Subsection 55(5)

Cases

Canada v. Kruco Inc., 2003 DTC 5506, 2003 FCA 284

"income earned or realized" was income computed under the Act

The taxpayer, which held approximately 32.5% of the common shares of another corporation ("Kruger"), took the position that it received a deemed dividend out of safe income of Kruger when Kruger repurchased the common shares held by the taxpayer. The Minister took the position that safe income on hand was reduced by investment tax credits claimed by Kruger (which resulted in a decrease in the undepreciated capital cost of depreciable properties of Kruger and, therefore, resulted in an increase in the taxable income of Kruger without any corresponding generation of cashflow); and by income inclusions to Kruger under s. 12(1)(t), which also represented taxable income for which there was no corresponding cash inflow.

In rejecting this position of the Minister, Noël J.A. noted (at p. 5512) that paragraph 55(5)(c) only made adjustments with respect to two specific items (ss.20(1)(gg) and 37.1) that represented deductions that were not associated with actual cash outflows and indicated that "what this shows is that Parliament had in mind the issue which the appellant now seeks to address and nevertheless opted to deem a corporation's 'income earned or realized' to be income computed under the Act subject only to the two stated exceptions." Accordingly, no adjustment should be made for other items in computing income earned or realized.

Paragraph 55(5)(b)

See Also

626468 New Brunswick Inc. v. The Queen, 2018 TCC 100

safe income reduced by corporate income taxes

An individual rolled his apartment building into a Newco in consideration for a mortgage assumption and shares with nominal paid-up capital, and then rolled those shares into a new Holdco. Following the realization shortly thereafter by Newco of a taxable capital gain and recapture of depreciation on a sale of the building, Newco increased the adjusted cost base to Holdco of its shares by effecting a series of s. 84(1) dividends (including a capital dividend) – following which the individual sold his shares of Holdco to a third party for a sale price based on the amount of cash sitting in Newco.

D’Auray J followed Deuce Holdings and a statement in Kruco in finding that the safe income of Newco was reduced by the amount of corporate income tax ultimately payable by it on its gain on the building sale. She also rejected the argument of Holdco that at the time of sale, no income taxes had yet become payable (because the income for the year had not yet been determined) so that there were not yet any corporate income taxes to deduct from safe income.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) safe income was reduced by corporate income taxes that would be computed on that income 321

Paragraph 55(5)(c)

Administrative Policy

14 February 2014 External T.I. 2012-0454481E5 F - Safe Income

no departures permitted from s. 34.2 adjustments

The only source of income of ABC, a CCPC, is its interest in a partnership with a fiscal period end of XX. ABC has an income inclusion under s. 34.2(2) and claims a reserve under s. 34.2(11). May ABC choose not to claim the transitional reserve provided under s. 34.2(11) for a taxation year for the purposes of the computation of its safe income on hand? In the course of responding, CRA stated (TaxInterpretations translation):

...[I]n the calculation of safe income on hand, a downward adjustment cannot be made to remove or modify the [adjusted stub perod accrual] included in computing a corporation's income for a particular taxation year under subsection 34.2(2) on the basis that the ASPA represents an approximate amount based on a partnership's past year's income.

Similarly, an upward adjustment cannot be made to ignore the Transitional Reserve deducted by virtue of subsection 34.2(11).

Such adjustments would have the effect of directly conflicting with the wording of paragraph 55(5)(c) and of subtracting or adding amounts that are part of taxable income determined as the basis for taxation for purposes of subsection 55(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 34.2 - Subsection 34.2(11) transitional reserve deduction is in taxpayer's discretion 53
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) not claiming s. 34.2(11) transitional reserve to increase SIOH 357

Paragraph 55(5)(d)

Articles

Jim Samuel, "Interaction of the Foreign Affiliate Surplus and Safe-Income Regimes: Selected Anomalies, Issues, and Planning Considerations", Canadian Tax Journal, (2018) 66:2, 269-307

Increasing the tax-free surplus balance for s. 55(5)(d)(i) purposes through Reg. 5907(2.1) election (p. 294)

[G]enerally, if a regulation 5907(2.1) election is made,…at a time when the accumulated depreciation for financial statement purposes is less than it is for tax purposes, the affiliate's earnings (and thus its exempt surplus pool, and ultimately its TFSB) will be increased by the difference between these amounts….

