CRA views on the capital dividend account anti-avoidance rule
In a recent technical interpretation (#2017-0704221E5), the Canada Revenue Agency (CRA) was asked to comment on a hypothetical situation involving capital dividends arising from life insurance received by a private corporation. The CRA addressed a series of questions involving the capital dividend account (CDA) and provided guidance on the application of the CDA anti-avoidance rule in the Income Tax Act.
Here’s the hypothetical scenario posed to the CRA:
Mr. X, a 100% shareholder of Canco, dies
Canco is and always has been the owner and beneficiary of a life insurance policy on Mr. X.
The life insurance had an adjusted cost base (ACB) of nil and was neither a leveraged insured annuity (LIA) nor a 10/8 policy
Canco receives life insurance proceeds of $500,000
Canco uses $200,000 of the insurance proceeds to repay corporate debt and $250,000 to pay a capital dividend to Mr. X’s estate
$50,000 of the life insurance proceeds remained in Canco
Mr. X’s estate sells his Canco shares to an arm’s-length party, Ms. Y.
Here are the questions that the CRA answered:
What is the CDA balance in Canco before and after the sale to Ms. Y?
What if Mr. X had held shares of Holdco, which owned 100% of Canco, and it was the Holdco shares that Mr.
X’s estate sells to Ms. Y?
Is it possible for Ms. Y to buy a private corporation that has a CDA balance resulting from life insurance proceeds and benefit from the CDA balance?
Here’s what the CRA had to say.
In general, yes, it is possible for a purchaser of a private corporation to benefit from a CDA balance that is the result of life insurance proceeds previously received by the corporation. But the general anti-avoidance rule (GAAR) could still apply.
The CRA confirmed that the CDA balance in Canco before and after the sale of its shares to Ms. Y would be $250,000. Because the life insurance had an ACB of nil and was not a LIA or 10/8 policy, and Canco always owned (and was the beneficiary of) the policy, there were no adjustments to the CDA credit relating to the policy.
Regarding the CDA after the sale to Ms. Y, the CRA stated, “The ability of a corporation to elect pursuant to subsection 83(2) and its CDA balance determined under subsection 89(1) are generally not impacted by an acquisition of control of the corporation.”
However, the CRA went on to analyze if the CDA anti-avoidance rule in subsection 83(2.1) would apply and turn any future capital dividend Ms. Y receives into a taxable dividend. This rule applies when one of the main purposes of acquiring the shares was to receive the dividend. However, the rule would not apply if one of the exceptions is met.
A key exception looks at the origin of the CDA credit or how the capital dividend being paid arose.
If all, or substantially all, of the CDA immediately before the capital dividend becomes payable did not arise:
from a capital dividend received on another corporation’s share that is acquired in a transaction or series of transactions with one of the main purposes being to receive the dividend (other than a capital dividend paid from the other corporation’s CDA arising from life insurance proceeds);
from an addition to the CDA that results from certain amalgamations or wind-ups;
while the corporation was controlled directly or indirectly, in any manner, by a non-resident; or
from a capital gain that accrued on property of the corporation that was controlled directly or indirectly, in any manner, by a non-resident,
then the CDA anti-avoidance rule would not apply.
The CRA confirmed that in the scenario where the shares sold are Canco shares, the CDA balance would not be from any of a) to d) above because the CDA balance was only attributable to life insurance proceeds. That means that a capital dividend Ms. Y receives -- up to $250,000 -- would not be recharacterized under the CDA anti-avoidance rule in subsection 83(2.1) as a taxable dividend.
The CRA confirmed that in the scenario where the shares sold are Holdco shares, the capital dividend Canco pays to Holdco would not be subject to the CDA anti-avoidance rule. Because Holdco did not acquire Canco’s shares, the main purpose test is not met.
In this same scenario, another exception from the CDA anti-avoidance rule applies to capital dividends paid between related corporations. This exception provides that the CDA anti-avoidance rule will not apply to capital dividends paid through a corporate chain unless all, or substantially all, of the CDA immediately before the dividend becomes payable consists of amounts listed in paragraphs 83(2.4)(a)-(e). Three of these amounts parallel b) to d) discussed above.
The other amounts involve CDA or gains accrued while the corporations were not related. In this scenario though, Canco and Holdco were always related. In summary, this means that the CDA anti-avoidance rule would not apply to the dividend paid from Canco to Holdco.
The CRA then confirmed that the capital dividend Holdco pays to Ms. Y would also not be subject to the CDA anti-
avoidance rule since Canco’s CDA balance immediately before a dividend is paid to Ms. Y would not consist of any amounts described in a) to d) above. Specifically, not a) because Holdco did not acquire the Canco shares to receive the dividend from Canco. The CRA also confirmed that, even if the capital dividend were paid to Ms. Y after there is a winding up of Canco into Holdco, or an amalgamation of Canco and Holdco, the capital dividend Holdco pays to Ms. Y would not be subject to the CDA anti-avoidance rule. In essence, this means that Canco’s CDA balance of $250,000 can be transferred to Holdco or to the new corporation resulting from an amalgamation and be paid in the future to Ms. Y in these circumstances.
The CRA did say that despite this, GAAR could still apply and would depend on the facts and circumstances of a series of transactions in any particular situation.
As a final comment, the CRA also suggested that another exception could apply. Subsection 83(2.3) provides that the CDA anti-avoidance rule will not apply to a dividend paid by a corporation “in order to distribute life insurance proceeds which were received by it and included in its capital dividend account as a consequence of death of a
Because the exception for life insurance proceeds is built right into the exception from the CDA anti-avoidance rule (in subsection 83(2.2)(a)), the CRA confirmed that the CDA anti-avoidance rule will not apply where a capital dividend funded by life insurance proceeds is paid to an individual either directly or through a holding company. This exception appears to be limited to the actual amount of proceeds available for distribution, which in this case was less than the CDA balance in question. The CRA concluded that “thus, assuming that Canco’s assets consist only of $50,000 cash which is funded by life insurance proceeds, the provision 83(2.3) could apply to a capital dividend equal to this
So, what does this mean?
What all this tells me is that the specific exception for life insurance would only relate to the amount available for distribution from life insurance proceeds. However, the other exceptions allow for a distribution of the rest of the CDA credit produced by life insurance since the CDA balance is permitted to be distributed without the CDA anti-avoidance rule applying. That means, if the corporation does have other assets or gets other assets, this distribution can be done at a later time without fear of the CDA anti-avoidance provision applying in the circumstances described. This is all subject to GAAR, of course!
Also, it’s interesting to note that this CRA commentary seems to clear up the interaction of the CDA anti-avoidance provision and the exceptions which were not ruled on in Groupe Honco Inc. v. The Queen (2013) FCA 128. (see AAMOT’s, CDA Anti-avoidance case & CDA Anti-avoidance case – No further analysis).