2018-0771831E5 Part IV Circular Calculation on cross redemption

Principal Issues: The calculation of the Part IV tax exigible when there is a cross-redemption of shares can become circular. Does CRA have an administrative position to ease the application of Part IV tax? Can the balance of RDTOH be estimated in such circumstances?

Position: No.

Reasons: Provisions in sections 186 and 129 are clear and should be applied even if they give rise to a circular calculation. Position confirmed in Les Entreprises Michèle l'Heureux Inc. v. HMQ,94 DTC 1689.

Author: McPherson, Ryan
Section: 186(1), 129, 84

XXXXXXXXXX                                                                                                               2018-077183
                                                                                                                                       Ryan McPherson
October 11, 2018

Dear XXXXXXXXXX:

Re:  Circular Refundable Dividend Tax On Hand (RDTOH) Calculations

This is in reply to your correspondence dated June 29, 2018, wherein you expressed some concerns about circular RDTOH calculations where a group of corporations undertakes a reorganization involving share redemptions between multiple corporations, and one or more of the corporations has an existing RDTOH balance.

Unless otherwise stated, every legislative reference herein is a reference to the relevant provision of the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended (hereafter the “ITA”).

You indicate in your correspondence that the impact of circular RDTOH calculations can make it virtually impossible to do a detailed RDTOH calculation for each specific corporation and that many corporate T2 software programs are not able to deal with the effects of circular RDTOH, and may generate misleading (or incorrect) RDTOH balances.

You want to know if the Canada Revenue Agency (CRA) can provide guidance on how best to deal with this issue and will the CRA accept reasonable attempts to estimate a corporation’s RDTOH balance in such situations?

OUR COMMENTS

This technical interpretation provides general comments about the provisions of the ITA 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.

Your question is similar to a question that was previously posed to the CRA at the APFF conference in 2003 (Document 2003-0030085). A translated version of that question (Question 13) and the CRA’s response is reproduced as follows:

Question 13

Circularity and Part IV tax

Part IV Tax in the ITA is difficult to establish where, for example, there are cross‑redemptions of shares (from which stems a deemed dividend within the meaning of subsection 84(3) of the ITA) between two connected corporations, one of which has a refundable dividend tax on hand (RDTOH).  This situation gives rise to a circularity issue with respect to the calculation of Part IV tax of the ITA because the calculation of one depends on the dividend refund of the other through the application of paragraph 186(1)(b) of the ITA.

Has the CCRA issued an administrative policy on relaxing the application of the Part IV tax rules to avoid this circularity issue?

The CCRA’s response

No, the CCRA has no administrative policy on relaxing the application of Part IV tax rules where there are cross-redemptions of shares that would give rise to the circular calculation of Part IV tax, RDTOH, and the dividend refund of two corporations.

It is our opinion that the provisions of sections 186 and 129 are clear and should be applied in respect of the operations realized even though they may give rise to circular calculation in a given situation.  The Tax Court of Canada’s decision in Les Entreprises Michèle l'Heureux Inc. v. HMQ, 94 DTC 1689, page 1693, a case in which there is a situation of cross-redemption of shares, confirms that:

Since the Act provides that the Part IV tax payable by a corporation on taxable dividends, received by it from a connected corporation, is a direct function of the refund obtained by the latter, it would seem logical to use the successive calculation method when the two corporations are deemed to have paid and received such dividends during the same year.

As noted at page 1691 of this case, there are a number of ways to avoid the problem of the circular calculation of Part IV tax, “…in particular by creating a subsidiary or by making share redemptions during different taxation years for each of the corporations.”

Our current position has not changed from the above-described position.  You should also refer to a Technical interpretation (2004-0099071E5) which describes how the amounts should be calculated.  We note that when the Part IV tax and the dividend refund are determined by successive circular calculations, the amounts of the Part IV tax and of the dividend refund of each connected corporation increase proportionally with each calculation.  We also note that, since a corporation’s dividend refund is applied against its Part IV tax payable, generally, one corporation’s net Part IV tax payable will equal the other’s net dividend refund.

In other words, even though computing a corporation’s Part IV tax and dividend refund by successive circular calculations inflate these amounts and that these calculations are tedious, they are not financially injurious to the connected corporations as the net amount of Part IV tax payable by one corporation (Part IV tax payable minus its dividend refund) will equal the net amount of the dividend refund (dividend refund minus Part IV tax payable) of the other.

We trust these comments will be of assistance to you.

Yours truly,

Michael Cooke, CPA, CA
Manager
Corporate Reorganizations Section II
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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