Relevance of deficits of lower-tier affiliates (p. 295)

[I]t is not clear whether in determining safe income on hand of a particular foreign affiliate, the deficit of a lower-tier foreign affiliate could reduce the safe income of the particular foreign affiliate even if the fair market value of its shares exceeds its TFSB. [fn 64: See… Brelco Drilling … [and] 2001-0093385] If a deficit of a lower-tier foreign affiliate does indeed reduce safe income on hand, the location of the deficit affiliate in a chain of foreign affiliates does not seem to be relevant—contrary to the general framework of the foreign affiliate surplus regime, in which so-called blocking deficits in a chain of foreign affiliates are generally more relevant (and potentially more problematic) than deficits in foreign affiliates that are at the bottom of the ownership chain.

Paragraph 55(5)(d) was amended in 2011. Arguably, one of the purposes of the fair market value test in paragraph 55(5)(d) was to capture deficits of lower-tier foreign affiliates, and therefore no adjustment should be required for lower-tier deficits in computing safe income on hand.

Use of FX rate at safe income determination time to translate surplus (p. 295)

[T]he general practice is for the surplus pools of a foreign affiliate to be included in computing safe income using the applicable foreign exchange rate at the safe-income determination time. [fn 65:… 9414365]

Blending of hybrid underlying tax applicable to maximize TFSB (p. 296)

[F]or the purposes of determining safe income, the TFSB is computed on a foreign-affiliate-by-foreign-affiliate basis….

[T]he TFSB includes hybrid surplus of a particular foreign affiliate only if such surplus is "fully sheltered" (that is, that hybrid surplus, if paid by the affiliate as a dividend to the Canadian corporation, would be fully offset by a deduction under paragraph 113(l)(a. 1)). As a result, if one foreign affiliate in a chain has a hybrid surplus pool with an insufficient amount of hybrid underlying tax applicable [fn 66: …[D]efined in … 5907(1).] whereas another affiliate has an excess of hybrid underlying tax applicable, that pool is not available for the purposes of the determination of safe income, notwithstanding that the hybrid surplus would be fully sheltered with hybrid underlying tax applicable if the surplus pools of those two affiliates were combined. Accordingly, and if circumstances permit, it might be prudent to try to "match up" or blend, prior to the safe-income determination time and through the payment of an interaffiliate dividend or other mechanism, the applicable excess hybrid underlying tax of one affiliate with a "low-taxed" hybrid surplus pool of another…

Increasing TFSB through interaffiliate dividends (p. 297)

Notwithstanding that the payment of a dividend from the exempt, hybrid, and/or taxable surplus of the affiliate reduces the surplus pool(s) from which the dividend is considered to be paid, depending on the facts this may not necessarily result in a corresponding reduction in the affiliate's TFSB. [fn 69: [F]or example,…only fully sheltered hybrid surplus is included in computing a foreign affiliate’s TFSB….] Similarly, whether or not the receipt of such a dividend increases the safe income of the recipient also depends on the facts.

For example, the receipt of such a dividend by another foreign affiliate of the taxpayer could increase that affiliate's TFSB by an amount up to the dividend amount, depending on

  • the surplus pool of the distributing affiliate from which the dividend was paid and
  • the surplus balance (deficit) of the recipient. [fn 71: For example, if the recipient has an exempt deficit at the time of receipt of an exempt surplus dividend from another affiliate (and such a deficit is, for one reason or another, not relevant for the purposes of determining safe income, in accordance with the court's rationale in Brelco Drilling, supra note 64), such a deficit could wholly or partially offset (or absorb) the exempt surplus so distributed, whereas that exempt surplus might have been included in computing safe income had it not been distributed by the other affiliate….]

[C]onsideration could be given to timely filing a regulation 5901(2)(b) election (or, alternatively, a subsection 90(3) election)…

Administrative inclusion of stub period surplus income (pp. 298-299)

[S]afe income includes income earned or realized up to the safe-income determination time. In contrast, the exempt and taxable earnings of a foreign affiliate (which include, among other things, a foreign affiliate's earnings [loss] from an active business) are added to the affiliate's exempt and taxable surplus pools, respectively, only at the end of its taxation year….

