October 23, 2015
Subsection 55(2) of the Income Tax Act (Canada) is an anti-avoidance provision intended to prevent capital gains stripping by deeming an inter-corporate dividend to be proceeds of disposition or a capital gain if one of the purposes (or, if subsection 84(3) applies, one of the results) of the dividend is to effect a significant reduction of a capital gain attributable to anything other than safe income on hand. There are exceptions to the application of subsection 55(2), such as those relating to Part IV tax and paragraphs 55(3)(a) and 55(3)(b).
Budget 2015 announced amendments to section 55, referring specifically to the Tax Court of Canada’s decision in D & D Livestock Ltd., 2013 TCC 318. The case involved a complex series of transactions that resulted in the double-counting of a subsidiary’s safe income. The Court held that subsection 55(2) was not applicable because the safe income attributable to shares of a subsidiary is not reduced by a dividend paid on the shares of its parent company. The Crown did not rely on GAAR, but the CRA says it will apply GAAR to such planning in the future.
On July 31, 2015, the Department of Finance released updated draft amendments for consultation. The consultation period ended on September 30, 2015. The proposed amendments, once enacted, will be effective as of April 21, 2015. Here are the five key changes proposed to section 55 and advice to help deal with the consequences of the changes.
5 Key Changes To Section 55. The proposed amendments entail these five key changes to section 55:
Consequences of Section 55 Changes for Ordinary Dividends. Ordinary dividends will no longer have the benefit of the related party exception, but must qualify for the safe income exception or “fail” the purpose test. This makes discretionary dividend shares now dangerous to use because the only protection is the purpose test. To address this increased risk:
The Purpose Test. The leading case on the purpose test is The Queen v. Placer Dome 1996 DTC 6562 (FCA). The key aspects of the test are:
The test is met if only one of the purposes of the dividend is an enumerated improper purpose. Although every dividend reduces the fair market value of a share, section 55 is an anti-avoidance provision that the CRA (and courts) will not, hopefully, apply too widely.
Family Trusts. If the regular distribution of earnings will be structured as redemptions more often, then reliance on paragraph 55(3)(a) must be carefully considered. Paragraph 55(5)(e) provides that a person is only related to a trust if the person is a corporation controlled by the trust or a person related to each beneficiary of the trust. It will be even more important under the new rules to consider and ensure, when the trust is established, that trust beneficiaries are related (or related to the person who controls the corporation, as applicable) for purposes of section 55.
Advice. The proposed changes to section 55 mean transactions involving inter-corporate dividends will be even more complex. As a result, practitioners must:
Please contact your McInnes Cooper lawyer or any member of our McInnes Cooper Tax Solutions Team to discuss this topic or any other legal issue.
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
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