Publication
TITRE
Ordinary Course Dividends Not Part of Series of Transactions
DATE
18 décembre 2003
EXPERTISE
Barry N. Segal*
As most practitioners are aware, subsection 55(2) of the Income Tax Act (Canada)1 can apply to recharacterize all or part of an otherwise tax-free intercorporate dividend (including a deemed dividend) as proceeds of disposition if the dividend was received as part of a series of transactions or events one of the purposes (or, in the case of deemed dividends, one of the results) of which was to reduce a capital gain on the disposition of a share. The amount of the dividend to be recharacterized as proceeds of disposition is reduced to the extent that Part IV tax is applicable to the dividend, unless the Part IV tax is refunded as a consequence of the payment of a dividend to a corporation where the payment was part of the same series.
In the recent case of Canutilities Holdings Ltd. and Canadian Utilities Limited v. The Queen,2 the taxpayers successfully argued that the payment of normal course dividends that generated Part IV tax refunds were not part of the same series of transactions or events that gave rise to deemed dividends.3 As a result, the taxpayers were able to defeat the recharacterization by the Canada Customs and Revenue Agency ("CCRA") of the entire deemed dividend as proceeds of disposition. The taxpayers' arguments were successful even though the normal course dividends were clearly an important factor in the planning that resulted in the deemed dividends.
The facts of the case, as discussed below, are rather unique and are unlikely to serve as a model for planning around subsection 55(2). However, the Tax Court of Canada's guidance on what constitutes a series of transactions or events, especially with respect to subsection 248(10), will no doubt be useful in other situations.
The Facts
The taxpayers, Canadian Utilities Limited ("CU") and Canutilities Holdings Ltd. ("CU Holdings") were public companies listed on the Toronto Stock Exchange. Both CU Holdings and CU were shareholders of ATCOR Resources Ltd. ("ATCOR"), a publicly-listed oil and gas company. Both CU and CU Holdings had a history of paying normal course, substantial dividends on their listed preferred shares.
By late 1995, Forest Oil Corporation ("Forest"), a U.S. company, had agreed to acquire all of the outstanding shares of ATCOR for a price of $4.88 per share, in a friendly take-over. Three possible acquisition structures were contemplated: a takeover bid, a plan of arrangement and an amalgamation (with a related shell corporation) followed by share redemptions. ATCOR and Forest settled on the amalgamation/redemption structure. The court found, after a comprehensive review of the evidence given by the lawyers involved in the transaction, that the decision to use this structure was dictated solely by commercial (and not at all by tax) considerations.
On the amalgamation, ATCOR shareholders were permitted to elect to receive one of three special classes of redeemable shares in exchange for their ATCOR shares. Each share of each class of shares was redeemable for $4.88, representing the purchase price per share to be paid by Forest for ATCOR.4 At the request of tax advisors to CU and CU Holdings, the paid-up capital allocated to the Class A and Class B Special Shares was approximately equal to the respective adjusted cost bases to CU and CU Holdings in their ATCOR shares.
CU and CU Holdings elected to exchange their ATCOR shares for Class A and Class B Special Shares of the amalgamated company, respectively. As the court noted, prior to the exchange CU and CU Holdings would have been able to accurately predict the amount of the (tax-free) deemed dividend that would arise on the redemption of their shares. They were also assured that they would have little or no capital gain as a result of the redemption of their shares. The Class A and Class B Special Shares were subsequently redeemed. The elections, the paid-up capital allocations, the amalgamation and the redemptions were referred to in the decision as the "ATCOR/Forest transactions".
It was common ground that, at the time of the redemptions, CU and CU Holdings were not "connected" with the amalgamated ATCOR and that they were "subject corporations" for purposes of Part IV tax.5 Therefore, Part IV tax applied to the entire deemed dividend arising on the redemptions. CU and CU Holdings subsequently had their Part IV tax refunded when they paid their normal course dividends to their respective shareholders. It is important to note that the court accepted (based in part on the admission of a CCRA auditor) that these normal course dividends would have been paid in the years under appeal regardless of whether the sale of ATCOR had taken place.
The Minister reassessed CU and CU Holdings under subsection 55(2) on the basis that the Part IV tax exception did not apply. The principal issue before the court was whether the Part IV tax refunds were part of the same series of transactions or events that gave rise to the deemed dividends (i.e., the amalgamation and the redemptions).6
What Series?