Nevertheless, the CRA has previously indicated, albeit prior to the changes to paragraph 55(5)(d), that it will administratively accept the inclusion of stub-period earnings in computing the safe income of a corporation when the affiliate was a foreign affiliate of another corporation. [fn 73: 9523075…and 9611945…]

Exclusion of pre-acquisition earnings (p. 299)

[T]he CRA has previously taken the position, in respect of the former version of paragraph 55(5)(d), that the preacquisition earnings of a foreign affiliate that were included in determining the surplus pools of a foreign affiliate should be excluded in determining safe income on hand, on the basis that the inclusion of such amount would, in effect, result in double-counting of the adjusted cost base of the shares of the foreign affiliate as safe income. [fn 77: 2013-049914117…]

Quaere whether there is a look-through rule for partnerships notwithstanding non-application of s. 93.1 (pp. 300-301)

[A]lthough subsection 93.1(1) permits looking through a partnership for the purposes of determining whether a direct or indirect subsidiary of the partnership is considered to be a foreign affiliate of a Canadian corporation that is a partner of a partnership, this lookthrough mechanism applies only for the purposes of the provisions that are specifically identified in subsection 93.1(1.1), and paragraph 55(5)(d) is not one of those provisions….

[However] paragraph 55(2.1)(c) merely refers to the amount of the income earned or realized by any corporation….

[L]amont Management…concluded that the reference to “any corporation” in subsection 55(2) (the predecessor of paragraph 55(2.1)(c)) can include a foreign non-affiliate.

Retroactive adjustments to surplus pools from amending Cdn or local returns (p. 301)

[I]f the Canadian tax return originally filed by a particular corporation is subsequently amended, it might be necessary to make one or more corresponding retroactive adjustments to the safe income that is determined as at a particular safe income determination time.

Likewise, since an affiliate's TFSB is potentially relevant in computing safe income, any retroactive adjustment that is required to be made to the surplus pools of a foreign affiliate could correspondingly affect its TFSB otherwise determined at the safe-income determination time….

[I]f one or more dividends have been paid in that intervening period, either by a foreign affiliate or by a Canadian corporation in the chain, it is possible that such adjustments could affect the quantum of safe income that was otherwise believed to have been available in respect of the dividend at the safe-income determination time.

There are a few instances where it might be necessary to make a retroactive adjustment to the surplus pools of a foreign affiliate. For instance, this might be the case if a foreign affiliate is solely engaged in carrying on an active business and the income (loss) reported by the affiliate in its income tax return filed with the tax authorities in its country of residence is amended or otherwise adjusted….

Retroactive adjustments to surplus pools from adjustments under Reg. 5907(1.1) to reduce (or increase) each group member’s surplus pools for tax borne by (or refunded to) it (pp. 302-303)

[A]ssuming that the entire tax liability of the combined or consolidated group has been paid by one affiliate ("the primary affiliate"), in principle regulation 5907(1.1)(a) only adjusts the surplus pools of the primary affiliate. As the initial step in this process, regulation 5907(1.1)(a) disregards the actual income or profits tax liability (refund) of the combined or consolidated group for the particular taxation year, and then requires the stand-alone tax liabilities of each of the primary affiliate and the other members of the group (each of which is referred to as a "secondary affiliate") to be computed on the basis that each of those affiliates had instead filed its own tax return and had no other taxation year. [fn 83: Regulations 5907(1.1)(a)(i) through (iv).]…

[I]f a loss"" arose in one year and is used by the combined or consolidated group in the immediately following year, the surplus pools of the primary affiliate are increased at the end of the prior taxation year as opposed to the year in which the loss is used.

Prior-year adjustments to surplus pools of the primary and/or secondary affiliates can also arise under regulation 5907(1.1)(b)… [I]f the primary affiliate compensates a secondary affiliate for the use of a loss of the secondary affiliate that arose in a prior taxation year, [so that] the surplus pools of both the primary and secondary affiliates are adjusted only as at the end of the year of the loss regardless of when the payment is made [fn :86: Regulation 5907(1.1)(b)(ii).] Similarly, if a secondary affiliate makes a tax compensatory payment to the primary affiliate in respect of a particular taxation year, the surplus pools of both the primary and secondary affiliates are adjusted only at the end of that taxation year. [fn 87: Regulation 5907(1.1)(b)(i).] This is the case regardless of whether that payment occurs in the particular taxation year or in a subsequent year….

Paul Dhesi, Korinna Fehrmann, "Integration Across Borders", Canadian Tax Journal, (2015) 63:4, 1049-72

Safe income of foreign affiliate (pp. 1069-1071)

Conceptually, the modified "tax-free surplus balance" definition in paragraph 55(5)(d) is the amount of tax-free surplus balance that could hypothetically be paid as a dividend by the foreign affiliate to the Canadian corporation free from Canadian tax, as if the shares of the foreign affiliate were directly owned by the Canadian corporation. [fn 50: Not including preacquisition surplus. The carve-out of regulation 5905(5.6) results in an effective "flattening" of a foreign affiliate structure for the purposes of the safe-income calculation, such that all foreign affiliates are treated as if they were direct subsidiaries of the relevant Canadian corporation.]...

