Advanced Tax: Corporations – Spring 2013 Final Outline

Derek Deacon

Table&of&Contents&
Introductory*Topics*and*Policy*..........................................................................................*2!
Corporate*Residence*..............................................................................................................*4!
Classification*of*Corporations*..........................................................................................*10!
Corporate*Control*.................................................................................................................*13!
Arm’s*Length*..........................................................................................................................*20!
Related*Persons*.....................................................................................................................*22!
Associated*Corporations*....................................................................................................*26!
THE*SMALL*BUSINESS*DEDUCTION*.................................................................................*30!
Purpose*of*Canada’s*Integration*System*......................................................................*33!
Taxation*of*Dividends*.........................................................................................................*36!
Intercorporate*Dividends*..................................................................................................*42!
Part*IV*Tax*on*Certain*Intercorporate*Dividends*......................................................*42!
Refundable*Tax*on*CCPC*Aggregate*Investment*Income*........................................*45!
Stop*Loss*Rule*in*112(3)*and*(3.01)*and*Capital*Dividends*83(2);*Capital*
Dividend*Account*89(1)*.....................................................................................................*49!
Stock*Dividends,*Dividends*in*Kind*and*Deemed*Dividends*.................................*53!
General*AntiZAvoidance*Rule*(“GAAR”)*........................................................................*56!
Shareholder*Benefits*and*Loans*......................................................................................*60!
Acquisition*of*Control*(Basic*Corporate*Reorganization*Stuff)*............................*62!
Appendix*(Cases*and*Handouts)*......................................................................................*65!

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Introductory Topics and Policy

• Corporations are taxpayers because they are persons ! calculate their income
separately from shareholders and directors
• Corporations exist to earn profit ! can earn from business and investment,
including specified investment businesses and personal services businesses
• Partnerships and SPs are flow-through entities ! not taxpayers, taxpayers are
the partner themselves who pay on their share of profit
o Flow-through status can be useful for tax planning ! corporations can be
partners in partnerships
• CCPC justification ! smaller companies have less chance of growth ! want to
encourage them to grow and employ more Canadians
• Bird paper ! goes through reasons not to tax corporations
o Who really bears the burden of corporate tax? Borne on shareholders,
employees, consumers ! NOT the corporation itself
o Taxing shareholders through corporate taxation does NOT improve
progressivity ! corporate tax is a flat rate; also, they can pass on costs to
consumers
o Compliance costs ! stronger rules affecting avoidance = more expensive
for taxpayers to comply
o However, Bird says we should still tax corporations
" Abolishing is a huge windfall for current shareholders
" “Desirable, necessary, and convenient
" Taxing corporations for benefits they receive from society
(municipal stuff)
" Perhaps they should pay for their limited liability and separate
entity status
" Mount Everest argument ! tax corporations because they are
there
• Tax research sources
o CCH, QuickLaw, Canadian Tax Foundation OECD, CRA, Department of
Finance, Lexis-Nexis/WestLaw/e-Carswell/Hein-on-line/LegalTrac/SSRN,
Interlibrary loan, Tax Analysts

Base Case Tax Rates

s.123(1)(a) 38% is the base federal rate for corporations
s.123.4(2) (13%) general rate reduction: applies to full rate taxable income
123.4(1) full rate taxable income excludes specific types of
income that are caught by rate deductions in other
sections, namely, CCPCs and investment corporations.
123.4(1) general rate reduction percentage the total of (c)
9% for 2009.
s.124(1) (10%) provincial abatement
s.14(2) BC 10% provincial corporate income tax
25% BASE CASE CORPORATE RATE

117(2)(c) 29% top individual federal rate

s.4.1(e) 14.7% top individual provincial rate

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43.7% TOP INDIVIDUAL RATE

*Absent the gross up/DTC system, there is a significant disintegration between (1)
income earned through a corporation and distributed as a dividend to an individual and
(2) income earned by an individual.

The Gross-Up and Dividend Tax Cred System

s.12(1)(j) dividends from resident corporations included in individual income.

s.82(1) individual income is ‘grossed up’ through:
(a) adding the amount by which received non-eligible dividends exceed paid
non-eligible dividends
(a.1) adding the amount by which received eligible dividends exceed paid
eligible dividends
(b) if the taxpayer is an individual, other than a trust or charity,
(i) 25% of the non-eligible dividend gross up
(ii) 45% of the eligible dividend gross up

s.121 Federal Dividend Tax Credit System

(a) 2/3 of the amount that is required by s.82(1)(b)(i)
(b) 6/11 of the amount that is required by s.82(1)(b)(ii)
s.4.69 Provincial Dividend Tax Credit System
(a) 21% of the gross up for ordinary dividends, s.82(1)(b)(i)
(b) 354/9% of the gross up for eligible dividends, s.82(1)(b)(ii)

* Ideally, the Gross Up amount should be equal to the DTC. *************

*Ordinary dividends: 2/3 of the DTC is federal, with the remaining 21% provincial. So, for
a BC resident, the total DTC is 87.67% of the gross-up. Result is a disintegration of
around 9%. This is partially offset by 13.7% deferral advantage (the difference between
top rate individual tax and corporate base case).

*Eligible dividends: have a DTC equal to 96.55% of a higher gross up (45%). This DOES
achieve integration.

* The Gross-Up and DTC scheme does not apply to inter-Corporate dividends

• *Consider the implication for an individual who is not taxed at the top rate. Refer
to example on P.11, a low-rate individual can receive up to 30k of dividends tax
free. However, note the existence of the ‘kiddie tax’, which assigns the ‘income’
earned by children to their parents.

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Corporate Residence
2(3) for non-resident corporations taxable on their income from business carried on in
Canada and disposition of Canadian assets

253 - extended definition of carrying on business - very broad - catches a lot of activity

Looking at Article VII Business Profits of the Canada-US Tax Treaty

• "permanent establishment" is an important term to be aware of
• big gaps in current treaty regime - Taiwan and Hong Kong in particular
• Forco with CdnSub and PE in Canada - PE is basically Forco in Canada, while
CdnSub is taxed on its own

250(4) Corporation deemed resident

For the purposes of this Act, a corporation shall be deemed to have been resident in
Canada throughout a taxation year if
(a) in the case of a corporation incorporated after April 26, 1965, it was
incorporated in Canada;
(b) (…), and
(c) in the case of a corporation incorporated before April 27, 1965 (other than a
corporation to which subparagraphs (b)(i) to (iv) apply), it was incorporated in
Canada and, at any time in the taxation year or at any time in any preceding
taxation year of the corporation ending after April 26, 1965, it was resident in
Canada or carried on business in Canada.

(5) Deemed non-resident (If tie-breaker tax treaty used, this deems the
corporation non-resident of Canada)
Notwithstanding any other provision of this Act (other than paragraph 126(1.1)(a)), a
person is deemed not to be resident in Canada at a time if, at that time, the person
would, but for this subsection and any tax treaty, be resident in Canada for the purposes
of this Act but is, under a tax treaty with another country, resident in the other country
and not resident in Canada.

(5.1) Continued corporation (changing jurisdiction of incorporation)

Where a corporation is at any time (in this subsection referred to as the “time of
continuation”) granted articles of continuance (or similar constitutional documents) in a
particular jurisdiction, the corporation shall
(a) for the purposes of applying this Act (other than subsection (4)) in respect of
all times from the time of continuation until the time, if any, of continuation in a
different jurisdiction, be deemed to have been incorporated in the particular
jurisdiction and not to have been incorporated in any other jurisdiction; and
(b) for the purpose of applying subsection (4) in respect of all times from the time
of continuation until the time, if any, of continuation in a different jurisdiction, be
deemed to have been incorporated in the particular jurisdiction at the time of
continuation and not to have been incorporated in any other jurisdiction.

Canada-US Tax Treaty

Article III.1 General Definitions

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1. For the purposes of this Convention, unless the context otherwise requires:
(e) The term “person” includes an individual, an estate, a trust, a company and any other
body of persons;
(f) The term “company” means any body corporate or any entity which is treated as a
body corporate for tax purposes;

Article IV Residence
1. For the purposes of this Convention, the term “resident” of a Contracting State means
any person that, under the laws of that State, is liable to tax therein by reason of that
person's domicile, residence, citizenship, place of management, place of incorporation or
any other criterion of a similar nature, (…)
3. Where by reason of the provisions of paragraph 1, a company is a resident of both
Contracting States, then
(a) If it is created under the laws in force in a Contracting State, but not under the
laws in force in the other Contracting State, it shall be deemed to be a resident
only of the first-mentioned State; and
(b) In any other case, the competent authorities of the Contracting States
shall endeavor to settle the question of residency by mutual agreement and
determine the mode of application of this Convention to the company. In the
absence of such agreement, the company shall not be considered a resident of
either Contracting State for purposes of claiming any benefits under this
Convention.

OECD Model Tax Convention

Article 3 General Definitions
1. For the purposes of this Convention, unless the context otherwise requires:
(a) the term “person” includes an individual, a company and any other body of persons;
(b) the term “company” means any body corporate or any entity that is treated as a body
corporate for tax purposes;

Article 4 Resident
1. For the purposes of this Convention, the term “resident of a Contracting State” means
any person who, under the laws of that State, is liable to tax therein by reason of his
domicile, residence, place of management or any other criterion of a similar nature, and
also includes that State and any political subdivision or local authority thereof. This term,
however, does not include any person who is liable to tax in that State in respect only of
income from sources in that State or capital situated therein. (…)
3. Where by reason of the provisions of paragraph 1 a person other than an individual is
a resident of both Contracting States, then it shall be deemed to be a resident only of
the State in which its place of effective management is situated.

Common Law Test

Laerstate BV (full thingy in appendix) – A corporation is resident where it is centrally
managed and controlled ! illustrates the importance of the nature and location of a
board’s decision-making process in the determination of corporate residency. One
should not assume that the board exercises central management and control or that the
company resides where the board meets ! “mere physical acts of signing resolutions or
documents do not suffice for actual management.”

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Provincial allocation of corporate income for tax purposes

ITA s. 124(4)(a) and IT Regulations 400, 401, 402.

IT-177R2 (Consolidated)

Income Tax Act

124. (1) Deduction from corporation tax (PROVINCIAL ABATEMENT)

There may be deducted from the tax otherwise payable by a corporation under this Part
for a taxation year an amount equal to 10% of the corporation's taxable income earned in
the year in a province.

(4) Definitions

“taxable income earned in the year in a province”

“taxable income earned in the year in a province” means the amount determined under
rules prescribed for the purpose by regulations made on the recommendation of the
Minister of Finance.

Income Tax Regulations

400. (1) In applying the definition “taxable income earned in the year in a province” in
subsection 124(4) of the Act for a corporation's taxation year
(a) the prescribed rules referred to in that definition are the rules in this Part; and
(b) the amount determined under those prescribed rules means the total of all
amounts each of which is the taxable income of the corporation earned in the
taxation year in a particular province as determined under this Part.

(1.1) In this Part, a corporation's taxable income for a taxation year is equal to the total of
(a) the corporation's taxable income for the taxation year (determined without
reference to this subsection) or the corporation's taxable income earned in
Canada for the taxation year, as the case may be, and
(b) the positive or negative amount determined by the formula

A–B

where

A is the total of all amounts that are, because of the application of section 33.1 of
the Act, not required to be added in computing the corporation's income for the
taxation year, and
B is the total of all amounts that are, because of the application of section 33.1 of
the Act, not allowed to be deducted in computing the corporation's income for the
taxation year.

(2) For the purposes of this Part, “permanent establishment” in respect of a

corporation means a fixed place of business of the corporation, including an office, a

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branch, a mine, an oil well, a farm, a timberland, a factory, a workshop or a warehouse,

and
(a) where the corporation does not have any fixed place of business it means the
principal place in which the corporation's business is conducted;
(b) where a corporation carries on business through an employee or agent,
established in a particular place, who has general authority to contract for his
employer or principal or who has a stock of merchandise owned by his employer
or principal from which he regularly fills orders which he receives, the corporation
shall be deemed to have a permanent establishment in that place;
(c) an insurance corporation is deemed to have a permanent establishment in
each province and country in which the corporation is registered or licensed to do
business;
(d) where a corporation, otherwise having a permanent establishment in Canada,
owns land in a province, such land shall be deemed to be a permanent
establishment;
(e) where a corporation uses substantial machinery or equipment in a particular
place at any time in a taxation year it shall be deemed to have a permanent
establishment in that place;
(e.1) if, but for this paragraph, a corporation would not have a permanent
establishment, the corporation is deemed to have a permanent establishment at
the place designated in its incorporating documents or bylaws as its head office
or registered office;
(f) the fact that a corporation has business dealings through a commission agent,
broker or other independent agent or maintains an office solely for the purchase
of merchandise shall not of itself be held to mean that the corporation has a
permanent establishment; and
(g) the fact that a corporation has a subsidiary controlled corporation in a place or
a subsidiary controlled corporation engaged in trade or business in a place shall
not of itself be held to mean that the corporation is operating a permanent
establishment in that place.

401. This Part applies to determine the amount of taxable income of a corporation
earned in a taxation year in a particular province.

402. (1) Where, in a taxation year, a corporation had a permanent establishment in a

particular province and had no permanent establishment outside that province, the whole
of its taxable income for the year shall be deemed to have been earned therein.

(2) Where, in a taxation year, a corporation had no permanent establishment in a

particular province, no part of its taxable income for the year shall be deemed to
have been earned therein.

(3) Except as otherwise provided, where, in a taxation year, a corporation had a

permanent establishment in a province and a permanent establishment outside that
province, the amount of its taxable income that shall be deemed to have been earned in
the year in the province is
(a) in any case other than a case specified in paragraph (b) or (c), 1/2 the
aggregate of

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(i) that proportion of its taxable income for the year that the gross revenue
for the year reasonably attributable to the permanent establishment in
the province is of its total gross revenue for the year, and
(ii) that proportion of its taxable income for the year that the aggregate of
the salaries and wages paid in the year by the corporation to employees
of the permanent establishment in the province is of the aggregate of all
salaries and wages paid in the year by the corporation;
(b) in any case where the gross revenue for the year of the corporation is nil, that
proportion of its taxable income for the year that the aggregate of the salaries
and wages paid in the year by the corporation to employees of the permanent
establishment in the province is of the aggregate of all salaries and wages paid in
the year by the corporation; and
(c) in any case where the aggregate of the salaries and wages paid in the year by
the corporation is nil, that proportion of its taxable income for the year that the
gross revenue for the year reasonably attributable to the permanent
establishment in the province is of its total gross revenue for the year.

BC Income Tax Act

Liability for tax

2 (1) An income tax must be paid as required in this Act for each taxation year by every
individual

(a) who was resident in British Columbia on the last day of the taxation year,
or

(b) who, not being resident in British Columbia on the last day of the taxation
year, had income earned in the taxation year in British Columbia as defined in
section 4 (1).

(2) An income tax must be paid as required in this Act for each taxation year by every
corporation that maintained a permanent establishment in British Columbia at any time in
the year.

Subsection 4(1) "income earned in the taxation year in British Columbia" means
the income earned in the taxation year in British Columbia as determined in accordance
with federal regulations made for purposes of the definition of "income earned in the year
in a province" in section 120(4) of the federal Act;

Section 13.3 "taxable income earned in the year in British Columbia" means the
taxable income earned in the year in British Columbia by a corporation as determined in
accordance with regulations made under section 124 (4) of the federal Act.

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Exercise in provincial allocation

Corporation X is incorporated under the Alberta Business Corporations Act.

Its taxable income for the year computed under Part I of the federal Act is $10 million.
It has a PE in each of BC, Ontario and Nova Scotia
Its total gross revenue is $60 million.
Its total gross revenue reasonably attributable to the BC PE is $30 m., to Ontario is $20
m. and to NS is $10 m.

Its total payroll is $20 million.

The proportion of its salary and wages paid to employees of its PE in BC is $12 million,
in Ontario is $6 million and in NS is $2 million.
Apply the provincial allocation formula to determine how much of its taxable income will
be subject to tax in each province. Assume that the relevant provisions of the provincial
income tax acts of Ontario and Nova Scotia are the same as BC’s, but with the
necessary changes.
----------------------------------------------------------------------------------------------
• For BC, 402(3)((a)(i) amount is ½ of $10 million or $5 million of the taxable
income. The amount under 402(3)(a)(ii) is 12/20ths X $10m or $6 million total
taxable income. Adding $5 million plus $6 million = $11 million; divide by 2 gives
$5.5 million. [provincial tax rate of 10%] so $550,000 of BC tax payable.

• For Ontario, one third (proportion of total taxable income under (i)) is $3.33
million, and 6/20 of total taxable income totals $3million. $6.333 million divided by
two = $3,166,666 [provincial tax rate of 11.5%] so $364,166 in Ontario tax
payable.

• For Nova Scotia, 1/6 (proportion of gross revenue) of total taxable income =
$1,666,667 and 1/10 (proportion of payroll) of total taxable income = $1 million
for a total attributable to the PE of $1,333,333 [provincial tax rate 16%]. $213,333
in NS tax.

IT-177R2 (Consolidated) - Summary

In order for a corporation to have “taxable income earned in the year in a province”, it is
necessary to determine whether it has a permanent establishment in that province in the
year. A corporation will have a permanent establishment in a province if it has a fixed
place of business there. It may also have a permanent establishment in certain other
circumstances, such as when it carries on business through an employee or agent, or
uses substantial machinery or equipment in a province. Where a corporation has a
permanent establishment in a province in a year, 10% of its taxable income earned in
the year in that province may be deducted from its Part I tax otherwise payable.
(Eligible for the provincial abatement)

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Classification of Corporations
Subsections 89(1) and 125(7)
Definitions of: private corporation, public corporation, Canadian corporation, Canadian
controlled private corporation (“CCPC”).

• s. 262: designated stock exchanges (link from course syllabus)

• Regulation 7100: prescribed federal crown corporations (not of importance to this
course; noted only).

Significance of CCPC status:

• access to small business rate for active business income for first $500,000 of
income
• enhanced SRED preferences
• various other less important preferential treatment
• private corporations and their shareholders also have certain other administrative
preferences.

s. 89.(1) Definitions
In this subdivision,

“Canadian corporation”
“Canadian corporation” at any time means a corporation that is resident in Canada at
that time and was
(a) incorporated in Canada, or
(b) resident in Canada throughout the period that began on June 18, 1971 and that ends
at that time,
and, for greater certainty, a corporation formed at any particular time by the
amalgamation or merger of, or by a plan of arrangement or other corporate
reorganization in respect of, 2 or more corporations (otherwise than as a result of the
acquisition of property of one corporation by another corporation, pursuant to the
purchase of the property by the other corporation or as a result of the distribution of the
property to the other corporation on the winding-up of the corporation) is a Canadian
corporation because of paragraph (a) only if
(c) that reorganization took place under the laws of Canada or a province, and
(d) each of those corporations was, immediately before the particular time, a Canadian
corporation;

CCH Editorial note: “Canadian corporation” status is a prerequisite for “Canadian-controlled

private corporation” and “taxable Canadian corporation” status. While the corporation must be
resident in Canada at the particular time, and incorporated in Canada (or continuously resident in
Canada since 1971), subsection 250(4) deems a corporation to be resident in Canada
throughout a taxation year in certain circumstances, including if it was incorporated in Canada
after April 26, 1965; see, however, subsections 250(5) (re residence under a treaty) and (5.1) (re
continuance and residence).

“private corporation”
“private corporation” at any particular time means a corporation that, at the particular
time, is resident in Canada, is not a public corporation and is not controlled by one or

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more public corporations (other than prescribed venture capital corporations) or

prescribed federal Crown corporations or by any combination thereof and, for greater
certainty, for the purposes of determining at any particular time when a corporation last
became a private corporation,
(a) a corporation that was a private corporation at the commencement of its 1972
taxation year and thereafter without interruption until the particular time shall be deemed
to have last become a private corporation at the end of its 1971 taxation year, and
(b) a corporation incorporated after 1971 that was a private corporation at the time of its
incorporation and thereafter without interruption until the particular time shall be deemed
to have last become a private corporation immediately before the time of its
incorporation;

CCH Editorial note: “Private corporation” status is a prerequisite for “Canadian-controlled private
corporation” status, as well as obtaining dividend refunds and capital dividend elections. A private
corporation must be resident in Canada, and cannot be a public corporation or a corporation
controlled by one or more public corporations (other than prescribed venture capital corporations),
prescribed federal Crown corporations, or a combination. (A private corporation may be controlled
by a non-resident.) Subsection 250(4) deems a corporation to be resident in Canada throughout a
taxation year in certain circumstances, including if it was incorporated in Canada after April 26,
1965; see, however, subsections 250(5) (re residence under a treaty) and (5.1) (re continuance
and residence).