For subsection 55(2) to apply to the taxpayers, a dividend must have been received as part of a series of transactions or events (referred to in the case as the "base series of transactions") one of the results of which was to effect a significant reduction in a capital gain. For the Part IV tax exception to apply, the subsequent dividend that generated the Part IV tax refund must not have formed part of the series. The identification of the transactions or events that constitute a series is often a daunting task, despite (or perhaps because of) several cases that purport to explain how transactions must be linked to form a series.7 In addition, subsection 248(10) provides that, where the Act contains a reference to a series of transactions or events, the series shall be deemed to include any related transactions or events completed in contemplation of the series.
The challenge faced by the Minister was to show that the normal course dividends were part of the same series of transactions or events that led to the deemed dividend. In particular, the Minister had to overcome the fact that the normal course dividends would have been paid regardless of whether the ATCOR/Forest transactions were ever consummated.
Attaching ATCOR/Forest Transactions to the Normal Course Dividends
The Minister's main argument was that the normal course dividends could be viewed as the base series of transactions. Relying on subsection 248(10), the Minister argued that the ATCOR/Forest transactions were related to and completed in contemplation of the normal course dividends and were therefore, included in the base series of transactions. This approach was somewhat counterintuitive, as one would have expected the base series of transactions to be the ATCOR/Forest transactions, which were most directly responsible for the deemed dividend. The Minister must have believed (correctly, as it turns out) that it could not attach the normal course dividends to the ATCOR/Forest transactions (see below). The court rejected the Minister's argument, and in so doing, it offered the following interpretation of subsection 248(10):
Subsection 248(10) by its express language seeks to identify a series referred to in the Act and includes transactions or events as part of "the series" (i.e., as part of that series) so referred to in the Act such as the series referred to in subsection 55(2) if they (such transactions or events) are related to and are completed in contemplation of that particular series. The particular series in subsection 55(2) to which subsection 248(10) can attach transactions or events is the series as a part of which a corporation has received a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1). To use subsection 248(10) other than to attach transactions related to that series requires a somewhat circular construction of subsection 55(2) that its language does not in my view invite ? In the jargon of the Appellants' submissions, the "base series of transactions" for the purposes of the Part IV exception to the application of subsection 55(2) is the ATCOR/Forest transactions not the normal course dividends paid by the Appellants.8
The court appears to have concluded that subsection 248(10) cannot be used to assemble transactions to form the base series of transactions or events. The base series must exist independently of the application of subsection 248(10). Other transactions can be attached to the base series if the criteria under subsection 248(10) are met, but they cannot themselves form part of the base series.
Attaching Normal Course Dividends to ATCOR/Forest Transactions
Having rejected the Minister's approach, the court went on to consider the opposite argument: whether the normal course dividends were part of the series of transactions or events that included the ATCOR/Forest transactions, either under the ordinary (also called the "common law") meaning of "series" or having regard to subsection 248(10).
The court found that the normal course dividends were not part of the common law series of transactions that included the ATCOR/Forest transactions. In coming to this conclusion, the court considered the degree of connection that would be required for transactions to form a common law series. The court found that a series would only exist if there was a "common subject matter or motivation" or a "common conscious volition" existing between transactions. Although the normal course dividends were certain to be paid and were relied on in tax-planning by CU and CU Holdings, the court found that mere "reliance on a known, pre-ordained future event would not at common law bring that future event into the series of transactions that relied on it." This may be a stricter test than the one set out by the Federal Court of Appeal in OSFC.
Ultimately, the court reduced the issue to whether the paid-up capital allocations (forming part of the ATCOR/Forest series of transactions) and the normal course dividends were sufficiently linked to make them into a single series. The court found that the paid-up capital allocations were arrived at by taking the normal course dividends into account and were relied upon to eliminate taxes payable. Thus, a link was established. However, because of the independent nature of the normal course dividends, the link was not sufficient to establish a series. The base series of transactions was therefore limited to the ATCOR/Forest transactions. The court explained that:
The normal course dividends have nothing in common with any element of the ATCOR/Forest transactions. They are not driven or guided by the same conscious volition. The normal course dividends are not a continuation of any aspect of the ATCOR/Forest series of transactions. They do not exist to facilitate any aspect of the ATCOR/Forest series of transactions. They do, in fact, facilitate a tax planned element of the ATCOR/Forest series and reliance is placed on them. That is not sufficient however to constitute them, the normal course dividends, as part of the ATCOR/Forest series of transactions ? That an event in a series is related to another event, even adapted in reliance on such other event, to achieve a tax advantage, is not sufficient at common law to make the other event part of the series if it has a genuine independent purpose and existence. In my view, no common law definition of "series" would include the normal course dividends as part of the ATCOR/Forest series of transactions.9
Because the normal course dividends were independent events and were not paid in contemplation of ATCOR/Forest transactions, the court also concluded that subsection 248(10) could not be used to attach the normal course dividends to the ATCOR/Forest transactions.
