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

Principal Issues: Taking into consideration the recent Tax Court of Canada decisions with respect to surplus stripping, is the CRA of the opinion that the GAAR would apply to a particular series of transactions the purpose of which is to rely on subsection 55(2) to convert a dividend into a capital gain.

Position: A similar series of transactions (“Transactions”) was recently considered by the GAAR Committee. Although the GAAR Committee recognized that the 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. It was also recognized that results similar to those obtained from the Transactions could be achieved in a variety of ways. The CRA is nevertheless concerned about this type of surplus stripping arrangement and has expressed its concerns to the Department of Finance. However, the CRA will continue applying the GAAR and/or subsection 84(2) to cases like The Queen v. Macdonald where a taxpayer uses losses or other tax shelter to reduce a capital gain realized as part of a surplus stripping scheme. Also, the CRA will rely on the reasoning in Descarries where a taxpayer seeks to extract corporate surplus in a manner contrary to the object, spirit or purpose of specific anti-avoidance provisions, such as sections 84.1 and 212.1.

Reasons: According to the jurisprudence.

Author: Lafrenière, Jean
Section: 55(2), 55(5)(f), 245(2)

2015 CTF Annual Conference
CRA Roundtable

Question 4: GAAR Committee Decision – Planning Involving the Intentional Use of Subsection 55(2) to Generate Capital Gains

Consider the following scenario: 

Mr. A is one of the shareholders of OPCO and wants to extract OPCO’s surplus allocable to his shares, but not in the form of taxable dividends. 

Approximately 25% of the fair market value (“FMV”) of the OPCO shares owned by Mr. A is attributable to something other than safe income on hand (“SIOH”). 

The series of transactions described below is undertaken.

1)    Mr. A transfers some of his OPCO shares to a new corporation (“HOLDCO A”) on a rollover basis pursuant to subsection 85(1) (footnote 1)  in return for HOLDCO A shares.

2)    OPCO redeems the OPCO shares held by HOLDCO A.  Because the amount of the dividend deemed to arise on the share redemption is greater than the SIOH attributable to those shares, and because no designation is made under paragraph 55(5)(f), the entire amount of the dividend is recharacterized by subsection 55(2) as proceeds of disposition and results in a capital gain to HOLDCO A. (footnote 2)   Consequently, HOLDCO A adds the non-taxable portion of the capital gain to its capital dividend account (“CDA”).

3)    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. 

Question

Is the CRA of the opinion that the GAAR applies to this particular series of transactions taking into consideration, among others, the Tax Court of Canada decisions in Evans v. The Queen (footnote 3) , Gwartz v. The Queen (footnote 4)  and Descarries v. The Queen (footnote 5)  and, notably, the following comments of the court in the Descarries decision: 

As stated by the appellants in their written submissions, I noted in Gwartz v. The Queen that the Act does not contain any general prohibition stating that any distribution by a company must be done in the form of a dividend.  However, I also specified in that case that, although the taxpayers may arrange to distribute surpluses in the form of dividends or of capital gains, that option is not limitless.  Any tax planning done for that purpose must comply with the specific anti-avoidance provisions found in sections 84.1 and 212.1 of the Act (footnote 6) . [Footnotes omitted]

CRA Response

A file with a similar series of transactions (the “Transactions”) was recently referred to the GAAR Committee for consideration. 

Although the GAAR Committee considered that the 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. 

It was also recognized that results similar to those obtained from the Transactions could be achieved in a variety of ways.  For example, in a corporate structure similar to that in the Transactions, instead of using subsection 55(2), HOLDCO A could realize a capital gain by selling its OPCO shares to a new sister corporation or by transferring its OPCO shares to OPCO in exchange for new OPCO shares.

The CRA is nevertheless concerned with the type of surplus stripping arrangement described above and has expressed those concerns to the Department of Finance. 

The CRA will still maintain its position of applying the GAAR and/or subsection 84(2) to cases like The Queen v. Macdonald (footnote 7)  where a taxpayer uses losses or other tax shelter to reduce a capital gain realized as part of a surplus stripping scheme. 

Also, the CRA will rely on the reasoning in Descarries (footnote 8)  where a taxpayer seeks to extract corporate surplus in a manner contrary to the object, spirit or purpose of specific anti-avoidance provisions, such as sections 84.1 and 212.1. 

Jean Lafrenière
2015-061070
November 24, 2015

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  Unless otherwise stated, all statutory references herein are to the Income Tax Act. 
2  Paragraph 55(3)(a) does not apply to prevent the application of subsection 55(2) in this case.
3  2005 TCC 684. 
4  2013 TCC 86. 
5  2014 TCC 75 (“Descarries”). 
6  Idem, at paragraph 43. 
7  2013 FCA 110. 
8  Supra note 5. 

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