Dividend Refund Denied upon Redemption of Donated Private Company Shares
Owner-managers often use spousal trusts to fulfill their philanthropic
goals. The position taken by the CRA in a recent ruling
(2016-0628181R3(E), January 1, 2017), however, leads to a puzzling
result on the redemption of donated private company shares.
The ruling concerns taxpayer A, who created a testamentary spousal trust
for his spouse, taxpayer B. The spousal trust holds shares in a
portfolio holding company (Holdco), a CCPC. The residue of the spousal
trust was to be transferred to a private foundation upon B's death, and
the transferred holding company shares would subsequently be redeemed by
the private foundation. The CRA opined that subsection 129(1.2) would
apply to deny a dividend refund to Holdco on its redemption of the
shares held by the private foundation because one of the main purposes
of the transactions was to generate a dividend refund.
The ruling is frustrating in that it offers no support for this key
conclusion. The transactions appear to be for a philanthropic purpose,
not for the purpose of a dividend refund. In the same ruling, however,
the CRA opined that if B's estate (not the spousal trust) transferred
the Holdco shares to the same private foundation, which then redeemed
the shares, a dividend refund would not be denied.
Furthermore, the denial of a dividend refund appears to be inconsistent
with the legislative purpose of subsection 129(1.2). According to the
explanatory notes (SC 1988, c. 55 (Bill C-139)), subsection 129(1.2) is
an anti-avoidance rule that prevents a corporation from structuring
arrangements in order to obtain a dividend refund without the related
shareholder tax being paid. This point was confirmed by the CRA in Interpretation Bulletin IT-243R4 (February 12, 1996), at paragraph 6.
In this case, the shareholder-level tax would have been paid. This is
because, upon B's death, the shares are deemed to have been disposed of
at fair market value; in theory, fair market value would reflect the
corporate taxes inherent on the appreciation of the underlying portfolio
investments. The taxes on the capital gain realized on the deemed
disposition upon death would be approximately the same as the combined
corporate and personal taxes if the spousal trust had had all the shares
redeemed by the holding company immediately before death. For this
reason, the denial of the dividend refund would distort integration,
which is the general theme of section 129.
(Regrettably, this is not the first time that the CRA has indicated its
intention to apply subsection 129(1.2) even when the shareholder-level
tax had been paid: see CRA document no. 2013-0480361C6, June 10, 2013.)
A short opinion by the CRA like this one may worry some taxpayers and
may frustrate legitimate gift planning. Clarification of the CRA's
reasoning would be helpful. Absent that, it would require legislative
change to narrow the scope of subsection 129(1.2)—or taxpayers would
have to rely on the text, context, and purpose of subsection 129(1.2)
for comfort (see "When Does Subsection 129(1.2) Apply To Deny a Dividend
Refund?" Tax for the Owner-Manager, July 2017).
Grant Thornton LLP, Toronto