“public corporation”
“public corporation” at any particular time means
(a) a corporation that is resident in Canada at the particular time if at that time a class of
shares of the capital stock of the corporation is listed on a designated stock
exchange in Canada,
(b) a corporation (other than a prescribed labour-sponsored venture capital corporation)
that is resident in Canada at the particular time if at any time after June 18, 1971 and
(i) before the particular time, it elected in prescribed manner to be a public corporation,
and at the time of the election it complied with prescribed conditions relating to the
number of its shareholders, the dispersal of ownership of its shares and the public
trading of its shares, or
(ii) before the day that is 30 days before the day that includes the particular time it was,
by notice in writing to the corporation, designated by the Minister to be a public
corporation and at the time it was so designated it complied with the conditions referred
to in subparagraph (i),
unless, after the election or designation, as the case may be, was made and before the
particular time, it ceased to be a public corporation because of an election or designation
under paragraph (c), or
(c) a corporation (other than a prescribed labour-sponsored venture capital corporation)
that is resident in Canada at the particular time if, at any time after June 18, 1971 and
before the particular time it was a public corporation, unless after the time it last became
a public corporation and
(i) before the particular time, it elected in prescribed manner not to be a public
corporation, and at the time it so elected it complied with prescribed conditions relating to
the number of its shareholders, the dispersal of ownership of its shares and the public
trading of its shares, or

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(ii) before the day that is 30 days before the day that includes the particular time, it was,
by notice in writing to the corporation, designated by the Minister not to be a public
corporation and at the time it was so designated it complied with the conditions referred
to in subparagraph (i),
and where a corporation has, on or before its filing-due date for its first taxation year,
become a public corporation, it is, if it so elects in its return of income for the year,
deemed to have been a public corporation from the beginning of the year until the time
when it so became a public corporation;

125(7) “Canadian-controlled private corporation”

“Canadian-controlled private corporation” means a private corporation that is a Canadian
corporation other than
(a) a corporation controlled, directly or indirectly in any manner whatever, by one or more
non-resident persons, by one or more public corporations (other than a prescribed
venture capital corporation), by one or more corporations described in paragraph (c), or
by any combination of them,
(b) a corporation that would, if each share of the capital stock of a corporation that is
owned by a non-resident person, by a public corporation (other than a prescribed
venture capital corporation), or by a corporation described in paragraph (c) were owned
by a particular person, be controlled by the particular person,
(c) a corporation a class of the shares of the capital stock of which is listed on a
designated stock exchange, or
(d) in applying subsection (1), paragraphs 87(2)(vv) and (ww) (including, for greater
certainty, in applying those paragraphs as provided under paragraph 88(1)(e.2)), the
definitions “excessive eligible dividend designation”, “general rate income pool” and “low
rate income pool” in subsection 89(1) and subsections 89(4) to (6), (8) to (10) and
249(3.1), a corporation that has made an election under subsection 89(11) and that has
not revoked the election under subsection 89(12);

CCH Editorial note: CCPC status is based on being both a “Canadian corporation” and a
“private corporation”, per subsection 89(1). Further, the corporation must not be
controlled, (effectively or legally) by any combination of non-resident persons or public
corporations (other than a prescribed venture capital corporation). Finally, no class of its
shares can be listed on a designated stock exchange (whether Canadian or foreign).
Because control is defined in the negative, a deadlock will not disqualify a corporation. If
the control requirements are broken anywhere in a corporate chain, downstream
companies will not be Canadian-controlled private corporations. Per paragraph (b) of the
definition, non-residents' and public corporations' shareholdings must be notionally
attributed to one hypothetical person. If that person would control the corporation, then
the corporation is not a CCPC (paragraph (a) on its own would require a common
connection between non-residents and/or public companies).
Paragraph (d) relates to the eligible dividend regime, providing that, if the corporation
has elected not to be a CCPC pursuant to subsection 89(11) (so that it can pay eligible
dividends “by default” — see the editorial note to subsection 89(11)), CCPC status will
not apply, but only for the specific provisions listed (e.g., the small business deduction
per subsection 125(1) will not be available, but the RDTOH regime will continue to
apply).

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Corporate Control
De Jure Control – IT-64R4 13-18
The general test

¶ 13. If the reference to control of a corporation is not accompanied by the words

“directly or indirectly in any manner whatever,” such control means de jure control (i.e.,
control in law).

The general test for de jure control was established by the Exchequer Court of Canada
in Buckerfield's Limited et al. v. MNR, 64 DTC 5301, [1964] CTC 504, to be whether
the shareholder enjoys “effective control” over the affairs and fortunes of the corporation,
as manifested in the ownership of such a number of shares as carries with it the right to
a majority of the votes in the election of the board of directors. The test in Buckerfield's
was confirmed by the Supreme Court of Canada in Duha Printers (Western) Ltd. v.
The Queen, 98 DTC 6334, [1998] 3 CTC 303. In Duha Printers, the court stated that in
determining whether effective control exists, one must consider:

(a) the corporation's governing statute;

(b) the share register of the corporation; and

(c) any specific or unique limitation on either the majority shareholder's power to control
the election of the board or the board's power to manage the business and affairs of the
company, as manifested in either:

(i) the constating documents of the corporation; or

(ii) any unanimous shareholder agreement.

Voting power to wind up the corporation

¶ 14. A refinement of the meaning of de jure control can be found in Oakfield

Developments (Toronto) Limited v. MNR, 71 DTC 5175, [1971] CTC 283. In that case,
an “inside group” of shareholders owned all the corporation's common shares and
another group owned all the corporation's preferred shares with each group holding, in
aggregate, an equal number of votes. The preferred shares were issued after the
common shares and were entitled on winding up only to the amount paid to acquire the
shares plus a 10% premium. The Supreme Court of Canada held in Oakfield that control
of the corporation remained with the common shareholders who had the power to wind
up the corporation and to receive all the capital and surplus except the fixed amount
payable to the preferred shareholders. (See also the Supreme Court of Canada's
decision in The Queen v. Imperial General Properties Limited, 85 DTC 5500, [1985] 2
CTC 299.)

Beneficial owners of shares

¶ 15. The owners of shares of a corporation are considered to be those persons who are
the beneficial owners of such shares. This is the case even if the shares are registered

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in the corporation's share register in the name of another person or persons such as a
nominee or bare trustee. (See also ¶ 32 concerning a share held by a trustee.)

Effect of casting vote

¶ 16. Where the voting shares of a corporation are divided evenly between two persons,
the fact that the chairperson of a shareholder's meeting may have the right to cast a
deciding vote does not give that person de jure control of the corporation where the
deciding vote is conferred on that person as chairperson of the meeting and not by
ownership of voting shares (see Aaron's (Prince Albert) Ltd. et al. v. MNR, also known
as Allied Business Supervisions Ltd. v. MNR, 66 DTC 5244, [1966] CTC 330 (Ex.Ct.)—
confirmed in MNR v. Dworkin Furs (Pembroke) Ltd., 67 DTC 5035, [1967] CTC 50
(S.C.C.)). (However, the holding of a “casting vote” in the above circumstances may
constitute de facto control as defined in subsection 256(5.1).)

Indirect control

¶ 17. It is possible for a person to have de jure control over a corporation without
ownership of any of its shares if that person controls one or more other corporations
which, singly or among them, have voting control of the first-mentioned corporation. For
example, if Y controls Corporation A which in turn controls Corporation B, then Y also
controls Corporation B. Similarly, if Corporation P controls Corporations M and N which,
between them, own more than 50 per cent of the voting shares of Corporation X, then
Corporation P controls Corporation X, and all four of the corporations are associated with
each other. See Vineland Quarries and Crushed Stone Limited v. MNR, 66 DTC
5092, [1966] CTC 69 (affirmed from the bench without written reasons by the Supreme
Court of Canada, 67 DTC 5283). (Depending on the facts in the particular situation,
paragraph 256(1.2)(d) may also result in the corporations being associated with each
other—see ¶ 30.)

Effect of special provisions

¶ 18. As indicated in ¶ 13, it is also necessary to take into consideration the following:

• special provisions in the constating documents of a corporation, such as its

letters patent, articles of incorporation or by-laws; or
• unanimous shareholder agreements sanctioned by the relevant legislation.

For example, the articles of incorporation of a corporation may provide that a motion put
before a meeting of the shareholders will fail unless it receives the unanimous consent of
all the owners of voting shares. In these circumstances, the person or persons holding
the majority of the voting shares can be said to have de jure control over the corporation
only if that person or persons own all the voting shares. (However, even if the majority
shareholder or shareholders in the above example did not own all the voting shares, they
could still be deemed to control the corporation by means of the fair market value test in
paragraph 256(1.2)(c), as discussed in ¶ 28.)

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Control in Fact – IT-64R4 19-23 – subsection 256(5.1)

¶ 19. If the reference to control of a corporation is accompanied by the words

“directly or indirectly in any manner whatever,” such control encompasses
both de jure control (as discussed in ¶s 13 to 18) and de facto control (i.e.,
control in fact). For the purposes of the Act, a corporation is considered by
subsection 256(5.1) to be “controlled, directly or indirectly in any manner
whatever,” where another corporation, person or group of persons (referred to in
this paragraph, ¶s 20 and 25 as the “controller”) has any direct or indirect
influence that, if exercised, would result in control in fact of the corporation.

¶ 20. Subsection 256(5.1) further provides, however, that the corporation shall
not be considered to be controlled, directly or indirectly in any manner whatever,
by the controller where the corporation and the controller are dealing at arm's
length and the controller's influence is derived from an agreement or
arrangement such as a franchise, licence, lease, distribution, supply or
management agreement—i.e., a business agreement or arrangement—the main
purpose of which is to govern the relationship between the parties regarding the
manner in which a business carried on by the corporation is to be conducted.
Thus, for example, a franchise agreement or lease which provides to the
franchiser or lessor a measure of control over the products sold by the
corporation or the hours during which it conducts its business, would not by itself
result in the franchiser or lessor having de facto control of the corporation.

¶ 21. De facto control goes beyond de jure control and includes the ability to
control “in fact” by any direct or indirect influence. De facto control may exist even
without the ownership of any shares. It can take many forms, e.g., the ability of a
person to change the board of directors or reverse its decisions, to make
alternative decisions concerning the actions of the corporation in the short,
medium or long term, to directly or indirectly terminate the corporation or its
business, or to appropriate its profits and property. The existence of any such
influence, even if it is not actually exercised, would be sufficient to result in de
facto control.

¶ 22. The moment when the influence must exist, for the purposes of the de
factocontrol test, depends upon the context in which the notion of control is
applied. For example, in the case of the small business deduction, where the
status of “Canadian-controlled private corporation” (subsection 125(7)) must be
maintained throughout the year, control will be examined for the whole year for
which the deduction is claimed. In the case of the investment tax credit (section
127.1), the reference period will be restricted to the year in which the allowable
expenses are incurred.

¶ 23. Whether a person or group of persons can be said to have de facto control
of a corporation, notwithstanding that they do not legally control more than 50 per

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cent of its voting shares, will depend on each factual situation. The following are
some general factors that may be used in determining whether de facto control
exists:

(a) the percentage of ownership of voting shares (when such ownership is not more than
50 per cent) in relation to the holdings of other shareholders;

(b) ownership of a large debt of a corporation which may become payable on demand
(unless exempted by subsection 256(3) or (6)) or a substantial investment in retractable
preferred shares;

(c) shareholder agreements including the holding of a casting vote;

(d) commercial or contractual relationships of the corporation, e.g., economic

dependence on a single supplier or customer;

(e) possession of a unique expertise that is required to operate the business; and

(f) the influence that a family member, who is a shareholder, creditor, supplier, etc., of a
corporation, may have over another family member who is a shareholder of the
corporation.

Although the degree of influence in (f) is always a question of fact, close family
ties (between parents and children or between spouses) especially lend
themselves to the development of significant influences. Generally, these
persons must demonstrate their economic independence and autonomy before
escaping presumptions of fact which apply to related persons. However, with
respect to siblings, unless the facts indicate otherwise, generally one sibling
would not be considered to have influence over another.

In addition to the general factors described above, the composition of the board
of directors and the control of day-to-day management and operation of the
business would be considered

De Jure Control

The test of who controls the votes necessary to elect a majority of directors (de jure
control) is set out in Buckerfield’s. An extension of the examination from share register
to constating documents (articles, by-laws) for purpose of determining who controls “in
the long run” was approved in Imperial General Properties. The status and
interpretation of unanimous shareholder agreements in determining de jure control was
considered in Duha Printers. The SCC also (para. 36) recognized that the de jure
control test is an attempt to ascertain who is in effective control of the affairs and
fortunes of the corporation, so that if the board of directors does not, as a matter of the
constating documents including a USA have this power, the right to elect a majority of
the board may not indicate control. The de jure control test in (b) of the definition of

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CCPC allows a “look through” (following Vineland Quarries) from the actual owner of
shares to the controlling shareholder of that actual owner (Sedona Networks).

De jure and de facto control by one or more persons: what is a group in the case of a
widely held corporation: Silicon Graphics 2002 DTC 7112 (FCA). (Note that the
definition of CCPC has changed since this case arose, so we are only interested in this
decision for its statement about what is a group.)

De Facto Control

256(5.1) – interpretation of the phrase “controlled directly or indirectly, in any manner

whatever”. Note exception for arm’s length situations where control arises through
contractual relationship, and 256(6), exception for lenders protecting financial interests.

Multiview: issue was whether Multiview was a CCPC. A non-resident owned 37.5% of
Multiview’s shares directly, and held 50% of 990855 Ontario Ltd. which owned 43.6% of
Multiview’s shares. However, since the non-resident did not control 99085 Ontario Ltd. ,
it could not be said that Multiview was controlled directly or indirectly by one or more
non-residents. See also Timco Holdings 2005 DTC 1628.

International Mercantile Factors: A private Canadian company held 50% of IMF’s

voting shares and 2 public corps held the other 50%. However, a shareholders’
agreement (not amounting to a USA) provided that there would be no change in the
board, and the public companies had a majority of the nominees on the board at the
relevant time. Thus IMF was not a CCPC; it was controlled de facto by one or more
public companies.

Société Foncière d’Investissement: Paul Allain held .2% of the shares; his two
daughters held 99.8%. The board of SFI delegated total management control to Allain
as “general manager”. SFI was controlled de facto by Paul Allain, so that two other
corporations, of which he held 100% of the shares, were associated corporations of SFI.

Mimetix: Mimetix’s voting shares were held 50% by US corp and 50 % by two
Canadian resident individuals. The US corp also held 3 million redeemable and
retractable preferred shares of Mimetix and the licence to technology which had been
sublicenced without royalties to Mimetix. Mimetix also owed the US corp $1.1 million
under an interest free loan. The evidence indicated that all decisions regarding
management, as well as all administrative decisions, were made by a US resident
nominee of the US corp. Court held that Mimetix was not a CCPC.

Lenester Sales Ltd. 2003 DTC 997 (TCC); 2004 DTC 6461 (FCA)
Example of exception in 256(5.1) for arm’s length business relationships such as
franchises, distribution agreements etc.

9044-2807 Québec Inc. 2004 DTC 6636

De facto control, 256(5.1)

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Income Tax Technical News No. 32, p. 3 – CRA’s position on Lenester Sales and 9044-
9807 Québec Inc.

(5.1) Control in fact

For the purposes of this Act, where the expression “controlled, directly or
indirectly in any manner whatever,” is used, a corporation shall be considered to
be so controlled by another corporation, person or group of persons (in this
subsection referred to as the “controller”) at any time where, at that time, the
controller has any direct or indirect influence that, if exercised, would result in
control in fact of the corporation, except that, where the corporation and the
controller are dealing with each other at arm's length and the influence is derived
from a franchise, licence, lease, distribution, supply or management agreement
or other similar agreement or arrangement, the main purpose of which is to
govern the relationship between the corporation and the controller regarding the
manner in which a business carried on by the corporation is to be conducted, the
corporation shall not be considered to be controlled, directly or indirectly in any
manner whatever, by the controller by reason only of that agreement or
arrangement.

CCH Editorial note: Applying throughout the Income Tax Act, subsection 256(5.1)
requires the application of the de facto control test as specified in this subsection,
whenever the expression “controlled, directly or indirectly in any manner whatever” is
used in respect of control of a corporation. Potentially applying where de jure control
does not, the CRA has increasingly relied on this provision to associate corporations.
The Silicon Graphics case (2002 DTC 7112 (FCA)) indicates that de facto control
requires the ability to effect a significant change in the board of directors or its powers, or
to influence in a very direct way the shareholders who otherwise have the ability to elect
the board. However, other cases have focused on a broader test relating to operational
and economic dependency. An exception pertains to arm's length situations where
influence derives only from an agreement or arrangement (e.g., a franchise) the main
purpose of which is to govern the manner in which a business is conducted.

From a UBC outline:

Factual Control

s.256(5.1) Where the expression “controlled directly or indirectly in any manner

whatever” is used, a corporation shall be considered to exercise control
where they have any direct or indirect influence that would, if exercised,
result in control in fact of the other corporation....Except where arms
length and franchise/license/lease/distribution/etc. agreement.
s.256(6) Factual control deemed not to exist where a creditor exercises indirect
control for the purpose of securing a loan.
s.251(5)(b) Factual control deemed to exist where at any time a person has the right
to acquire/redeem/cause reduction in voting rights in shares that would
give that person control (other than as a beneficiary in death, bankruptcy,
disability, etc).

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*Administrative exception to this rule. The CRA will not deem

rights to have been exercised in shotgun clauses.

CASES Silicon Graphics: must be a common link or interest for factual control
Lenester Sales: Division of the SBD between companies. This fell within
the franchise exception for factual control and did not meet the legal
control test (avenue to affect the board of directors) laid out in Silicon.
Ratio: Giant Tiger did not control the two stores.
Transport Couture: Factual control found because of (1) economic
dependence (2) operational control and (3) family relationship between
the shareholders.

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Arm’s Length
IT-64R4 Summary – Applies to arm’s length, relatedness and association (full text in
appendix)

This bulletin discusses provisions in the Income Tax Act that contain rules with respect
to the association of corporations (the “association rules”). There are a number of
provisions in the Act for which the association rules are relevant (e.g., those pertaining to
the small business deduction); however, a discussion of such provisions is outside the
scope of this bulletin.

Section 256 contains the association rules. Subsections 256(1) and (2) provide the
general rules with respect to whether one corporation is associated with another.
Subsections 256(3), (4), (5) and (6) provide for certain exceptional circumstances under
which the association of one corporation with another does not occur.

The essential test in determining whether a corporation is associated with another relies
on the control of the corporation that is exercised “directly or indirectly in any manner
whatever.” This expression encompasses:

• de jure control (i.e., control in law), the meaning of which has been determined by
caselaw; and
• de facto control (i.e., control in fact), as determined under subsection 256(5.1).

There are a number of additional rules in section 256, including rules which:

• provide or extend the meaning of certain terms and concepts, such as a “group of
persons” and “control by a group of persons”;
• can result in deemed control by means of a fair market value test;
• can result in deemed ownership of shares by means of “look-through” rules;
• can deem the shares of a child under 18 to be owned by the child's parent;
• can result in deemed ownership of shares or control by means of options or
rights; and
• allow for simultaneous control by two or more persons or groups of persons.

Any statement in this bulletin with respect to the question of whether corporations are
associated with each other, or with respect to any rule that relates to that question,
should implicitly be taken as meaning that such question or rule is being considered at a
particular point in time, unless otherwise stated.

IT-419R2 Summary – Applies to Arm’s Length (full text in appendix)

This bulletin discusses the criteria used to determine whether or not persons deal with each other
at arm's length under the Act. Although the term “at arm's length” is used throughout

the Act, the Act does not contain any precise definition of the term. Section 251, which is the
statutory provision for determining arm's length relationships, refers to three categories of
persons. This bulletin deals with each category separately. The first category of persons is

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“related persons”, the second category involves personal trusts and their beneficiaries, while the
third category includes “persons not related to each other”. Persons described in the second and
third categories are referred to as “unrelated persons” in this bulletin.

251. (1) Arm's length

For the purposes of this Act,

(a) related persons shall be deemed not to deal with each other at arm's length;
(c) where paragraph (b) does not apply, it is a question of fact whether persons
not related to each other are at a particular time dealing with each other at arm's
length.

CCH Editorial note: Subsection 251(1) determines when persons do not deal at arm's length
whenever that term is used in a large number of provisions throughout the Income Tax Act.
Related persons, determined elsewhere in section 251, are deemed not to deal at arm's length. If
a taxpayer, or non-arm's length person, is beneficially interested in a personal trust, the taxpayer
is deemed not to deal at arm's length with the trust. Otherwise, non-arm's length status will be a
question of fact, determined under case law by whether there is a “common mind” directing both
sides of a transaction, the parties are acting in concert without separate interests, or there is de
facto (effective) control by one party.

Peter Cundill & Associated (FCTD), aff’d by FCA

In this case, a Canadian resident individual, P, held 100% of the shares of a Bermuda
company and 50% of the shares of a Canadian corporation, “Canco”. Canco paid
management and investment counsel fees to the Bermuda company. Paragraph
212(1)(a) requires the Canadian resident payer corp to withhold and remit 25% of
management fees paid to a non-resident who is not at arm’s length on account of the
Bermuda company’s Canadian tax liability. Canco had not withheld the tax. It was held
that Canco and Bermuda co did not deal at arm’s length, because a single directing mind
controlled them both. Even though P held only 50% of Canco’s shares, and so did not
have de jure voting control of Canco, he was the directing mind of Canco, and exercised
an influence and control over the affairs and future of Canco that was disproportionate to
his shareholding. The financial well-being of Canco depended on the decisions he
made, his personal expertise was the main product of the Company and the source of its
goodwill. It was clear that in negotiating the terms of the management services
agreement with the Bermuda co that P was in a bargaining position of great strength
because of Canco’s reliance on him.

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Related Persons
(2) Definition of “related persons”
For the purpose of this Act, “related persons”, or persons related to each other, are
(a) individuals connected by blood relationship, marriage or common-law
partnership or adoption;
(b) a corporation and
(i) a person who controls the corporation, if it is controlled by one person,
(ii) a person who is a member of a related group that controls the corporation, or
(iii) any person related to a person described in subparagraph (i) or (ii); and
(c) any two corporations
(i) if they are controlled by the same person or group of persons,
(ii) if each of the corporations is controlled by one person and the person who
controls one of the corporations is related to the person who controls the other
corporation,
(iii) if one of the corporations is controlled by one person and that person is
related to any member of a related group that controls the other corporation,
(iv) if one of the corporations is controlled by one person and that person is
related to each member of an unrelated group that controls the other corporation,
(v) if any member of a related group that controls one of the corporations is
related to each member of an unrelated group that controls the other corporation,
or
(vi) if each member of an unrelated group that controls one of the corporations is
related to at least one member of an unrelated group that controls the other
corporation.

CCH Editorial note: This subsection, supplemented by subsections 251(3)–(6), provides a series
of rules as to when individuals and corporations are related under the Income Tax Act.
Subsection 251(1) determines non-arm's length status (see editorial note). Whereas individuals
are related based on blood relationships (see subsection 251(6)), marriage or common-law
relationships and adoption, corporations are related based on the concept of control, which for the
purposes of paragraphs (b) and (c) means de jure (legal) control and not de facto control (which
is described in subsection 256(5.1)). See also the cases summarized below (“Cases”).
Particularly important are subsections 251(5), which expands the concept of control for certain
purposes (see editorial note) and subsection 251(3), which provides a “connective” rule: where
two corporations are related to the same corporation, they are generally related to one another.
(…)

(3) Corporations related through a third corporation

Where two corporations are related to the same corporation within the meaning of
subsection (2), they shall, for the purposes of subsections (1) and (2), be deemed to be
related to each other.

[subsections (3.1) and (3.2) omitted]

(4) Definitions concerning groups

In this Act,
“related group”
“related group” means a group of persons each member of which is related to
every other member of the group;

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“unrelated group”
“unrelated group” means a group of persons that is not a related group.

