Is the redemption of shares a transfer of property without consideration?
Bear with me. You’ll see where I’m going by the end of this article.
In the case of The Queen vs. 594710 British Columbia Ltd. 2018 FCA 166, a subsidiary (Subco) issued a stock dividend to a parent company (Holdco) in the form of redeemable preferred shares. Subco immediately redeemed these shares for cash. The Court found that, like a cash dividend, “the combination in this case of stock dividends followed by a redemption has the same effect and similarly results in a transfer of property without consideration.”
The Court quoted from the Algoa Trust v. Canada, 93 DTC 405 as follows:
a shareholder gives consideration for the shares and not for what the shares may bring… When the shareholder receives a dividend, it is not as a result of any consideration he or she gave the corporation and which the corporation is obliged to pay for investing.
Why do we care?
What if a dividend in kind is paid on the redemption of shares using a life insurance policy. Is the shareholder giving consideration to the corporation whose shares are redeemed? Maybe not, according to this case.
So why do we care?
When a dividend in kind is made, the CRA has confirmed (see previous AAMOT-Life insurance policy distributed as a dividend in kind to a shareholder and Policy as a dividend in kind – Ditto) that subsection 148(7) of the Income Tax Act applies in determining the proceeds of the disposition of the life insurance policy to the corporation and the adjusted cost basis (ACB) to the shareholder. The proceeds of the disposition would occur at the greatest of:
“value” (defined in 148(9) as cash surrender value (CSV) or nil, if there is no CSV);
fair market value (FMV) of consideration given on the transfer; or
the ACB immediately before the transfer.
So, when the dividend in kind is a redemption, this case may suggest there would be no consideration given and the operative factors would be the greater of the CSV or the ACB.
But not so fast.
At the APFF Conference CRA Round Table (Question 1) on October 5, 2018 the Canada Revenue Agency (CRA) considered a situation where, instead of paying a dividend in kind to transfer a policy from Subco to Holdco, the subsidiary redeems a number of preferred shares equivalent to the policy’s FMV. In the
example used, the policy’s CSV is $50,000, its ACB is $25,000 and its FMV is $100,000. The CRA’s unofficially translated response is:
…where, in connection with a redemption of shares, the redemption price paid by the corporation is an interest in a life insurance policy that the corporation transfers to the shareholder, the CRA is of the opinion that the shareholder gives consideration (the redeemed shares) to the corporation for the interest so transferred.
In this situation, Subco would have a taxable policy gain of $75,000 ($100,000-$25,000) on a redemption satisfied by a life insurance policy vs. $25,000 ($50,000-$25,000) where the policy is paid as a dividend in kind and not on a redemption.
The CRA acknowledges that the result differs depending on whether the policy transfer is made by way of a dividend in kind or if the dividend in kind is in satisfaction of a share redemption. They question the tax policy rationale and have notified the Department of Finance.
If the CRA’s view had been in line with the case law, it could have solved a problem for the purposes of subsection 55(2) when paying an inter-corporate dividend of this type. Instead of paying such a dividend out of “safe income”, a redemption satisfied with an in-kind distribution of a policy might not have had subsection 55(2) applied to it, so safe income would not have had to be used for the dividend payout. (See AAMOT, Budget 2015 Changes – Potential impact on Inter-corporate dividends). That, along with the transaction being reported at CSV as opposed to FMV, would have been too good a result.
Maybe that’s why the CRA answered the way they did!