At various Round Tables, including the 2010 Canadian Tax Foundation National Conference Round Table (2010 Round Table),1 the Canada Revenue Agency (the "CRA") has indicated that an eligible dividend received by a corporation that is deemed to be a capital gain or proceeds of disposition pursuant to subsection 55(2) will not increase the general rate income pool ("GRIP") of the recipient, but will reduce the GRIP of the payer. The CRA has stated that it will generally accept that the dividend recipient can add to its GRIP the part of the dividend that is covered by safe income, provided that the dividend recipient made or makes a designation under paragraph 55(5)(f).
The definition of "eligible dividend" in subsection 89(1) refers to "a taxable dividend that is received by a person resident in Canada . . .". Paragraph (a) of element E of the definition of GRIP in subsection 89(1) provides for a corporation's GRIP to be increased by "an eligible dividend received by the corporation". Subparagraph (a)(i) of element G reduces a corporation's GRIP by the "total of all amounts each of which is the amount of an eligible dividend paid by the corporation in its preceding taxation year".
If subsection 55(2) is applicable to an intercorporate dividend, the dividend received by a corporation "shall be deemed not to be a dividend received by the corporation". As such, it seems clear that a dividend that is recharacterized by subsection 55(2) cannot be an eligible dividend as defined in paragraph (a) of the definition of "eligible dividend" in subsection 89(1) because, in order to be an eligible dividend, the dividend must be "a taxable dividend that is received by a person resident in Canada . . .". If the amount received is deemed not to be a dividend, then it cannot be an eligible dividend. If it is not an eligible dividend, subparagraph (a)(i) of element G in the definition of GRIP cannot be applicable, and the recharacterized dividend cannot reduce the GRIP.
The CRA is not in agreement with the above and is of the view that, at the time it is paid, the dividend is a taxable dividend that is received by a person resident in Canada for the purposes of the application of the definition of "eligible dividend" in subsection 89(1). Thus, the dividend remains an eligible dividend for purposes of calculating the GRIP of the payer, notwithstanding that the recipient is deemed by subsection 55(2) not to have received a dividend. In its response at the 2010 Round Table the CRA stated:
. . . the effect of the deeming provision in paragraph 55(2)(a) should be limited to the dividend recipient and should have no bearing on the computation of the GRIP of the payer CCPC.
The CRA also stated:
We believe, as was expressly stated at the 2008 APFF Conference, that our interpretation of the provisions of the definition of "eligible dividend" in subsection 89(1) and the provisions of subsection 55(2) is in accordance with a textual, contextual, and purposive analysis of those provisions, the purpose of which is to find a meaning that is harmonious with the Act as a whole, as mandated by the Supreme Court of Canada (SCC) in Canada Trustco Mortgage Co. v. Canada.2
If the CRA is correct in its view, the financial cost to the taxpayer (assuming dividends are eventually flowed through the corporate chain and paid to an individual) can be calculated as the difference in income taxes payable in respect of eligible dividends versus ineligible dividends and will vary by jurisdiction, in 2012 from a low of 0.15% (Nova Scotia) to a high of 14.48% (Yukon) but on average will be approximately 7%. A 7% difference in income taxes payable is material. Of course, this assumes that the payer corporation will be able to pay dividends in the future that it would designate as eligible dividends.
With respect, the CRA's position is not defensible. Subsection 55(2) does not contain language that deems a dividend to be a capital gain or proceeds of disposition at a particular point in time. Paragraph 55(2)(a) states that the dividend "shall be deemed not to be a dividend" without reference to time. Therefore, in the absence of such language, the only logical conclusion is that the dividend is not a dividend at any point in time, thereby defeating the CRA's view that "at the time that the dividend is paid by the payer CCPC and received by the recipient CCPC the dividend is a taxable dividend that is received by a person resident in Canada". The closest subsection 55(2) comes to making reference to time can be found in paragraph 55(2)(c), which provides that, where a corporation has not yet disposed of the share that gave rise to the particular dividend, the dividend shall be deemed to be a gain from the disposition of a capital property for the year in which the dividend was received. Again, given the absence of language that specifies a particular point in time during the year, it is logical to assume that the provision is applicable to the entire year, not just at a certain point in time during the year.