251(5) Control by related groups, options, etc

For the purposes of subsection (2) and the definition “Canadian-controlled private
corporation” in subsection 125(7),
(a) where a related group is in a position to control a corporation, it shall be
deemed to be a related group that controls the corporation whether or not it is
part of a larger group by which the corporation is in fact controlled;
(b) where at any time a person has a right under a contract, in equity or
otherwise, either immediately or in the future and either absolutely or
contingently,
(i) to, or to acquire, shares of the capital stock of a corporation or to control the
voting rights of such shares, the person shall, except where the right is not
exercisable at that time because the exercise thereof is contingent on the death,
bankruptcy or permanent disability of an individual, be deemed to have the same
position in relation to the control of the corporation as if the person owned the
shares at that time,
(ii) to cause a corporation to redeem, acquire or cancel any shares of its capital
stock owned by other shareholders of the corporation, the person shall, except
where the right is not exercisable at that time because the exercise thereof is
contingent on the death, bankruptcy or permanent disability of an individual, be
deemed to have the same position in relation to the control of the corporation as
if the shares were so redeemed, acquired or cancelled by the corporation at that
time;
(iii) to, or to acquire or control, voting rights in respect of shares of the capital
stock of a corporation, the person is, except where the right is not exercisable at
that time because its exercise is contingent on the death, bankruptcy or
permanent disability of an individual, deemed to have the same position in
relation to the control of the corporation as if the person could exercise the voting
rights at that time, or
(iv) to cause the reduction of voting rights in respect of shares, owned by other
shareholders, of the capital stock of a corporation, the person is, except where
the right is not exercisable at that time because its exercise is contingent on the
death, bankruptcy or permanent disability of an individual, deemed to have the
same position in relation to the control of the corporation as if the voting rights
were so reduced at that time; and
(c) where a person owns shares in two or more corporations, the person shall as
shareholder of one of the corporations be deemed to be related to himself,
herself or itself as shareholder of each of the other corporations.

CCH Editorial note: Subsection 251(5) expands the control concept, for the purposes (only) of
related person (and consequently non-arm's length) status and the CCPC definition in subsection
125(7). (A similar provision, subsection 256(1.4), applies re associated corporation status.)
Subsection 251(5) does not apply, for example, to subsection 111(5) (loss streaming) or 249(4)
(deemed year end). Paragraph 251(5)(b) applies to rights under contract (e.g., shareholders' or
share purchase agreements), in equity or otherwise, including contingent rights, to acquire
shares, control voting rights, or to cause a corporation to redeem/acquire shares owned by
others. Exceptions apply to rights contingent on death, bankruptcy or permanent disability of an

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individual. The CRA's longstanding policy excludes a right of first refusal or shotgun arrangement,
but it has recently indicated that it is not prepared to extend administrative concessions to other
situations in shareholders agreements (see Doc. No. 2007-0243211C6); therefore one may
question pre-existing administrative concessions based on the lack of a “clear right”. A number of
ITA provisions based on related-person status exclude rights under paragraph 251(5)(b).
Paragraph 110.6(14)(b) ignores rights under a share purchase and sale agreement which might
otherwise jeopardize the availability of the capital gains exemption. Subsection 256(8) may treat
such subsection 251(5)(b) rights as exercised, if acquired to avoid/affect specified provisions.

(6) Blood relationship, etc

For the purposes of this Act, persons are connected by
(a) blood relationship if one is the child or other descendant of the other or one is the
brother or sister of the other;
(b) marriage if one is married to the other or to a person who is so connected by blood
relationship to the other;
(b.1) common-law partnership if one is in a common-law partnership with the other or
with a person who is connected by blood relationship to the other; and
(c) adoption if one has been adopted, either legally or in fact, as the child of the other or
as the child of a person who is so connected by blood relationship (otherwise than as a
brother or sister) to the other.

252. (1) Extended meaning of “child”

In this Act, words referring to a child of a taxpayer include
(a) a person of whom the taxpayer is the legal parent;
(b) a person who is wholly dependent on the taxpayer for support and of whom
the taxpayer has, or immediately before the person attained the age of 19 years
had, in law or in fact, the custody and control;
(c) a child of the taxpayer's spouse or common-law partner; and
(d) [Repealed.]
(e) a spouse or common-law partner of a child of the taxpayer.

(2) Relationships
In this Act, words referring to
(a) a parent of a taxpayer include a person
(i) whose child the taxpayer is,
(ii) whose child the taxpayer had previously been within the meaning of
paragraph (1)(b) [former de facto adopted child], or
(iii) who is a parent of the taxpayer's spouse or common-law partner;
(b) a brother of a taxpayer include a person who is
(i) the brother of the taxpayer's spouse or common-law partner, or
(ii) the spouse or common-law partner of the taxpayer's sister [or brother?];
(c) a sister of a taxpayer include a person who is
(i) the sister of the taxpayer's spouse or common-law partner, or
(ii) the spouse or common-law partner of the taxpayer's brother [or sister?];
(d) a grandparent of a taxpayer include a person who is
(i) the grandfather or grandmother of the taxpayer's spouse or common-law
partner, or

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(ii) the spouse or common-law partner of the taxpayer's grandfather or

grandmother;
(e) an aunt or uncle of a taxpayer include the spouse or common-law partner of
the taxpayer's aunt or uncle, as the case may be;
(f) a great-aunt or great-uncle of a taxpayer include the spouse or common-law
partner of the taxpayer's great-aunt or great-uncle, as the case may be; and
(g) a niece or nephew of a taxpayer include the niece or nephew, as the case
may be, of the taxpayer's spouse or common-law partner.

UBC Law outline stuff on Related Corporations

Related Persons - note: DISTINCT FROM ASSOCIATED CORPS!!!!!!!
• Some rules apply for associated corps rules and other rules for other sections of the Act too.
• if related then deemed not to be dealing at arm’s length.
• NOTE: related corporations are distinct from associated corporations. For associated corporations
need to have the cross-shareholding. Not necessary for related corps.
O CAN BE RELATED WITHOUT BEING ASSOCIATED

Definition of Related Persons s.251(2)(a):

• blood relationship- s.251(6)(a) lineal up and down, brother, sister, grandma, parents
• marriage- s.251(6)(b) marriage partner and their blood relations
• common-law partnership- s.251(6)(b.1) common-law partner and their blood relations
• or adoption- s.251(6)(c) adopted family only vertically, not brothers and sisters.

Corporation and one person related

• s.251(2)(b): (i) person controls the corporation de jure (legal only) ,
o (ii) person is member of “related group” that controls the corp,
o (iii) person related to person in (i) or (ii).

Two corporations related

• s.251(2)(c)(i) if controlled (legal only) by the same person or group of persons. (Group of persons:
not defined for related provisions, don’t use associated provision definition. Silicon Graphics:
Beyond simple mathematical majority. Need common connection such as voting agreement,
agreement to act in concert, business or family relationship.)
• s.251(2)(c)(ii): if each controlled by person, and those people are related.
• s.251(2)(c)(iii): one corp controlled by a person and that person is related to any member of a
“related group” that controls the other corp.

Related Group:
• s.251(4): group of persons EACH member of which is related to EVERY other member.

Corps related through a third Corp:

• s.251(3): if 2 corps are related to the same corp then deemed to be related for the purposes of
s.251(1)&(2)

Control by related groups, options etc:

s.251(5):
• (a) a related group that is in position to control corp is deemed to be a related group that controls
the corp.
• (b) Contingent rights: If person has absolute or contingent right to acquire shares, votes or cancel
shares that person is deemed to own.
(c) If person owns shares in 2 or more corps, deemed to be related to self.

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Associated Corporations
The issue of whether two or more corporations are associated is primarily of importance
with respect to access to the small business deduction for active business income of a
CCPC up to $500,000.

Association is based on de facto control as defined in 256(5.1). Recall that de jure

control is included in the test of whether one corporation or individual “controlled, directly
or indirectly, in any manner whatever” another corporation.

Paragraphs 256(1)(a)-(e) are the basic rules regarding when one corporation is
associated with another. Students should review these carefully.

(1) Associated corporations

For the purposes of this Act, one corporation is associated with another in a taxation
year if, at any time in the year,
(a) one of the corporations controlled, directly or indirectly in any manner
whatever, the other;
(b) both of the corporations were controlled, directly or indirectly in any manner
whatever, by the same person or group of persons;
(c) each of the corporations was controlled, directly or indirectly in any manner
whatever, by a person and the person who so controlled one of the corporations
was related to the person who so controlled the other, and either of
those persons owned, in respect of each corporation, not less than 25% of the
issued shares of any class, other than a specified class, of the capital stock
thereof;
(d) one of the corporations was controlled, directly or indirectly in any manner
whatever, by a person and that person was related to each member of a group
of persons that so controlled the other corporation, and that person owned, in
respect of the other corporation, not less than 25% of the issued shares of any
class, other than a specified class, of the capital stock thereof; or
(e) each of the corporations was controlled, directly or indirectly in any manner
whatever, by a related group and each of the members of one of the related
groups was related to all of the members of the other related group, and one or
more persons who were members of both related groups, either alone or
together, owned, in respect of each corporation, not less than 25% of the
issued shares of any class, other than a specified class, of the capital stock
thereof.

The definition of “specified class” is found in subsection 256(1.1) and (somewhat

simplified) has the effect of treating non-voting, non-convertible shares with a set
redemption price (which may not exceed the amount paid as consideration for the issue
of the shares) and a fixed dividend rate (which may not exceed the prescribed rate under
Regulation 4301(c) in relation to the amount paid as consideration for the issue of the
shares) as irrelevant to the determination of control for the purposes of the associated
corporation rules in paragraph 256(1)(c)-(e).

Deeming provisions: The association rules are further complicated by “deeming

provisions” in paragraphs 256(1.2)(a)-(c).

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(a) provides essentially that a group means any two or more persons each of whom
owns shares. Thus members of the group need not be related or otherwise not
at arm’s length to form a group, but they must own shares directly.

(b) has the effect of deeming both a large group which controls (de jure) a
corporation and any smaller group within the large group, including a single
individual, which also controls the corporation, to both simultaneously control the
corporation.

(c) Provides a fair market value test of control. A person or group which holds
shares which have a fmv of greater than 50% of all the issued shares, or which
holds common shares which have a fmv of greater than 50% of all the issued
common shares are deemed to control the corporation. 256(1.2)(g) provides that
all shares are deemed to be non-voting for the purpose of determining fmv.

Look-through rules: 256(1.2)(d) and 256(1.3) (omit the look-through rules for
partnerships and trusts in 256(1.2)(e) and (f)).

256(1.2)(d): a shareholder of a corporation (holding co) which owns or is deemed to own

shares of another corporation, Bco, is deemed to hold that proportion of the shares of
Bco that the shareholder holds of holding co, based on fair market value.

256(1.3) deems a parent to be the owner of shares owned by a child under 18 for
purposes of determining de facto control under 256(5.1) and association. An exception
applies where the child effectively manages the business and affairs of the corporation
without a significant degree of influence by the parent.

Control in fact
256(5.1) For the purposes of this Act, where the expression "controlled, directly or
indirectly in any manner whatever," is used, a corporation shall be considered to be so
controlled by another corporation, person or group of persons (in this subsection referred
to as the "controller") at any time where, at that time, the controller has any direct or
indirect influence that, if exercised, would result in control in fact of the corporation,
except that, where the corporation and the controller are dealing with each other at arm’s
length and the influence is derived from a franchise, licence, lease, distribution, supply or
management agreement or other similar agreement or arrangement, the main purpose
of which is to govern the relationship between the corporation and the controller
regarding the manner in which a business carried on by the corporation is to be
conducted, the corporation shall not be considered to be controlled, directly or indirectly
in any manner whatever, by the controller by reason only of that agreement or
arrangement.

Miscellaneous rules: 256(1.4)(a), (2), (2.1).

256(1.4)(a) – options to acquire shares are treated as if they have been exercised

256(2) – two otherwise unassociated corps, which are both associated with a third corp,
are deemed associated with each other

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256(2.1) – anti-avoidance rule – deemed association where one of the main reasons for
separate existence of corporations is to reduce tax or increase the SRED investment tax
credit.

256(6.1) – simultaneous control and Parthenon Investments case.

UBC Law Outline stuff on Associated Corporations

Associated Corporations - note: can be related without being associated!!
• small business limit must be shared among “associated corporations” and they
must allocate a percentage of the limit amongst themselves, failure to do so and
the limit might be nil or the CRA will allocate. s.125(2), (3), and (4).

Associated corporations s.256(1): (can be related without being associated!!)

• One corporation is associated w/ another in a taxation year, if at any time in the
year:
(a) one corp is controlled “directly or indirectly in any manner whatever”
" “any manner whatever” = (legal or factual control) by the other
corp.
(b) both corps controlled legal or factual by same person or “group of
persons”
(c) both corps controlled legal or factual by a person who is related to the
person who controls the other corp AND either of these people own
25% or more of any class of shares of the other corp, other than
“specified class.”
" “Spec class” def’n = s. 256(1.1)(c)
(d) both corps controlled legal or factual by one person that is related to
each member of a “group of persons” who controls the other corp. And
the one person who controls the first corp owns 25% of shares of the
other corp.
(e) both corps controlled by “related groups.” Each member of first group
is related to each member of second group and one or more persons
who are members of BOTH groups, either alone or together own 25%
of shares of BOTH corps (Cross- shareholding).

Corporations associated through a third corporation

• s.256(2): connective rule. Where two corporations not otherwise associated are
associated with the same third corporation, they are deemed to be associated
with another. The third corporation can elect out of any entitlement to the small
business rate in s.125.

Group of persons
• s.256(1.2)(c):
o (i): groups of persons means any two or more persons each of who
own shares in the capital stock of the corp.
" REGARDLESS of connections with each other
o (ii): for greater certainty one group of persons can control a corp,
notwithstanding another person or group of persons also controls it.

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o (iii): Economic control test: corp deemed to be controlled by person or

group if own shares having value of greater than 50% value of all shares
or greater than 50% of common shares. Note: specified shares not
included.

Specified Class:
• s.256(1.1): specified shares which are not included in 25% ownership rules or
economic control test.
o Characteristics:
" Must be: not convertible or exchangeable, not voting, fixed
dividend entitlement, prescribed interest,* amount on
redemption not more than consideration for which shares were
issued pay any declared and unpaid dividends (ie. no entitlement
to assets on wind-up).
• * dividends cannot > proscribed interest rate at time of
issuance (reg 4300)
• basically, these shares are not really “shares,” but more
like “bonds.” Therefore not included
• Rule allows persons to have their own separate corps for small business rate and
hold these special preferred shares (analogous to debt) w/o causing the two
corps to be associated.

Deeming rules re ownership for purposes of associated corp rules: “Look through
Rules”:
! flatten corporate structure to see who’s actually running the show
• s.256(1.2)(d) shares owned* by corp are deemed to be owned by the person
who own the shares of that corp in proportion to the relative value of their shares
in the corp. Pulls back veil.
o * owned or DEEMED to be owned
• s.256(1.3) shares owned by child under 18 deemed to be owned by parent,
unless child manages affairs w/o influence of parent.
• s.256(1.4): person with absolute or contingent right to acquire shares, to acquire
votes, to redeem cancel or acquire shares deemed to own. Except on the death,
bankruptcy or permanent disability of an individual.
o If you have a right to get shares, you are deemed to exercise that right
" Both owner and deemed owner would then own the shares
simultaneously for tax purposes
Deemed not to be associated where:
• s.256(5): corporate trustee rule: corp controls another as a trustee / pursuant to a
trust
• s.256(4): common executor rule: both corps controlled by same executor

Anti-avoidance deemed associated:

• s.256(2.1): two corps otherwise not related deemed to be associated if:
o reasonable to conclude that one of the main reasons for their separate
existence is to reduce amt of tax paid (ie. multiply the small business
deduction).

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THE SMALL BUSINESS DEDUCTION

The relevant definitions are found in subsection 125(7): “active business carried on by a
corporation”, “Canadian-controlled private corporation”, “income of the corporation for
the year from an active business”, “personal services business”, “specified investment
business”, 129(4) “income or loss from property”, and 129(6) deemed active business
income.

The provisions determining a particular CCPC’s business limit are found in subsections
125(2) – (5).

“Active business carried on by a corporation” is any business other than a “specified

investment business” or a “personal services business”. Students should review these
two definitions which were covered in Law 345, and in particular, the exceptions to
these definitions regarding businesses which have more than 5 full time employees.
Note that there is a degree of uncertainty in the case law as to what constitutes more
than five full time employees – must there be 6 full time, or are 5 full time plus a part
time employee sufficient? What constitutes “full time”? See Lerric Investments Corp.
2001 DTC 5169 (FCA); Town Properties Ltd. 2004 DTC 2833; 489599 BC Ltd. 2008
DTC 4107 as examples of positions the courts have taken.

Section 125(7) – Definitions

“Active Business Carried on by a Corporation” – business carried on by the

corporation other than a specified investment business or a personal services business
and includes an adventure or concern in the nature of trade

“Personal Services Business” – Business of providing services where

- (a) An individual who performs services on behalf of the corporation (“incorporated
employee”), OR
- (b) Any person related to the incorporated employee (See Arms-Length s. 251)
- Is a specified shareholder (s. 248(1)) of the corporation and the incorporated
employee would reasonably be regarded as an officer/employee of the person to
whom the services were provided (see test below), but for the existence of the
corporation; UNLESS:
- (c) The corporation employs in more than five full-time employees throughout the
year OR
- (d) The amount paid to the corporation was received from a corporation with which it
was associated

Test for Personal Services Business:

- Would the incorporated employee be reasonably regarded as an employee using the
Wiebe Door test?

“Specified Business Investment” – a business (other than a Credit Union or a

business leasing property other than Real Property) with the principle purpose of
deriving income from a property

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“Canadian Controlled Private Corporation (CCPC)” – a corporation that is resident in

Canada, its shares are not listed on a stock exchange, and it is not controlled by non-
residents of Canada, by a corporation whose shares are traded on a stock exchange, or
a combination of these

Note that the more than 5 full time employees requirement can be met through an
associated corporation. A corporation’s business will not be considered a personal
services business where the income is for services performed for and the income is
receivable from an associated corporation. See the corresponding exception in the
definition of specified investment business.

“income of the corporation for the year from an active business” includes any
income for the year pertaining to or incident to that business (but excluding income from
a source in Canada that is a property within the meaning assigned by subsection
129(4)).

129(4) “income” or “loss” of a corporation for a taxation year from a source that is
a property
(a) includes income or loss from a Canadian specified investment business but
(b) excludes income or loss from any property (i) that is incident to or pertains to an
active business carried on by it, or (ii) that is used or held principally for the purpose
of gaining or producing income from an active business carried on by it.

Result: income from property that pertains to or is incident to an active business is not
income from property under 129(4) and is included in active business income.

The meaning of “pertaining to or incident to” has been considered in numerous cases. A
good reference is the following from Atlas Industries Ltd. v. MNR [1986] 2 CTC 2392:

“Giving the words ‘incident to or pertains to an active business’ their grammatical and
ordinary sense, and bearing in mind their context, there must I think be a financial
relationship of dependence of some substance between the property and the active
business before the exclusion in paragraph 129(4.1)(b) comes into play. The operations
of the business ought to have some reliance on the property in the sense that recourse
is had to it regularly or from time to time or that it exists as a back-up asset to be called
on in support of those operations when the need arises.”

Another test adopted in the cases is “was the property employed and risked in the
taxpayer’s business”? The reasons in Ensite Ltd. v. The Queen [1986] 2 SCR 509 state:

“But ‘risked’ means more than a remote risk. A business purpose for the use of
the property is not enough. The threshold of the test is met when the withdrawal
of the property would ‘have a decidedly destabilizing effect on the corporate
operations themselves’: March Shipping Ltd. v. MNR.”

Subsection 129(6) contains another source of active business income. Where an

amount is paid by Aco (“associated corp.”) to Bco (“recipient corp.”) and Aco and Bco
are associated, an amount which would otherwise be income from property of Bco is

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treated as income from an active business (deemed active business income) of Bco if
the amount is deductible by Aco in computing income from an active business carried on
in Canada. The amount which is so deductible by Aco is called the “deductible portion”
in 129(6).

Paragraph (a) of 129(6) excludes the deductible portion from Bco’s income from
property, and disallows, in computing Bco’s income from property, any expense of Bco
incurred to earn the amount it received from Aco.

Paragraph (b) deems the deductible portion to be income from an active business of
Bco, and allows any expense of Bco for the purpose of earning the deductible portion to
be deducted in computing Bco’s income from an active business.

Business Limit: 125(2) – (4) and (5)(b)

125(2) – business limit is $500,000 unless the CCPC is associated with another CCPC
in the year, (not throughout the year) in which case, subject to the rest of the section, the
business limit (BL) is deemed nil.

125(3) – if all the associated CCPCs file an agreement allocating the $500,000 among
them, then the amounts they jointly allocate to each of them is their BL.

125(4) – if any of the CCPCs fails to file an agreement within 30 days after the Minister
gives notice to file, Minister can allocate the $500,000.

125(5)(a) – technical provision with limited application – students need not review.
125(5)(b) – limits the amount of the BL where tax year is less than 51 weeks to
proportion of the $500,000 that the number of days in the short tax year is to 365.

125(5.1) – the small business deduction is phased out for corporations (or groups of
associated corporations) with between $10 million and $15 million of capital (as defined
in the now repealed, except for this purpose, large corporation tax rules in Part I.3).
This is essentially stated capital, debt capital and contributed surplus. For our purposes,
it is enough to know that where a CCPC and its associated corporations together have
“capital” of $15 million, the small business limit is reduced to nil.

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Purpose of Canada’s Integration System

Integration of corporate profits and shareholder dividends

- Purpose of integration mechanism is to address the problem of double taxation of

income earned through a corporation, and to attempt to provide neutrality in the
decision to incorporate. The dividend tax credits “impute” the tax paid by the
corporation to the individual who receives the dividend, so that the combined tax
paid by the individual and the corporation is approximately the same as if the
corporation’s income had been earned directly by an individual as a sole proprietor.

- Two basic mechanisms: the dividend tax credits and the deduction for
intercorporate dividends.

Comparison of income earned directly vs. income earned through a corporation

a. Taxation of individuals: progressive rates, basic personal and dependent spouse

and other credits, certain deductions available only to individuals (RRSP, child
care expense, moving expense).

b. Taxation of corporations: no untaxed portion of profits; no “personal” credits or

deductions, the relevant corporate tax rate applies to first dollar of income; limited
small business rate to first $500,000 of profit, reduced to nil at $15 million of
capital.