The CRA has commented that it believes that

in general, in computing the safe income on hand attributable to the shares of the capital stock of a corporation, the losses of a subsidiary of the corporation must be taken into account when the loss results in a decrease in the FMV [fair market value] of the corporation's shares. [fn 54: ...2001-0093385.]

Nothing specific in the 2011 amendments to paragraph 55(5)(d) appears to directly address the exempt deficit issue in the computation of a foreign affiliate's safe income on hand.

...[S]ince safe income would generally be calculated in Canadian dollars, it is usually necessary to translate the tax-free surplus balance into Canadian dollars for the purposes of determining the amount of safe income in respect of a foreign affiliate. The CRA has stated that "[w]hen computing exempt or taxable surplus of a foreign affiliate at any particular time the exchange rate at that time should be used. [fn 57: ...9414365... .] In the context of foreign affiliate safe income, the CRA noted that the particular time would be the safe-income determination time.

[A] foreign affiliate's surplus balances are increased by the earnings of the foreign affiliate only at the end of the taxation year in which the earnings arise. [fn 60: The definition of "earnings" in regulation 5907(1) refers to the "earnings" of a foreign affiliate…for a taxation year."…] The CRA has provided administrative relief by indicating that this stub period income may be included in the calculation of safe income in respect of a foreign affiliate. [fn 61: ...9611945... .]

An election made under section 338(h)(10) of the US Internal Revenue Code by the purchaser and vendor in a share purchase permits the purchaser to treat the transaction as an asset purchase for US tax purposes, thereby achieving a step-up in US tax basis of the assets of the acquired corporation. The CRA has commented that tax depreciation in excess of amounts paid for assets would be added back in computing the safe income of a foreign affiliate in respect of which a Code section 338(h)(10) election has been made. [fn 63: ...2013-049914117... .]

Paragraph 55(5)(e)

Cases

Gestion B. Dufresne Ltée v. Canada, 99 DTC 5614 (FCA)

Because of s. 55(5)(e), two corporations each of which was controlled by an individual who was the brother-in-law of the other controlling shareholder (i.e., they were the respective husbands of two sisters) were not related for purposes of applying s. 55(2). Marceau J.A. stated that:

"There is nothing in the text to suggest that the fiction or assumption set out in that 'deeming provision' - to the effect that where applicable for the specific purpose identified, siblings are not to be treated as such, i.e., are to be deemed not to be related to one another but on the contrary to be dealing at arm's length - should apply only at the level of and with regard siblings themselves and have no effect on relationships that stem directly and exclusively from that sibling relationship, such as brothers-and sisters-in-law."

Administrative Policy

21 July 1992 External T.I. 5-921027 -

s. 55(5)(e) would not preclude a finding that two brothers who each owned 50% of the shares of two companies, acted in concert in respect of the control of the companies, with the result that each individual did not deal at arm's length with the corporation, and that the two corporations did not deal with each other at arm's length.

Subparagraph 55(5)(e)(ii)

Administrative Policy

10 October 2014 APFF Roundtable, 2014-0538021C6 F - Meaning of beneficiary

beneficiary under s. 55(5)(e)(ii) includes beneficially interested under s. 248(25)(a)

In Fiducie Famille Salammbô c. Ville de Montréal (2011 QCCQ 11322), a mutations tax case, the Court found that potential non-designated beneficiaries should not be taken into account as beneficiaries at the moment of registration of the land transfer. In considering whether a person is related to each beneficiary under a trust, does CRA accept that it should consider only the persons who have been designated as beneficiaries at the particular time?

After referring to Propep, where the definition of "beneficially interested" in s. 248(25) was stated to apply for determining that an individual was a beneficiary, CRA stated (TaxInterpretations translation):

The CRA considers that the courts would adopt this expanded sense of the concept of beneficiary for purposes of subparagraph 55(5)(e)(ii). It also could be argued that this expanded concept of beneficiary is inter alia engaged by the text of subparagraph 55(5)(e)(ii), which refers to "each beneficiary under a trust who is or may (otherwise than by reason of the death of another beneficiary under the trust) be entitled to share in the income or capital of the trust." Consequently, the position stated at the 2004 APFF Conference [2004-0086961C6] on the meaning of "beneficiary" for the purposes of subparagraph 55(5)(e)(ii), which was to disregard subsection 248(25), is not valid.

