Section 246.1

Table of Contents


25 September 2017 CTF Finance Roundtable, Q.11

focus on NAL transactions

The surplus stripping changes are intended to focus on non-arm’s length transactions, so that they would not apply, for example, where an arm’s length purchaser uses the assets of the target to pay off acquisition debt. S. 246.1 is not intended merely as a backstop to s. 84.1 so that, for example, it could apply if there were transactions which avoided s. 84(2).

2017 CTF Finance Roundtable, Q.10

example of surplus-stripping transaction not within s. 84.1

S. 246.1 was developed because the courts were not observing the scheme of the Act to prevent surplus stripping or, at least, the conversion of dividends into capital gains.

The shareholders of a company would like to extract its excess cash. There is a drop-down into a second company, triggering a capital gain. The money is extracted using a capital dividend and the other half comes out taxable effectively at a 25% rate.

Those types of situations are not literally caught by s. 84.1, and may not be caught by GAAR or other rules. That is the backdrop to s. 246.1.


Joint Committee, "Part D of Tax Planning Using Private Corporations – “Converting Income into Capital Gains” Proposals", 2 October 2017 Joint Committee Submission

Listing of issues under s. 246.1 (pp. 27-31)

It is unclear if, for example, there is receipt of, say, a promissory note, there is a deemed dividend on such receipt or only on subsequent distributions (principal payments).

The Explanatory Notes indicate that the amount receivable by an individual subject to s. 246.1 could be received indirectly through a trust. In many (or perhaps most) cases, though, the rule could apply to the trust itself, together with individual beneficiaries that receive a distribution from the trust, because the application of the rule is not limited to “individuals (other than a trust).”

Where the rule applies to an individual beneficiary who receives a distribution from a trust of a portion of a capital dividend, the trust should be deemed not to have received the capital dividend, to the extent of that portion, so that “stop‐loss” rules (e.g., s. 112(3.2)) will not apply inappropriately to the trust.

The description of inclusion in the individual’s “income for the year as a taxable dividend received” should be expanded to provide that it is also received “from a corporation resident in Canada,” in order to engage the dividend tax credit provisions.

It may not be clear that, under s. 246.1(2)(b), the non‐arm's length status of the parties is to be tested only at the time that the amount in question is received so that, for example, the receipt of amounts from a corporation operated and controlled by a bona fide arm's length party is not potentially subject to the proposed rule if the recipient had previously sold shares of the corporation to that arm's length person.

The non‐arm’s length standard also should apply to ss. 246.1(2)(c)(i) and (ii) relating to dispositions of property and changes in paid‐up capital. As currently drafted, it appears possible for arm’s length transactions to be the basis for the application of the proposed rule.

One of the purposes of the transaction or series must be to effect a significant “reduction or disappearance” of assets. The language of the provision suggests that assets for this purpose are to be determined on some type of consolidated or look‐through approach but there is no guidance on the manner in which this is to be done.

Does the test look to whether specific identifiable assets have been reduced or disappeared (an "asset tracing test"), or is the test of whether the corporation’s gross assets or aggregate net asset value has been reduced (a "value test")? The purchase of a business asset from the shareholder for fair market value consideration could be caught under an asset tracing test but not a value test.

Ss. 88(2) and 84(2) contemplate that a distribution of paid‐up capital occurs first and then (in the case of s. 88(2)) comes next out of the CDA. Therefore, the basis for concluding that a taxable dividend distribution will in all cases be the normative comparator is questionable.

Michael N. Kandev, "Proposed Section 246.1", Canadian Tax Highlights, Vol. 25, No. 8, August 2017, p.5

Breadth and harshness of proposed s. 246.1 (pp. 5-6)

New Section 246.1…as drafted,…can in theory, apply to any receipt that is a capital dividend or is proceeds on a disposition of capital property as long as property leaves the corporate group as part of the series….

[I]t treats the receipt as a taxable dividend but does not explicitly deem a corporation to be its payer—an omission that most likely makes it problematic to elect eligible dividend treatment or to claim a dividend refund in the corporation….

Interpretive issues (p. 6)

[T]he SCC in Copthorne made the "series" concept unpredictable… . Thus, because a capital dividend can be paid only if a capital dividend account was previously generated, the CRA would probably argue that a disposition that gives rise to a capital dividend account and a capital dividend therefrom are part of the same series despite the fact that the capital dividend was not specifically planned… .

The rule relies on a "one of the purposes" test… . If a taxpayer is assumed to intend the consequences of a transaction he undertakes, this test is likely to turn into a mere results test for a CRA auditor.

The avoidance purpose addressed by section 246.1 is a "significant reduction or disappearance of assets" (an odd expression that seems to refer broadly to any distribution or appropriation of corporate assets) of a private corporation, such that the tax otherwise payable on a corporate distribution is avoided. It will be difficult to assess the meaning of "significant," but the CRA| may apply a de minimis threshold as it does in the context of section 55.

Permanent elimination of credit to capital dividend account (p. 6)

[T]he capital dividend account should not be eliminated. It should be suspended only until the capital property leaves the affiliated group….