Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: In a particular acquisition of shares of a corporation from an estate, whether subsection 83(2.1) would apply to recharacterize the capital dividend as a taxable dividend.
Position: In the scenario submitted, subsection 83(2.1) would probably not apply. However, depending on the facts of a series of transactions, subsection 245(2) could apply.
Reasons: Technical application of provisions.
Author: Séguin, Marc
Section: 83(2.1), 83(2.2), 83(2.3), 83(2.4)
November 9, 2017
Re: Paragraphs 83(2), (2.1), (2.2), (2.3) and (2.4)
We are writing in response to your letter of May 8, 2017, in which you requested our opinion concerning the capital dividend account (“CDA”) balance of a corporation in a particular hypothetical situation.
Your questions relate to the following hypothetical scenario:
Mr. X, a Canadian resident, was the sole shareholder of Canco at the time of his death. Canco was the owner and beneficiary of a life insurance policy on the life of Mr. X. The insurer paid $500,000 to Canco pursuant to the policy and the adjusted cost basis of the policy was nil. The policy was not a LIA policy nor a 10/8 policy, and was always owned by Canco. Prior to receiving the insurance funds, Canco had a CDA balance of nil.
Canco disbursed from the insurance funds an amount of $200,000 to reduce an outstanding loan of Canco and an amount of $250,000 was paid as a capital dividend to the estate. The balance of $50,000 was retained in Canco as working capital.
The estate sold the shares of the capital stock of Canco to Ms Y, a Canadian resident not related to Mr. X. Since the sale, the CDA of Canco has remained unchanged.
You asked what would be Canco’s CDA balance before and after the sale of the shares of the capital stock of Canco to Ms Y.
Also, you asked us to consider the situation where Mr. X would have owned the shares of the capital stock of Canco indirectly through Holdco and the estate of Mr. X would have sold to Ms Y the shares of the capital stock of Holdco. You would like to know if our response would be different from our response with respect to the first situation described above.
We assume that the purpose of your questions is to establish if Ms Y could eventually receive, following an election in prescribed manner, a capital dividend from the CDA balance of either Canco or Holdco. For the capital dividend to be received from Holdco, we assume that Holdco and Canco would have always been related to each other. You have not provided information as to how such dividend would be financed or if other assets would be owned by Canco other than the $50,000 that would be retained in Canco.
This technical interpretation provides general comments about the provisions of the Income Tax Act (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 IC70-6R7, Advance Income Tax Rulings and Technical Interpretations.
All references to sections or components of a statute are references to the Act unless otherwise specified.
Subsection 83(2) will allow a private corporation to elect to deem any dividend to be a capital dividend which will not be included in computing the recipient’s income to the extent of the corporation’s CDA balance immediately before the dividend. The amount of a corporation’s CDA balance is determined by a formula set out in the definition of CDA in subsection 89(1).
The ability of a corporation to elect pursuant to subsection 83(2) and its CDA balance determined under subsection 89(1) are generally not impacted by an acquisition of control of the corporation. Therefore, Canco’s CDA balance of an amount of $250,000 before the acquisition of the shares of the capital stock of Canco by Ms Y would remain the same in the present situation after such acquisition.
However, subsection 83(2.1) provides a specific anti-avoidance rule which limits the right to receive an amount from the CDA balance of a corporation tax-free as a capital dividend under certain circumstances. Under subsection 83(2.1), where a dividend paid on a share would otherwise be deemed to be a capital dividend under subsection 83(2) and the share was acquired by the holder in a transaction or as part of a series of transactions or events one of the main purposes of which was to receive the dividend, the dividend will be deemed for purposes of the Act to be a taxable dividend and not a capital dividend. However, subsection 83(2.1) will not apply if one of the exceptions described in subsections 83(2.2) to (2.4) is met.
We assume that in the situation described, Ms Y would acquire the shares of the capital stock of either Canco or Holdco and that one of the main purposes of such acquisition would be to receive a capital dividend.
