Key Reminders About the Deliberate Triggering of Subsection 55(2)
Statements of the CRA's position on the deliberate triggering of new
subsection 55(2) have appeared in a variety of places, so it may be
useful to gather and summarize its position here. Three issues are
discussed below: (1) one of the purpose tests must be met; (2) the part
IV tax exception must not apply; and (3) the dividend must be in excess
of safe income.
The Purpose Tests
Before the enactment of the new subsection 55(2) regime, taxpayers could
choose to extract corporate funds through capital gains instead of
taxable dividends. Now that the regime has been amended, taxpayers can
pay intercorporate dividends while anticipating the dividends'
recharacterization into capital gains by reason of the combined effects
of subsections 55(2) and (2.1). Rather than pay a taxable dividend to
the ultimate shareholder, taxpayers can file a CDA election and have
that shareholder receive the non-taxable portion of the corporation's
capital gain realized on the recharacterization tax-free (see
"Deliberate Triggering of Subsection 55(2)," Canadian Tax Focus
February 2016). The CRA confirmed that it would not invoke GAAR in
these circumstances, but the strategy nonetheless raised some concerns
for Finance (2015-0595641C6, October 9, 2015). In the 2017 federal
budget, the government stated that it would address the issue (and
others relating to the taxation of private corporations) in a paper "in
the coming months."
Upon the payment of dividends to which subsection 84(2) or (3) does not
apply, subsection 55(2.1) requires that the dividends meet one of three
purpose tests: (1) a significant reduction of the capital gain that
otherwise would have been realized on a disposition of a share, (2) a
significant reduction in the FMV of any share, or (3) a significant
increase in the cost of property of the dividend recipient. Thus, it
should theoretically be easier to satisfy the purpose tests under the
new regime (and, as a consequence, to trigger the application of
However, it could be argued that if a taxpayer intentionally sought to
meet one of the purpose tests, none of the tests would in fact be met
because the purpose of the dividend payment would then not be to effect
one of the purposes of paragraph 55(2.1)(b), but rather
recharacterization as a capital gain. One could analogize to
loss-consolidation strategies (see question 9 of the CRA Round Table in
the 2015 Conference Report, where the CRA stated that no purpose test
was met on dividend payments because they are in fact paid in order to
use tax attributes within a corporate structure).
Part IV Tax Exception
Before the amendments to the subsection 55(2) regime, subsection 55(2)
did not apply to dividends subject to part IV tax if the tax was
refunded as a consequence of the payment of a dividend to a person other
than a corporation as part of the same series. Under the new regime,
this exception applies only to dividends that are subject to part IV tax
when no dividend refund is received as a consequence of the payment of
the dividend by a corporation and the payment is part of the same
In question 4 of the CRA Round Table at the 2016 annual conference, the
CRA analyzed the possibility that a taxpayer might benefit from the
subsection 55(2) dividend recharacterization if the RDTOH balance was
positive and the dividend recipient was subject to part IV tax. The CRA,
following the TCC's decision in Ottawa Air Cargo Centre Ltd.
(2007 TCC 193
, aff'd. 2008 FCA 54
stated that for the dividend to be recharacterized, a tax return must
be filed and the part IV tax actually refunded; after the dividend
refund, the dividend could be recharacterized. The increase in CDA could
therefore apply only to future dividend payments.
Dividend in Excess of Safe Income
Finally, following the subsection 55(2) legislative changes, paragraph
55(5)(f) now applies automatically: any part of a taxable dividend paid
in excess of the safe income on hand attributable to the share on which
the dividend is paid will be considered a separate taxable dividend to
the extent of the lesser of the taxable part and the safe income.
Therefore, any tax planning involving the deliberate triggering of
subsection 55(2) can occur only if the amount of the taxable dividend
paid exceeds the safe income on hand attributable to the share.
Otherwise, subsection 55(2) will not apply and the dividend will be
fully deductible to the dividend recipient under subsection 112(1).
KPMG LLP, Montreal