Economic double taxation of corporate profits

Taxation of corporate profits and dividends in the absence of imputation (“classical

system”)

These examples illustrate the tax implications of a classical system of dividend taxation.

A Non-CCPC earns $100,000 in profit from a business carried on in BC in 2012. It pays

combined federal and provincial tax of $25,000, leaving $75,000 of retained earnings.
The $75,000 is paid as a dividend to shareholders. Assuming the shareholders are
individuals in the top tax bracket (43.7%) , the combined BC and federal tax on the
dividend would be $32,775. The total tax burden on the $100,000 in profits is $57,775.
This compares to the top combined individual tax rate of 43.7% in BC which would be
the tax rate on the income over about $130,000 if the individual carried on business as a
sole proprietor.

A CCPC earns $100,000 of income from an active business carried on in BC in 2012.

Tax payable is $13,500. It pays a dividend of $86,500 to its sole shareholder, an
individual who already has employment income of over $130,000 after all deductions. If
the dividend were taxed at her 43.7% combined marginal rate, she would pay $37,800.
The total tax paid on the $100,000 of income earned by the corporation is $51,300, still
much higher than if the individual had earned the income directly as a sole proprietor or
partner.

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Example 1 - Integration of tax on corporate profits and dividends received

by individuals: CCPCs earning active business income eligible for a small
business deduction
CCPC ABI $1000

Federal tax 110

BC tax 25

After-tax income
of the corporation 865
paid as a dividend

Add 25%“gross-up” 1081 (865 X 25% = $216)

Fed tax payable 314 (at top 29% rate)

BC tax payable 159 (at top 14.7% rate)

Federal credit (144) (2/3 of the $216 gross up)

BC credit (37) (17% X $216)

Net fed tax 170

Net BC tax 122

Total tax on the dividend: $292

Total tax on profits and dividend: $427

Federal ITA

121. Deduction for taxable dividends

There may be deducted from the tax otherwise payable under this Part by an individual
for a taxation year the total of
(a) 2/3 of the amount, if any, that is required by subparagraph 82(1)(b)(i) to be included
in computing the individual's income for the year; and

BC Income Tax Act

Section 4.69 For the purpose of computing the tax payable under this Act for a taxation
year by an individual who was resident in British Columbia on the last day of the taxation
year, there may be deducted the total of the following:
(a) 17% of any amount that is required by section 82 (1) (b) (i) of the federal Act to be
included in computing the individual's income for the year under that Act;

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Example 2 – Non-CCPCs: Integration and Eligible Dividends

See 82(1)(b)(ii) and 121(b).
Assume a Canadian corporation has profit of $1000 not eligible for the small business deduction
and not included in aggregate investment income. Assume the corporation has a nil LRIP.
2012

BC and federal corporate tax on $1000 250

Eligible dividend received by BC residents 750
Dividend grossed up by 38% 1035 (285)
Federal tax on dividend and gross up (29%) 300
Federal tax credit (6/11 X 285) (155)
Net federal tax payable by shareholder 145

BC tax on dividend and gross up (14.7%) 152 (1035 X 14.7%)

1
BC dividend tax credit (103.5)
Net BC tax payable by shareholder 48.5

Total federal and BC tax on dividend 193.5

Effective rate 25.8% (193/750)

Total federal and BC tax on corporate profit of and dividend combined: 443.50
Total federal and BC tax if shareholder had earned income directly: $437
Effective top marginal rate in BC on capital gains: 21.85% (1/2 of the top marginal rate of 43.7%).
Compare this to top rate paid by a shareholder on eligible dividends of about 26%.
Since 2006, an individual can receive over $50,000 of eligible dividend income without
being subject to tax, provided they have no other income. The following illustrates this using
2012 federal rates only, but the same effect is achieved in respect of provincial income tax
because there is a matching personal credit and dividend tax credit for provincial purposes.

50,000 X 1.38 = $69,000 (income under 82(1)(a.1)(i) and 82(1)(b)(ii))

42,706 x 15% = $6406 [tax payable at bottom bracket]

26294 x 22% = 5785
FTOP = 12,191
Personal credit: (1623) (15% x 10,822)
DTC (10,363) (6/11 x $19,000)
Tax payable: 205

BC Income Tax Act

4.69 For the purpose of computing the tax payable under this Act for a taxation year by an
individual who was resident in British Columbia on the last day of the taxation year,
there may be deducted the total of the following:

(a) 17% of any amount that is required by section 82 (1) (b) (i) of
the federal Act to be included in computing the individual's income
for the year under that Act;
(b) 36.316% (36 6/19ths) of any amount that is required by section
82 (1) (b) (ii) of the federal Act to be included in computing the
individual's income for the year under that Act.
***Notice that with CCPC there’s slight over integration, while without there’s slight under
integration.

1
36.316% X 285

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Taxation of Dividends
GRIP and LRIP and Eligible Dividends

• Most of the definitions are in subsection 89(1) (above)

• The system is actually pretty simple. Dividends paid out of income of a
corporation that has been taxed at the small business rate is subject to a lower
gross-up, and the Canadian resident individual who receives the dividend is
entitled to a lesser dividend tax credit, than for dividends paid out of income of a
Canadian corporation that has been taxed at the normal corporate rate. The
overall system is intended to ensure that business income earned through a
corporation is subject to about the same tax burden as income earned directly.
• An “eligible dividend”, properly designated as such by the distributing corporation,
receives the more favourable treatment from the recipient shareholder’s
perspective.
• A CCPC must calculate its “general rate income pool” (GRIP) each year. To the
extent that a CCPC has a positive GRIP, it can pay eligible dividends.
• A non-CCPC must calculate its “low rate income pool” (LRIP), as it must have
eliminated any balance in this pool before it can pay an eligible dividend. A
non-CCPC may have LRIP if it has previously been a CCPC, or if it has a
received a dividend from a CCPC.
o “Excessive eligible dividend designation” (EEDD) are penalized 20%
under Part III.1
Calculate using formulae from s. 89(1)
• For our purposes, taxable dividends are anything other than a capital dividend. If
not identified as a capital dividend, it is not a capital dividend.
• When thinking about tax of dividends, do this:
o Is it a corporation or individual?
" If a corporation, go to s. 112
" If an individual, go to the imputation stuff

• Two types of dividends

o Eligible dividends – eligible for better rate because corporation was
taxed more heavily – thus, the shareholders should be taxed less
o Non-eligible dividends – these are regular dividends – paid out of
corporate profits that have been taxed at the small business rate – thus,
the shareholder should pay more because the corporation paid less
upfront
o Note: the policy idea is for both of them to net out – it’s just that one pays
more and the other pays less, depending on the situation

12. (1) Income inclusions

There shall be included in computing the income of a taxpayer for a taxation year as
income from a business or property such of the following amounts as are applicable:
• 12(1)(j) – dividends from resident corporations
• 12(1)(k) – dividends from other corporations

82. (1) Taxable dividends received

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• 82(1)(a)(i): the recipient (corporation or individual) includes the actual cash (non-
eligible) dividend in income.

• 82(1)(a.1)(i) the recipient includes the actual cash amount of the eligible dividend
in income.

• 82(1)(b)(i) an individual includes an additional amount called “the gross-up”

equal to 25% of the dividend and under 82(1)(b)(ii) a gross up equal to 38% (in
2012) of “eligible dividends”.
CCH Editorial note: The amount under paragraph 82(1)(b) is the so-called gross-up in respect of
taxable dividends received by individuals from Canadian resident corporations. For “eligible
dividends” (see the definition in subsection 89(1)) received after 2005 and before 2010, the gross-
up is 45%, reducing to 44% for 2010, 41% for 2011, and 38% thereafter. The gross-up for non-
eligible dividends is 25%. The dividend tax credit under section 121 equals 11/18 of the gross-up
for eligible dividends received before 2010, 10/17 for those received in 2010, 13/23 in 2011, and
6/11 thereafter. The dividend tax credit for non-eligible dividends is two-thirds of the gross-up.
The 2008 Federal Budget, which implemented these changes, noted that these changes were
necessary as a result of the reduction in the general corporate tax rate, in order to more closely
resemble full integration.

89(1)
• 89(1) “taxable dividend” is (a) a dividend other than a capital dividend (paid out of
a special account kept by certain classes of corporations and containing the tax
exempt portion of capital gains realized by the corporation). (b) is irrelevant to
this course.

“eligible dividend”
• 89(1) “eligible dividend” means
o a taxable dividend that is received by a person resident in Canada, paid
after 2005 by a corporation resident in Canada and designated, as
provided under subsection (14) to be an eligible dividend, and
o in respect of a person resident in Canada, an amount that is deemed by
subsection 96(1.11) or 104(16) to be a taxable dividend that is received
by the person. [dividends flowed through a partnership or trust]
s.89(1): eligible dividends:
• Eligible dividends paid by CCPC are paid from GRIP: (income pool where private
co paid general rate tax)
• All public co dividends are eligible, except if they have an LRIP account. Can’t
pay eligible divs until LRIP account exhausted.
• Eligible for enhanced div tax credit w/ gross-up on 44%, SH ends up paying less
tax.
CCH Editorial note: Eligible dividends will qualify for a 38% gross-up and a dividend tax credit of
6/11 of that amount, when the gross-up/credit rates are phased-in in 2012. Prior to this, more
generous gross-up and tax credit rates will apply (see s. 82(1) and s. 121). CCPCs can pay
eligible dividends without potential penalties to the extent that post-2005-taxation-year income is
taxed at the general (business) corporate tax rate, as such income enlarges a CCPC's general
rate income pool (GRIP); a special GRIP addition may apply to taxation years ending after 2000
and before 2006. Non-CCPCs (as well as SIFT partnerships and trusts) can pay eligible
dividends without potential penalties, after they have exhausted their low rate income pool (LRIP)
by paying ineligible dividends. Eligible dividends must be designated, per s. 89(14), and received

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by a Canadian resident. See also the editorial notes to s. 89(1), “excessive eligible dividend
designation”, “general rate income pool”, “low rate income pool”, ss. 89(7) and 89(11), s. 185.1
and s. 249(3.1) (regarding a change of status to/from a CCPC).

“Eligible Dividend” example

Individual’s total income inclusion, including gross-up, equals the profit which the
corporation would have had to earn to pay the dividend, if corp. had paid tax at 20% rate
(82(1)(b)(i)) or at approximately 30% rate in 82(1)(b)(ii) .

E.g. If Co earns $100 of income, pays 20% tax (i.e. it is a CCPC with active business
income), it has $80 to distribute as dividends.

The dividend received by the shareholder of $80, plus the gross-up of 25%, is $100.

Then, s. 121 (a) provides a tax credit of 2/3 of the gross up under 82(1)(b)(i); 121(b)
provides a tax credit of 6/11 of the gross up under 82(1)(b)(ii) (for 2012).

121. Deduction for taxable dividends

There may be deducted from the tax otherwise payable under this Part by an individual
for a taxation year the total of
(a) 2/3 of the amount, if any, that is required by subparagraph 82(1)(b)(i) to be included
in computing the individual's income for the year; and
(b) the product of the amount, if any, that is required by subparagraph 82(1)(b)(ii) to be
included in computing the individual's income for the year multiplied by
(i) for the 2009 taxation year, 11/18,
(ii) for the 2010 taxation year, 10/17,
(iii) for the 2011 taxation year, 13/23, and
(iv) for taxation years after 2011, 6/11.

Examples of tax implications of classical system of dividend taxation

A Non-CCPC earns $100,000 in profit from a business carried on in BC in 2012. It pays
combined federal and provincial tax of $25,000, leaving $75,000 of retained earnings.
The $75,000 is paid as a dividend to shareholders. Assuming the shareholders are
individuals in the top tax bracket (43.7%) , the combined BC and federal tax on the
dividend would be $32,775. The total tax burden on the $100,000 in profits is $57,775.
This compares to the top combined individual tax rate of 43.7% in BC, which would be
the tax rate on the income over about $130,000 if the individual carried on business as a
sole proprietor.

A CCPC earns $100,000 of income from an active business carried on in BC in 2012.

Tax payable is $13,500. It pays a dividend of $86,500 to its sole shareholder, an
individual who already has employment income of over $130,000 after all deductions. If
the dividend were taxed at her 43.7% combined marginal rate, she would pay $37,800.
The total tax paid on the $100,000 of income earned by the corporation is $51,300, still
much higher than if the individual had earned the income directly as a sole proprietor or
partner.

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Income-Splitting Example
CCPCs and active business income

Note that an individual with no other income can receive over $40,000 in dividends from
the profits of a CCPC taxed at the low rate without being subject to tax. This makes
income splitting with a spouse that has no other income very attractive. Note that the
“kiddie tax” rules prevent such income splitting with minor children.
In this example, the rates and brackets for 2012 are applied.

40,000 x 1.25 = $50,000 (income inclusion with gross-up)

42,706 x 15% = 6406

7294 x 22% = 1605
FTOP = 8011

personal credit (1623) (15% x 10,822)

DTC (6667)

Tax payable (279) (nil, since the credits are not refundable)

Since 2006, an individual can receive over $50,000 of eligible dividend income without
being subject to tax, provided they have no other income. The following illustrates this
using 2012 federal rates only, but the same effect is achieved in respect of provincial
income tax because there is a matching personal credit and dividend tax credit for
provincial purposes.

50,000 X 1.38 = $69,000 (income under 82(1)(a.1)(i) and 82(1)(b)(ii))

42,706 x 15% = $6406 [tax payable at bottom bracket]

26294 x 22% = 5785
FTOP = 12,191
Personal credit: (1623) (15% x 10,822)
DTC (10,363) (6/11 x $19,000)
Tax payable: $205

Note that although the above examples show only the effect of the federal dividend tax
credit, the BC credit will have the same effect of reducing BC tax payable to nearly nil or
nil.

“general rate income pool” (GRIP)

GRIP is an account to track eligible dividends ! private corporations have GRIP, but
these create no other preferential tax treatment ! all dividends paid by private
corporation are NOT eligible dividends UNLESS they are paid out of the GRIP account
! at the end of the year, the eligible dividends paid MUST BE LESS THAN the GRIP
account
s.89(1): GRIP: income for the year before losses carried back A-B
• A= full rate taxable income

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o Amount that CCPC was paying in tax at the general corporate rate.
o Includes previous year’s GRIP + dividends from subsidiaries, foreign
affiliates, etc.
• B= reduction for losses carried back

• Backs out income eligible for small business deduction and AII income.
• cumulative account
• only CCPCs have GRIP
• not CCPC then have LRIP, not computed at year end, determined at any time a
dividend is paid. LRIP is low rate income pool.
• Public Co must pay out all LRIP before can pay out eligible dividends out of
GRIP.
• NOTE: GRIP can be NEGATIVE.

CCH Editorial note: This tax account is relevant to eligible dividends paid by CCPCs. If dividends
exceed the corporation's GRIP, the “excessive eligible dividend designation” penalty regime will
apply. GRIP is a year-end calculation, where dividends can be paid without potential penalties at
a time when there is no GRIP, provided that by year-end, there is enough GRIP to cover the
dividend. Generally, and in simplified form, the following are components of the GRIP account of
a CCPC (applicable to taxation years after 2005):
The description of A:
GRIP at the end of the preceding taxation year (the description of C).
Add 68% of taxable income (paragraph (a) of the description of D), less income subject to the
small business deduction (the description of E) and investment income (the description of F).
Add eligible dividends received by the corporation (paragraph (a) of the description of G),
dividends which are deductible under section 113 (e.g., dividends from exempt surplus[ of a
foreign affiliate]) (paragraph (b) of the description of G), and GRIP additions on becoming a
CCPC or in respect of amalgamation or winding-up (the description of H).
Less eligible dividends paid in the preceding taxation year (net of excessive eligible dividend
designations) (the description of I).
Subsequent years' losses that are carried back to a particular year (and other “specified future tax
consequences”), do not reduce that year's GRIP, but instead reduce GRIP at the end of the year
in which the loss arises (the description of B). A CCPC may qualify for an addition to GRIP in
respect of years prior to its 2006 taxation year, by virtue of subsection 89(7). Separate
calculations apply upon becoming a CCPC (subsection 89(4)), to amalgamations, and to
windings-up (subsections 89(5) and (6)). Dividends subject to subsection 55(2) as deemed capital
gains to the recipient nonetheless deplete the GRIP of the payor — see CRA Document No.
2007-0233771C6.
To account for lower corporate tax rates, Bill C-10 will change the 68% amount (above) to 69%
for 2010, 70% for 2011, and 72% for subsequent years (see the definition of “general rate factor”
in subsection 89(1)). In addition, a number of mainly-clerical changes to the formula will be made:
The descriptions of D, E and F will be moved to the definition of “adjusted taxable income” in
subsection 89(1), so that the description of D is based on “general rate factor” multiplied by
“adjusted taxable income”, which cannot be negative. Corresponding changes to the lettering of
subsequent descriptions will be made. The formula in B will refer to the “general rate factor” (the
description of H), with descriptions in paragraphs (a) and (b) thereof redesignated as I and J but
otherwise unchanged.

“low rate income pool” (LRIP)

CCH Editorial note: This tax account, which generally applies to non-CCPCs, must be “cleared-
out” before such corporations can pay eligible dividends without potential penalties under the

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“excessive eligible dividend designation” regime. Unlike GRIP, which is a year-end calculation
applying to CCPCs, LRIP is a point-in-time calculation.
Generally, and in simplified form, the following are the components of LRIP (applicable to taxation
years after 2005):
LRIP at the end of the preceding taxation year (the description of A).
Add ineligible dividends payable before the particular time to the non-CCPC from a corporation
resident in Canada (the description of B).
Add LRIP additions on ceasing to be a CCPC or in respect of an amalgamation or winding-up
(the description of C).
Add 80% of investment income if the corporation would be a CCPC but for a change-of-status
election (paragraph (a) of the description of D).
Less eligible dividends payable in the taxation year before the particular time (net of excessive
eligible dividend designations) (the descriptions of G and H — the descriptions of E and F apply
to special status corporations).
Separate calculations apply upon ceasing to be a CCPC (s. 89(8)), to amalgamations, and to
windings-up (ss. 89(9) and 89(10)).

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Intercorporate Dividends
112(1) – deduction for dividends received by a corporation resident in Canada
from a corporation resident in Canada.

This permits enterprises to be organized in tiers of corporations without additional

taxation between the corporation which earns the income and the individual which
eventually receives the distribution of after-tax profit. *Note that there are many
exceptions to this provision to address abusive tax planning using corporations.

112. (1) Deduction of taxable dividends received by corporation resident in

Canada
Where a corporation in a taxation year has received a taxable dividend from
(a) a taxable Canadian corporation, or
(b) a corporation resident in Canada (other than a non-resident-owned
investment corporation or a corporation exempt from tax under this Part) and
controlled by it,
an amount equal to the dividend may be deducted from the income of the receiving
corporation for the year for the purpose of computing its taxable income.

Remember, if the dividend is going to a corporation ! go to s. 112

Part IV Tax on Certain Intercorporate Dividends

Part IV imposes a special tax on private corporations and certain other corporations
(subject corporations ! public corporations controlled by an individual or family).
• Intended to prevent any deferral benefit from the earning of dividend income on
portfolio (non-controlling) investments through a closely-held corporation
• Goal is realized by imposing Part IV tax at a rate approximating highest marginal
personal rate (combined federal and provincial) on tax-free intercorporate
dividends received by the relevant corporation, then refunding the tax when the
dividends are distributed to shareholders who are individuals
• Current rate of Part IV tax is 33 1/3%

Part IV of the Act applies where dividends deductible under 112(1) are received by
private and “subject” corporations.

A “subject corporation” (186(3)) is a corporation resident in Canada that is controlled,

whether by reason of a beneficial interest in one or more trusts or otherwise, by or for
the benefit of an individual or a related group of individuals. It can include a public
corporation which is controlled by an individual or related family group. “Private
corporation” is defined in 89(1).

• 186(1): Part IV tax is a refundable tax equal to (a) 1/3 of all “assessable
dividends” received from corporations other than “connected” corporations, plus
(b) where the corporation which pays the dividend is entitled to receive a refund
of Part IV tax in respect of the dividend, the recipient corporation’s proportionate
share of the distributing (or payer) corporation’s refund of Part IV tax.

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o Part (a) of this definition in effect imposes a 33 1/3% refundable tax on

portfolio dividends received by a private or subject corporation, meaning
dividends received from companies of which the private or subject
corporation holds less than 10% by votes or value, and which it does not
control. (See connected corporations definition in 186(4) below.)
o Part (b) of the definition applies where the corporation receives a
dividend from a connected corporation which itself is entitled to receive a
refund of tax. The recipient corporation is liable to pay Part IV tax equal
to its proportionate share of the connected payer’s dividend refund.
o If the recipient corporation has non-capital losses, farm loss, or loss
carryforwards, it may deduct one-third of these amounts in computing its
Part IV tax. However, if it uses these losses to reduce Part IV tax, it may
not also use them to reduce Part I income or tax.
• 186(3): “assessable dividends” dividend received by a private or subject
corporation which is deductible under 112(1) or 113 (113 deals with dividends
received from foreign affiliates and is beyond the scope of this course).
• 186(4). “connected corporations”: A payer corporation is connected with a
particular (recipient) corporation where the payer corporation is controlled by the
particular corporation or the particular corporation owned more than 10% of the
issued voting shares of the payer corporation and shares that represent more
than 10%, by FMV, of all the issued shares of payer corporation (“more than
10% by votes and value”).
• Control: 186(2) – for the purposes of Part IV, one corporation is controlled by
another if more than 50% of its issued voting shares are owned by the other
corporation, by persons not at arm’s length from the other corporation, or by a
combination of both. This definition of control does not apply for the purposes of
determining whether a corporation is a subject corporation. d
IC-88-2 on GAAR and Part IV tax on Taxable Dividends Received
Facts
• Each of two private corporations owns less than 10% of the common shares of a
payer corporation that is to pay a substantial taxable dividend. The payer
corporation will not be entitled to a dividend refund on the payment of the
dividend. None of the corporations is related to any of the others. The private
corporations form a corporation, Newco, transfer their shares of the payer
corporation to Newco in exchange for common shares of Newco and elect under
subsection 85(1) in respect to the transfer. Following the transfer of the payer
corporation's shares to Newco, Newco will be connected with the payer
corporation. The payer corporation pays the dividend to Newco, free of Part IV
tax. Newco pays the same amount to the private corporations as a dividend, free
of Part IV tax. The primary purpose for the transfer of the shares is to avoid the
Part IV tax which would be payable if the dividend were received directly by the
private corporations.
Interpretation
• As the transfer of shares to the Newco is part of an arrangement undertaken to
avoid the tax required by Part IV of the Act to be paid in respect of dividends
received on portfolio shares, the transfer of the shares would be a misuse of a
provision of the Act or an abuse of the Act as a whole and subsection 245(2)
would be applied.

