Section 129

Mr. A transfers all the shares of Opco 1 to Opco 2 (which is owned 50-50 by him and his spouse) in consideration for a note. 2002-0128955 indicated that a corporation is not entitled to a dividend refund respecting a dividend it is deemed to have paid under s. 84.1(1)(b). Does this position apply to the s. 84.1(1)(b) dividend deemed to be received by Mr. A?

CRA noted that, as indicated in Q.1 of the 2019 APFF Roundtable, 2002-0128955 no longer represents CRA’s position, and the granting of a dividend refund to a corporation deemed by s. 84.1 to have paid a dividend provides an outcome that better accords with the integration principle.

CRA went on to note that the deemed dividend treatment under s. 84.1 allows the individual taxpayer on the receipt side to benefit from the integration mechanisms that are provided in the Act such as the gross-up and the dividend tax credit.

CRA also takes the position that, if the individual taxpayer is already a shareholder of the corporation, the individual can also benefit from another integration mechanism: the CDA account with respect to deemed dividend under s. 84.1. Accordingly, it is hard to justify why an individual taxpayer could benefit from the various integration mechanisms while the purchaser corporation could not.

Mr. A transferred his shareholding of Opco 1 (wholly-owned by him) to a corporation (Opco 2) equally owned by him and his spouse in consideration for a note. Per 2002-0128955, the resulting deemed dividend under s. 84.1(1)(b) would not generate a dividend refund (DR). Does CRA maintain this position? CRA responded:

No. We conducted a fresh analysis of this problem and reconsidered our previous positions in that regard. In the light of that analysis, we have come to the conclusion that the position described in the Interpretation no longer represents the position of the CRA. In particular, according a DR to a corporation deemed to have paid a dividend by virtue of paragraph 84.1(1)(b) provides in our view a result that is more compatible with the integration principle enshrined in the Income Tax Act.

Starting structure

An investment holding company (DC1) is held directly by A and his brother B (apparently, a non-resident) and by an upper-tier holding company (DC2), whose shares are held by A and B, as well as by their mother (X).

Proposed transactions

In order to accomplish a split-up of DC1’s assets amongst A, B and X,

1. X’s shares are redeemed by DC2, and
2. there then is a pro rata butterflying of the assets of DC1 amongst DC2 and newly-formed holding companies for A and B (TC1 and TC2, the latter, a ULC) followed by
3. a s. 88(2) wind-up of DC1 into TC1, TC2 and DC2.

Preliminarily to the next set of transactions,

4. DC1 pays a s. 84(1) safe income dividend to DC2 in amount sufficient to trigger a full refund of its RDTOH balance

Next:

5. Next there is a single-wing split-up butterfly of DC2's assets so that a pro rata portion of its two types of property is butterflied to TC1.
6. X then steps back into the picture by subscribing for preferred shares of DC2,.
7. DC2 continues as a ULC and amalgamates with a wholly-owned ULC subsidiary of B to which he had previously transferred a portion of his [common] shares of DC2, and
8. B then receives his share of Amalco’s assets first by way of a s.84(1) dividend followed by a PUC distribution, and second by way of having all of his shares redeemed.

In order to create CDA to facilitate the redemption (in 1 above) of X’s preferred shares in DC2, DC1 first effects a taxable drop-down of low-ACB marketable securities to a Newco subsidiary, with the resulting CDA being pushed out to DC2 under s.84(1). In addition “redeeming the…preferred shares held by Ms. X crystalizes the additional RDTOH so that it is an asset for the purposes of the butterfly, which allows for a more equitable distribution of assets on the single-wing butterfly of DC2’s assets.”

In order that the safe income dividend in Step 4 generates a full refund of the RDTOH (having regard to a deemed dividend also being paid in Step 5 to only one of the TCs) CRA agrees to there being a taxation year end immediately after Step 4.

Rulings

Including that with respect to the s. 84(1) deemed dividend in 4 above resulting in a dividend refund to DC2 of all of its RDTOH., so that each of TC1 and TC3 will be liable under s. 186(1)(b) for Part IV tax thereon. Ss. 55(2) and 55(2.1) should not apply to deem such deemed dividends to be capital gains, provided that such deemed dividends do not exceed the safe income on hand that could reasonably be considered to contribute to the capital gain that could be realized on a disposition at FMV, immediately before the dividend, of the Class A and Class B common shares of DC2 held by each of TC1 and TC3 at the safe income determination time for the series of transactions that includes the payment of the deemed dividends.

