Canada: New Rules For Inter-Corporate Dividends

The 2015 federal budget introduced a number of amendments to subsection 55(2) of the Income Tax Act (the Act) that could have an impact on the tax treatment of certain inter-corporate dividends. Draft legislation released on July 31 kept most of the original proposals intact.

The following is a summary of the key changes and their possible impact.

Subsection 55(2)

Subsection 55(2) is an anti-avoidance rule intended to prevent the conversion of a taxable capital gain into a tax-free inter-corporate dividend. For example, it was intended to stop transactions where an Opco would pay a significant tax-free dividend to a Holdco, and then sell the shares of Opco for a much lesser amount. Due to its largely subjective "purpose" test and the availability of a number of exceptions that can get you out of the rules (for example, safe income dividends and butterfly reorganizations), subsection 55(2) has always been a very complicated provision to understand. Another key exception is the paragraph 55(3)(a) exception for related party dividends (this provision is addressed more fully below).

If subsection 55(2) applies, the portion of the inter-corporate dividend that is not sheltered by one of the exceptions is converted to proceeds of disposition, resulting in a taxable capital gain.

There are five main changes to the rules:

1 Broadening of the "purpose test"

2 Limitation on scope of related party exception

3 Changes for inter-corporate stock dividends

4 Allocation of safe income to certain types of shares

5 Changes to the Part IV tax exception

In its 2015 budget, the Department of Finance explained the mischief that it was trying to prevent. By using an inter-corporate dividend to cause the fair market value (FMV) of a share to fall below cost or the shareholder's cost of properties to increase, the shareholder could use the unrealized loss to shelter an accrued capital gain in respect of other property.

However, the proposals can potentially have a much broader impact than this. They apply to inter-corporate dividends received after April 20, 2015.

Broadening of the "purpose" test

One of the most notable differences between the old rules and the proposed rules is the addition of new "purpose" tests that could cause subsection 55(2) to apply. Under the old purpose test, subsection 55(2) could only apply where the purpose of the dividend was to reduce a capital gain on any share of capital stock immediately before the dividend was paid. Although this test continues to apply, the new added tests are no longer tied to a reduction in a capital gain, but can also apply where one of the purposes of the dividend is to effect either (a) a significant reduction of the FMV of any share or (b) a significant increase in the aggregate cost of property to the dividend recipient. This test can potentially be extremely broad, since the threshold for satisfying the "one of the purposes" test could be quite low. Adding to the subjectivity involved regarding what would constitute a "significant" reduction or increase, these new tests have created considerable uncertainty as to how they will be interpreted by the Canada Revenue Agency (CRA).

Limitation on scope of related party exception

The old rules also provided a related party exception to subsection 55(2) as long as the inter-corporate dividend was not paid as part of a series of transactions or events that involved an unrelated party. This exception applied to all types of dividends—cash dividends, stock dividends, deemed dividends, dividends-in-kind, etc.—and was commonly relied upon as a means to avoid subsection 55(2) in related party situations. However, effective for dividends received after April 20, 2015, the rules have been changed so that this exception now only applies to subsection 84(2) dividends and subsection 84(3) deemed dividends. This now puts all significant cash dividends that satisfy the "one of the purposes" tests at risk.

Changes for inter-corporate stock dividends

Under the old rules, the amount of a stock dividend for tax purposes was generally equal to the increase in paid-up capital of the issued shares (generally nominal). As a result, stock dividend shares could avoid being caught by subsection 55(2) as the amount of the dividend would be nominal. The proposed changes will essentially deem the "amount" of an inter-corporate stock dividend for purposes of applying section 55 to be the FMV of the issued shares. Consequently, high-low inter-corporate stock dividends that were previously not subject to a section 55 risk are now fully exposed.

Allocation of safe income to certain types of shares

One of the exceptions to being caught by subsection 55(2) is to show that the dividend was paid out of "safe income." The proposals have changed the way in which safe income is applied to dividends. Under the old rules, safe income could theoretically attribute to preferred shares if the preferred shares were entitled to share in the income of the corporation during the holding period. It was not always clear as to how this would apply to discretionary dividend preferred shares; however, this was seldom an issue due to the related party exception.

The proposed rules clarify that no safe income can attribute to dividends paid on discretionary dividend or dividend streaming shares (on the assumption that such shares cannot increase in value). Also, since safe income can only be applied to shares with a gain, no safe income can be allocated to loss shares. This was never an issue under the old rules; however, the new purpose tests discussed above provide that subsection 55(2) can now apply in loss situations.

Changes to the Part IV tax exception

Under the old rules, subsection 55(2) did not apply to any portion of a dividend for which the recipient was subject to Part IV tax that was not refunded to the recipient as a consequence of the payment of a dividend to a corporation (where that payment was part of the series of transactions or events). The new rules have narrowed the Part IV tax exception by providing that subsection 55(2) does not apply to any portion of a dividend for which the recipient was subject to Part IV tax that was not refunded to the recipient as a consequence of the payment of a dividend by the corporation as part of the series. This now includes situations where the corporation receives a dividend refund by paying a dividend to any person, including an individual, as part of the series.

What does this mean going forward?

A strict interpretation of the draft rules could cause the following types of common transactions involving inter-corporate dividends to be caught where a) the amount of the dividend is significant and b) one of the new "purpose" tests is satisfied:

  • Asset protection transactions
  • Capital gains exemption purification transactions
  • The payment of dividends on dividend streaming shares

The CRA has confirmed that standard in-house loss consolidation arrangements, whereby dividends are paid on preferred shares between related companies, would not be within the ambit of the new purpose test. On the other hand, a standard creditor proofing technique involving the declaration of a large cash dividend by an operating company to a holding company would generally satisfy one of the new purpose tests. In this situation, the company would have to rely on the safe income exception to avoid having the dividend reclassified as a capital gain. The CRA's unfavourable position on this matter has increased the importance of safe income on hand.

The proposed changes to Section 55 have added significant uncertainty and complexity to what was already a very complex section of our tax rules. The CRA has stated that, over time, this uncertainty should be lessened as future rulings and interpretations are issued. In the interim, there are means of structuring most transactions to ensure that one of the exceptions permitted in the Act are met. Nevertheless, extreme care should always be taken when planning transactions involving inter-corporate dividends.

Please contact one of our firm's tax practitioners if you would like to discuss how these new rules might impact you and your corporation.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Crowe Soberman LLP
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Crowe Soberman LLP
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions