55(3)(a) purpose test?

The CRA believes that a dividend otherwise exempt under paragraph 55(3)(a) of the Income Tax Act (Canada) will be subject to GAAR if one of the purposes of the dividend was to increase the cost of property contrary to the purpose test in 55(2.1)(b)(ii)(B). The CRA believes that cross-redemptions do not have such a purpose because they do not create tax cost for shareholders. The author argues that the CRA position is wrong.

The two new purpose tests in paragraph 55(2.1)(b)—one relating to a reduction in the FMV of a share and the other relating to an increase in cost—appear to be precisely designed to counter such planning and to avoid the multiplication of tax attributes. The amendment to paragraph 55(3)(a) follows the same logic. By requiring a share redemption to occur in order to allow the payment of a non-taxable dividend, the government is ensuring that taxpayers cannot benefit from both the tax cost of the dividend received and the ACB of the shares from which it is derived: the redemption of shares necessarily cancels the ACB of the shares. The government is thereby limiting the proliferation of tax attributes while continuing to allow the free flow of intercorporate dividends.

Paragraph 55(3)(a) doesn’t have a purpose test. Instead, it has triggering events and the series of transactions concept to prevent abuse. The CRA shouldn’t seek to inject a purpose test via the back door.

Éric Hamelin “Paragraph 55(3)(a): A Safe Harbour for Related-Party Dividends or a GAAR Trap?” 20:2 Tax for the Owner-Manager (April 2020)

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