Section 55: What is the New Reality?

Transcription

1 Section 55: What is the New Reality?, KPMG LLP, KPMG LLP 67 th Annual Tax Conference 67e Conférence fiscale annuelle 2015 Agenda Evolution of subsection 55(2) 2015 Federal Budget The new purpose tests and examples Safe income Part IV exception Paragraph 55(3)(a) Stock dividends 2

2 Evolution of 55(2) Until the 2015 Budget Before 1972: No taxation on capital gains 1972 : Introduction of taxable capital gains 1980 : Introduction of the subsection 55(2) anti-avoidance provision and its exceptions : Prevention of the Purchase Butterfly ; introduction of safe-income determination time Imprecise concepts influencing the application of subsection 55(2): The purpose test Series of transactions Safe income 3 55(2) Until the 2015 Budget Was there a dividend deductible under 112(1), (2) or 138(6)? Was purpose of dividend to reduce a capital gain; or Was result of 84(3) deemed dividend to reduce a capital gain? Was the gain attributable to anything other than safe income? Was dividend subject to Part IV tax that was not refunded on payment of dividend to a corporation? 4

3 55(2) Until the 2015 Budget Subsection 55(2) did not apply if, as part of the series, there were no events described in paragraph 55(3)(a) Paragraph 55(3)(a) applied to all dividends: Cash dividend Dividend-in-kind Stock dividend Deemed dividends under subsections 84(1), (2), (3) 5 55(2) Until the 2015 Budget Purpose test: One of the purposes is the reduction of capital gain An objective or subjective test? Purpose of the recipient or the payer of the dividend? What if dividend created or increased a loss on a share? 6

4 55(2) Until the 2015 Budget Series of transactions: Depends on the specific facts Difficulties in assessing the application of paragraphs 55(3)(a) and (b) 7 55(2) Until the 2015 Budget Safe income vs. safe income on hand: CRA s approach regarding the attributable to anything other than income earned or realized by any corporation Case law 8

5 2015 Federal Budget 55(2) applies where a dividend reduces a capital gain Same tax policy concern arises where dividends cause the FMV of a share to fall below its cost or where dividends increase cost of recipient s property because capital gains could be sheltered Budget provides as an example the Tax Court case of D&D Livestock Finance Explanatory Notes broadly similar to comments in budget 9 The New Purpose Tests One of the purposes of the payment or receipt of the dividend is to effect: a significant reduction in the capital gain on any share Results test for 84(3) a significant reduction in the fair market value of any share Certain 84(2), (3) dividends excluded a significant increase in the cost amounts of property of the dividend recipient Certain 84(2), (3) dividends excluded 10

6 D&D Livestock (Simplified) Before After Stock Dividend 0 ACB = 0 Safe income = 1 FMV = 9 ACB = 0 Preferred PUC = 1 Stock dividend ; Paid-up capital = 1; under 52(3)(a) Under existing rules, ACB in stock dividend shares up to safe income 11 D&D Livestock (Simplified) transfers Pref to Newco FMV = 9 ACB = 0 Newco Preferred Newco transfers Pref to as Dividend-in-Kind FMV = 9 ACB = 0 Preferred FMV = 0 Newco 12

7 D&D Livestock (Simplified) transfers shares to Newco FMV = 9 ACB = 0 Newco 0 ACB = 2 Preferred can sell shares of Newco Gain of 8 instead of 9 13 D&D Livestock (Simplified) FMV = 9 ACB = 0 Newco Preferred Old 55(2) Did not apply to dividend-in-kind No gain on Newco shares therefore no gain reduced by dividend 112(3) After dividend-in-kind, transfer all of shares to Newco and sell Newco 112(3) does not apply because Newco value above ACB 14

8 FMV = 9 ACB = 0 D&D Livestock (Simplified) Newco Preferred Proposed 55(2.1) Was purpose to reduce gain on Newco shares? Was purpose to reduce FMV of Newco shares? Was purpose to increase total cost amounts to? Total cost amounts of property before: $1 Total cost amounts of property after: $2 15 New Purpose Test Steps: 1. Subco pays a cash dividend of $1 to 2. transfers Gain Property to Subco under 85(1) for Subco shares 3. sells Subco shares to Buyer Buyer 1 Cash Dividend 3 Subco X Cash of $1 ACB = 0 X 2 Gain Property 16

9 Overview of New Rules Three conditions must be met for 55(2) to apply 55(2.1) three conditions The dividend is deductible under 112(1), (2) or 138(6) One of the three purpose tests or the results test is met The dividend exceeds the SI contributing to the capital gain that would have been realized 17 Overview of New Rules 55(3)(a) exception Applicable only to deemed dividends received under 84(2) and (3) on the redemption, acquisition or cancellation of shares 18

10 Overview of New Rules Exception for Part IV taxes narrowed Exception no longer applies if any dividend refund received New rules for stock dividends The new regime applies to dividends received after April 20 st, Cash Dividends How do the new rules impact cash movements within corporate groups? Consider FMV, ACB, SI Preferred Topco Dividends Debt How significant is any reduction in gain or FMV? Dividends Sub 1 Sub 2 20

11 Lend Cash? Pubco acquired LRIP is $200 has cash of $200 which is needed by Pubco If lends to Pubco due to concern over new 55(2), must consider LRIP antiavoidance rules FMV 1,000 ACB 1,000 SI 0 Pubco LRIP Purpose of Payment or Receipt Applicable to each recipient? If it is purpose of and Aco, does that mean Bco and Cco are caught? Dividends to Aco, Bco and Cco Aco Bco Cco Dividend to 75% 20% 5% 22