For the purposes of subparagraph 55(5)(e)(ii), as the term "beneficiary" is not defined in the Act, it would be interpreted in the light of its meaning under applicable private law. The definition of "beneficially interested" in subsection 248(25) would also be interpreted in the light of the applicable private law.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(25) Propep applied: beneficiary under s. 55(5)(e)(ii) included beneficially interested per s. 248(25)(a) 205

8 October 2004 Miscellaneous 2004-0086961C6 - Interaction of 55(5)(e)(ii) and 248(25)(a)

s. 248(25)(a) does not expand "beneficiary" in s. 55(5)(e)(ii)

Can CRA indicate whether s. 55(5)(e)(ii) should be interpreted in light of s. 248(25)(a)?

CRA indicated that "the concept of 'person beneficially interested' is irrelevant for the purposes of subparagraph 55(5)(e)(ii)," but it also indicated that it "we feel that the right described in subparagraph 55(5)(e)(ii) I.T.A. and paragraph 248(25)(a) I.T.A. are fairly similar."

Articles

Michael Goldberg, "Not Quite Chicken Soup – Part II: Are Powers to Add and Remove Beneficiaries Safe for Canadian Family Trust Precedents", Tax Topics, Number 2175, November 14, 2013, p.1.

Effect of power to add and remove beneficiaries (PARB) (p. 2)

However, if the beneficially interested concept is applicable for purposes of subsection 55(2), then it appears that PARBs in trusts could cause those trusts to be unable to avail themselves of the exception to that provision, which might otherwise be available under paragraph 55(3)(a). The reason for this is that only trusts that meet the restricted related persons provisions in paragraph 55(5)(e) [Note 6: Generally, trusts where the only beneficiaries are the lineal descendants of an individual and/or registered charities, which is quite typical in many traditional Family Trust situations.] qualify for this exception. In this regard, although the CRA has indicated that "the concept of 'person beneficially interested' is irrelevant for the purposes of subparagraph 55(5)(e)(ii)", it also indicated that it "feel[s] that the right described in subparagraph 55(5)(e)(ii) I.T.A. and paragraph 248(25)(a) I.T.A. are fairly similar". [Note 7: See CRA document No. 2004-0086961C6, October 8, 2004.]

It is unclear whether the CRA's views regarding subparagraph 55(5)(e)(ii) would also be applicable to situations caught by paragraph 248(25)(b). Nevertheless, given the CRA's conclusion, it would appear that the inclusion of a PARB might well be problematic for the purposes of subsection 55(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(25) 422

Paragraph 55(5)(f)

Cases

The Queen v. Nassau Walnut Investments Inc., 97 DTC 5051 (FCA)

late s. 55(5)(f) designation available

Although it had been planned that the portion of deemed dividends received by the taxpayer (arising on the redemption of shares held by it) that did not come out of safe income would be subject to a designation under s. 55(5)(f), all of such amounts were reported by the taxpayer in its return as deemed dividends due to an error by a subsequently-appointed accounting firm. In finding that the taxpayer was entitled to make a designation under s. 55(5)(f) after being reassessed by the Minister under s. 55(2), Robertson J.A. characterized the making of a late designation as being in the nature of seeking an amendment to an income tax return, rather than seeking to file a late election, and found that such a late amendment was not objectionable where it arose as a result of a subsequent reassessment by the Minister under s. 55(2) (it being clear that s. 55(5)(f) related directly to the issues surrounding the applicability of s. 55(2)).

See Also

101139810 Saskatchewan Ltd. v. The Queen, 2017 TCC 3

55(5)(f) designation may be made after assessment under s. 55(2)

An individual (Case) held his 1/3 shareholding in a small business corporation through a personal holding company (8231) which also held 1/3 of its assets in the form of investment assets. In order to accomplish a sale of the SBC shareholding to the two other SBC shareholders, that shareholding was first split between two new wholly-owned corporations of Case (807 and 810), essentially using butterfly mechanics, with Case then selling his shares of 807 and 810 to the other two shareholders, and applying the capital gains exemption to a modest portion of the resulting gain. This plan did not work because the purchasers were unrelated, thereby precluding access to the butterfly or s. 55(3)(a) spin-off safe harbour.