Comment
The most intriguing aspect of this case is the assertion that subsection 248(10) cannot be used to expand a base series of transactions. The assertion appears logical, at least in the context of subsection 55(2), since the "series" referred to in subsection 248(10) (the base series of transactions) must, by definition, exist independently of the other transactions that would be deemed by subsection 248(10) to form part of that series. An interesting question is whether this logic could be extended to apply to other provisions of the Act that refer to a "series of transactions or events".
The general anti-avoidance rule ("GAAR"), contained in section 245, is one such provision. GAAR can apply to recharacterize tax consequences where there has been an avoidance transaction and a tax benefit has resulted from a series of transactions that includes that avoidance transaction. A transaction can be an "avoidance transaction" if it was part of a series of transactions that resulted in a tax benefit.10 Following Canutilities, the first step would be to find a common law series of transactions that resulted in the tax benefit that was sought to be recharacterized. This would be the base series of transactions. If the avoidance transaction was not part of the base series of transactions, under the common law meaning of series, to be included in the series under subsection 248(10), it would have to be related to and completed in contemplation of the series. If the avoidance transaction would have occurred independently of the base series of transactions, it could be argued that the base series did not include the avoidance transaction. As a result, GAAR would not apply.
For example, suppose two unrelated taxpayers regularly invested in shares through a single a holding corporation. If with respect to a particular investment each taxpayer was to own only 6% of the shares, the combination of their shareholdings could be viewed as an transaction that resulted in a tax benefit (the "first tax benefit") - the avoidance of Part IV tax - and therefore, an avoidance transaction. Suppose that with respect to a particularly lucrative investment in shares it was decided for business reasons that liquidation of their investment would be effected through a share redemption, resulting in a significant tax-free deemed dividend. Because the dividend would be received free of tax (assuming subsection 55(2) did not apply), it might be a tax benefit (the "second tax benefit") that the CCRA would seek to recharacterize under GAAR.
Adopting the analysis in Canutilities, the base series of transactions that resulted in the second tax benefit would be the liquidation transactions that caused the deemed dividend. Because the combination of the shareholdings would have occurred independently of these transactions, they would not form part of the series, either under the common law definition or as expanded under subsection 248(10). As well, because the base series must exist independently of subsection 248(10), it would not be open to the CCRA to assert that the combination transactions were the base series of transactions and to attempt to link them to liquidation transactions under subsection 248(10) in order to enlarge the base series. Thus, GAAR might not apply to recharacterize the liquidation transactions. Of course, the CCRA may apply GAAR to recharacterize the first tax benefit arising from the combination transactions and try to collect Part IV tax, but this would be a better result for the taxpayers.
* Barry N. Segal
Ogilvy Renault
(416) 340-6161
bsegal@ogilvyrenault.com
- RSC 1985, c.1, 5th supp. (the "Act"). All statutory references in this article are to the Act.
- 2003 DTC 1029 (TCC).
- The taxation years relevant to the appeal predate amendments made to the opening words of subsection 55(2) in 1998. However, the substance of the subsection has not changed as a result of those amendments.
- A Canadian subsidiary of Forest subscribed for common shares of amalgamated ATCOR in order to fund the redemption price of the special shares.
- CU and CU Holdings were not "connected" with amalgamated ATCOR because the Class A and Class B Special Shares were non-voting shares. They were "subject corporations" because they were controlled at all times by an individual.
- The other issue was whether CU and CU Holdings received their Part IV tax refund as a consequence of dividends paid to corporations, to individuals or both. The court did not have to decide this issue, although it noted that it would have found that the refunds were obtained as a consequence of dividends paid to corporations.
- See, for example, OSFC Holdings Ltd. v. The Queen 2001 DTC 5471 (FCA) and the cases referred to therein.
- Canutilities, at paragraph 124.
- Canutilities, at paragraphs 148-150.
- It is assumed that a transaction will be an avoidance transaction if it results directly in a tax benefit that is different from the tax benefit that results from the series of transactions.