Subsection 55(2) contains the phrase "notwithstanding any other section of this Act", thereby defeating the argument that, for purposes of subsection 89(1), the deeming provision in paragraph 55(2)(a) should be limited to the dividend recipient and should have no bearing on the computation of the GRIP of the payer CCPC.
The CRA accepts that dividends designated as eligible dividends that are paid to non-residents will not reduce the GRIP of the payer corporation.3 To draw a distinction between a non-resident that does not receive the benefit of the dividend tax credit and a corporation that is deemed not to have received a dividend is too subtle for the writer to understand and is inconsistent as between taxpayers.
Finally, we may gain some insight as to how the courts would view this situation by examining the decision in Tawa Developments Inc. v. H.M.Q.4 In Tawa, the appellant received a dividend from a connected corporation and paid an identical dividend to its shareholders the same year. The appellant claimed a dividend refund in respect of the dividend paid by it, but the Minister of National Revenue (the "Minister") denied the claim for the dividend refund because the connected corporation filed its corporate income tax return more than three years late. The Minister also refused to adjust the balance in the appellant's refundable dividend tax on hand ("RDTOH") account the following year by an amount equal to the dividend refund that had been denied. Ultimately, the Court ruled against the appellant and denied the dividend refund, but ordered the Minister to increase the RDTOH account by an amount equal to the dividend refund that was denied.
While Tawa deals with different subject matter, in general, the principles are not dissimilar. In Tawa, the Minister was required to increase the RDTOH account in recognition of the fact that a claim for a dividend refund was disallowed. It does not seem to be a stretch to apply a similar pattern of logic to the GRIP account adjustment where an otherwise eligible dividend is recharacterized to be something other than an eligible dividend.
It is not clear why the CRA has taken its position. No income tax savings (unintended or otherwise) result from the application of subsection 55(2) in the above circumstances. The intent of introducing the eligible dividend provisions was to eliminate, to the extent possible, the double taxation that occurred when a dividend was paid from retained earnings resulting from income subject to taxation at general rates and the dividend tax credit failed to adequately compensate for corporate income taxes actually paid.
The CRA states that it is basing its conclusions on a textual, contextual, and purposive analysis of the relevant provisions; however, we are left to wonder which provisions it is referring to. It seems that the stated purpose of the eligible dividend provisions has been defeated by reducing the GRIP of the payer without a corresponding increase to the GRIP of the recipient. It seems more logical and fair that, in general, a GRIP reduction only occurs where the result is mirrored in the accounts of the Canadian-resident dividend recipient. A textual analysis of the relevant provisions does not support the CRA's conclusions and, when the provisions are read in the context they are written, nothing suggests that the GRIP account should be reduced in these circumstances.
Given that the CRA has confirmed the above position numerous times, it is doubtful that it will change its view due to taxpayer dissatisfaction. Accordingly, it appears that this is an issue that must ultimately be decided by the courts or by legislative reform. Perhaps the issue has been addressed in the draft technical amendments legislation that is rumoured to be released shortly by the Department of Finance. In any event, this is an issue that should be resolved in favour of the taxpayer to be consistent with the purpose of the eligible dividend provisions.
1 "Canada Revenue Agency Round Table," in Report of Proceedings of the Sixty-Second Tax Conference, 2010 Conference Report (Toronto: Canadian Tax Foundation, 2010), p.4:1 at 4:5/6, question 5.
2 2005 DTC 5523.
3 Question 6, 2008 Association de planification fiscale et financi`ere du Qu´ebec ("APFF") conf´erence, CRA Document No. 2008-0284951C6, October 10, 2008.
4 2011 DTC 1324 (TCC).
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