When implementing an estate freeze for a private corporation
using one of the rollover provisions of the Act, there can be
concern that the corporate attribution rule will apply. One way to
avoid this problem is to use a stock dividend freeze, but care must
be taken to deal with potential problem areas.
The corporate attribution rule in section 74.4 may apply when
one of the rollover provisions (section 51, 85, or 86) is used to
implement the exchange of common shares for fixed-value preferred
shares on a tax-deferred basis. When a shareholder transfers
property (for example, a share) to the corporation, and one of the
main purposes of the transfer is to reduce the shareholder's
income and to benefit "designated persons" (which for
purposes of section 74.4 includes spouses and minor children), the
attribution rule may apply to deem the shareholder to have received
the income. The rule does not apply in certain circumstances, the
most important of which is that the corporation is a small business
A "stock dividend estate freeze" could be implemented
to avoid the corporate attribution rules as described above. This
can be done by issuing preferred shares in the form of a stock
dividend to the shareholder, provided that the governing corporate
statute allows it. The shares would have a low paid-up capital and
a high redemption value, with the redemption value being equal to
the FMV of the corporation at that time. Family members can then
purchase common shares of the company at nominal value. Because no
property is transferred to the corporation through this method,
corporate attribution will not apply.
Several issues should be considered on a stock dividend estate
freeze. One is the potential conferral of a benefit as outlined in
subsection 15(1.1). If it is determined that one of the purposes of
the stock dividend is to significantly alter the value of the
interest of any "specified shareholder" of the
corporation, the FMV of the stock dividend (except to the extent of
any taxable dividends received under paragraphs 82(1)(a), (a.1),
and (c) to (e)) is included in the income of the recipient of the
stock dividend. Caution should be taken when dividends are declared
on one class of shares to the exclusion of another.
Another issue to consider is subsection 69(1). It can apply
where the CRA determines that the value of the corporation is in
excess of the redemption value of the preferred shares issued, and
non-arm's-length persons (typically family members) have
subscribed for shares at nominal value. Because a benefit has been
conferred on those shareholders—they paid less than FMV for
the shares—subsection 15(1) will deem an income inclusion.
Importantly, the CRA's position is that a price adjustment
clause is not valid on a stock dividend, whereas under section 51,
85, or 86 a price adjustment clause is generally valid protection
against the CRA assessing a different value of the corporation
(assuming that a reasonable attempt at valuation is made) (see CRA
document no. 2003-0004125(F)).
There can also be accounting consequences. Accounting Standards
for Private Enterprises (ASPE) state that fixed-value preferred
shares issued by way of a stock dividend are to be shown on the
balance sheet as debt at the redemption amount. (The exception for
preferred shares issued in a tax-planning arrangement under section
51, 85, 85.1, 86, 87, or 88 of the Act does not apply here.) This
can affect items such as debt covenants.
As with any tax-planning transaction, the issue of GAAR may be
raised. However, there are no court decisions to support this and
the CRA has not made any public statements on this point.
Previously on the Canadian Tax Foundation website
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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