CRA assessed 807 and 810, to convert their s. 84(3) deemed dividends realized on the cross-redemption of the shareholdings between them which arose under the butterfly mechanics, into capital gains - subject to deductions of $564,246 for the safe income of 8231 considered to be received by them, notwithstanding that neither had made a s. 55(5)(f) designation.

In this regard, Favreau J stated (at paras. 82-83):

It is well established in Nassau Walnut…that the right to claim the benefit of paragraph 55(5)( f ) is available to taxpayers once the taxpayer is assessed under subsection 55(2).

As the appellants have been reassessed under subsection 55(2), they are entitled to rely on paragraph 55(5)(f) to designate a separate dividend but this dividend election would serve no purpose in this instance as safe income deduction in the amount of $564,246 has been allowed to each appellant… .

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(b) s. 55(2) assessment of corporate tax on bad butterfly confirmed notwithstanding same accrued gain reported at individual shareholder level 452
Tax Topics - Income Tax Act - Section 248 - Subsection 248(28) taxation of same appreciation at individual shareholder level and corporate level under s. 55(2) was not double taxation 270

Gestion Jean-Paul Champagne Inc. v. MNR, 97 DTC 155 (TCC)

The taxpayer, which failed to report the receipt of a deemed dividend in its tax return for the relevant taxation year, was found to be entitled to benefit from a designation under s. 55(5)(f) following a reassessment by the Minister under s. 55(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2) 88

Administrative Policy

21 November 2017 CTF Roundtable Q. 5, 2017-0726381C6 - 55(5)(f) and 55(2.3) with 55(2.1)

bifurcated dividends are one dividend for s. 55(2.1)(b) purpose test but not under s. 55(2.1)(c)

CRA rejected the suggestion that safe income of Opco effectively can be duplicated on the basis that where a dividend in excess of safe income is paid by Opco to Holdco, the bifurcation by s. 55(5)(f) of the dividend into two parts means that the first component is protected as coming out of safe income, and the second component also is not subject to s. 55(2) if, as per s. 55(2.1), its purpose is not to significantly reduce the gain on or the value of the shares. However, for purposes of s. 55(2.1)(c) the dividend is only the portion exceeding safe income.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(b) notwithstanding dividend bifurcation under s. 55(5)(f) (or 55(2.3), the s. 55(2.1)(b) purpose test is to be applied to the whole dividend 223
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.3) dividend bifurcation under s. 55(2.3) does not detract from s. 55(2.1) purpose tests being applied to whole dividend 156

9 March 2016 External T.I. 2016-0630281E5 F - Redemption of shares and changes to 55(2)

s. 55(2) application to separate dividend

Where the dividend resulting under s. 84(3) from a redemption of shares exceeds the safe income stipulated in ss. 55(5)(b) to 55(5)(d), will it be treated as a separate taxable dividend of the recipient corporation under s. 55(5)(f)?

CRA responded (TI translation):

This designation [s. 55(2.1)(f)] can be made in respect of a dividend deemed to be received under subsection 84(3). Moreover, as your question does not apply to a stock dividend, subsection 55(2.3)…will not apply.

The amount of the excess dividend that is taxable to the party designated by the corporation pursuant to subparagraph 55(5)(f)(i) is deemed to be a separate taxable dividend.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2.1) - Paragraph 55(2.1)(c) exemption of s. 84(3) deemed dividend not exceeding safe income 144
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2) - Paragraph 55(2)(b) demarcation between ss. 55(2)(b) and (c) 278

24 November 2015 CTF Roundtable Q. 4, 2015-0610701C6 - Surplus Stripping and GAAR

deliberate non-use of s. 55(5)(f) designation does not violate GAAR

Approximately 25% of the fair market value of the OPCO shares owned by Mr. A, who is one of its shareholders and who wants to extract its surplus, is not attributable to safe income on hand (“SIOH”). He transfers some of his OPCO shares to a new corporation (“HOLDCO A”) on a s. 85(1) rollover basis for HOLDCO A shares, and OPCO redeems its shares held by HOLDCO A, with the entire amount of the dividend is recharacterized by s. 55(2) as proceeds of disposition in the absence of a s. 55(5)(f) designation. HOLDCO A then pays a capital dividend to Mr. A equal to its CDA balance.