Subsection 83(2.2) provides that subsection 83(2.1) will not apply to a capital dividend paid to an individual unless it is reasonable to consider that all or substantially all of the corporation’s CDA immediately before the dividend became payable consisted of amounts described in paragraphs 83(2.2)(a) to (d). Therefore, a capital dividend treatment on a dividend paid to an individual will not be available where the CDA from which such dividend was paid arose (a) from a capital dividend received by the corporation on a share of another corporation acquired in a transaction or as part of a series of transactions one of the main purposes of which was to receive the dividend (other than a capital dividend paid from the CDA of the other corporation that arose from certain life insurance proceeds); (b) from an addition to the CDA under paragraph 87(2)(z.1) on a winding-up or amalgamation of another corporation that would not have been so added had the amalgamation or winding-up occurred or the series of transactions been commenced after 4:00 p.m. Eastern Daylight Saving Time, September 25, 1987; (c) while the corporation was controlled directly or indirectly, in any manner whatever, by non-resident(s); or (d) from a capital gain that accrued on a property while the property was a property of the corporation that was controlled directly or indirectly, in any manner whatever, by non-resident(s).
According to facts of the hypothetical situation that you described, the CDA balance of Canco would not consist of amounts described in paragraphs 83(2.2)(a) to (d) (such CDA balance being only attributable to an insurance policy proceeds in this scenario). Consequently, subsection 83(2.1) would not apply to deem a capital dividend received by Ms Y (that would not exceed Canco’s CDA balance immediately before the dividend) to be a taxable dividend.
In the situation where Ms Y would have acquired the shares of the capital stock of Holdco as described above, the capital dividend paid by Canco to Holdco would also not be subject to subsection 83(2.1). The shares of the capital stock of Canco held by Holdco would not be acquired in the context described in subsection 83(2.1). In addition, subsection 83(2.4) provides that subsection 83(2.1) will not apply to capital dividends paid between related corporations, other than where it was reasonable to consider that all or substantially all of the amounts of the CDA immediately before the dividend became payable consisted of amounts described in paragraphs 83(2.4)(a) to (e). The CDA balance of Canco immediately before the dividend would not consist of amounts described in paragraphs 83(2.4)(a) to (e).
The capital dividend paid by Holdco to Ms Y would also not be subject to subsection 83(2.1) since the CDA balance of Holdco would not consist of amounts described in paragraphs 83(2.2)(a) to (d). More specifically, the CDA balance of Holdco would not consist of an amount described in paragraph 83(2.2)(a) since Holdco did not acquire the shares of the capital stock of Canco in a transaction or as part of a series of transactions one of the main purposes of which was that Holdco receive the dividend from Canco.
If, instead of Holdco paying a capital dividend to Ms Y after having received a capital dividend from Canco, there is a winding-up of Canco into Holdco or there is an amalgamation of Canco and Holdco, paragraph 87(2)(z.1) provides (by virtue of paragraph 88(1)(e.2) in case of a winding-up of Canco into Holdco) that Holdco or the new corporation resulting from the amalgamation to be the same corporation and the continuation of Canco and the exception in paragraph 87(2)(z.1) would not apply. As mentioned above, if a dividend had been paid by Canco immediately before the amalgamation or winding-up, subsection 83(2.1) would not have applied. This allows the CDA balance of Canco to be transferred to Holdco or to the new corporation resulting from the amalgamation. Although the amount would be added to the CDA balance of Holdco or of the new corporation resulting from the amalgamation by virtue of paragraph 87(2)(z.1), paragraph 83(2.2)b) would not apply with respect to the capital dividend paid to Ms Y by Holdco or the amalgamated corporation.
However, even if in the scenarios described above, there is an exception to the application of the specific anti-avoidance rule provided for in subsection 83(2.1) pursuant to subsections 83(2.2) and (2.4), a review of all the relevant facts and circumstances of a series of transactions in a particular situation should be done to determine whether subsection 245(2) could apply in a situation.
Finally, subsection 83(2.3) provides that subsection 83(2.1) will not apply to a capital dividend paid by a corporation in order to distribute life insurance proceeds which were received by it and included in its capital dividend account as a consequence of the death of a person. Subsection 83(2.1) does not apply where a capital dividend funded by life insurance proceeds is paid to an individual either directly or through a holding corporation by reason of the exception provided in paragraph 83(2.2)(a).
Depending on the facts and circumstances in a file, these exceptions could apply to the extent it is reasonable to consider that the purpose of paying the dividend was to distribute an amount that was received by the corporation and included in computing its capital dividend account by reason of paragraph (d) of the definition “capital dividend account” in subsection 89(1). Thus, assuming that Canco’s assets consist only of $50,000 cash which is funded by life insurance proceeds, the provision 83(2.3) could apply to a capital dividend equal to this amount.
We trust these comments will be helpful.
Urszula Chalupa, LL.B, M. Fisc.
for Division Director
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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