2018-0780071C6 2018 CTF - Q2 - Impact of 55(2) deeming rules

Principal Issues: Impact of 55(2) deeming rules on the calculation of cost, the capital dividend account and the application of subsection 112(3).

Position: see below.

Reasons: see below.

Author: Ton-That, Marc
Section: 55(2), 52(2), 52(3), 53(1)(b), 112(3), CDA calculation

2018 CTF Annual Conference

CRA Roundtable

Question 2: Follow-up to JCT submission on 55(2): impact of subsection 55(2) deeming rules in some situations

At the Round Table of the 2017 CTF conference, the CRA has made the following announcement:

“There was a second category of questions that will require further study and possibly some discussions with our colleagues of the Department of Finance and a response to those questions will be published in the following months in the form of technical interpretations.  Those were questions on the impact of the application of subsection 55(2) to the computation of cost, calculation of CDA, the GRIP, LRIP accounts and the application of subsection 112(3).”

Does the CRA have an update regarding this category of questions?

CRA Response

We have considered the remaining issues submitted by the joint committee and would like to share with you the CRA’s view on some of those issues:

1.    Effect of the application of subsection 55(2) to the calculation of cost and capital dividend account (“CDA”)

The CRA’s position is that a dividend subject to subsection 55(2) remains a dividend for purposes of subsections 52(2), 52(3) and paragraph 53(1)(b).  With respect to the references to subclause 52(3)(a)(ii)(A)(II) and subparagraph 53(1)(b)(ii) in the capital dividend account calculation (“CDA calculation”), the CRA will ensure that the taxpayer will not be penalized in the CDA calculation when the stock dividend or paid-up capital increase was previously subject to the application of subsection 55(2).  Also, when a portion of a dividend was subject to the application of subsection 55(2), for purposes of the application of subparagraph 53(1)(b)(ii), we consider that the taxpayer was not permitted a deduction under subsection 112(1) on such portion of the dividend even though the dividend was deductible under subsection 112(1).

As discussed at the 2016 CTF conference round table (Question #8), subsection 55(2) and the concept of cost are cornerstones of the corporate taxation system and the main purposes of subsection 55(2) is to preserve a form of corporate taxation integration and to tax inappropriate increases in cost.  The evolution of the role of subsection 55(2), as reflected in the 2015 legislative amendments to subsections 55(2), 52(3) and paragraph 53(1)(b), invites the conclusion that the application of subsection 55(2) to a dividend should not result in the denial of cost to the property that is received by the dividend recipient on the payment of the dividend.

Dividend in kind

A dividend in kind that is subject to the application of subsection 55(2) remains a dividend for purposes of the application of subsection 52(2).  Therefore, the dividend recipient will be considered to have acquired the property that is acquired as a dividend in kind at a cost equal to the fair market value of the property at that time.

It would not be logical to say that a property received as a dividend in kind that was subject to the application of subsection 55(2) because its purpose was to increase cost or to reduce gain because of the increase in cost would, in turn, not have a cost.

The views expressed in document #9830665 are no longer valid.

Stock dividend

The calculation of cost of a stock dividend is governed by subsection 52(3).  Finance’s intent is to give cost to the portion of the stock dividend that is protected by safe income and the portion of stock dividend that was subject to the application of subsection 55(2).  Furthermore, the preamble to paragraph 52(3)(a) makes it obvious that a stock dividend that was subject to the application of subsection 55(2) remains a dividend for purposes of application of subsection 52(3) and cost should be recognized on an amount of stock dividend that was subject to the application of subsection 55(2).

Again, the views expressed in document #9830665 are no longer valid.

Paid-up capital increase

Our view is that a dividend on paid-up capital increase that was subject to the application of subsection 55(2) remains a dividend for purposes of the application of subparagraph 53(1)(b)(i).  As such, the “amount of a dividend on the shares deemed by subsection 84(1) to have been received by the taxpayer” is the amount determined by subsection 84(1) and before the application of subsection 55(2).  However, we would consider that a dividend that was subject to subsection 55(2) was not permitted a deduction under subsection 112(1) for purposes of the application of subparagraph 53(1)(b)(ii).

We understand that the reduction of cost under subparagraph 53(1)(b)(ii) is to deny cost on the amount of dividend that exceeds safe income and on which a deduction under subsection 112(1) was obtained.  However, such denial should not apply to the portion of the dividend that was subject to subsection 55(2).

We understand this position will provide a fair result to taxpayers in that cost will not be denied when a dividend on paid-up capital increase has been subject to the application of subsection 55(2).

CDA calculation

The purpose of the exclusion of the application of subclause 52(3)(a)(ii)(A)(II) and subparagraph 53(1)(b)(ii), in the calculation of CDA in clause (a)(i)(A) of its definition, is to deny CDA on the portion of the gain that is increased as a result of a reduction of cost on shares received as a stock dividend or on paid-up capital increases.  The reduction of cost would apply when the dividend that results from such stock dividend or paid-up capital increase is not covered by safe income.  Finance’s intent was that such gain increase should not give rise to a CDA.

Our position on the interpretation of subparagraph 53(1)(b)(ii) should carry through to the calculation of CDA.  In the situation where a dividend on PUC increase that exceeds safe income was subject to the application of subsection 55(2), there would be no reduction of cost and no reversal of gain for CDA purposes because the taxpayer is considered not to be permitted a deduction under subsection 112(1) with respect to such portion of the dividend.

Regarding the exclusion of subclause 52(3)(a)(ii)(A)(II) in the calculation of CDA in clause (a)(i)(A) of its definition, the CRA will restrict such exclusion to situations where subsection 55(2) did not apply to the previous payment of the stock dividend.  This makes sure that the taxpayer will not be penalized in the CDA calculation when the stock dividend was previously subject to the application of subsection 55(2).

2.    Effect of the application of subsection 55(2) to the application of subsection 112(3)

Subsection 112(3) denies a loss that can be realized on a sale of shares to the extent of the amount of loss that is caused by non-taxable dividends received on the shares.  Under subsection 112(3), a loss on a share is reduced by the total of all amounts received by the taxpayer on the share each of which is a taxable dividend deductible under subsection 112(1), 115(1) or 138(6) or a CDA dividend or life insurance capital dividend.

Denying a loss on a share that is caused by a dividend that has been subject to tax under subsection 55(2) would seem to be contrary to the scheme of subsection 112(3) which aims to deny losses caused by non-taxable dividends.

The CRA will consider that a dividend that has been subject to the application of subsection 55(2) is not a taxable dividend referred to in subparagraph 112(3)(b)(i).

We have relayed the above views to the Department of Finance.

Marc Ton-That
2018-078007
November 27, 2018

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