. C as trustees), (ii) Trust B (settled by Mr. A for the benefit of Mr. B’s family, and with Mr. B, his daughter, and Mr. C as trustees), and (iii) Mr. C;
• holding companies for Mr. A and for Mr. B (Newcos A and B), and Mr. C himself, will hold non-voting preferred shares of Opco; and
• the Class E voting shares will be held by Newcos A and B and by Messrs. A and B directly.

Proposed transactions

1. The shareholders of Opco will transfer their shares on a s. 85(1) rollover basis to a newly-incorporated corporation (Holdco – which had no shares issued on its incorporation by Messrs. A and B) in consideration for shares issued to each transferor whose attributes are collectively similar to those so transferred by the transferor.
2. Holdco will transfer some of its preferred shares of Opco on a s. 85(1) rollover basis to a newly-incorporated corporation (Realtyco) in consideration for Class A voting common shares and Class C non-voting preferred shares of Realtyco, so that Realtyco (which had no shares issued on its incorporation by Holdco) is wholly-owned by Holdco.
3. Opco will transfer realty properties to Realtyco in consideration for the assumption of mortgage obligations and the issuance of non-voting preferred shares, and with an s. 85(1) election being made.
4. Realtyco will redeem the preferred shares issued in 2 above, and Opco will redeem the preferred shares transferred to Realtyco in 3 above, in each case through the issuance of a non-interest bearing demand promissory note, with the two notes then set off.

Additional information

The estate planning transactions … will not be carried out with a view to completing the series of transactions that includes the Proposed Transactions and would be completed notwithstanding the implementation of the Proposed Transactions, and vice versa.

Rulings

Including that the proposed transactions will not be considered in themselves to result in a disposition or increase in interest described in any of ss. 55(3)(a)(i) to (v) and, in particular, the transaction in 1 above will not be described in s. 55(3)(a)(ii) by virtue of s. 55(3.01)(g).

Other comments

CRA has not reviewed the allocation of safe income between Opco and Realtyco but is "generally of the view that Safe Income should be allocated in a manner consistent with documents 2020-0861031C6 and 2021-0889611E5".

Background. Opco, a CCPC, in addition to holding residential condos on upper floors, holds the “Vacant Premises” for the purpose of leasing them under long-term commercial leases, as well as storage lockers for use by the residential condos (the “Lockers”). The only issued and outstanding shares of Opco are Class A shares which are held by Holdco 1 (held by Holdco A, which is controlled by A and his mother), Holdco 2 (held by Holdco B, which is wholly–owned by B, and by Holdco C, which is wholly-owned by C), Holdco 3 and Opco 3 (each held by Holdco D, which is wholly-owned by D), and Holdco 4 (wholly-owned by Trust E, a discretionary personal trust for E and members of E’s family).

Proposed transactions.

1. Holdco 1, Holdco 2, Holdco 3, Opco 3 and Holdco 4 incorporate Holdco and (following the incorporation of Realtyco by Holdco) transfer their shares of Opco to Holdco on a rollover basis under s. 85(1) in consideration for Class A common shares of Holdco.
2. By articles of amendment, the Class A shares of Opco are exchanged for new Class A common shares, and for non-voting discretionary-dividend redeemable retractable Class B shares with a value equal to that of the Vacant Premises, Lockers and related parking spaces (and with paid-up capital allocated on a pro rata basis).
3. Holdco transfers its Class B shares of Opco to Realtyco on a s. 85(1) rollover basis in consideration for Class A common shares of Realtyco.
4. Opco redeems its Class B shares for a demand note (the “Note”) and makes an eligible dividend designation respecting the resulting deemed dividend. (Per para. 17, "the fiscal period of Realtyo will be fixed at a date which will permit the avoidance of Part IV tax circularity.")
5. Immediately following an early termination of the fiscal period end of Opco made pursuant to an advance [“préalable”] request to CRA, Opco transfers the Vacant Premises and related parking spots to Realtyco on a rollover basis under s. 85(1) in consideration for “Note 1”) and for Class C non-voting, non-participating non-cumulative redeemable retractable preferred shares of Realtyco (whose share provisions have a price adjustment clause).
6. Realtyco redeems the Class C shares held by Opco in consideration for Note 2.
7. Realtyco uses proceeds of a third-party secured borrowing to partly repay Note 1, with Opco using that amount to partly repay the Note.
8. A second amount received by Realtyco on signing a new lease is used to repay the balance of Note 1 due to Opco, with Opco using that amount to repay a further portion of the Note to Realtyco.
9. The balance of the Note and Note 2 are then set-off.