12 Cash Dividends Asset Protection 1. pays cash dividend to Does 55(2) apply? Was dividend paid out of safe income on hand? What is the purpose of the dividend? Cash Dividend 1 23 Cash Dividends Asset Protection 1. pays cash dividend to 2. lends cash to Does 55(2) apply? Was dividend paid out of safe income on hand? What is the purpose of the dividend? Cash Dividend 1 2 Loan 24

13 Cash Dividends Asset Protection 1. pays cash dividend to 2. uses cash to purchase shares of Targetco Does 55(2) apply? Cash Dividend 1 Purchase Shares 2 Targetco Was dividend paid out of safe income on hand? What is the purpose of the dividend? 25 Loss Utilization Transactions IB Loan Profitco Lossco CS Pref CS NIB Loan Newco Newco will pay cash dividends on Preferred shares Is the sole purpose of the dividends loss consolidation? What if there are minority shareholders? 26

14 55(2.1)(c) Safe Income Exception Dividend is not subject to 55(2) if the dividend does not exceed safe income that can reasonably be considered to contribute to a capital gain on the share on which the dividend is received 55(2) can apply where there is no gain on the share Safe income only available if share has gain 27 55(2.1)(c) Safe Income Exception In the past, had acquired shares of Subco for $1,000 Subco has after-tax earnings of $10 post-acquisition FMV of Subco has decreased to $800 (+$10 cash) If a cash dividend of $10 is paid, the safe income exception does not apply Subco FMV 810 ACB 1,000 Cash from earnings = 10 28

15 Safe Income Discretionary Shares Discretionary Shares: Non-voting, no participation in liquidation proceeds, entitled to discretionary dividends A B pays all of its excess cash annually as dividends on the Discretionary Shares Old 55(2) If dividends on Discretionary Shares reduce gain on common shares, dividends might be protected by safe income if less than safe income attributable to common shares New 55(2) Safe income exception refers to earnings contributing to a gain on the share on which the dividend is paid Aco Discretionary Share CS CS Bco Discretionary Share 29 Safe Income Freeze Shares Shares (FMV 1,000; SI = 700) held by X were exchanged for New Shares and Freeze Shares X Freeze Shares transferred to Earnings since freeze have increased value of CS Dividends paid on non-cumulative Freeze Shares 55(2.1)(b) refers to reduction of gain / FMV of any share 55(2.1)(c) refers to earnings contributing to a gain on the share on which the dividend is received New CS Freeze F 1000 A 0 P 0 SI

16 55(2.1)(c) Safe Income Exception In the past, had acquired shares of Subco for $150 Subco has after-tax earnings of $21 represented by cash FMV of Subco s assets has decreased to $130 Would the safe income exception available be $1 or $21? FMV Assets 130 Subco FMV 151 ACB 150 After-tax Cash Safe-Income Determination Time The earlier of: the time that is immediately after an event in paragraph 55(3)(a) the time that is immediately before the earliest time that a dividend is paid as part of the transaction, event or series Definition has not been amended Is a revision needed under the new rules? 32

17 Part IV Exception Subco redeems Preferred shares held by 1 Subco receives dividend refund Individual subject to Part IV tax pays dividend to Individual and receives dividend refund Preferred Subco Part IV exception no longer applies RDTOH 33 Paragraph 55(3)(a) The 55(3)(a) exception will only apply to 84(2) and (3) deemed dividends on share redemptions, acquisitions or cancellations by the corporation 55(2) can apply to other dividends even if there are no transactions with unrelated persons 34

18 Paragraph 55(3)(a) Explanatory Notes The amended exception in paragraph 55(3)(a) for related-person dividends 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. 35 Paragraph 55(3)(a) to distribute $200 to Cash dividend Not protected by 55(3)(a) Preserves ACB Subject to purpose tests Share cancellation 84(3) dividend protected by 55(3)(a) If redeem 20% of shares, reduce 20% of basis Finance explanatory notes FMV 1,000 ACB

19 Internal Reorganization Parentco transfers Property B to Subsidiary for Prefs which are redeemed for Note The Note can be cancelled in different ways: transfers the Note to Parentco by dividend and Parentco converts the Note into shares of Subsidiary Property A Note PS Property B Subsidiary Property B redeems some shares held by Parentco and pays the redemption price with the Note. Parentco converts the Note into shares of the Subsidiary Parentco transfers shares of to the Subsidiary (FMV equal to Property B) and redeems these shares and pays the redemption amount with the Note How do the new rules impact the choice? 37 Stock Dividends Under the definition of amount in 248(1) The amount of a dividend for tax purposes is generally equal to the increase in paid-up capital Certain exceptions apply 38

20 Stock Dividends 55(2.2) For the purpose of 55(2), the amount of the dividend is greater of Amount of paid-up capital increase FMV of stock dividend shares issued Subjects high-low stock dividends received by corporations to the rules in 55(2) 39 Stock Dividends Is purpose of stock dividend to reduce gain or FMV? Can have deemed gain of $70 ACB for safe income + deemed gain Starting Point 00 ACB = 0 PUC = 0 SI = 30 High-low stock dividend FMV = 0 ACB = 0 PUC = 0 Stock Dividend Preferred PUC = 30 40

21 Stock Dividends Public company stock split Is purpose of stock dividend to reduce FMV of existing common shares? Privateco Pubco Stock Dividend of Shares 41 Thank You, KPMG LLP, KPMG LLP 42