In 2012-0436181E5, the Canada Revenue Agency (CRA) disagreed with the Tax Court decision in Tawa Developments Inc. v The Queen 2011 DTC 1324, and said the Crown may legally confiscate a dividend refund under s. 129 if the taxpayer corporation does not file its tax return within the required three year period. The issue is somewhat complicated, but here are the essential points.
- In broad terms, under s. 129 a Canadian-controlled private corporation (payer corporation) becomes entitled to a “dividend refund” for a particular year if it previously earned certain investment income, paid the applicable tax in relation to that investment income (generating a “refundable tax account”), and subsequently paid taxable dividends to its shareholder(s) in the particular year. The dividend refund amount then reduces the payer corporation’s refundable tax account going forward. Further, under s. 186, a “connected” corporate shareholder (receiving corporation) is generally taxable on the dividends it receives from the payer corporation, with the tax being equal to the dividend refund to the payer corporation.
- In disagreeing with the Tax Court in Tawa Developments Inc., the CRA said that if the tax return of the payer corporation is not filed within the required three year period, the payer corporation can never obtain its dividend refund – because both the legal entitlement to the dividend refund and its related refundable tax account are wiped out going forward. In the CRA’s view, the payer corporation’s refund (in these circumstances) has essentially been confiscated by the Crown. Further, and to add insult to injury, the CRA also believes the receiving corporation must still pay its tax under s. 186 on the dividend received from the payer corporation. The CRA’s view is based on a notional (defined) dividend refund amount in s. 129 for the year of the dividend, as it pertains to s. 186. The CRA considers this to be the correct technical reading of s. 129 and s. 186, notwithstanding that the actual refund and the refundable tax account for the payer corporation are, in the CRA’s view, completely eliminated going forward.
- The CRA’s technical position is unfortunate and can produce harsh results. The actual transaction considered in 2012-0436181E5 involved a spin-off (butterfly) transaction with large inter-corporate dividends that engaged the dividend rules in s. 129 and s. 186. Tax returns claiming the applicable dividend refunds under s. 129 were not filed within the required three year period. The CRA confirmed its technical view that legitimate confiscation (double tax) arose in the circumstances, as just described. It will be interesting to see if the CRA’s position is sustained by the courts in the coming years.