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IT-269R4 Summary
The purpose of Part IV is to prevent the deferral of tax on portfolio dividend income through the
use of private or other closely held corporations. Since corporations are generally permitted to
deduct dividend income in calculating theirtaxable income, Part IV imposes a tax on dividends
received by private corporations or closely-held corporations in order to eliminate the incentive for
an individual to obtain a significant deferral of tax on dividend income by transferring investments
in shares to such corporations. Part IV tax is intended to approximate the tax that would be paid
by an individual taxable at the highest marginal tax rate had the dividends been received by that
individual. Generally, this tax is fully refundable as a dividend refund to the corporation when the
corporation pays dividends to its shareholders, since the shareholders will then be subject to tax
at their marginal rates on the dividends.

IT-243R4 Summary
This bulletin outlines the rules for determining the dividend refund of a private corporation.
Basically, a dividend refund is available to a private corporation in respect of any Part IV tax paid
on its portfolio dividend income and a portion of any Part I tax paid on its investment income if it
has paid taxable dividends in a taxation year. The bulletin explains the meaning of the term
"taxable dividends" for this purpose. It also deals with the calculation of a corporation's refundable
dividend tax on hand (RDTOH).

Refundable Dividend Tax on Hand (RDTOH)

¶ 7. Subsection 129(3) provides the definition of a corporation's RDTOH. This notional account is
used to calculate the tax refund available to a corporation when it has paid taxable dividends in a
taxation year. A corporation's RDTOH at the end of a particular taxation year can generally be
described as the amount, if any, by which the total of:

(a) the refundable portion of Part I tax computed in accordance with the rules in paragraph
129(3)(a) (see ¶s 8 and 9 below);

(b) the total of the Part IV tax payable by the corporation for the year and any previous taxation
years ending after it last became a private corporation (see the current version of IT-269, Part IV
Tax on Taxable Dividends Received by a Private Corporation or a Subject Corporation); and

(c) the corporation's addition at December 31, 1986, of RDTOH as defined in subsection 129(3.3)

exceeds the total of:

(d) the total of dividend refunds for taxation years ending after the corporation last became a
private corporation and before the particular taxation year;

(e) the corporation's reduction at December 31, 1977, of RDTOH as defined in

subsection 129(3.1); and

(f) the corporation's reduction at December 31, 1987, of RDTOH as defined in

subsection 129(3.5).

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Refundable Tax on CCPC Aggregate Investment Income

123.3. Refundable tax on CCPC's investment income
There shall be added to the tax otherwise payable under this Part for each taxation year
by a corporation that is throughout the year a Canadian-controlled private corporation an
amount equal to 6 2/3% of the lesser of
(a) the corporation's aggregate investment income for the year (within the
meaning assigned by subsection 129(4)), and
(b) the amount, if any, by which its taxable income for the year exceeds the least
of the amounts determined in respect of it for the year under paragraphs
125(1)(a) to (c).

Section 123.3 imposes a 6 2/3% refundable tax on the “aggregate investment income” of
a CCPC. This brings the applicable rate from 28% to 34.667% federally, and combined
with 10% BC corporate tax, totals 44.67% on aggregate investment income earned by
the corporation. Again, the purpose of this tax is to try to equate the tax payable on
investment income earned directly by an individual in the top tax bracket with the total of
tax paid by a CCPC on its income other than income from an active business, plus the
income its individual shareholders would pay on dividends from the CCPC. Like Part IV
tax, it is intended to eliminate any tax deferral from earning investment income through a
corporation.

“Aggregate investment income” of a CCPC is defined in 129(4). It comprises (for our

purposes):

(a) the net taxable capital gains realized by a CCPC which accrued on property while the
corporation was a CCPC (129(4)(a));

(b) income from property other than dividends which are deductible in computing income
(i.e. other than dividends deductible under s 112(1));

minus

(c) losses for the year from property sources.

Recall that “income” or “loss” of a corporation from a source that is a property includes
income or loss from a specified investment business (125(7)) carried on by it in Canada.

The definition of RDTOH in 129(3) includes, in paragraph (a) 26 2/3% of a CCPC’s

aggregate investment income. (The calculation can obviously be much more
complicated depending on the circumstances).

RDTOH at the end of a private corporation’s tax year thus includes (a) 26 2/3 of its
aggregate investment income if it is a CCPC; (b) the corporation’s Part IV tax payable for
the year; (c) the corporation’s RDTOH balance from the end of the previous year; minus
the corporation’s dividend refund for its preceding tax year.

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Here is an edited version of CCH’s explanation of the RDTOH calculation. It is

rather more detailed than what we will cover, (and a little bit dated) but it is a clear and
full explanation. In particular, we are not concerned with the impact of foreign tax
credits, which are shaded.

129(3) RDTOH: “refundable dividend tax on hand” is an account kept by the corporation
of Part IV tax (and other amounts) it has paid. The calculation of RDTOH is provided
below. Part IV tax is refundable under 129(1) at the rate of $1 for every $3 of the
amount of dividends paid by the corporation, up to its RDTOH.

Note that the corporation must be a private corporation at the time when it pays the
dividend entitling it to a refund. Also note 186(5) deems a subject corporation that
would not otherwise be a private corporation to be a private corporation for the purpose
of s. 129.

The recipient corporation must pay Part IV tax on or before its “balance due day”
(248(1)(d)). This is, generally, the day that is three months after the day on which the
corporation’s tax year end falls in the case of a CCPC with taxable income subject to the
small business deduction and which does not have income in excess of its small
business limit for the previous year. For other corporations, the balance due day is the
day two months after the tax year end. The corporation may avoid paying Part IV tax by
paying a dividend equal to the dividend it received from the payer corporation before the
time its Part IV tax is due. Its refund will then fully offset its Part IV tax liability.

[¶20,052] Editorial Comment: Calculation of refundable dividend tax on hand

The calculation of a corporation's refundable dividend tax on hand (RDTOH) found in

subsection 129(3) has been somewhat simplified for taxation years ending after June,
1995. In addition, it has been increased to include 26 2/3% of a corporation's aggregate
investment income (up from 20%) to take into account the new additional 6 2/3% tax
levied on a corporation's investment income under section 123.3. The RDTOH
calculation is made in respect of each taxation year, starting with the corporation's
RDTOH balance at the end of the preceding taxation year (in which it was a private
corporation), and then adding amounts in respect of its “aggregate investment income”
for the year and the amount of its Part IV taxes payable for the year. One then subtracts
the amount of the corporation's dividend refund (under subsection 129(1)), if any, for its
preceding taxation year.
(…)

A corporation's RDTOH for a taxation year equals the total of three amounts, described
in each of paragraphs (a), (b) and (c) of subsection 129(3). The first amount set out in (a)
includes a percentage of the corporation's aggregate investment income for the year,
with some modifications as described in more detail below. The second amount in (b) is
the total of the corporation's Part IV tax payable for the year. The third amount in (c) is
the corporation's RDTOH balance at the end of the preceding taxation year (if it was a
private corporation at the end of that year).

Subtracted from this total is the corporation's dividend refund for its preceding taxation
year under subsection 129(1) (see paragraph 129(3)(d)).

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Aggregate investment income and RDTOH

A corporation's RDTOH is meant to reflect a portion of its “aggregate investment income”

earned in the year. Generally speaking, 26 2/3% of a corporation's aggregate investment
income for a year throughout which the corporation was a Canadian-controlled private
corporation (CCPC) is eligible for the RDTOH (with adjustments as discussed below),
and each dollar of RDTOH is refundable to the corporation for every 3 dollars paid out as
a taxable dividend (see subsection 129(1)).

“Aggregate investment income” is defined in subsection 129(4). Generally, it includes

income from property (net of losses), net taxable capital gains, and net income earned
from a specified investment business (see ¶20,061). There are some exceptions, which
are also discussed at ¶20,061.

The shaded portions can be ignored for purpose of Law 346A but are included for
completeness.

A corporation's RDTOH is generally reduced if it has claimed a foreign non-business

income tax credit in respect of foreign investment income. In some cases there will be a
reduction in RDTOH where the corporation is eligible for the small business deduction of
subsection 125(1), if the corporation has claimed a foreign business income tax credit, or
if it has made deductions under Division D in computing its taxable income for the year.
These points are discussed further below.

Under paragraph 129(3)(a), where a corporation was a CCPC throughout a taxation

year, it includes in its RDTOH for the year the least of the amounts (i) through (iii):
(i) 26 2/3% of the corporation's aggregate investment income for the year,
minus the amount by which any foreign non-business income tax credit deducted under
subsection 126(1) exceeds 91/3% of the corporation's “foreign investment income” for
the year (defined in subsection 129(4), and generally meaning that portion of its
aggregated investment income from sources outside of Canada)
(ii) 26 2/3% of the amount by which the corporation's taxable income for the
year exceeds the total of amounts (A), (B), and (C) listed in subparagraph 129(3)(a)(ii).
A is basically the amount of the corporation's active business income eligible for the
small business credit of subsection 125(1). Amount B is 25/9ths of the corporation's
foreign non-business income tax credit claimed in respect of foreign investment income
under subsection 126(1). Amount C is 10/4 of any foreign business income tax credit
claimed under subsection 126(2). [NB: for this course, only A is relevant.]
(iii) The corporation's Part 1 tax payable for the year. (…) In other words, the
amount added to RDTOH in the year cannot exceed the Part I tax liability
for the year.

It can be seen that the corporation's RDTOH is in some cases reduced if the corporation
claims a foreign income tax credit.

A corporation's current year losses from property, allowable capital losses and losses
from a specified investment business are deducted in computing its aggregate
investment income for the year under subsection 129(4), so that such losses are
reflected in the RDTOH calculation under subparagraph 129(3)(a)(i).

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Net capital losses and non-capital losses (carried over from other years) deducted under
subsection 111(1) serve to reduce the corporation's taxable income, and therefore may
reduce the corporation's RDTOH under the calculation in subparagraph 129(3)(a)(ii). Net
capital losses deducted in the year also reduce a corporation's aggregated investment
income, which will reduce the amount calculated under subparagraph 129(3)(a)(i).

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Stop Loss Rule in 112(3) and (3.01) and Capital Dividends 83(2);
Capital Dividend Account 89(1)
1. Capital dividends and the capital dividend account

S. 83(2) allows a private corporation to elect to pay a tax-free capital dividend to its
shareholders out of its CDA.
• Primarily advantageous to Canadian resident shareholders (non-residents liable
to 25% withholding tax)
• To prevent private corporations from distributing amounts in excess of CDA !
penalty tax levied under Part III equal to 75% of the excess dividend over the
account balance (proposed amendments reduce this to 60%)

Optional background reading: Materials 14th pp. 692-693

89(1) : relevant definitions

“taxable dividends” paragraph (a) – exception for a dividend in respect of which the
corporation has elected in accordance with subsection 83(2).

“capital dividend account” – a formula comprising numerous elements is set out in s.

89(1). For our purposes, it consists of (a) non-taxable portion of capital gains minus
non-allowable portion of capital losses accrued while the corporation is a private
corporation; and (b) capital dividends received by the corporation from other private
corporations. When a capital dividend is paid, it reduces the CDA.
• CDA is designed to permit private corporations to flow through the untaxed
portion of certain amounts to shareholders with no tax consequences

83(2) Capital dividend

Where at any particular time after 1971 a dividend becomes payable by a private
corporation to shareholders of any class of shares of its capital stock and the corporation
so elects in respect of the full amount of the dividend, in prescribed manner and
prescribed form and at or before the particular time or the first day on which any part of
the dividend was paid if that day is earlier than the particular time, the following rules
apply:
(a) the dividend shall be deemed to be a capital dividend to the extent of the
corporation's capital dividend account immediately before the particular time; and
(b) no part of the dividend shall be included in computing the income of any
shareholder of the corporation.

CCH Editorial note: The full amount of the elected dividend is excluded from the income
of each resident shareholder, even if the total dividend exceeds the corporation's “capital
dividend account” (subsection 89(1)) such that the excess is not a capital dividend.
However, the corporation may be subject to a penalty tax in respect of the excess under
subsection 184(2); alternatively, the corporation can elect under subsection 184(3) to
have the excess treated as a separate taxable dividend. A capital dividend paid to a non-
resident is subject to withholding tax under subsection 212(2).

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- applies only to private corporations

- election must apply to full amount of dividend
- election must be filed at earlier of day dividend became payable or any part of it is
paid
- dividend is deemed a “capital dividend” to extent of capital dividend account
- dividend is exempt – not included in recipient shareholder’s income

Capital Dividend Example

Canco is a CCPC. It has a nil balance in its capital dividend account. It then sells
shares of a public corporation, and realizes a capital gain of $50,000. It has net capital
losses from other dispositions of capital property in previous years of $15,000.

What is Canco’s Part I tax liability in respect of the sale of the shares?
• Calculate 40(1)(a) capital gain
• 38(a) to divide in half
• under 111(1)(b) bring forward existing net capital losses
• Taxable CG in that year of $10,000
• Non-taxed portion will be equal to taxed portion*
• Taxed portion added to income for the year taxed at the 40 something rate
• 26 2/3 of the Part I tax gets added to its RDTOH**
• Untaxed portion would be added to capital dividend account ! can elect
to pay capital dividend of $10,000
* always assume there is an equivalent non-taxed portion
** The definition of RDTOH in 129(3) includes, in paragraph (a) 26 2/3% of a CCPC’s aggregate investment
income. (The calculation can obviously be much more complicated depending on the circumstances).

What is Canco’s capital dividend account, from the above facts?

How is the portion of the net taxable capital gain that is not included in the CDA taxed?

2. Stop-loss rules for capital losses realized on shares where capital

dividends have been received on the shares.

112(3) provides a “stop-loss” rule to limit capital losses on shares on which capital
dividends or other exempt dividends have been received.

This restriction prevents a taxpayer from realizing a capital loss on the disposition of a
share held as capital property to the extent of the lesser of:

(a)(i) tax free capital dividends received on the share and

(ii) taxable dividends received on the share (where the shareholder is an individual).

Subsection 112(3.01) restricts the stop-loss rule to instances where the taxpayer and
non-arm’s length persons hold 5% or more of the issued shares or have not held the
shares for at least 365 days.

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112. (1) Deduction of taxable dividends received by corporation resident in

Canada
Where a corporation in a taxation year has received a taxable dividend from
(a) a taxable Canadian corporation, or
(b) a corporation resident in Canada (other than a non-resident-owned
investment corporation or a corporation exempt from tax under this Part) and
controlled by it,
an amount equal to the dividend may be deducted from the income of the receiving
corporation for the year for the purpose of computing its taxable income.

(3) Loss on share that is capital property

Subject to subsections (5.5) and (5.6), the amount of any loss of a taxpayer (other than a
trust) from the disposition of a share that is capital property of the taxpayer (other than a
share that is property of a partnership) is deemed to be the amount of the loss
determined without reference to this subsection minus,
(a) where the taxpayer is an individual, the lesser of
(i) the total of all amounts each of which is a dividend received by the
taxpayer on the share in respect of which an election was made under
subsection 83(2) where subsection 83(2.1) does not deem the dividend to
be a taxable dividend, and
(ii) the loss determined without reference to this subsection minus all
taxable dividends received by the taxpayer on the share; and
(b) where the taxpayer is a corporation, the total of all amounts received by the
taxpayer on the share each of which is
(i) a taxable dividend, to the extent of the amount of the dividend that was
deductible under this section or subsection 115(1) or 138(6) in computing
the taxpayer's taxable income or taxable income earned in Canada for
any taxation year,
(ii) a dividend in respect of which an election was made under subsection
83(2) where subsection 83(2.1) does not deem the dividend to be a
taxable dividend, or […]

(3.01) Loss on share that is capital property — excluded dividends

A dividend shall not be included in the total determined under subparagraph (3)(a)(i) or
paragraph (3)(b) where the taxpayer establishes that
(a) it was received when the taxpayer and persons with whom the taxpayer was not
dealing at arm's length did not own in total more than 5% of the issued shares of any
class of the capital stock of the corporation from which the dividend was received; and
(b) it was received on a share that the taxpayer owned throughout the 365-day period
that ended immediately before the disposition.

CCH Editorial note: S. 112(3) is a stop-loss rule which may deny a portion of a capital
loss on the disposition of a share of a corporation by a natural person (i.e., an individual
other than a trust, to which separate provisions apply), or by a corporation, as a result of
the receipt of tax-advantaged dividends (including by virtue of deemed dividends on a
share redemption, which may trigger the loss itself).
In the case of a natural person, the loss is reduced by the total amount of capital
dividends received on the share (more precisely, a dividend on which a capital dividend
election has been made including excessive elections, but not including a separate

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taxable dividend per a s. 184(3) election or a would-be capital dividend subject to the
capital dividend anti-avoidance rules in s. 83(2.1)). However, the amount subject to the
stop-loss is reduced if the loss otherwise determined, less taxable dividends received on
the share, is less than this amount; in other words, taxable dividends can enlarge the
loss that can be claimed (s. 112(3)(a)).
In the case of a corporation, the capital loss on a disposition of a share in another
corporation is reduced by: (i) tax-free intercorporate dividends (e.g., dividends deductible
under s. 112, but not under s. 113); (ii) capital dividends (as described above); and (iii)
life insurance capital dividends received on the share (s. 112(3)(b)).
Dividends which would otherwise enlarge the disallowed loss are ignored in computing
the amount of the denied losses, per a “5/365 exception” (per s. 112(3.01)), which
applies if the dividend was received when the shareholder and non-arm's length persons
did not own more than 5% of the shares of any class (or series) in the corporation, and
the shares were owned throughout the 365-day period before the disposition
(s. 112(3.01)). This means that the stop-loss rules will not apply if a taxpayer and non-
arm's length persons did not hold more than 5% of the class (or series) of shares, if held
for the 365 day period.

Practice Problem – s. 112 stop loss rules re: capital dividends

Ms. T holds 100 shares of Canco, a private corporation. This amounts to 3% of the
shares of Canco. Her father, Mr. T, holds 5% of the shares of Canco. Ms. T acquired
the shares of Canco in 2005 at a cost of $50 per share, for a total of $5000. In 2006,
Canco paid a capital dividend of $20 per share on its issued shares. In the recession of
2008-2009, Canco suffered severe losses. Ms T sold her Canco shares for $30 per
share in October 2009.

What is Ms T’s loss on the shares in October 2009?

How would your answer change if Canco had paid taxable dividends of $10 per share
during the period Ms. T held her shares?

How would your answer change if Mr. T did not own any shares of Canco?

How would you calculate the loss of R Corporation, a Canadian resident corporation,
that held 1000 Canco shares from 2006 to 2010? It acquired its shares for $60 per
share, and sold them in 2010 for $20 per share. Assume R Corp received both the
capital dividend and the taxable dividend.

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Stock Dividends, Dividends in Kind and Deemed Dividends

Examples of tax consequences of non-cash dividends
Dividend in kind

X Co holds 200,000 shares of Y Co which it acquired at a cost of $1 per share. The

shares of Y co are now worth $2 each. X Co distributes 10,000 shares of Y Co to each
of its 20 common shareholders as a dividend in kind.

The shareholders must each report a dividend under 12(1)(j) of $20,000, gross it up
under 82(1)(b), and pay tax, claiming the dividend tax credit, on the dividend.

X Co will have a capital gain of $100,000 (POD of $200,000 minus ACB of $100,000;
40(1)(a)(i)) and each shareholder will be deemed to have acquired the Y Co shares at
the cost of $2 per share.

Stock dividend

A Co has 5 shareholders, all members of a family. Each shareholder holds 20 common

shares of the total 100 issued common shares. A Co has retained earnings of $500,000.

A Co declares a stock dividend on its common shares of 5 Class B preferred shares per
common share, so that each shareholder has 100 Class B preferred shares. Each Class
B preferred share has a par value of $.01 and is redeemable and retractable at the price
of $1000.00 per share. Class B shares do not entitle the holder to any dividends, and
once the redemption price is paid, the Class B shares do not participate in surplus
assets.

Each common shareholder now holds 100 Class B preferred shares; a total of 500 Class
B preferred shares are issued.

A Co must reflect the issue of the Class B shares in its stated capital account. Under
248(1) “amount” the stated capital of the Class B shares is $5.00, or $.01 per share. The
stock dividend would result in a dividend of $1 per shareholder.

A shareholder who has no other income in a year might decide to retract 30 Class B
shares. This would result in a deemed dividend under subsection 84(3) of $30,000
(actually $29,999.70), which as we saw can be received free of tax when the basic
personal credit and the dividend tax credit are combined.

Anti-avoidance provision: 15(1.1)

S. 248(1) definitions
“dividend”
“dividend” includes a stock dividend (other than a stock dividend that is paid to a
corporation or to a mutual fund trust by a non-resident corporation);

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“amount”
“amount” means money, rights or things expressed in terms of the amount of
money or the value in terms of money of the right or thing, except that,
(a) notwithstanding paragraph (b), in any case where subsection 112(2.1),
112(2.2) or 112(2.4), or section 187.2 or 187.3 or subsection 258(3) or 258(5)
applies to a stock dividend, the “amount” of the stock dividend is the greater of
(i) the amount by which the paid-up capital of the corporation that paid the
dividend is increased by reason of the payment of the dividend, and
(ii) the fair market value of the share or shares paid as a stock dividend at
the time of payment,
(b) in any case where section 191.1 applies to a stock dividend, the “amount” of
the stock dividend for the purposes of Part VI.1 is the greater of
(i) the amount by which the paid-up capital of the corporation that paid the
dividend is increased by reason of the payment of the dividend, and
(ii) the fair market value of the share or shares paid as a stock dividend at
the time of payment and for any other purpose the amount referred to in
subparagraph (i), and
(c) in any other case, the “amount” of any stock dividend is the amount by which
the paid-up capital of the corporation that paid the dividend is increased by
reason of the payment of the dividend;

“common share”
“common share” means a share the holder of which is not precluded on the
reduction or redemption of the capital stock from participating in the assets of the
corporation beyond the amount paid up on that share plus a fixed premium and a
defined rate of dividend;

“preferred share”
“preferred share” means a share other than a common share;

52.(3) Cost of stock dividend

Where a shareholder of a corporation has, after 1971, received a stock dividend in
respect of a share owned by the shareholder of the capital stock of the corporation, the
shareholder shall be deemed to have acquired the share or shares received by the
shareholder as a stock dividend at a cost to the shareholder equal to the total of
(a) where the stock dividend is a dividend, the amount of the stock dividend,
(a.1) where the stock dividend is not a dividend, nil, and
(b) where an amount is included in the shareholder's income in respect of the
stock dividend under subsection 15(1.1), the amount so included.

