2016-0653451E5 Subsection 55(2) and Part IV tax

Principal Issues: 1. Does the Part IV tax exception to 55(2) apply when the Part IV tax is refunded as a consequence of a payment of a dividend to an individual? 2. If subsection 55(2) applies because the Part IV tax is refunded, could an election be made on a portion of the taxable dividend that generated the refund of Part IV tax to be a capital dividend, giving retroactive effect to the application of subsection 55(2)?

Position: 1. No. Subsection 55(2) applies when the Part IV tax is refunded as a consequence of payment of dividend by the corporation. It does not matter who receives the dividend paid by the corporation. 2. No. For subsection 55(2) to apply, Part IV tax has to be actually paid on the dividend received and a dividend refund has to be actually obtained. Subsection 55(2) requires, instead of negating, the prior application of sections 186 and 129. A payment of capital dividend and consequently a reduction of taxable dividend paid by the recipient corporation would not trigger a full refund of Part IV tax, resulting in a circular calculation. Full effect has to be given to the application of Part IV tax and the refund of such Part IV tax before the application of subsection 55(2). No capital dividend can therefore be paid before all taxable dividends are paid to generate a full refund of the Part IV tax paid for subsection 55(2) to be fully applicable to the dividend received.

Reasons: See above. This position is also supported by Ottawa Air Cargo Centre Ltd v. The Queen (2007 D.T.C. 661).

Author: Ton-That, Marc
Section: 55(2), 129(1), 129(3), 186

XXXXXXXXXX                                                                                                                                    2016-065345
                                                                                                                                                            Marc Ton-That
                                                                                                                                                            (819) 327-3357
XXXXXXXXXX

October 11, 2016

Dear XXXXXXXXXX,

Re: Subsection 55(2) and Part IV tax

This is in response to your e-mail of June 15, 2016 in which you requested our view on the following set of transactions (unless otherwise stated, all statutory references herein are to the Income Tax Act (Canada)):

*     Holdco owns all the shares of Opco.  Opco is therefore connected with Holdco by virtue of subsection 186(4).

*     All transactions occur in Holdco’s and Opco’s taxation years beginning after XXXXXXXXXX.

*     Opco’s refundable dividend tax on hand, as defined in subsection 129(3) (“RDTOH”), is approximately $XXXXXXXXXX.

*     Taking its RDTOH into account, Opco will pay a taxable dividend of $XXXXXXXXXX to Holdco.  Opco expects to receive a dividend refund under subsection 129(1) of $XXXXXXXXXX (based on the lesser of XXXXXXXXXX% of the taxable dividend paid and the RDTOH at the end of its taxation year).

*     Holdco will then pay a taxable dividend of the same amounts to a shareholder who is an individual.

*     Consequently, Holdco will pay Part IV tax of $XXXXXXXXXX but will be eligible for an offsetting dividend refund.

Since all of the steps described are related to a distribution of cash to the shareholder, you have stated that they are part of the same series.

You noted that, under the previous version of subsection 55(2), prior to the enactment of Bill C-15 on June 22, 2016, the Part IV exception to subsection 55(2) would have applied to the taxable dividend received by Holdco because, although the Part IV tax on that dividend is refunded to Holdco, the dividend triggering the refund was not paid to a corporation.

You asked how the current version of subsection 55(2) would apply in this situation.

You also wanted us to assume that there is no safe income that could be considered to contribute to the gain, if any, on the shares of Opco held by Holdco and that paragraph 55(2.1)(b) applies to the dividend received by Holdco.

OUR COMMENTS

This technical interpretation provides general comments about the provisions of the Act and related legislation. 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 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

Subsection 55(2) applies to the amount of the dividend that satisfies the conditions of application in subsection 55(2.1), other than the portion of such amount that is subject to Part IV tax that is not refunded as a consequence of the payment of a dividend by a corporation, where the payment is part of the series referred to in subsection 55(2.1).  It does not matter that the Part IV tax is refunded as a result of a payment of dividend to an individual as opposed to a corporation.  Under current subsection 55(2), if the Part IV tax is refunded as a result of the payment of a dividend by a corporation in the same series of transactions referred to in subsection 55(2.1), then the Part IV tax exception does not apply.

Although you have not raised the question, the application of subsection 55(2) is predicated on the actual payment of the Part IV tax and the actual receipt of the refund of such Part IV tax.  In the situation described above, although paragraph 55(2)(c) deems the dividend received by Holdco to be a capital gain, the deeming effect does not apply to change the application of section 186 to the dividend received by Holdco and consequently, the application of section 129 to the dividend paid by Holdco. Concluding otherwise would make the Part IV tax condition of application of subsection 55(2) redundant.

Taking the logic further, Holdco’s election under subsection 83(2) in respect of the dividend paid to the individual shareholder that results in a refund of Part IV tax paid on the dividend received from Opco is not compatible with the application of subsection 55(2) to the dividend received from Opco. 

As stated above, full effect has to be given to the application of Part IV tax and the refund of such Part IV tax before the application of subsection 55(2).  A payment of a capital dividend of $XXXXXXXXXX and a taxable dividend of $XXXXXXXXXX by Holdco to the individual shareholder would not trigger a full refund of the Part IV tax of $XXXXXXXXXX (using a refund rate of XXXXXXXXXX% under subsection 129(1)), and subsection 55(2) would become applicable to a declining amount resulting from a circular calculation.

The $XXXXXXXXXX increase of Holdco’s CDA resulting from the application of subsection 55(2) to the dividend of $XXXXXXXXXX received from Opco will be available to Holdco only for an election under subsection 83(2) on future dividends.

The above position is consistent with the views of the Court in Ottawa Air Cargo Centre Ltd v. The Queen (2007 D.T.C. 661).

We trust the above comments to 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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