ADMS 4562 Lecture Notes - Lecture 9: Dividend Tax, Corporate Tax, General Partnership
11 May 2018
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Copyright © Joanne Magee/Jason Fleming
ADMS 4562 LECTURE 9 NOTES
Last updated on June 11, 2015
The Final Content Exam will be on Thursday, July 30 from 7 to 10pm.
The exam covers lectures 5 to 9.
The exam location is VH (Vari Hall) room A
The exam handout (provided with this lecture’s material) will be given
to you at the exam
Students who have a conflict should contact your course director at least 2 weeks
prior to the exam to be put on the list to write an alternate ADMS 4562 exam
Past final content exams will not be posted
The format of the exam is described on the course outline
Topics
1. Sale of Shares and Section 55(2)
– Problem Set Question 1 (in separate document)
Readings: S. 55(2), FIT Chapter 16 (16240)
Recommend: Ch 16, Exercise 10
2. Partnerships
- Problem Set Question 2 (in separate document)
Readings: ADMS 3520 Lecture 10 Notes (separate document), FIT Chapter 18 (18000)
Recommend: Ch. 18, Multiple Choice 1 and 2, Exercises 1 and 2
3. The General Anti-avoidance Rule (GAAR):
Readings: Chapter 13 (13500)
Recommend Ch. 13, Multiple Choice 4 and 5, Exercise 11; and Ch. 17 Review Question 6
4. Major Causes of Liability Insurance Claims in Tax Practice
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Copyright © Joanne Magee/Jason Fleming
1 Subsection 55(2)- Arm’s length sale of shares by a corporation
Legislative intent:
s. 55(2) prevents the conversion of a capital gain (CG) on an arm's length sale of shares
by a corporation to a tax-free (s. 112) dividend if the dividend is greater than “income
realized and retained after 1971” (also called "post-1971 retained earnings" or "safe
income"). Subsection 55(2) only applies to limit dividends to safe income when the
dividend is paid in the course of an arm’s length sale.
S. 55(2) applies automatically if all of the following conditions are met:
1. Vendor of shares is a corporation
2. Purchaser and vendor deal at arm’s length (i.e., are not related). Siblings are deemed
to be at arm’s length for purposes of s. 55(2) only [ITA 55(5)(e)]
3. Vendor receives a tax-free inter-corporate dividend (s. 112) at any time prior to the
sale
4. One of the purposes or results of the dividend is to reduce the CG on the ultimate sale
of shares
Result S. 55(2) limits the dividend to safe income. The remaining dividend is
deemed to be proceeds of disposition (POD) and this typically results in an
additional CG. [Discussed in more detail below, plus see 55(5)(f) election]
S. 55(2) actually limits the dividends to the greater of
1. the dividend subject to Part IV tax or
2. safe income portion
The courts have ruled that the two exemptions cannot be added together. In this course
we will be concentrating on the safe income rule.
1.1 S. 55(5)(f) Election- Dividends in excess of safe income
If the dividend exceeds safe income, the recipient can (and should) elect under s. 55(5)(f)
to split the dividend into two separate dividends in order for the “safe income” portion to
remain a dividend – otherwise the entire dividend will be deemed to be proceeds of
disposition. In other words, the s. 55(5)(f) designation allows part of the dividend to be
treated as a separate dividend paid out of safe income. The other part (i.e., the part of the
dividend in excess of safe income) will be deemed to be proceeds of disposition and this
typically results in an additional capital gain
Some taxpayers will be aware of s. 55(2) and will pay 2 separate dividends (one out of
safe income, one not) rather than relying on an election under s. 55(5)(f) either by
1. paying two cash dividends, or two stock dividends or
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Copyright © Joanne Magee/Jason Fleming
2. having two deemed dividends (by increasing the PUC of shares twice to create two
dividends).
However, if they don’t know about s. 55(2) and/or if they pay one dividend that is in
excess of safe income the s. 55(5)(f) designation is a way of mitigating the problem
retroactively (by electing to split the dividend into two separate dividends)
The exact calculation of safe income is complex and beyond the scope of this course.
1.2 Test yourself on 55(2)
P Ltd. owns 100% of S Ltd. S Ltd.'s shares have a paid-up capital and an ACB of
$20,000 and a FMV of $85,000. S Ltd.'s post-1971 tax retained earnings amounts to
$55,000 and its pre-1972 CSOH account amounts to $40,000. P Ltd. is planning to sell S
Ltd. to an arm's length purchaser. Prior to the sale, S Ltd. borrows $85,000 from a bank
to pay P Ltd. two amounts: $20,000 in respect of a reduction in S Ltd's paid-up capital
and $65,000 in respect of a taxable dividend. After the payments, P Ltd. sells S Ltd.
shares for a nominal amount. Which of the following statements is true, assuming the
optimal election is made under s. 55(5)(f)?
(a) P Ltd. should include a $85,000 dividend in its Division B net income.
(b) P Ltd. would include a $65,000 dividend in its Division B net income.
(c) P Ltd. would include a $55,000 dividend and a $5,000 taxable capital gain in its
Division B net income.
(d) P Ltd. would include a $50,000 dividend in its Division B net income.
The correct answer is (c).
S. 55(2) applies since all of the following conditions are met:
1. Vendor of shares (P Ltd.) is a corporation
2. Purchaser and vendor deal at arm’s length (i.e., are not related)
3. Vendor receives a tax-free inter-corporate dividend (s. 112) at any time prior to the
sale (P Ltd. receives a $65,000 dividend).
4. One of the purposes or results of the dividend is to reduce the CG on the ultimate sale
of shares
Since safe income is $55,000 and since the 55(5)(f) election is filed $55,000 can stay as a (tax-
free) dividend and the excess amount $10,000 will be deemed to be a separate dividend and
additional proceeds of disposition (P of D)
P of D = $0 (nominal) plus $10,000 = $10,000
less ACB $0
Capital gain $10,000
Document Summary
The final content exam will be on thursday, july 30 from 7 to 10pm. The exam location is vh (vari hall) room a. The exam handout (provided with this lecture"s material) will be given to you at the exam. Students who have a conflict should contact your course director at least 2 weeks prior to the exam to be put on the list to write an alternate adms 4562 exam. Past final content exams will not be posted. The format of the exam is described on the course outline. Topics: sale of shares and section 55(2) Problem set question 1 (in separate document) Problem set question 2 (in separate document) Readings: adms 3520 lecture 10 notes (separate document), fit chapter 18 (18000) 18, multiple choice 1 and 2, exercises 1 and 2: the general anti-avoidance rule (gaar): 13, multiple choice 4 and 5, exercise 11; and ch. 17 review question 6: major causes of liability insurance claims in tax practice.