CCH Editorial note: The “amount of the stock dividend” is the amount by which the
corporation's paid-up capital is increased by reason of the payment of the dividend
(s. 248(1), "amount"). If s. 15(1.1) applies to the stock dividend, the fair market value of
the stock dividend in excess of the amount of the stock dividend is also added to the
cost of the share.

S. 15(1.1) – Anti-Avoidance

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(1.1) Notwithstanding subsection (1), if in a taxation year a corporation has paid a stock
dividend to a person and it may reasonably be considered that one of the purposes of
that payment was to significantly alter the value of the interest of any specified
shareholder of the corporation, the fair market value of the stock dividend shall, except to
the extent that it is otherwise included in computing that person’s income under any of
paragraphs 82(1)(a), (a.1) and (c) to (e), be included in computing the income of that
person for the year.

89(1) “paid-up capital”

“paid-up capital” at any particular time means,
(a) in respect of a share of any class of the capital stock of a corporation, an
amount equal to the paid-up capital at that time, in respect of the class of shares
of the capital stock of the corporation to which that share belongs, divided by the
number of issued shares of that class outstanding at that time,
(b) in respect of a class of shares of the capital stock of a corporation, (…)
(iii) where the particular time is after March 31, 1977, an amount equal to
the paid-up capital in respect of that class of shares at the particular time,
computed without reference to the provisions of this Act except
subsections 51(3) and 66.3(2) and (4), sections 84.1 and 84.2,
subsections 85(2.1), 85.1(2.1) and (8), 86(2.1), 87(3) and (9), 128.1(2)
and (3), 138(11.7), 139.1(6) and (7), 192(4.1) and 194(4.1) and
section 212.1,
except that, where the corporation is a cooperative corporation (within the meaning
assigned by subsection 136(2)) or a credit union and the statute by or under which it was
incorporated does not provide for paid-up capital in respect of a class of shares, the
paid-up capital in respect of that class of shares at the particular time, computed without
reference to the provisions of this Act, shall be deemed to be the amount, if any, by
which
(iv) the total of the amounts received by the corporation in respect of
shares of that class issued and outstanding at that time
exceeds
(v) the total of all amounts each of which is an amount or part thereof
described in subparagraph (iv) repaid by the corporation to persons who
held any of the issued shares of that class before that time, and
(c) in respect of all the shares of the capital stock of a corporation, an amount
equal to the total of all amounts each of which is an amount equal to the paid-up
capital in respect of any class of shares of the capital stock of the corporation at
the particular time;

CCH Editorial note: The paid-up capital of a class of shares is initially computed “without
reference to the provisions of this Act”, which is understood to mean the amount
determined for corporate law purposes (the amount determined under corporate law is
often referred to as the “stated capital” of the class of shares). The paid-up capital of
the class of shares is then subject to adjustments under specific provisions of the Act as
set out in paragraph (b) of the definition.

***See appendix for an explanation of stated capital vs. market value

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General Anti-Avoidance Rule (“GAAR”)

A. What students should take away from study of the GAAR:

Be able to explain:

• Sham and incomplete transactions (element of deceit is critical to a sham)

(step was missed or transaction didn’t have effect in law that TPs wanted it to)
• How the court may identify a tax benefit
o From Trustco ! court may look at alternative transaction where TP would
pay more tax; but don’t have to do this ! Point here: courts have said
many times the right approach is not to look at alternative transaction
where TP would pay more money then recharacterize; but when looking
to see if there was a tax benefit, you CAN consider an alternative to see if
this was a better, more tax efficient transaction ! MAY mean you have a
tax benefit
• The test of what constitutes a series, at common law and as expanded by
248(10)
o Underlying portion on page 2 on the handout, expanded by 248(10),
related transaction in contemplation of moving forward (has enough time
passed between; is there some disconnecting factor ! in Copthorne they
argued that change in the law was a sufficient disconnecting fact, but
court wasn’t impressed with that
• What constitutes an avoidance transaction, and how a transaction that is part of
a series can constitute an avoidance transaction
o Test for avoidance transactions and transactions that are part of a series
• Two step application of the “abuse test” in 245(4): 1. Determine the underlying
rationale, or object, spirit, purpose of the relevant provisions; 2. Does the
transaction circumvent, defeat, frustrate that purpose? (para 55 Canada Trustco)
• Standard of review
o Comes from Hyson and Nicholison (sp.) – case on negligence (so not
related to GAAR), but can see court has to instruct itself as to the TCP
provisions at issue ! misinterpretation of that could be an error of law;
fact-intensive analysis
• Know for which issues the taxpayer has the burden of proof, and on which the
Minister bears the burden, at least initially
• What is the CRA’s power to re-determine the tax consequences? How broad is
this power?
o What they’ll do is reassess, but TP has the right to make submissions

248(10) Series of transactions

For the purposes of this Act, where there is 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.
• Came up in Copthorne, SCC 2011

Note: GAAR is terrible to examine ! may only have a very small part on the final exam

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Canada Trustco Mortgage Co.

[66] The approach to s. 245 of the Income Tax Act may be summarized as follows.

1. Three requirements must be established to permit application of the GAAR:

(1) A tax benefit resulting from a transaction or part of a series of
transactions (s. 245(1) and (2));
(2) that the transaction is an avoidance transaction in the sense that it
cannot be said to have been reasonably undertaken or arranged primarily
for a bona fide purpose other than to obtain a tax benefit; and
(3) that there was abusive tax avoidance in the sense that it cannot be
reasonably concluded that a tax benefit would be consistent with the
object, spirit or purpose of the provisions relied upon by the taxpayer.

2. The burden is on the taxpayer to refute (1) and (2), and on the Minister to establish
(3).

3. If the existence of abusive tax avoidance is unclear, the benefit of the doubt goes to
the taxpayer.

4. The courts proceed by conducting a unified textual, contextual and purposive analysis
of the provisions giving rise to the tax benefit in order to determine why they were put in
place and why the benefit was conferred. The goal is to arrive at a purposive
interpretation that is harmonious with the provisions of the Act that confer the tax benefit,
read in the context of the whole Act.

5. Whether the transactions were motivated by any economic, commercial, family or

other non-tax purpose may form part of the factual context that the courts may consider
in the analysis of abusive tax avoidance allegations under s. 245(4). However, any
finding in this respect would form only one part of the underlying facts of a case, and

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would be insufficient by itself to establish abusive tax avoidance. The central issue is the
proper interpretation of the relevant provisions in light of their context and purpose.

6. Abusive tax avoidance may be found where the relationships and transactions as
expressed in the relevant documentation lack a proper basis relative to the object, spirit
or purpose of the provisions that are purported to confer the tax benefit, or where they
are wholly dissimilar to the relationships or transactions that are contemplated by the
provisions.

7. Where the Tax Court judge has proceeded on a proper construction of the provisions
of the Income Tax Act and on findings supported by the evidence, appellate tribunals
should not interfere, absent a palpable and overriding error.

Stubart – Fco owned 100% of Grover and Stubart – G has losses and S had profit – S
transferred profits to G to reduce Fco’s tax bill ! court held the transaction as
ineffective/incomplete, but “sham” is a “false transaction ! Estey: “heart and core of it is
deceit”. Court rejected strict interpretation rule and ruled that a transaction not for
business purposes is NOT invalid because of that alone.

Husky Energy – example of inter-provincial planning and the GAAR

Rothstein in OSFC Holding Ltd. (affirmed in Canada Trustco at para. 25)

• “Thus, for there to be a series of transactions, each transaction in the series must
be pre-ordained to produce a final result. Pre-ordination means that when the first
transaction of the series is implemented, all essential features of the subsequent
transaction or transactions are determined by persons who have the firm
intention and ability to implement them. That is, there must be no practical
likelihood that the subsequent transaction or transactions will not take place.”

“GAAR” ITA Provision 245 CCH Commentary

CCH Editorial note: S. 245 sets out the general anti-avoidance rule (the “GAAR”). The GAAR was
enacted in 1987 partially in response to the Supreme Court of Canada's decision in Stubart (84
DTC 6305), and more generally for the purpose of combating abusive tax avoidance transactions
and arrangements which technically comply with the provisions of the Act.

The GAAR applies to any transaction that is an “avoidance transaction”. An “avoidance

transaction” is defined in s. 245(3) as a transaction that results in a tax benefit or a transaction
that is part of a series of transactions that results in a tax benefit. However, it does not include a
transaction arranged primarily for bona fide purposes other than to obtain a tax benefit. A tax
benefit is defined in s. 245(1) as a reduction, avoidance or deferral of tax, an increase in a
deferral of tax or an increase in a refund of tax, under the Act or under a tax treaty. In addition,
the GAAR only applies to a transaction that results directly or indirectly in a misuse of the
provisions of the Act, the Regulations, or a tax treaty or an abuse of those provisions other than
s. 245 read as a whole. Therefore, a transaction which otherwise is subject to the GAAR, will not
be subject to the GAAR if it does not involve such a misuse or abuse. In Canada Trustco
Mortgage Company 2005 DTC 5523, the SCC stated that the “misuse” and “abuse” requirement
is determined having regard to the text, context and purpose of the relevant provisions of the Act
and whether the transaction frustrates or defeats the object, spirit and purpose of the relevant
provisions.

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If the GAAR applies under s. 245(5), the tax consequences of the transaction will be determined,
as is reasonable in the circumstances, to deny the tax benefit resulting from the transaction.

It should be noted that the Act contains numerous specific anti-avoidance provisions such as s.
69 which deals with property transferred to a person not at arm's length, s. 74.1 to 74.5 which
deals with transfers of property or income between spouses or between a parent and a minor
child, s. 15 which deals with benefits conferred by a corporation, s.110.6 which deals with the
capital gains exemption and s. 40(3.3) and 54 which prohibit certain losses from being realized.
The GAAR supplements the anti-avoidance provisions in the Act and normally is a provision of
“last resort”.

It should also be noted that there are a large number of court decisions, including three Supreme
Court of Canada decisions which have considered the GAAR. Despite these decisions, the
applicability of the GAAR to a specific fact pattern is difficult to predict because in many cases, it
is not clear whether a tax benefit realized by a taxpayer is inconsistent with the object, spirit and
purpose of a provision of the Act, or the Act read as a whole.

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Shareholder Benefits and Loans

• a company is NOT a piggy bank – article by Tim Cestnick

Shareholder Benefits

• S. 15(1) – benefits conferred on shareholder by corporation

o Treated as income from a source (not a dividend ! no presumption that
tax has been paid by the corporation)
o Unless deemed dividend or something else, it’ll be treated as income
o “What types of benefits am I talking about? There is no shortage of
examples from the case law. Your company might pay for personal items
on your behalf; you might make personal use of corporate assets such as
a cottage or vacation property; the company might use its assets as
collateral on a loan from the bank to you; you might acquire something
from your own corporation at below fair market value; your company
might pay for a “business” trip that has a personal element to it; and so
on.”
" Keep in mind that your corporation is a separate legal entity and a
taxpayer ! CRA d/n like shareholders making personal use of
company assets, even though you may own and control the
company
• 15(1): benefits conferred on a shareholder by a corporation are included in
computing the shareholder’s income, but are not treated as dividends subject to
the gross-up and tax credit mechanism. They are not deductible by the
corporation.
o - note exceptions in (a) through (d), and for amounts deemed to be
dividends under s. 84
• 69(4): corporation is deemed to have disposed of property appropriated to or for
the benefit of a shareholder at fair market value

52(1) provides step up in cost to recipient of the property for capital gains purposes

Section 52(1) adds the amount of the benefit included in the shareholder’s income to the
cost to the shareholder of the property received. This prevents double taxation of the
shareholder benefit, but the benefit is still taxed as ordinary income, even where the
property is capital property.

Section 69(4) applies specifically to shareholder appropriations, so when property is

acquired by a shareholder from the corporation, the corporation is deemed to dispose of
it at FMV, rather than for the consideration actually paid for it. Unlike the case in
69(1)(b) and (c), which apply to non-arm’s length transfers at nil or below market
consideration, 69(4) and 52(1) can apply to shareholder appropriations/benefits where
the shareholder deals at arm’s length from the corporation.
EXAMPLES OF SHAREHOLDER BENEFITS – CASES in Appendix
• Youngman and Fingold: valuation of benefit to shareholder of use of residence
owned by corporation

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Shareholder Loans

15(2): loans by a corporation to individual shareholders (does not apply between corporations
resident in Canada) are included in income of the shareholder unless repaid as provided in 15(2.6)
within one year after the end of the tax year of the lender during which the loan was made or the
indebtedness arose.

15(2.1): connected persons: arm’s length test

20(1)(j): deduction for repayment of amount included in income under 15(2)

15(1.2): forgiveness of shareholder loan

15(2.3) and 15(2.4): situations where 15(2) doesn’t apply. 15(2.3) – where loan is made in the
ordinary course of the lender’s business and bona fide arrangements are made for repayment
within a reasonable time. 15(2.4) – where employee is a shareholder, but not a “specified
shareholder” (see 248(1)), loan is to acquire a home, to allow employee to buy shares of the
corporation or related corporation (exercise stock options) or to acquire a car for use in
performing employment duties. In all cases, it must be reasonable to conclude the loan was made
because of employment relationship, not because borrower was a shareholder, and bona fide
repayment arrangements requirement applies.

15(9) Deemed benefit conferred on a shareholder: low or interest-free loan

80.4(2): deemed interest benefit to shareholder in respect of loan – difference between prescribed
rate (Reg 4301(c)) and interest actually paid.

80.4(3): exception for commercial loans, or when principal included in taxpayer’s income under
15(2).

80.4(8): persons connected with shareholder – arm’s length test

80.5: deemed interest on certain loans deductible

SH Benefits and Loans – Practice Problem

Joe holds 8% of A Co’s shares. His common law partner, Leo, holds 45% of A Co’s
shares. A Co advances $10,000 to Joe on January 1, 2005. The loan is interest free,
and the only documentation is an entry in the A Co’s books showing “loan to Joe”. Joe
buys interest bearing bonds issued by provincial and federal governments with the
funds.

Assuming the loan is not repaid as of June 30 2007, what are the tax consequences for
Joe?

Does your answer change if Joe is a director of A Co? (review definitions of employee
and director.)

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Acquisition of Control (Basic Corporate Reorganization Stuff)

ITA sections

249(3.1) – applies to deem a year end when a CCPC ceases to be a CCPC otherwise
than because of an acquisition of control. This could occur if the CCPC lists a class of
shares on a stock exchange, if its controlling shareholder lists a class of shares on a
stock exchange, its controlling shareholder(s) ceases to be resident, or the corporation
itself ceases to be resident. In many cases, the deemed year end will have particular
consequences, such as reducing the available small business limit because of the short
tax year: 125(5)(b). Loss carryforwards under 111(1)(a) would also be reduced by a
year. This provision is also relevant to the transition from CCPC to non-CCPC status in
respect of LRIP and GRIP accounts. We are not covering transitional calculations of
LRIP and GRIP.

CCH Editorial note: This provision deems a year-end immediately before a change of
status to/from a CCPC, after which the corporation can then set a new year-end.
Situations include where there is an agreement to acquire control of the corporation by a
public company and/or a non-resident (see paragraph 251(5)(b)), the corporation
becomes public, or the controlling shareholder becomes non-resident. This permits the
small business deduction and RDTOH build-up for the stub taxation year preceding the
change of status, since CCPC status would be maintained throughout that year.
Opening GRIP/LRIP accounts (re: eligible dividends) are calculated (using a “tax
balance sheet” approach) immediately before the end of the stub taxation year (see
subsections 89(4) and (8)). Subsection 249(3.1) does not apply where subsection 249(4)
(providing a separate deemed year end on an acquisition of de jure control) applies, nor
does it apply to “change of status” elections/revocations re: subsections 89(11) or (12).

249(4)
(a) – deemed year end on acquisition of control (“A/C”)
(b) – commencement of new tax year
(c) – if A/C occurs within first 7 days following the corporation’s normal tax year end, the
corporation may elect to extend previous year so that it ends with the A/C
(d) – corporation can now establish a new fiscal period (provided it complies with
249.1(1) and 249(3)).

Consequences of Acquisition of Control

- change in Targetco’s status? Has it ceased to be a private corporation? Has it

become controlled by non-residents? (affects access to refund of Part IV tax; ability
to pay capital dividends, LRIP and eligible dividends)
- non-capital loss carry forwards: 111(1)(a) – one extra tax year expires

Review of 256(6) and (6.1) re deemed control.

256(7)(a)(i)(A) and (B): situations in which there is deemed to be no A/C – where

corporations were related before the A/C - recall Duha Printers fact situation.

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Derek Deacon

Timing: 256(9) Date of acquisition of control

For the purposes of this Act, other than for the purposes of determining if a corporation
is, at any time, a small business corporation or a Canadian-controlled private
corporation, where control of a corporation is acquired by a person or group of persons
at a particular time on a day, control of the corporation shall be deemed to have been
acquired by the person or group of persons, as the case may be, at the beginning of that
day and not at the particular time unless the corporation elects in its return of income
under Part I filed for its taxation year that ends immediately before the acquisition of
control not to have this subsection apply.

111(5) – limitations on non-capital loss utilization

111(5)(a) and 111(5)(b) restrict the carry forward of non-capital losses from years
before the A/C to years following the A/C, and the carry back of non-capital losses from
years after the A/C to years before the A/C.

For losses from years before the A/C to be available to offset profits in a subsequent
year, the losses must be incurred from the carrying on of a business (not from a source
that is property), which must be the same business or a similar business to that carried
on before the A/C. The business must be carried on after the A/C throughout the year
in which the losses are to be utilized, for profit or with a reasonable expectation of profit.
Losses from years prior to the A/C may only be deducted to the extent that the business
has income in the post A/C year, to prevent an excess loss from the business being
utilized to offset profits in another business carried on by the corporation.

Losses may be carried back from years subsequent to the A/C to years prior to the A/C
only if the business in which the loss was sustained was carried on throughout the loss
year and both in the loss year and in the year in which the loss is sought to be applied.
Again, the loss can only be used to offset income from the business in the year to which
the loss is carried back, and may not be applied against income from other businesses
in that year.

See Garage Montplaisir Inc. v. The Queen 2001 DTC 5366 (FCA) – see 1992 decision
of TCC as one example of the court making an assessment of whether the requirements
of 111(5)(a) are met.

CCH Editorial note: S. 111(5) prohibits the carryforward or carryback of non-capital

losses and farm losses of a corporation after a change in the control of the corporation.
An exception is made under the “streaming rules” under paragraphs (a) and (b), which
can apply to allow the losses if the corporation continues to carry on the pre-change of
control business for profit or with a reasonable expectation of profit, and generally to the
extent of income from that business and similar businesses in the year in which the loss
is claimed.

111(4) – effects on net capital losses and capital properties of A/C

(a) and (b): net capital losses cannot be carried back or carried forward “across” an
acquisition of control – normal rule is back three, forward “forever” – 111(1)(b).

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(c): the ACB of non-depreciable capital property is written down to its fair market value
(if less than ACB)

(d): the amount of the write down in (c) is deemed to be a capital loss which was realized
immediately before the A/C (and so cannot be used in a future year)

(e): the corporation may designate certain non-depreciable capital properties in respect
of which a capital gain has accrued at the time of the A/C to be deemed to be disposed
of. The proceeds of disposition are the lesser of FMV and the amount designated by the
corporation between the ACB and the FMV. This creates capital gains to absorb the
capital losses deemed to be realized under (d), and which cannot be carried forward
under (a).

CCH Editorial note: S. 111(4) ensures that net capital losses of a corporation cannot be
carried forward or back after a change of control of the corporation. Similarly, accrued
capital losses cannot be utilized beyond the change of control, owing to the “write-down”
of cost to fair market value under s. 111(4)(c). This write-down will generate capital
losses in the year ending immediately before the change of control (paragraph (d)). The
corporation can elect under paragraph (e) to generate a deemed disposition of other
capital property — for example, for the purpose of generating capital gains that can be
offset by the capital losses triggered by the write-down. See s. 111(5.1) regarding
accrued terminal losses in respect of depreciable property.

111(5.1) – depreciable property [not examinable]

For each class of depreciable property, if the UCC of the class exceeds the sum of the
FMV of property in the class, and the amount of CCA or terminal loss which could be
deducted for that class for the year ending with the A/C, the difference is required to be
deducted as CCA in the year. This requires property to be written down to its FMV, and
any excess of UCC over FMV will not be deductible in years after the change of control
except as a non-capital loss subject to 111(5).

CCH Editorial note: S. 111(4)(e) allows an elective "write-up" for depreciable property,
generally where the fair market value of the property exceeds the cost amount of the
property. The election could be advisable if any resulting recapture could be offset by the
deduction in respect of accrued losses under s. 111(5.1).

256.(7) Acquiring control

For the purposes of subsections 10(10), 13(21.2) and (24), 14(12) and 18(15), sections
18.1 and 37, subsection 40(3.4), the definition “superficial loss” in section 54, section 55,
subsections 66(11), (11.4) and (11.5), 66.5(3) and 66.7(10) and (11), section 80,
paragraph 80.04(4)(h), subsections 85(1.2), 88(1.1) and (1.2) and 110.1(1.2), sections
111 and 127, subsection 249(4) and this subsection,
(a) control of a particular corporation shall be deemed not to have been acquired
solely because of
(i) the acquisition at any time of shares of any corporation by
(A) a particular person who acquired the shares from a person to
whom the particular person was related (otherwise than because

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Derek Deacon

of a right referred to in paragraph 251(5)(b)) immediately before

that time,
(B) a particular person who was related to the particular
corporation (otherwise than because of a right referred to in
paragraph 251(5)(b)) immediately before that time, (…)

Acquisition of Control Examples

1. 111(4) example (non-depreciable capital property)

Targetco has two capital properties

Capital property 1 has an ACB of 10,000 and a FMV of 5000

Capital property 2 has an ACB of 5000 and a FMV of 20,000

What amount should Targetco designate under 111(4)(e) for capital property 2?

