The practical difficulties in dealing with the 2016 amendments to s. 55(2) – concerning inter-corporate dividends in Canada – are now well documented. Among other things, this anti-avoidance provision can potentially apply to convert a tax-free inter-corporate cash dividend into a taxable capital gain if “one of the purposes” of the dividend is any of the following:
- to significantly reduce a capital gain on a share that (hypothetically) would have been realized if the share were sold at fair market value before the dividend;
- to significantly reduce the fair market value of a share, or
- to significantly increase the total cost of all properties held by the dividend recipient after the dividend (see s. 55(2.1)(b)(i) and (ii)).
An important exception to s. 55(2) is potentially available if the dividend arises instead under s. 84(2) or (3) on a redemption or acquisition of a share by the paying corporation and, broadly speaking, the transaction occurs solely within the confines of a related group (see s. 55(3)(a)). However, in 2016-0627571E5 the CRA cautioned that “a mere redemption of shares for cash” might frustrate the object, spirit and purpose of s. 55(2) if such redemption has one of the three purposes described above (see page 11). The clear implication is that the CRA may seek to apply the general anti-avoidance rule in s. 245(2) (the GAAR) to deny the s. 55(3)(a) related-party exception in these circumstances. The CRA said its position is based on the Department of Finance’s 2016 Technical Notes to s. 55(3)(a), which state that the related-party exception:
"...is intended to facilitate bona fide corporate reorganizations by related persons. It is not intended to be used to accommodate the payment or receipt of dividends or transactions or events that seek to increase, manipulate, manufacture or stream cost base.”
It follows that carefully documenting all purposes of any inter-corporate dividend – including a dividend arising on a related-party share redemption – would be prudent in order to manage the issues presented by amended s. 55(2).