Will CRA follow recent decisions (e.g., MSH) that have not required the reduction of a corporation’s RDTOH balance where it was denied a dividend refund because it failed to file its applicable income tax return within the required three-year period; and will it 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:

The CRA will follow these recent… decisions with respect to the computation of a corporation’s RDTOH balance. In 1057513 Ontario Inc.... the Federal Court of Appeal has also recently stated, in obiter, that unclaimed dividend refunds did not reduce the corporation’s RDTOH balance. …

As well, the 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.

CRA accepts MSH and has reversed 2012-0436181E5, in now considering that a dividend refund which is not claimed on a timely basis does not reduce the refundable dividend tax on hand of the payor corporation. Accordingly, the dividend recipient will not be subject to Part IV tax under s. 186(1)(b) (based on the dividend refund calculated for the payor) if the dividend refund is not received by the dividend payor.

In finding that an agricultural cooperative corporation, as defined in s. 135.1(1), that is a private corporation and has an RDTOH balance may be eligible to a dividend refund pursuant to s. 129(1), CRA stated (TaxInterpretations translation):

A "share" under subsection 248(1) includes a share of the capital of an agricultural cooperative corporation and a cooperative corporation, as defined in subsections 135.1(1) and 136(2), respectively, as well as a share of the capital of a credit union. Furthermore...that an amount which is annually paid to the holders of preferred fractional interests in a cooperative as a return on the invested capital and proportionally among the holders...generally will be taxable as dividends.

In finding that a cooperative formed under the Quebec Cooperatives Act that is neither an agricultural cooperative corporation nor a cooperative corporation is eligible for a dividend refund, CRA, after having noted that such a cooperative is a legal person and a corporation, stated:

Even if a cooperative has an RDTOH balance, it will likely not obtain a dividend refund in accordance with section 129 if the fractions of its capital do not constitute shares as defined under subsection 248(1).

As a fraction of the capital of a cooperative other than an agricultural cooperative corporation, a cooperative corporation and a credit union does not constitute a share…this type of cooperative is not able to obtain a dividend refund.

An extension of time to make a return using s. 220(3) does not alter or affect whether a corporation has factually filed its return of income within the period required under the Act, so that if the corporation has not filed its return of income within three years of the end of the taxation year, it cannot obtain a dividend refund.

There is a cross-redemption of preferred shares held by two connected corporations (Aco and Bco) in each other, thereby giving rise to Part IV tax based on their respective dividend refunds (which, in these circumstances, are generally determined on a circular basis). However, Aco misses the return filing deadline to obtain a dividend refund for that year. Bco submits that, based on Tawa Developments, Aco accordingly has no dividend refund for the year, so that there is no Part IV tax liability to Bco.

In rejecting this interpretation, CRA stated that in Tawa the Tax Court wrongly interpreted the definition of "dividend refund" in light of "the ordinary meaning of the word 'refund' instead of the precise and unequivocal meaning of the expression Dividend Refund under paragraph 129(1)(a)," which refers to an amount which arises on the payment of a taxable dividend, irrespective of whether the corporation in fact receives the refund.

Portfolioco, which had a RDTOH account on December 31, 1997 of $200,000, paid a taxable dividend of $300,000 in its taxation year ended December 31, 1997, but did not file its return for that year within three years after the end of that taxation year, so that CCRA did not pay any dividend refund to Portfolioco. The Directorate stated:

[W]here a corporation has paid a taxable dividend, the amount in its RDTOH account must be reduced by the refund to which the corporation would be entitled under subsection 129(1) if it had filed its return within the three-year period provided for in subsection 129(1), even if the CCRA has not paid an amount to the corporation under subsection 129(1). For the purposes of subsection 129(3) … the "dividend refund" means the amount equal to the lesser of the amounts set out in subparagraphs 129(1)(a)(i) and (ii).

Consequently … the amount of Portfolioco's RDTOH account for its 1998 taxation year would be reduced by the $100,000 dividend refund that would have been made by the CCRA had Portfolioco filed its return of income in accordance with paragraph 150(1)(a).

S.129(1)(a) does not permit the payor corporation to apply for less than the full amount of its dividend refund.

In order to make a donation to a registered charity and public foundation (the "Donee"), a CCPC wholly-owned by Mr. X and with a NERDTOH balance of $750,000 (the “Corporation) has its capital reorganized under s. 86(1) such that 10% of its outstanding common shares (having an FMV of $1 million and a nominal ACB and PUC) are converted into preferred shares (the “Shares”) with a $1 million redemption value. Mr. X makes a donation (being an excepted gift described in s. 118.1(19) ) of the Shares to the Donee with which (and with whose officers etc.) he deals at arm's length.

Mr. X thereby realizes a capital gain of $1 million, while being entitled to a donation receipt in the same amount. Shortly after the donation, the Corporation redeems all of the Shares, thereby resulting in a $1 million deemed dividend under s. 84(3) (with no s. 89(14) designation being made.) This generates a $383,333 dividend refund ("DR").