2. 111(5.1) example

Targetco has class 8 property (20%) with a UCC of 100, a FMV of 60, and would be able
to deduct 20 as CCA for the year ending with the acquisition of control.

How much must Targetco deduct in respect of the year ending with the acquisition of
control?

Appendix (Cases and Handouts)

65
Appendix(
(
1. Corporate*Income*Tax*Rates*by*Province*–*2012*;*Extra*
2. Corporate*residence*–*the*common*law*test*–*in*Appendix*
3. IT;177R2*(Consolidated)*;*Extra*
4. Designated*Stock*Exchanges*;*Extra*
5. De*Jure*Control*Cases*–*in*Appendix*
• Buckerfield’s,*Dworkin*Furs,*Vineland*Quarries,*Imperial*General*
Properties,*Duha*Printers,*Sedona*
6. De*Factor*Control*Cases*–*in*Appendix*
• Multiview,*International*Mercantile,*Societe,*Minetix,*Lenester,*
Fashion*Coutour,*Silicon,*Parthenon*
7. Bagtech*Summary*;*Extra*
8. Income*Tax*Technical*News*No.*32*–*Control*in*Fact:*Impact*–*in*Appendix*
9. IT;64R4*–*the*entire*thing*(has*some*sweet*diagrams)*;*Extra*
10. IT;419R2*–*the*entire*thing*;*Extra*
11. Related*Persons*Examples*–*in*Appendix*
12. Associated*Corporation*Problems*–*in*Appendix*
13. Specified*Class*and*Prescribed*Interest*Rates*Handout*;*Extra*
14. Small*Business*Deduction*Provisions*;*Extra*
15. Billco*and*Barbco*PSB*and*Associated*Corporations*Exception*–*Extra*
16. Taxation*of*Dividends*Provisions*;*Extra*
17. GRIP,*LRIP*and*Eligible*Dividends*–*Extra*
18. Addams*Family*example*and*RDTOH*example*–*in*Appendix*
19. Stop*Loss*and*Capital*Dividend*Stuff*–*Extra*
20. Deemed*Dividend*and*PUC*;*Extras*
21. Stated*Capital*Handout*;*Extras*
22. ITA*Provisions*related*to*PUC*and*deemed*dividends*–*Extras*
23. Examples*of*tax*consequences*of*non;cash*dividends*–*in*Appendix*
24. GAAR*Provisions*;*Extras*
25. Shareholder*Benefits*and*Loans*cases*–*in*Appendix*
26. Acquisition*of*Control*provisions*
(
Corporate residence: The common law test Laerstate BV emphasizes that one should not assume that the board exercises central
B, a German resident individual, incorporated a Dutch holding company, “BV”. B and an management and control or that the company resides where the board meets; as the
unrelated Netherlands resident, T, were at all times the directors of BV. BV’s articles court said, "mere physical acts of signing resolutions or documents do not suffice for
provided that one director could bind BV. BV acquired its sole asset, a significant actual management." It is crucial that the board actually make decisions, even if it is
investment in shares of a UK resident public company, L plc. Shortly after, B was made influenced by shareholders. The court described a scale of behaviour that serves as a
a director of L plc. useful guideline for offshore directors. At one extreme, directors mindlessly sign
documents without knowing their content. Moving up the scale, directors are aware of
The board of directors of BV met in the Netherlands. Three years after BV acquired the what they are signing but cannot determine whether it is in the company's best interest
shares of L plc, B resigned from the board of L plc. Once month later BV sold the L plc because they lack the minimum information required. Next are the directors who follow
shares, realizing a significant capital gain. the shareholders' wishes after due consideration of the minimum information required;
the decisions may be ill informed or ill advised but nevertheless are still management
The UK revenue authorities assessed BV on the gain as a UK resident. What would decisions. At the top end, directors have sufficient information to make--and do make--
they have to show to be successful? informed decisions.

See Laerstate BV ([2009] UKFTT 209 (TC)) a decision of the First Tier Tribunal (Tax).
Buckerfield’s Ltd. – “Group” of persons with majority voting shares have
-------------------------------------------------------------------------------------------------------------- control
- 50% of shares owned by PG and 50% by FG. FG
The UK First Tier Tribunal (Tax) recently decided in Laerstate BV ([2009] UKFTT 209 Issue: Was the payment made to T income, and therefore taxable?
(TC)) that a Dutch-incorporated company (BV) was centrally managed and controlled Held: Appeal was dismissed
from the United Kingdom and was thus resident there even though the board of directors Reasons:
met in the Netherlands. The decision is a reminder of the nature and location of a - “Control” within the meaning of s. 39(4)(b) contemplated that right of control that
board's decision-making process necessary to establish corporate residence. rested in ownership of such # of shares… to majority of the votes… BOD
- When a single person did not own sufficient shares to have control in that sense, it
BV was a personal holdco of a German-resident individual (Bock). In 1993, BV acquired became a question of fact whether “group of persons” did own enough shares
its sole asset, shares in a UK company (Lonrho), of which Bock shortly thereafter - “Group” could refer to any # of persons – “Group” did not imply a group that came
became director and CEO. In 1996, BV disposed of the shares; HMRC assessed the together specifically to gake advantage of the low tax rate
gain, saying that BV was a UK resident when the gain arose. Takeaway Points: Buckersfield’s says the test for de jure control is whether the majority
shareholder enjoys “effective control” over the “affairs and fortunes” of the corporation,
BV's directors were always Bock and an unrelated Dutch-resident individual (Trapman); as manifested in “ownership of such a number of shares as carries with it the right to a
Bock resigned one month before the Lonrho sale, but under BV's articles any one majority of votes in election of the BOD – look at governing statute, share register,
director could bind the company. Bock as director acted alone from within the United constating documents and USAs.
Kingdom in the management and control of BV's affairs, including all negotiations
involving the share investment, and he continued to do so after his resignation, usurping Dworkin Furs
Trapman's power. On the facts, the court said that Bock dealt with top-level "policy, - DF had 48%, Saipe had 2%, Sadie had 50%.
strategic and management matters," while Trapman merely signed documents and dealt Held: The corporation was NOT controlled by Dworkin Furs for purposes of s. 39(4)(a)
with routine matters such as accounts. of pre-1972 Act
Reasons:
The court scrutinized evidence, including Bock's travel schedules, diary entries, letters, - Affirmed Buckerfield’s “effective control” test considering ownership of such number
memos, and notes of his telephone discussions with, for example, BV's professional of shares as carries with it majority of votes in election of BOD
advisers and Lonrho's purchaser. Although the board minutes indicated that decisions Takeaway Points: 50% voting control is NOT control – must have or be part of group
were made and documents executed by Trapman alone outside the United Kingdom, that has more than 50%
there was ample evidence to suggest otherwise. Trapman had only peripheral
knowledge of and involvement in the discussions, meetings, and correspondence
between Bock and others, even when as sole director Trapman alone had authority to
bind BV and purportedly decided to sell Lonrho; Trapman was found to have merely
signed documents on Bock's instructions.

Vineland Quarries – “Associated corporations”; same group of persons; chain, and a lower-tier corporation can be controlled by more than one person or group
100% look-through rule of persons higher up the chain. In particular, under paragraph 256(6.1)(a), if a lower-tier
- VQ was one of group of corporations Minister regarded as “associated corporations” corporation (Subsidiary) would be controlled by another corporation (Parent) if one
within meaning of s. 39 of Act – VQ = 50% by S and 50% by T – S&T = 50% by ignored the persons who controlled Parent, Subsidiary is deemed to be controlled by
corporation controlled by S and 50% by T – Verben = 50% by S and 50% by T Parent and any person or group of persons that controls Parent.
- Minister viewed as all three controlled by “same group of persons”, namely, S&T – Under paragraph 256(6.1)(b), if a particular corporation would be controlled by a “first-
that is, VQ was controlled 50-50 by S (directly) and T (indirectly, through control of tier” group of persons if one ignored the persons who controlled any corporations in the
corporation which owned 50% of VQ’s voting shares) first-tier group, then the particular corporation is deemed to be controlled by the first-tier
- VQ looked only to direct share ownership and took view that persons who controlled group, and every group of persons that is comprised of, in respect of each member of
it were not S&T, but S and corporation, who comprised a different “group” from that the first-tier group, either the member or the person or group of persons that controls the
which controlled other two corporations – so “association” was not established. member. In the explanatory notes provided by the Department of Finance, the following
- So, VQ challenged Minister’s right to “look through” the interposing companies and to example is provided: X owns 100% of the voting shares of Xco, and Y and Z each own
impute ultimate control to their shareholders 50% of the voting shares of YZco. Xco and YZco each own 50% of the voting shares of
Reasons: XYZco. In this example, XYZco is considered to be simultaneously controlled by: (i) the
- “Controlled” in s. 39(4)(b) contemplated and included such a relationship as brought first-tier group comprised of Xco and YZco, (ii) the higher-tier group comprised of X, Y
about a control by virtue of majority voting power, no matter how that result was and Z, (iii) the higher-tier comprised of Xco, Y and Z, and (iv) the higher-tier group
effected (directly or indirectly) comprised of X and YZco.
- It was inappropriate to end the inquiry after looking at the share registers of the three Subsection 256(6.2) effectively provides that the simultaneous control rules of
corporations; must look at share registers of their corporate shareholders to answer subsection 256(6.1) apply in determining de facto control of a corporation as described
whether VQ and the other two corporations were controlled by “same group of in subsection 256(5.1). As a result, there can be simultaneous de facto control of a
persons”. corporation in a multi-tiered corporate structure.
- Minister was right in assuming VQ and the other two corporations were controlled by
S and T and the corporations were therefore “associated corporations” within Imperial General Properties (SCC) – How you figure out de jure control
meaning of s. 39 Held: Corporation was not a CCPC because it was controlled directly or indirectly by
Comments: one or more public corporations
Takeaway Points: Where a person controls one corporation, that person is considered Takeaway Points: Not just voting rights, but the effect of the constating documents
to control any corporation that is controlled by the first corporation (indirect control) taken as a whole (USA, articles, etc.) to determine control

256(6.1) and (6.2) – simultaneous control through a chain of corporations - CCH Duha Printers (Western) Ltd. (SCC)
Commentary ! Parthenon Overrule Takeaway Points: Where one shareholder controls in excess of 50% of the voting rights
By virtue of the Vineland Quarries case (66 DTC 5092), it is clear that de jure control of a corporation ! deemed to have de jure control UNLESS other constating documents
can flow through a chain of intermediary corporations. For example, if Parent of the corporation, such as a USA, derogate from this position of control
Corporation owns all of the shares in Subsidiary I which in turn owns all of the shares in
Subsidiary II, Parent will have de jure control of Subsidiary II. However, it is not clear 249 (4) Year end on change of control
whether Subsidiary I will have de jure control of Subsidiary II in this circumstance, since Where at any time control of a corporation (other than a corporation that is a foreign
ultimate control of the latter rests with Parent. Prior to the Federal Court of Appeal affiliate of a taxpayer resident in Canada and that did not carry on a business in Canada
decision in the Parthenon case (97 DTC 5343), the CCRA took the view that more than at any time in its last taxation year beginning before that time) is acquired by a person or
one person or group of persons in a multi-tiered corporate structure could exert de jure group of persons, for the purposes of this Act,
control over a lower-tier corporation in the corporate chain. Under this view, Parent and (a) subject to paragraph (c), the taxation year of the corporation that would, but for this
Subsidiary I in the above example would have simultaneous de jure control over paragraph, have included that time shall be deemed to have ended immediately before
Subsidiary II. However, the Court in the Parthenon case rejected this view and held that that time;
de jure control in such circumstance means ultimate control. Applying the Parthenon (b) a new taxation year of the corporation shall be deemed to have commenced at that
approach to the above example, Parent would have de jure control over Subsidiary II, time;
but Subsidiary I would not. (Note, however, that for the purposes of the associated (…); and
corporation rules, both Parent and Subsidiary I would be deemed to control Subsidiary II; (d) for the purpose of determining the corporation's fiscal period after that time, the
see paragraphs 256(1.2)(c) and (d).) corporation shall be deemed not to have established a fiscal period before that time.
Subsection 256(6.1) overrides the Parthenon finding. Effectively, it provides that control 111.(5) [When non-capital losses may be used after an acquisition of control]
in a multi-tiered corporate structure is to be determined at each level in the corporate Where, at any time, control of a corporation has been acquired by a person or group of
persons, no amount in respect of its non-capital loss or farm loss for a taxation year Sedona Networks Corporation v. The Queen (FCA 2007)
ending before that time is deductible by the corporation for a taxation year ending after - De jure control – 125(7)(b)
that time and no amount in respect of its non-capital loss or farm loss for a taxation year Comments:
ending after that time is deductible by the corporation for a taxation year ending before - Affirmed Vineland Quarries “look through” rule
that time except that - “Mythical shareholder” – creates a person and attributes to that person all shares of
(a) such portion of the corporation's non-capital loss or farm loss, as the case may be, non-qualifying shareholders
for a taxation year ending before that time as may reasonably be regarded as its loss - If they’d have control, then that is de jure control
from carrying on a business and, where a business was carried on by the corporation in
that year, such portion of the non-capital loss as may reasonably be regarded as being Multiview
in respect of an amount deductible under paragraph 110(1)(k) in computing its taxable - Non-resident owned 37.5% of Multiview’s shares directly, and 50% of another
income for the year is deductible by the corporation for a particular taxation year ending corporation which owned 43.6% of Multiview’s shares
after that time Issue: Whether Multiview was a CCPC
(i) only if that business was carried on by the corporation for profit or with a reasonable Comments: Since non-resident did not control the other corporation, it could not be said
expectation of profit throughout the particular year, and that Multiview was controlled directly or indirectly by one or more non-residents
(ii) only to the extent of the total of the corporation's income for the particular year from
that business and, where properties were sold, leased, rented or developed or services
rendered in the course of carrying on that business before that time, from any other
business substantially all the income of which was derived from the sale, leasing, rental
or development, as the case may be, of similar properties or the rendering of similar
services; and
(b) such portion of the corporation's non-capital loss or farm loss, as the case may be,
for a taxation year ending after that time as may reasonably be regarded as its loss from
carrying on a business and, where a business was carried on by the corporation in that
year, such portion of the non-capital loss as may reasonably be regarded as being in
respect of an amount deductible under paragraph 110(1)(k) in computing its taxable
income for the year is deductible by the corporation for a particular year ending before
that time
(i) only if throughout the taxation year and in the particular year that business was
carried on by the corporation for profit or with a reasonable expectation of profit, and
(ii) only to the extent of the corporation's income for the particular year from that
business and, where properties were sold, leased, rented or developed or services
rendered in the course of carrying on that business before that time, from any other
business substantially all the income of which was derived from the sale, leasing, rental
or development, as the case may be, of similar properties or the rendering of similar
services.

256(7) Acquiring control

For the purposes of subsections (…) sections 111 and 127, subsection 249(4) and this
subsection,
(a) control of a particular corporation shall be deemed not to have been acquired solely
because of
(i) the acquisition at any time of shares of any corporation by
(A) a particular person who acquired the shares from a person to whom the particular
person was related (otherwise than because of a right referred to in paragraph 251(5)(b))
immediately before that time,
(B) a particular person who was related to the particular corporation (otherwise than
because of a right referred to in paragraph 251(5)(b)) immediately before that time,

International Mercantile Factors Mimetix Pharmaceuticals

- Private company held 50% of IMF’s voting shares and two public corporations held - Mimetix’s voting shares were held 50% by a US corporation and 50% by two
the other 50%. However, a shareholders agreement (not unanimous) provided that Canadian resident individuals. The US corporation also held $3 million redeemable
there would be no change in the board, and the public companies had a majority of and retractable preferred shares of Mimetix and the licence to technology which had
the nominees of the board at the relevant time. been sublicensed without royalties to Mimetix. Mimetix also owed the US corporation
Comments: IMF was NOT A CCPC ! it was controlled de facto by one or more public $1.1 million under an interest free loan
companies Held: Evidence indicated that all decisions regarding management and administrative
decisions were made by a US resident nominee of the US corporation ! thus, Mimetix
was NOT a CCPC

Société Foncière d’Investissement

- Paul Allain held 0.2% of the company’s shares, while his two daughters held 99.8%.
The board of the company designated total management control to Allain as
“General Management”.
Held: The company was controlled de facto by Paul Allain ! thus, two other
corporations, of which Paul Allain held 100% of the shares were associated
corporations
Lenester (2003) Transport Couture (2004)
Comments: Franchise exception to de facto control - Old Mr. C liked trucks, started company (TC1), kids like business and started huge
(5.1) For the purposes of this Act, where the expression "controlled, directly or indirectly enterprise (TC), Minister argued that TC controlled TC1 as TC’s only customer, and
in any manner whatever," is used, acorporation shall be considered to be so controlled was in effective (de facto) control
by another corporation, person or group of persons (in this subsection referred to as the - Because TC was entirely economically dependent on TC1, there was control ! like
"controller") at any time where, at that time, the controller has any direct or indirect a pornography test, very subjective “you know it when you see it” type of test
influence that, if exercised, would result in control in fact of the corporation, except that, Held: Factual control found because of 1. Economic dependence, 2. Operational
where the corporation and the controller are dealing with each other at arm’s length and control, and 3. Family relationship between the shareholders
the influence is derived from a franchise, licence, lease, distribution, supply or
management agreement or other similar agreement or arrangement, the main purpose
of which is to govern the relationship between the corporation and the controller
regarding the manner in which a business carried on by the corporation is to be
conducted, the corporation shall not be considered to be controlled, directly or indirectly
in any manner whatever, by the controller by reason only of that agreement or
arrangement.
• Would have to share the small business deduction
Takeaway Points:

Silicon Graphics (2002) – on De Facto Test impossible to list all of the factors that might be taken into consideration in determining
Held: For SH to be in control there must be coordinating their activities in some way, not whether a corporation might be subject to de facto control and, after restating the test in
just a numerical majority of foreigners. Thus, definition is looking for someone who is Silicon Graphics without explicitly applying it, concluded that the evidence must
actually legally controlling the corporation demonstrate that the decision-making powers of the corporation rest with persons other
Reasons: than those with de jure control. Footnote 9 In this instance, the Court was of the view that
- De facto control requires ability to effect a significant change in BOD or its powers, or operational control, economic dependency, and the close familial relationship between
to influence it in a very direct way the SH who otherwise have ability to influence the the various shareholders were sufficient factors establishing factual control within the
board meaning of subsection 256(5.1) of the Income Tax Act.
Comments:
- Elements of factual control: 1) Clear direct influence to effect a significant change We believe that the criteria contained in paragraphs 21 and 23 of IT-64R4 Footnote 10
in BOD, 2) Influence powers of directors, 3) influence SH who would choose remain valid criteria for determining whether de facto control exists for the purposes of
directors the Income Tax Act.
- Note: overruled by s. 248(1)(c ). “mythical person” created that holds all non-
resident shares, regardless of connect between
Takeaway Points: Related Persons Examples
Related Corporations
Control in Fact Technical News No. 32: Question – CRA’s position on Section 251(2)-(5)
Lenester Sales and Transport Couture
Question
1. 251(2)(b)(i)
A Co B Co
To what extent is the CRA abiding by the principles set out by the Federal Court of
Appeal and the Tax Court of Canada in Lenester Sales Footnote 3 and 9044-9807 Québec 51% 49%
Inc. Footnote 4 in determining the scope of the rule in subsection 256(5.1) of the Income
Tax Act and the concept of “control in fact”?
C Co
Response
Are A Co and C Co related?
The Lenester Sales case involved a franchise operator. The franchisor exercised
extensive control over the corporation that operated the local franchise. In our view, the
Federal Court of Appeal's decision in Lenester Sales acknowledges that there are two
tests for determining whether control in fact exists for the purposes of subsection
256(5.1). The first is the narrower test enunciated in Silicon Graphics Footnote 5 requiring
that a person or a group of persons must have the clear right and ability to effect a
significant change in the board of directors or their powers or to directly influence the
shareholders who would otherwise have the ability to elect the board. The second is the
broader test applied in another series of cases referred to by the Tax Court of Canada in
2. 251(2)(b)(ii)
its decision and cited in our previous response with respect to the impact of Silicon
100%
Graphics at the 2002 Canadian Tax Foundation annual conference. Footnote 6 Since 2002,
the Tax Court of Canada's decision in Mimetix Pharmaceuticals Inc. has been upheld,
Footnote 7
and the appellant in Rosario Poirier Footnote 8 withdrew its appeal of the Tax Court A Co Mr A Mrs A Mr Z
of Canada's decision following the release of the Federal Court of Appeal's decision in 10 10 49
9044-2807 Québec Inc. in January 2004. 31
B Co
In 9044-2807 Québec Inc., the Federal Court of Appeal considered a situation involving
three corporations owned by members of a family. The Minister denied two claims for the Are Mrs A and B Co related?
small business deduction on the basis that all three corporations were associated by
virtue of de facto control. The Federal Court of Appeal upheld the Tax Court of Canada's
decision denying the appeal. In arriving at its decision, the Court indicated that it is 3. 251(2)(b)(iii)
 With reference to the structure in 2., would a corporation all the shares of which are owned by Edward Brad Andrew Catherine Dianna
Mrs A, be related to B Co? 100% 24 25 26 25

E Co F Co
4. 251(2)(c)(i)
A Co
If Catherine is Andrew’s and Brad’s niece and Edward’s daughter, and Brad and Andrew are
60% 55% Edward’s brothers, are E Co and F Co related? (Dianna is a business associate of Andrew.)

B Co C Co [no example for 251(2)(c)(v)]

9. 251(2)(c)(vi)
B Co and C Co are related.

W X Y Z A B C Z
5. 25% 25% 25% 25% 35% 35% 20% 10%
X Y Z X Y Z
40 25 35 20 45 35
BlueCo YellowCo
A Co B Co

W, X, Y, and Z are business associates. A, B, C are the common law partners of W, X and Y.
Are A Co and B Co related? Do the members of the group need to be related for A and B to be
related?

6. 251(2)(c)(ii)

Ms. Y Mr. J Ms. K

100 51 49

A Co B Co

Mr. J is Ms. Y’s brother; Ms K is his business partner. Are A Co and B Co related?