The overall result of this series of transactions is that the amount of tax payable by Mr. A, OPCO and HOLDCO A, with respect to OPCO’s surplus distributed first to HOLDCO A and then to Mr. A, is significantly less than the amount of tax that would have been payable if OPCO had distributed the same surplus to Mr. A as taxable dividends. Does CRA consider that GAAR should be applied? CRA responded:

Although the GAAR Committee considered that [similar] Transactions circumvented the integration principle, it recommended that the GAAR not be applied. The GAAR Committee was of the view that it would be unlikely that the GAAR could be successfully applied to the Transactions given the current state of the jurisprudence.

…The CRA…has expressed [its] concerns to the Department of Finance.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) deliberate triggering of s. 55(2) gain does not violate GAAR 212

16 June 2014 STEP Roundtable, 2014-0522991C6 - Safe Income

s. 55(5)(f) designations are unnecessary

CRA stated that its long-standing practice "is to apply subsection 55(2) only to the excess of the taxable dividend paid on a share over the safe income on hand attributable to that share, when issuing an assessment based on subsection 55(2)." Accordingly when a corporate shareholder receives a dividend in excess of SIOH and does not make s. 55(5)(f) designations to carve the dividend up into safe income and taxable dividends, CRA will only apply s. 55(2) to the portion of the dividend in excess of SIOH. See summary under s. 55(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(2) s. 55(5)(f) designation unnecessary 154

1992 A.P.P.F. Annual Conference, Q. 2 (January - February 1993 Access Letter, p. 50)

RC will accept a designation that is filed with a late-filed income tax return, or a designation that is filed after the filing of the income tax return but before the expiry of the period for filing a notice of objection in respect of the original assessment for that taxation year. RC also has a policy under which it may only assess the appropriate portion of the deemed dividend as proceeds of disposition or a capital gain.

June 1990 Meeting of Alberta Institute of Chartered Accountants (November 1990 Access Letter, ¶1499, Q. 5)

Rulings have been granted wherein a corporation is permitted to make more than one s. 55(5)(f) designation provided that there is an explanation of the specific uncertain elements in the calculation of safe income on hand that results in the need for more than one designation.

June 1990 Meeting of Alberta Institute of Chartered Accountants (November 1990 Access Letter, ¶1499, Q. 6)

There is no provision for a taxpayer to make late or amended designations under s. 55(5)(f).

90 C.P.T.J. - Q.21

It is the practice of RC to accept a designation under s. 55(5)(f) which is filed before the time has expired for filing a notice of objection in respect of the initial assessment for the year in which the dividend is received.

90 C.P.T.J. - Q.19

s. 55(5)(f) does not allow for the use of a formula, rather than an amount, in the designation of a separate taxable dividend.

Articles

Rick McLean, Jeff Oldewening, Jonas Lau, "Capital Gains Stripping and Surplus Stripping", 2017 Annual CTF Conference draft paper

Introduction of the bifurcation rules (p. 10)

Any other taxable dividend is no longer protected from recharacterization by the internal reorganization exception. Each such taxable dividend does not arise as a foundational component of a sanctioned divisive reorganization but, rather, has the potential, as in D & D Livestock, to effect a significant reduction in a capital gain on any share, a significant reduction in the fair market value of any share, or a significant increase in the total cost of property of the dividend recipient….

However, the holding corporation could forgo a designation under paragraph 55(5)(f). The full amount of the taxable dividend could be recharacterized by subsection 55(2) as a deemed capital gain that would increase its CDA. In that case, a portion of the safe income on hand of the dividend payer attributable to its shares held by the dividend recipient could be realized as a capital gain. This is the very notion of surplus stripping. The holding corporation could then elect to distribute to its individual shareholder another source of income, such as its active business income, as a capital dividend using such CDA generated by the deemed capital gain.

[T]o neutralize that threat, amended paragraph 55(5)(f) (and new subsection 55(2.3) for high-low stock dividends) (collectively, the "bifurcation rules") now compel die distribution of safe income on hand pursuant to a taxable dividend….

Each of the bifurcation rules divides a taxable dividend into a safe income dividend and a non-safe income dividend. As the safe income dividend reduces the dividend recipient's accrued gain in its shares of the dividend payer, the shareholder's CDA cannot be increased to the extent of the amount of that safe income dividend. This ensures that subsection 55(2) cannot transform the portion of a capital gain that is attributable to safe income on hand into a positive balance of CDA for purposes of surplus stripping.

Issue of whether the purpose of a whole taxable dividend is determined before or after bifurcation (pp. 10-11)

If the purpose of the whole taxable dividend under a safe income crystallization must be identified before bifurcation, one might concede that one of the purposes of the dividend…is to achieve that outcome of significantly reducing a capital gain, significantly reducing the fair market value of any share, or significantly increasing the total cost of property of the dividend recipient.