Considering that the Corporation had liquid assets of $4 million, which would have allowed it to claim the DR had it instead paid a taxable dividend to, or redeemed shares of, Mr. X, would CRA nonetheless apply s. 129(1.2) to deny the DR? CRA responded:

CRA is of the view that the series of transactions of which the acquisition of the Shares by Donee is a part could satisfy the Purpose Test [in s. 129(1.2)] and subsection 129(1.2) could have application… .

Furthermore, the CRA took a similar approach in … 2016-0628181R3 by adding an opinion that any dividend … paid … on the shares of … the private corporation (Holdco) to the foundation (Foundation), which had previously acquired the shares as a result of the transfer of the shares by the testamentary spousal trust for the spouse of the deceased following the death of the spouse, would be considered not to be a taxable dividend, with the result that subsection 129(1. 2) would apply … .

Whether the Purpose Test is satisfied is a question of fact that can only be resolved on the basis of the facts and circumstances … .

The estate of B gifts her shares of a portfolio holding company (“Holdco”) with an RDTOH Balance to a private foundation, with Holdco thereafter using its liquid assets to redeem the common shares held by the private foundation. The balance of the Holdco shares were held before B’s death in a spousal trust, whose terms in the wills of B’s deceased husband (A) provided that the residue (including such shares) was to be transferred to the Foundation on B’s death.

CRA ruled that s. 129(1.2) would not deny a dividend refund to Holdco on the deemed dividend arising on the redemption of the shares that had been gifted to it. However, it also opined that any dividend or deemed dividend that is paid on the Holdco shares that had been transferred to the Foundation out of the residue of the spousal trust will be deemed by s. 129(1.2) not to be a taxable dividend for s. 129(1) purposes. The CRA summary states:

The main purpose test in subsection 129(1.2) is not met where the estate transfers the shares of the holding company to the foundation because subsections 118.1(4.1) and (5), as amended by Budget 2014 second bill, do not apply to the estate. However, we are of the view that subsection 129(1.2) would apply to the transfer of shares held by the spousal trust to the foundation. Similarly, we are of the view that subsection 129(1.2) might have applied had the surviving spouse’s death occurred after 2015 as the estate would then have been governed by the amended wording of subsections 118.1(4.1) and (5).

" In response to a request for an update on its position on s. 129(1.2), CRA noted that it had issued favourable s. 129(1.2) rulings on post-mortem estate planning transactions (2004-008855, 2010-0377601R3 and 2012-0456221R3) and further stated that where the purpose test in s. 129(1.2) was met, s. 129(1.2) could technically apply to deny a dividend refund to a payer corporation even if tax was paid by the shareholder on the dividend received from the payer corporation.

An estate owns all the shares of Corporation A, which has a capital dividend account (CDA) and refundable dividend tax on hand account (RDTOH) but owns no assets. The estate sells its shares to Corporation X, which has assets but not CDA or RDTOH - following which Corporation A and Corporation X amalgamate, with the amalgamating corporation paying a capital dividend to Corporation X. One of the main purposes of these transactions was to allow Corporation X to benefit from Corporation A's CDA and RDTOH

CRA indicated that prima facie s. 129(1.2) would apply to any dividend paid by Corporation A to Corporation X given the stated main purpose. Now taking under consideration the amalgamation, s. 87(2)(aa) provided that if a dividend were paid by a predecessor corporation and a portion thereof would be deemed not to be a taxable dividend by s. 129(1.2), the RDTOH of the predecessor corporation is not transferred to the amalgamated corporation. Since “[i]n contrast to the application of subsection 83(2.1), there are no exceptions to the application of subsection 129(1.2),” the latter provision would apply to notional dividend under s. 87(2)(aa), so that the RDTOH of Corporation A would not carry through to Amalco.

"The provisions of subsection 129(1.2) of the Act will apply to a dividend in any situation where 'one of the main purposes' of acquiring a share and paying a dividend on that share is to enable a corporation to obtain a dividend refund. The Department has not adopted any administrative position with respect to transactions undertaken to shift refundable dividend tax on hand within a related corporate group."

It would be difficult to conclude that there has been an avoidance of Part IV tax by a recipient corporation where a related group carries out transactions so that a corporation with a balance in its refundable dividend tax on hand account generates a dividend refund on the payment of a dividend, and the recipient corporation eliminates its Part IV tax liability through the deduction of non-capital losses.

