2016-0626371E5 Subsection 185.1(2) election

Principal Issues: 1. In the scenarios described, is it possible to use the election in subsection 185.1(2) to stream all excessive eligible dividend designations in respect of three separate eligible dividends paid in a year to one eligible dividend paid, deeming it to be an ordinary dividend, while the other two dividends remain eligible? 2. If not, do three separate elections under subsection 185.1(2) need to be made, or can the corporation file one election for all eligible dividends?

Position: 1. No, the election under subsection 185.1(2) does not operate in that manner because an excessive eligible dividend designation is made in respect of each eligible dividend paid in the year pursuant to the definition of "excessive eligible dividend designation" in subsection 89(1), and the election only permits the corporation to elect up to the amount of the excessive eligible dividend designation in respect of each eligible dividend paid. 2. While the election must be made in respect of each excessive eligible dividend designation on each eligible dividend, these elections can be combined into one letter to your tax centre, provided that all of the required information in respect of each dividend is provided, in accordance with the instructions at http://www.cra-arc.gc.ca/tx/bsnss/tpcs/crprtns/dvdnds/lctn-eng.html.

Reasons: 1. Wording of the legislation. 2. Currently there is no prescribed form and no prescribed manner for making this election, therefore administrative guidance is provided on the CRA website.

Author: Verlinden, Nicole
Section: 89(1), 84(3), 185.1(1) and 185.1(2)

XXXXXXXXXX                                                                            2016-062637
                                                                                                    Nicki Verlinden
                                                                                                   (416) 973-2228
May 13, 2016

Dear XXXXXXXXXX,

We are writing in reply to your email, in which you requested our comments to the questions listed below, pertaining to the two scenarios described below.

All legislative references are to the Income Tax Act (“Act”) unless otherwise stated.

Scenario #1

*    Canco is a Canadian controlled private corporation (“CCPC”), as defined in subsection 125(7), and it has three Canadian resident shareholders. Each shareholder holds a different class of shares of Canco (i.e., Classes A, B and C).

*    During the year, Canco paid three separate dividends of $30,000 to each shareholder on their respective classes of shares for a total of $90,000. Upon payment, each dividend was designated as an eligible dividend pursuant to subsection 89(14) and T5s were issued accordingly.

*    At the beginning of the year, the general rate income pool (“GRIP”), as defined in subsection 89(1), had a nil balance and at the end of the year, it had a $60,000 balance.

*    Canco was considered to have made an excessive eligible dividend designation (“EEDD”), as defined in subsection 89(1), of $10,000 in respect of each eligible dividend paid based on the formula described in paragraph (a) of the definition of EEDD. 

Questions for scenario #1

1) Is it possible to file the election under subsection 185.1(2) deeming the entire amount of one of the eligible dividends paid in the year as an ordinary taxable dividend, such that the Class A shareholder receives a $30,000 ordinary taxable dividend and the Class B and C shareholders each receive $30,000 eligible dividends?

2) If the answer to question one is no, would the corporation be obliged to file three separate elections under subsection 185.1(2), or could the corporation file one election for all dividends?

Scenario #2

*    Canco is a CCPC and has three Canadian resident shareholders. Each shareholder holds a different class of shares of Canco (i.e., Classes A, B and C).

*    During the year, Canco redeems all of the Class B and C shares for $30,000 each. On the redemption, subsection 84(3) deemed the Class B and C shareholders to receive taxable dividends of $30,000 each. Canco designated these deemed dividends as eligible dividends and T5s were issued accordingly. 

*    Canco also declared a dividend of $30,000 during the year on its Class A shares and designated it as an eligible dividend, and the T5 was issued accordingly.

*    The total eligible dividend designations in the year were $90,000.

*    At the beginning of the year, the GRIP had a nil balance and at the end of the year, it had a $60,000 balance.

*    Canco was considered to have made an EEDD of $10,000 in respect of each eligible dividend paid, based on the formula described in paragraph (a) of the definition of EEDD. 

Question for scenario #2

In this case, is it possible to file the election under subsection 185.1(2) deeming the entire amount of one of the eligible dividends on a redemption of shares in the year as an ordinary taxable dividend, such that one of the shareholders receives a $30,000 ordinary dividend and the other two shareholders each receive $30,000 eligible dividends? 

Our comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations. 

Subsection 89(1) defines an EEDD for a CCPC in paragraph (a), assuming paragraph (c) of that definition does not apply. An EEDD made by a corporation in respect of an eligible dividend paid by the corporation at any time in a taxation year, means

(a) … the amount, if any, determined by the formula

      (A – B) x C/A

      where

A    is the total of all amounts each of which is the amount of an eligible dividend paid by the corporation in the taxation year,

B    is the greater of nil and the corporation's general rate income pool at the end of the taxation year, and

C    is the amount of the eligible dividend,

In scenario #1, Canco makes an EEDD of $10,000 in respect of each $30,000 eligible dividend it paid in the year. The tax imposed by subsection 185.1(1) is computed as 20% of each EEDD, for a total of $6,000.  The election available in subsection 185.1(2) is made in respect of each EEDD that is made in respect of each eligible dividend paid by Canco in the year. Notwithstanding the definition of eligible dividend in subsection 89(1), the original eligible dividend paid by Canco and received by a shareholder may be reduced by an elected amount up to the EEDD in respect of the dividend. This upper limit is stated in subparagraph 185.1(2)(a)(ii). Therefore, in scenario#1, Canco can reduce the $30,000 original eligible dividend paid on the Class A shares by a maximum of $10,000 by electing on the full amount of the EEDD in respect of that dividend. The maximum elected amount of $10,000 is deemed to be a taxable dividend, other than an eligible dividend. It is not possible to elect on the full amount of the $30,000 eligible dividend paid to the Class A shareholder under subsection 185.1(2) to reduce the eligible dividend amount to nil. Consequently, in order to eliminate the Part III.1 tax in scenario #1, a subsection 185.1(2) election should be made up to the maximum of $10,000 in respect of each EEDD on each eligible dividend paid by Canco in the year. 

The fact that two of the eligible dividends paid in scenario #2 are deemed taxable dividends resulting from share redemptions, pursuant to subsection 84(3), does not change the answer above.

Presently, there is no prescribed form for making this election, nor is there an income tax regulation setting out the prescribed manner for making the election. CRA has published the prescribed manner (as authorized by the Minister) at http://www.cra-arc.gc.ca/tx/bsnss/tpcs/crprtns/dvdnds/lctn-eng.html. 

While the election must be made in respect of each EEDD on each eligible dividend, these elections can be combined into one letter to your tax centre, provided that all of the required information in respect of each dividend is provided.

We trust that our comments will be of assistance.

Yours truly,

Yves Moreno
for Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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