In contrast, if the bifurcation rules divide the whole taxable dividend into a safe-income dividend and a non-safe income dividend before the "purpose" of either divided is ascertained … [o]nly the purpose of the non-safe income dividend … must be ascertained. …

[C]onsider where a taxpayer miscalculates its safe income on hand before undertaking a safe income crystallization. The taxpayer's subjective purpose is not to give rise to a non-safe income dividend pursuant to the bifurcation rules….

[T]he three purpose tests are meant to inquire into the subjective purpose of the dividend payer and the dividend recipient in order to frustrate tax-driven capital gains stripping. Only the first interpretive approach meets that legislative objective….

CRA view consistent with purpose being identified before bifurcation (p. 11)

The CRA's position is that the 2015 amendments did not change the order of application of these rules but, rather, merely made the operation of paragraph 55(5)(f) automatic rather than discretionary. [fn 52: 2017-0726381C6]

[T]he CRA’s view ignores that bifurcation under paragraph 55(5)(f) occurs "for purposes of this section [55]", and that bifurcation under paragraph 55(2.3)(a) occurs "for the purpose of [subsection 55(2)]". This means that automatic bifurcation of the taxable dividend applies for purposes of the three purpose tests. Indeed, this is the very concept that raises the interpretive issue in the first place. Still, despite its unsound reasoning? the CRA came to the proper conclusion on that issue.

Incoherent scheme for divestitures: integration where Holdco sells Opco to arm’s length Holdco; no integration where Opco redeems Holdco shares (pp. 24-25)

To illustrate this incoherent legislative state, consider the following example. "Opco" is owned by three unrelated holding companies, "Holdco A", "Holdco B" and "Holdco C". Each of Holdco A, Holdco B and Holdco C are owned by individuals "A", "B" and "C", respectively. The shares of Opco owned by Holdco A have a fair market value of $100, PUC of nil, and ACB of nil. The safe income on hand attributable to the shares of Opco held by Holdco A is $30. "A" wishes to divest its indirect interest in Opco. Conceptually, a number of options are available, and the tax results differ depending on the structure chosen for the divestiture:

  • "A" sells the shares of Holdco A to "B" and realizes a capital gain of $100, resulting in personal tax at the rate applicable to capital gains realized by individuals.
  • Holdco A sells the shares of Opco to Holdco B and realizes a capital gain of $100. Although there is safe income of $30, the bifurcation rules do not apply because Opco did not pay a taxable dividend to Holdco A. Thus, Holdco A's capital gain augments its CDA. Holdco A can distribute its sale proceeds to A as a capital dividend and a noneligible dividend to achieve an effective combined tax rate on the distribution that approximates that applicable to capital gains realized directly by an individual.
  • Opco redeems its shares held by Holdco A. A triggering event under paragraph 55(3)(a) occurs, since unrelated persons have an increase in interest in Opco. On the share redemption, subsection 84(3) gives rise to a deemed dividend. Paragraph 55(5)(f) bifurcates the resulting deemed dividend into a safe income dividend of $30 and a non-safe income dividend of $70, solely for purposes of section 55. The safe income dividend is excused from recharacterization as a deemed capital gain pursuant to the safe income exception. However, subsection 55(2) recharacterizes the non-safe dividend as a deemed capital gain in the amount of $70. Only this smaller quantum of the non-safe income dividend recharacterized as a deemed capital gain augments Holdco A's CDA. As the safe income dividend reduced the quantum of the deemed capital gain, Opco's safe income on hand that is attributable to its redeemed shares cannot be surplus stripped. The share redemption is treated as a corporate distribution that is taxed differently than a sale of its shares.

Consequently, the statutory regime governing divestitures is not consistent. Share redemptions caught by subsection 55(2) produce the most punitive results….

The Department of Finance (Canada) sought, through its withdrawn proposed section 246.1, to deny CDA created on an internal reorganization that was not caught by subsection 55(2) but which could have facilitated surplus stripping. Upon the abandonment of that measure, there is no clear tax policy against surplus stripping achieved through realizing the economic value of a corporation's safe income on hand by a sale of shares that does not invoke the bifurcation rules. Further, withdrawal of proposed section 246.1 indicates that there is no abuse from surplus stripping through so-called "mixing-and-matching" distribution.