Regarding the situation where a CCPC (Bco) was subject to Part I tax for a year but also to a dividend refund (DR), CCRA stated:

Where a corporation is required to make a payment under the Act … the CCRA may, instead of paying the amount of the DR for the year, apply the amount of the DR for the year against that other obligation pursuant to subsection 129(2).

… In general, the CCRA applies subsection 129(2) on an initial assessment, for example, when a corporation's tax for the year is still unpaid at the time of the initial assessment and the corporation is entitled to a DR for the year.

Recapture of depreciation on the disposition of a building the rental income from which was active business income, will also be active business income.

Where a corporation whose principal business is farming owns certain rights to take petroleum from a well located on the farm land and leases such rights to an arm's length third party in consideration for a royalty, the royalty income will not be considered to be incidental to or to pertain to the corporation's farming business, nor will the rights be considered to be held or used principally for the purpose of gaining or producing income from the farming business.

As a result of an acquisition of its control, Corporation B ceased to be associated with Corporation A and had a fresh taxation year commence on March 28, 2018. Given that Corporation B carried on an active business, would s. 129(6) deem the rental income received by Company A from Corporation B to be “active business income” for its entire 2018 calendar taxation year, or only the portion there of ending on March 27, 2018?

In finding that s. 129(6) applied only to the shorter period, CRA stated:

[T]he taxation year referenced in regards to the deductible portion is that of the payer, rather than the recipient. In order to meet the requirements of subsection 129(6) of the Act during any particular taxation year of the payer, the payer must be an associated corporation in relation to the recipient in that taxation year.

In contrast to a problem in the July 29, 2016 draft legislation, under recently enacted s. 129(10), where an Opco earns all its income as active business income from arm’s length third parties and pays rents to an associated “Rentco,” an appropriate sharing of the $500,000 business limit between Opco and Rentco is permitted.

CRA followed Norco in finding that rents paid by an operating corporation to a limited partnershp having related corporations as its partners was deemed under s. 129(6) to be active business income.

Mr. A holds all the shares of a Canadian holding company ("Holdco") which holds all the shares of Opco. Holdco also holds 50% of the units of a Quebec partnership (SENC), with the other 50% held by the brother of Mr. A. SENC rents real property to Opco for use in Opco's Canadian active-business operations.

In finding that such rents are deemed to be active business income to Holdco to the extent of its 50% share of SENC, CRA discussed Norco Development, and then stated (TaxInterpretations translation):

Although in civil law a partnership is not a distinct juridical person, paragraph 96(1)(c) requires that the partnership calculate its income as if it were. According to paragraph 96(1)(f) ... the income earned by a partnership maintains its character in the hands of the partners. ...

...[T]he reasoning ... in Norco ... can be applied to the present facts. Otherwise, the interposition of the SENC between Holdco and Opco could lead to rents which were deductible to Opco in respect of its active business becoming income from property to Holdco.

Corporation A, a CCPC without employees or an active business, leases property for use in the active business of an associated corporation such that the rents are deemed to be active business income under s. 129(6). The leased property was damaged by a fire. Do the insurance proceeds received as compensation for the lost rental income qualify as active business income? After referencing the surrogatum principle, CRA stated:

Corporation A received payment from an insurance company as compensation for lost rents. Unless the conditions of subsection 129(6) are satisfied in this case, those rents are generated by a specified investment business and constitute income. As a result, the compensation paid by the insurance company to Corporation A constitutes income from property and does not constitute income from an active business.

A private corporation whose sole asset is a commercial rental property which is rented as to 75% to an associated corporation that carried on an active business and as to 25% to a non-associated corporation, was able under s. 129(6) to treat the rent received from the associated corporation (but not the other tenant) as active business income, notwithstanding that it had a specified investment business.

Aco lent money to Bco, its wholly owned subsidiary, which on-lent the funds to Cco, its wholly-owned subsidiary, which used the funds in its active business. Bco does not carry on any business and such interest income is its only income. CRA indicated that the interest paid by Cco to Bco, which was recharacterized in Bco’s hands as active business income, and that as:

the interest expense paid by Bco to Aco is or may be deductible in computing its income from an active business carried on by it in Canada. Consequently, the amount paid or payable by Bco as interest is deemed to be income of Aco from an active business carried on by it in Canada.

CCRA indicated that where s. 129(6) would not apply to the rents received by Holdco for the use of premises in the grocery store operation of its wholly-owned subsidiary (Opco) where, as a condition to Opco being a franchisee of a third-party franchisor, Holdco was required to lease such premises to the franchisor, which subleased them to Opco. Consequently, the rents received by Holdco from the franchisor would constitute income from property.

Where s. 129(6) applies to deem rental income received by a corporation to be active business income, any recapture on the sale of the building that produced the rental income constitutes active business income.