Purpose. The Opco shareholders wish to have the Vacant Premises and related assets held in a separate corporate vehicle to insulate them from operational risks of the Opco business.

Ruling: The proposed transactions will not by themselves be considered to result in a disposition or increase described in ss. 55(3)(a)(i) to (v), and will be deemed by s. 55(3.01)(g) to not be described in s. 55(3)(a)(ii).

Opinion. Re s. 55(2) not applying under the July 31, 2015 proposals to the deemed dividends arising in 4 and 6.

After referring to the CRA response to Q. 14(b) [16(b) below?] at the 2014 APFF Roundtable including the caution provided, the questioner referred to a situation where two unrelated individuals (A and B) are equal shareholders of Opco.

1. A and B incorporate Holdco, Holdco incorporates Realtyco and A and B transfer their Opco shares to Holdco under s. 85.
2. Holdco transfers part of its shares of Opco, having a value equal to that of the real estate, to Realtyco under s. 85(1).
3. Opco transfer the real estate to Realtyco in consideration for preferred shares of equal value, electing under s. 85(1).
4. Opco purchases for cancellation its shares held by Realtyco for a note.
5. Realtyco redeems its preferred shares held by Opco for a note.
6. The notes are set off.

Does s. 55(2) not apply in light of s. 55(3.01)(g)? CRA responded (TaxInterpretations translation):

The increase in the interest of A and B in Holdco resulting from the transfer of shares in the capital of Opco would be an increase described in subparagraph 55(3)(a)(ii) since neither A nor B would be related to Opco and Realtyco, the dividend recipients. However, these increases in interest could ["pourraient"] be excluded by virtue of paragraph 55(3.01) (g). For purposes of paragraph 55(3.01) (g), Holdco would be the "particular corporation." On this basis, the conditions provided in subparagraphs paragraph 55(3.01) (g)(i) to (v) would be satisfied and, consequently, the increase in the interest of A and B in Holdco, otherwise described in subparagraph 55(3)(a)(ii), would be deemed not to be described in that subparagraph.

Consequently…it is possible that Opco and Realtyco could access the exception to the application of subsection 55(2) provided in paragraph 55(3)(a)… .

…[I]f one or other of the equity investments of A and B in Opco were considered to be made as part of a series of transactions in the course of which the dividends were received by Opco and Realtyco… paragraph 55(3.01)(g) would not apply to the increase in interest described in subparagraph 55(3)(a)(v). Consequently, Realtyco could not utilize the exception to the application of subsection 55(2) provided in paragraph 55(3)(a).

Facts

The exception in s. 55(3)(a) would not be available where a new corporation was created in the series. Consider this example:

1. Husband, Wife and (unrelated) Third Party each subscribe for 1/3 of the voting common shares of newly-incorporated Realtyco.
2. They transfer equal portions of their current equal shareholdings of Opco to Realtyco under s. 85(1) in consideration for preferred shares of equivalent fair market value.
3. Opco transfers realty to Realtyco under s. 85(1) in consideration for preferred shares of equivalent FMV.
4. The cross-shareholdings between Opco and Realtyco are redeemed for notes, thereby giving rise to deemed dividends.
5. The notes are set-off.

Questions

Does s. 55(2) not apply in light of s. 55(3.01)(g)(v)? Would this change if before Step 1 Husband and Wife incorporated Holdco and they and Third Party rolled all their Opco shares into Holdco before Holdco (rather than they) proceeds with Steps 1 to 5?

