FA Dividends Must Be Pro Rata

By virtue of new subsections 90(2) and (5), effective August 19, 2011 (Bill C-48; royal assent June 26, 2013), some amounts that are dividends under the law of the payer's (the FA's) country will not be dividends for Canadian purposes. Therefore, the amount will effectively be taxable in Canada to the FA's parent company. This is a particularly important issue for FAs that are US LLCs. In such cases, taxpayers may wish to consider other means of repatriating cash to Canada.

Dividends that are paid out of the FA's exempt surplus account normally trigger an income inclusion, which is offset by a section 113 deduction. However, this outcome depends on the amount paid having the status of a dividend for Canadian tax purposes. In the past, the status of the amount in the FA's country was determinative; if it was a dividend under foreign law, it was a dividend under Canadian law. This is no longer the case. On the basis of the operation of subsections 90(2) and 90(5), an amount must be a pro rata distribution on a class of shares of the capital stock of the FA in order to be a dividend for the purposes of the Act.

However, the following pro rata distributions are nevertheless not deemed to be dividends: (1) distributions made in the course of a liquidation and dissolution of the corporation; (2) distributions made on a redemption, acquisition, or cancellation of a share of the corporation; or (3) distributions made on a qualifying return of capital in respect of a share. These types of distributions are dealt with separately.

The new pro rata rule can present probleMs. For example, a US LLC (which qualifies as an FA of a taxpayer) may have only one class of units but maintain a separate "capital account" for unitholders. Distributions from the US LLC to its unitholders may be made in relation to that particular unitholder's capital account and not in relation to its units. Accordingly, distributions to unitholders on the units in this manner cannot be made on a pro rata basis, will not be considered to be dividends for Canadian tax purposes, and will not receive the section 113 deduction. Instead, the non-pro-rata distribution will be treated as income from property--a subsection 15(1) shareholder benefit, according to paragraph 15(1)(a.1).

Michael Gemmiti
Thorsteinssons LLP, Vancouver

Canadian Tax Focus
Volume 3, Number 3, August 2013
©2013, Canadian Tax Foundation