55(2)-land

I didn’t understand CRA technical interpretation 2011-0394191 at first, but I think I get it now.

A and B own 85% and 15% respectively of the voting shares of Opco. A and B deal at arm’s length, and each of them owns a different class of shares. B incorporates BCo and transfers his shares of Opco to BCo under section 85. Opco then pays a $400,000 dividend to BCo, which uses the money to buy all of A’s shares. The CRA was asked whether 55(2) would apply to the dividend paid to BCo, to which the CRA responded as follows:

It is possible that subsection 55(2) of the ITA would likely not apply in the hypothetical situation described above by reason of the application of paragraph 55(3)(a) of the ITA which provides that subsection 55(2) of the ITA does not apply to any dividend received by a corporation if, as part of a transaction or event or series of transactions or events as a
part of which a dividend was received, there was no disposition or increase in interest described in paragraph 55(3)(a) of the ITA.

Moreover, in general, it is the Agency’s position that section 84.1 of the ITA would not apply to a situation known as a ”leveraged buyout”. An example of a leveraged buyout transaction is described in paragraph four in Supplement 1 of Information Circular IC 88-2.

The position taken in the last paragraph is no surprise—it reflects a long-standing CRA view—but the first paragraph is odd. I don’t understand how the payment of a $400,000 dividend could fail to reduce the value of A’s shares. Leaving that aside, how does 55(3)(a) help BCo? B deal’s at arm’s length with Opco, and so one would think that one of the conditions in the 55(3)(a) would be met such that the exception would be unavailable. The trick, of course, is that BCo is the dividend recipient, and so it is not an unrelated person, per paragraph 55(3.01)(a). The unrelated persons in the scenario above, then, are Opco and A, which means that the exception in 55(3)(a) would appear to apply.