1st Scenario

In finding that the s. 55(3)(a) exception was not available for the deemed dividends arising in Step 4 under the first Scenario, CRA first indicated (TaxInterpretations translation):

Respecting the issuance of shares on an incorporation…prior to the first issuance…the incorporator controls [the corporation] and consequently…he will be considered as being related to that corporation before the first issuance of shares. …[T]he initial subscriptions by Husband and Wife (the incorporators) would not result in an increase in interest described by subparagraphs 55(3)(a)(iii) to (v).

CRA noted:

• The initial subscription for Realtyco shares by Third Party resulted in a s. 55(3)(a)(ii) increase as Third Party was unrelated to the dividend recipients (Opco and Realtyco) as well as s. 55(3)(a)(v) increase of Third Party relevant to the deemed dividend paid by Realtyco to Opco.
• Third Party also would have a s. 55(3)(a)(ii increase of interest from its transfer of Opco shares to Realtyco for preferred shares (Step 2), as well as when the cross-shareholdings were redeemed (Step 4).

CRA then stated:

Furthermore, as regards the dividend deemed to be received by Opco, an increase in interest of Third Party described in subparagraph 55(3)(a)(v) would result from the transfer of the shares of Opco by Third Party to Realtyco in consideration for preferred shares in the capital of Realtyco, as well as on the redemption of the preferred shares in the capital of Realtyco held by Opco. Finally, on the purchase for cancellation of the shares in the capital of Opco held by Realtyco, Third Party increased its interest in Opco, which is a particular described in subparagraph 55(3)(a)(v) regarding the dividend deemed to be received by Realtyco.

Because paragraph 55(3.01)(g) does not exclude an increase in interest described in subparagraph 55(3)(a)(v), the dividend recipients, Opco and Realtyco, would be unable to utilize the exception…provided in paragraph 55(3)(a). ... [In any event] the condition provided in subpargraph 55(3.01)(g)(v) would not be satisfied as the shares of the recipients of the dividends, Opco and Realtyco, were held by individuals at the moment of receipt of the dividends.

2nd Scenario

Respecting the second Scenario, CRA assumed that Holdco and Realtyco were incorporated by Husband or Wife, so that Holdco was related to Realtyco and Opco, and Husband and Wife were related to Realtyco, and that the original investment of Third Party in Opco was not part of the same series of transactions as the receipt of the dividends in Step 4.

CRA then stated:

The disposition of the shares … of Opco by Husband, Wife and Third Party to Holdco would not result in a disposition described in subparagraph 55(3)(a)(i), (ii) or (v) as, immediately before the disposition, Holdco would be related to Opco and Realtyco, the dividend recipients.

However, the investment of Third Party in Holdco … would result in an increase in interest described in subparagraph 55(3)(a)(ii) as Third Party would be…unrelated to Opco and Realtyco, the dividend recipients.

Finally, the investment of Holdco in Opco…would not constitute an increase in interest described in subparagraph 55(3)(a)(ii) and (v) as … Holdco would be related to Opco and Realtyco immediately before the transfer of the shares.

…[T]he "particular corporation" [under s. 55(3.01)(g)] would be Holdco. …[T]he increase in interest of Third Party in Holdco described in subparagraph 55(3)(a)(ii) would be deemed not to be described in that subparagraph [by s. 55(3.01)(g)].

...[T]he other transactions of the series…would occur between persons related to the dividend recipients since Holdco would control both Opco and Realtyco.

Consequently, based on paragraph 55(3.01)(g)…it is possible that Opco and Realtyco could utilize the exception to the application of subsection 55(2) provided in paragraph 55(3)(a).

...[However] it would be important that the transactions respecting the formation of Holdco and Realtyco (the dividend recipients) be properly effected. …For example, the disposition of the shares of Opco by Husband, Wife and Third Party to Holdco could technically be described by subparagraphs 55(3)(a)(iii) and (v) respecting the dividend deemed to be received by Realtyco. In effect, immediately before the disposition, Holdco would be considered to not be related to Realtyco if the latter did not exist at that moment.