7. 251(2)(c)(iii)

Mr. X Janice Katherine

100 15 85

A Co B Co

If Janice is the common law partner of Mr. X’s son, and Katherine is Janice’s sister, are A Co and
B Co related?

8. 251(2)(c)(iv)

Associated Corporations - Problems 3. 256(1)(e)

Associated Corporations Andy, Bob, Julie Andy, Jane, Bill

1. 256(1)(c)
Mr. A Mrs. A. Mr. X

75% 25% 80% 20%

X Co. Y Co.

• Bob and Julie are Andy’s children, but not Jane’s

A Co. B Co. • Jane is Andy’s wife (i.e. she married Andy after he already had Bob and Julie with someone else)
• Bill is Andy and Jane’s son
• Each corporation is de facto controlled by a related group
• Each of the members of group 1 are related to all the members of group 2
Are A Co. and B Co. associated? • 252(1(c): Bob and Julie are related to Jane
• Andy and Jane are related by marriage: 251(6)(b)
2. 256(1)(d) • Andy is related to himself – 256(1.5)
Andy Mr. Brown Mrs. Brown Calvin • Is Bill related to Bob and Julie? If CRA is correct in its position that half-siblings are related, yes.
• So if Andy owns not less than 25% of the shares of each corporation X Co. and Y Co. will be
associated.
25% 25% 25% 25%

100%

A Corp. B Corp.

Under a shareholders’ agreement, Mr. And Mrs. Brown are both entitled to a seat on the Board of
Directors so long as they hold their shares, and the articles specify a maximum of 3 directors. Andy is
the Brown’s adopted son. Are A and B associated?
 Example – Refundable Taxes – 186(1)(b) Addams Family RDTOH Problem

• Investco receives a $1000 (eligible) dividend from Pubco. Investco can deduct the dividend
under 112(1) for the purposes of Part I tax. Investco is a private corporation so it must pay 33
1/3% Part IV tax on the dividend under 186(1)(a) ($333), and is entitled to a refund of this tax of
$1.00 for every $3.00 it distributes as a dividend to Subjectco. Investco’s RDTOH will increase
by the amount of Part IV tax it pays on the dividend, and decrease with the refund it receives.

• Subjectco must pay Part IV tax on the dividend it receives from Investco under 186(1)(b)
because Investco and Subjectco are connected. Investco is entitled to a dividend tax refund in
respect of the dividend paid to Subjectco, and Subjectco’s share of the dividend is 100%, so
Subjectco will be liable for $333 in Part IV tax, and this amount will be added to its RDTOH.

• Is the dividend Investco pays to Subjectco an eligible dividend?

• When Subjectco pays a dividend of $1000 to its shareholders, how will it be taxed?

Federal dividend tax credit (6/11 x 950) = (518) (ITA s. 121(b))

Analysis of RDTOH – AII problem BC dividend tax credit (36.315% x 950) = (345) (BC Income Tax Act s. 4.69(b))

Answers: Analysis of RDTOH – AII problem Combined BC and Federal personal tax payable on the $2500 dividend = $644 (effective rate of
25.8%).
1. Holdco has $10,000 in (eligible) portfolio dividends and $50,000 in aggregate investment
income (“AII”) for a total income of $50,000 for Part I tax purposes after 112(1) deduction. 7. continued: Now assume that Investco has designated an eligible dividend of $20,000 when its
year end GRIP balance was only $10,000. What are the consequences?
2. Holdco includes $10,000 dividends in income; claims 112(1) deduction
Since Holdco, a CCPC, had only $10,000 in income in the form of portfolio dividends, which were
3. Part IV tax on $10,000 = $3333 (186(1)(a)) most likely “eligible dividends”, it only had GRIP of $10,000 (89(1) “general rate income pool”. (AII
is effectively taxed at the preferential low rate of less than 20% after the refund of 26 2/3 from
4. Part I tax on AII @44.67% = 22,335 RDTOH, so would not be included in Holdco’s GRIP.) This means that Holdco could only
25,668 designate a $10,000 eligible dividend when it paid the total of $30,000 in dividends to Investco. If
we assume (and admittedly the question isn’t clear on this point) that Holdco didn’t designate an
Tax rate on AII is composed of 28% federal tax (net of provincial abatement, but without the general eligible dividend of $10,000, then Investco would probably have no GRIP. As a CCPC, if Investco
rate reductions, 6.67% refundable tax (123.3) and 10% BC tax. designates a dividend as eligible in excess of its GRIP at the end of the tax year in which it pays
the dividend, it has made an “excessive eligible dividend designation” (89(1)) and is subject to the
5. Holdco’s RDTOH will increase by $3333.33 (129(3)(b)) + 13,333 (26 2/3% x AII, under Part III.1 penalty tax of 20% of the excess (185.1(1)). It is important to remember, however, that
129(3)(a)) for a total of $16,667.00 [Question doesn’t give opening balance in RDTOH] the dividend is still eligible for the recipient shareholders, even if the paying corporation had
insufficient GRIP. Shareholders who are not at arm’s length from the distributing corporation may
6. Holdco in turn pays a dividend of $30,000 to Investco. Can Investco deduct the dividend under be jointly and severally liable with the distributing corporation for the Part III.1 tax (185.2(3)) and
112(1)? Yes. It’s a taxable dividend received from a taxable Canadian corporation. see second last paragraph of p. 8 of the Evans and Schusheim article).

How much is Holdco’s dividend refund (129(1))? $1 for each $3 of dividend, so $10,000 Note that a corporation that has made an EEDD may also elect within a given time to treat the
excessive amount as a separate “ineligible dividend” under 185.1(2), but the corporation and all its
How much Part IV tax will Investco be liable for under 186(1)(b)? $10,000 – 100% of Holdco’s shareholders must agree and the shareholders then become assessable for the additional tax,
dividend refund, since Investco holds 100% of Holdco. If Investco held only 40% of Holdco, it penalties and interest (185.1(3)) We didn’t cover this in the class on eligible dividends, but it is
would be liable for only $4000 as Part IV tax. another option.

What is Investco’s RDTOH upon receiving the dividend (i.e. after paying its Part IV tax under Investco, on paying the eligible dividend of $10,000 to its shareholders, becomes entitled to a
186(1)(b) if we assume it had nil RDTOH before? $10,000. dividend refund of? S. 129(1). $3333 (1/3 x10,000).

How is Holdco’s RDTOH affected by paying the dividend? It is reduced by its dividend refund Investco’s RDTOH after paying the eligible dividend refund will be? $6667, assuming it was
of 10,000, so if we assume it was $16,667 before paying the dividend, it will be $6,667.00. $10,000 before.

7. Investco pays an eligible dividend to its shareholders of $2500 each, totalling $10,000. If Investco takes its dividend refund and pays it out to its shareholders, it will receive a new
Assume all the shareholders are in the top tax bracket; calculate their income inclusions and dividend refund, and reduce its RDTOH as well. What will these amounts be, and under what
dividend tax credits for federal and BC purposes. provisions? It will receive $1 for each $3 it distributes, so it will receive a dividend refund of $1111,
and its RDTOH will be reduced by this amount.
Each shareholders include s $2,500 in income (82(1)(a.1)(i)
plus the gross up of 38% $ 950 (82(1)(b)(ii)) II. Opco Issues
Total: 3450
Opco has Active Business Income (ABI) of $500,000
Federal tax at 29% = 1000 It pays BC and federal tax @ 13.5% = $67,500
BC tax @ 14.7% = 507 It has $432,500 left in retained earnings. Are these included in its GRIP?
Total personal TOP = $1507
No, these earnings have been subject to the preferential tax rate for active business income of a
CCPC, and so do not form part of GRIP. Examples of tax consequences of non-cash dividends
Here are some simple examples of how the deemed dividends in section 84 apply.
What should it do with the retained earnings? Buy equipment, replenish reserves, pay down debt, These are the only two that are examinable in this course.
pay a dividend to its shareholder (Holdco), invest it in the capital markets?
Note that deemed dividends are treated the same as other dividends, so that the gross
If Opco invests its retained earnings in publicly traded Canadian company shares, interest bearing up and dividend tax credits on eligible or ineligible dividends apply in the case of
securities, capital properties that appreciate in value, etc., what will be its tax situation on this individuals, and 112(1) applies, and Part IV may apply, where the recipient is a
income? corporation. The point of this topic was to bring to your awareness the prevalence of
deemed dividends in the Income Tax Act, and the concept of PUC, not to require you to
It will have portfolio dividends, and aggregate investment income .The portfolio dividends, probably become corporate law experts. These examples are intended to illustrate how these
designated as eligible dividends, will be subject to Part IV tax because Opco is a private deemed dividends arise, and how they interact with the capital gains system.
corporation. Eligible dividends will be included in Opco’s GRIP. The aggregate investment income
will be subject to the refundable tax regime and will not be part of Opco’s GRIP. 1. 84(1): capitalization of surplus

If instead it pays a dividend of $100,000 to Holdco, what will be the tax consequences to Holdco? A Co has stated capital of $1,000,000, composed of 1 million common shares which
were issued for $1 per share. Accordingly, under s. 89, A Co’s paid up capital is $1 per
Holdco will have $100,000 in income in ineligible dividends (section 82(1)(a)) share, and $1 million in total.

Can Holdco deduct the dividend? Yes (section 112(1)) A Co has retained earnings (tax paid profits from preceding years not distributed to
shareholders) of $3,000,000.
How much Part IV tax will Holdco pay on the dividend? Nil. Opco and Holdco are connected, so
186(1)(a) doesn’t apply. Since Opco will not receive a dividend refund when it pays the dividend to A Co’s board of directors decides to increase the stated capital by capitalizing
Holdco (it appears to have no RDTOH), 186(1)(b) does not apply. $2,000,000 of the retained earnings. It obtains the approval by special resolution of the
shareholders, as required by CBCA 26(5). $2,000,000 will therefore be added to stated
How much refundable tax on AII will Holdco pay on the dividend? capital, and the same amount removed from retained earnings.
Nil. Dividends that are deductible under 112(1) are not included in AII.
A Co stated capital will then be $3,000,000, or $3 per share.
Holdco then pays a dividend of $100,000 to Investco. How much of a dividend refund will Holdco
be entitled to? 84(1) treats this allocation of retained earnings to share capital as a dividend to the
shareholders. Each common shareholder will be deemed to have received a dividend of
Potentially, $33,333 but only up to its RDTOH. Holdco’s RDTOH may be only $6667, and so that $2 on each share held, even though no cash is distributed. In addition, the cost base of
is the maximum refund it can receive – 129(1)(a)(ii). (see no. 6 on the first page). each share will be increased by the amount of the dividend deemed to have been
received, so that the ACB of each share will be $3.00 (53(1)(b)). Since the shareholder
How much Part IV tax will Investco be liable for? has already been taxed on the $2.00, it would be double taxation to tax this amount
$6667, according to 186(1)(b) again when the shareholder sells the share.
!
! 2. 84(3) Repurchase or redemption of shares

This is the most commonly encountered deemed dividend.

R holds 100 shares of D Co which have PUC of $500 ($5/share) and ACB to R of $1000
($10/share). D Co repurchases 10 of the shares for $200 ($20/share).

R is deemed to receive a dividend of $200 - $50 = $150.

R has also disposed of 10 shares for proceeds of $50 ($200 - $150) because the amount
of the deemed dividend is excluded from the POD. This gives R a capital loss of $50.

More complicated scenario:

million; $1 per share.

X Co has 100 million issued common shares. The PUC of the common shares is $500 5 years later, Corporation Y issues another million shares, but now, because Y Corp has
million or $5 per share. been successful, earned profits, acquired assets and grown its business, the market
price of a share of Y is $2, so each person who subscribes for the new issue pays $2 per
F purchased 1000 shares of X Co for $2 per share long ago. More recently, H share.
purchased 1000 shares of X Co for $8 per share. Total stated capital of Y is now $3 million. Stated capital per share = $1.50
Total value of issued shares = $4 million
X Co makes a general offer to shareholders to purchase up to 10 million shares for a Linda bought 1000 shares in the first offering of $1, so she has shares with a stated
purchase price of $12 per share. Z Co makes a takeover bid for all of X Co shares for capital of $1500, but they are now worth $2000. Her ACB is $1000.
$10 per share. Two years later, Corporation Y has been profitable and well-run, and her shares are
worth $5000, so she sells them to Bob. Linda will have a capital gain of $4000 (40(1)(a)),
Which offer should F and H accept? taxable capital gain of $2000 (38(a)).
Bob now has shares with a market value of $5000, and a stated capital of $1500.
Offer from X Co.(repurchase) Corporation Y then issues 1 million more common shares at $5 per share. What is the
stated capital per share of Bob’s shares? What is Bob’s ACB?
F will have a deemed dividend of $7 per share, and a capital gain of $3 per share.

H will have a deemed dividend of $7 per share and a capital loss of $3/share. Deferral of tax in a CCPC
It is still worthwhile to defer tax in a CCPC in respect of active business income. Imagine
Offer from Z Co. you are a doctor practicing through a private medical corporation. All the private medical
corporation’s fees are active business income earned in Canada. It has a tax year-end
F will have a capital gain of $8/share. H will have a capital gain of $2/share. of December 31.

Result before 2006: even though X Co. will pay more for the shares, the shareholders **Note: PMC can’t be a personal service business because doctors are not employees of
are probably better off after tax with the lower Z Co offer, because of the higher effective their patients.
rate of tax on dividends over capital gains. But after 2006, if the deemed dividend is an
eligible dividend, X Co’s offer is probably better after tax. Again after 2011 dividends The PMC has profits of $250,000 in Year 1 before paying your salary, but after deducting
became taxable at higher rates than capital gains, though the difference is not great all other expenses. PMC pays you $10,000 per month, or $120,000 annually. In
(25.8% is the top rate for eligible dividends; 21.85% for capital gains, in BC). It depends December of Year 1, PMC declares a bonus payable to you of $20,000, the maximum
in part on the ability of a particular shareholder to use the capital loss against capital contribution to your RRSP for the year. It deducts the bonus as an expense in Year 1,
gains, and/or their ability to offset gains with losses. but pays the bonus to you in January of Year 2, by depositing it directly into your RRSP.
When you file in April of Year 2, you deduct the $20,000 as an RRSP contribution from
your $120,000 income and receive a tax refund. Your top marginal rate on your salary
Explanation of stated capital vs. market value would be 40.7% BC/federal combined. (You also put $5000 or $5500 into a tax-free
Stated capital is an accounting entry, tracking the number of shares issued times the savings account each year.)
issue price. It reflects the capital contributed by the shareholders.
It is not the same as the market value of the shares. Note that in each subsequent year you will have the bonus of $20,000 to report as well,
Stated capital does not usually diminish, except in unusual situations where there is an so that your salary income will be $140,000. You have effectively deferred $20,000 in
actual decision to reduce stated capital by a repurchase [s. 34] or redemption of shares income indefinitely.
[s.36], or another reduction of the number of shares issued, or the stated capital per
share [s.38]. Note that the same solvency and stated capital tests apply to these PMC deducts $140,000 salary in computing its profit for Year 1, because at the end of
decisions as to the decision to declare and pay a dividend. the year it had a payable, the bonus. That leaves profit of $110,000.
Normally, stated capital is only increased, as more shares are issued.
The stated capital per share is not the value of the share. The value of the share is a Tax on the $110,000 = $20,150 (at 13.5%)
reflection of the success of the corporation, whether it is earning profits or making
losses, whether its assets are growing in value or diminishing, The remaining (approximately) $90,000 is retained earnings, from which a “ineligible”
Example dividend can be paid. If PMC declares the dividend (12(1)(j), 82(1)(a)(i), you will have to
Corporation Y issues 1 million common shares for $1 per share. Stated capital is $1 gross it up (x 25%, 82(1)(b)(i)) and pay tax on the grossed up amount, claiming the
dividend tax credits of 2/3 of the gross up (federal, 121(a)) and 17% of the gross up (BC, Examples of tax consequences of non-cash dividends
s. 4.69(a)). The effective rate of tax on the dividend is 33.75% if you are in the top tax Dividend in kind
bracket, which you would be for most of the dividend.
X Co holds 200,000 shares of Y Co which it acquired at a cost of $1 per share. The
Or the $90,000 can be left in the corporation. PMC would probably invest it (if the shares of Y co are now worth $2 each. X Co distributes 10,000 shares of Y Co to each
medical professional rules permit the corporation to do so), so that the PMC will end up of its 20 common shareholders as a dividend in kind.
having aggregate investment income subject to the 44.67% tax, and/or portfolio
dividends subject to Part IV tax. PMC may decide to pay dividends sufficient to clear its The shareholders must each report a dividend under 12(1)(j) of $20,000, gross it up
GRIP and the RDTOH and recover any refundable tax. To the extent that capital gains under 82(1)(b), and pay tax, claiming the dividend tax credit, on the dividend.
on investments are unrealized, this may not be a very high amount.
X Co will have a capital gain of $100,000 (POD of $200,000 minus ACB of $100,000;
After 3 or 4 years you take a sabbatical. This is the time for PMC to pay the ineligible 40(1)(a)(i)) and each shareholder will be deemed to have acquired the Y Co shares at
dividends, because while you aren’t receiving salary, you can receive about $45,000 tax the cost of $2 per share.
free as dividends due to the way the dividend tax credit and the personal credit interact.
This would also be an effective retirement savings plan to supplement your RRSP (and Stock dividend
TFSA).
A Co has 5 shareholders, all members of a family. Each shareholder holds 20 common
If PMC had paid you a higher salary, you would have paid tax on it at 43.7% in BC. shares of the total 100 issued common shares. A Co has retained earnings of $500,000.
Instead, the retained earnings have been subject to only 13.5% initially. When paid out
to you they are taxable, but at a lower marginal rate. If you assume that you can defer A Co declares a stock dividend on its common shares of 5 Class B preferred shares per
receiving a significant amount of the additional dividends until a year when you are on common share, so that each shareholder has 100 Class B preferred shares. Each Class
sabbatical or retired, there is a significant benefit to retaining earnings in the corporation. B preferred share has a par value of $.01 and is redeemable and retractable at the price
of $1000.00 per share. Class B shares do not entitle the holder to any dividends, and
Say PMC pays you $80,000 in dividends in the year you are not earning salary. Your top once the redemption price is paid, the Class B shares do not participate in surplus
marginal rate would be 32.5% combined. The calculation below applies the progressive assets.
rates to dividend income of $80,000.
Each common shareholder now holds 100 Class B preferred shares; a total of 500 Class
Income inclusion: $80,000 + gross up of $20,000 = $100,000 B preferred shares are issued.
Federal and BC tax before credits: 25,454
Federal dividend credit (13,400) A Co must reflect the issue of the Class B shares in its stated capital account. Under
BC credit (3400) 248(1) “amount” the stated capital of the Class B shares is $5.00, or $.01 per share. The
Personal credit (1623) stock dividend would result in a dividend of $1 per shareholder.

Tax after credits: $7031 A shareholder who has no other income in a year might decide to retract 30 Class B
Effective rate: $8.7% shares. This would result in a deemed dividend under subsection 84(3) of $30,000
(Plus 13.5% tax on initial income earned by PMC.) (actually $29,999.70), which as we saw can be received free of tax when the basic
personal credit and the dividend tax credit are combined.
Of course, if you have a low-income spouse, and the professional rules applicable to
your corporation allow them to hold shares in the professional corporation, there is a Anti-avoidance provision: 15(1.1)
very valuable opportunity to income split both while you are earning a salary, and during !
sabbatical years and retirement.
Youngman (1990, FCA) – Fair market value
In order to assess the value of a benefit for the purposes of paragraph 15(1), it is first necessary
! to determine what that benefit is, or in other words, what the company did for its
shareholder; second, it is necessary to find what price the shareholder would have had to
pay, in similar circumstances, to get the same benefit from a company of which he was not a
shareholder. In the present case, the benefit or advantage conferred on the appellant was not
merely the right to use or occupy a house for as long as he wished; it was the right to use or

occupy for as long as he wished a house that the company, at his request, had built specially for bona fide business transaction entered into with the respondent qua customer or arm's length
him in accordance with his specification. How much would the appellant have had to pay for contractor with the respondent.
the same advantage if he had not been a shareholder of the company? Certainly more than
what the two experts referred to as the free market rental value since, in my view, the Thus the learned Tax Court judge should have concluded that Fobasco had provided this
company would have then charged a rent sufficient to produce a decent return on its shareholder with a benefit consisting of a luxury home of his choice over which he had exclusive
investment. use and control. On that basis I can see no error in the assumptions of the Minister. An amount
equal to the equity rate of return is, I believe (in the words of this Court in Youngman) what price
Fingold (1997, FCA) – Have to value what the corporation gave the the shareholder would have had to pay, in similar circumstances, to get the same benefit from a
shareholder and what would their return on equity been if they hadn’t company of which he was not a shareholder.
conferred it on the shareholder
Therefore the appeal should be allowed with costs.
Because the learned Tax Court judge here had regard to some of the earlier jurisprudence without
consideration of the return to first principles mandated by this Court in Youngman he failed, I
believe, to take into account some of the relevant facts. In my view those facts lead to a Other cases on shareholder benefits
conclusion similar to that in Youngman. Some of these relevant facts are as follows. The Kallies v. The Queen 2002 DTC 6707 (FCA)
respondent himself testified that this particular unit was chosen because it was close to his
mother's apartment in the same building. He testified that it was a family tradition to vacation in • Amounts paid to racing car driving schools by a corporation of which Kallies was the
Palm Springs (sic; should be Palm Beach). During the years in question the respondent and his sole shareholder, to enable him to improve his skills as a driver, were included in his
family did not take any other winter vacation or go elsewhere than to the condominium. He stated income under 15(1). The TCC ruled that the expenses had not been incurred for the
that the business entertaining involved only one to five couples at a time. The room used in part benefit of the corporation, but were for the personal benefit of the taxpayer.
as an office was some 300 square feet in size (compared to the total apartment dimensions of
4,600 square feet). All these matters lead to the conclusion that the selection and character of this Spicy Sports Inc. and Steve Cousins v. The Queen 2004 UDTC 123 (Informal)
apartment were primarily for the personal accommodation of the taxpayer and were essentially
for his benefit. • Cousins owned 51% of the shares of SSI and was its president. His wife owned 32% of
the shares of SSI. The amount paid by the insurer for SSI for knee surgery for Cousins,
Of equal importance to the analysis is the total lack of certain kinds of evidence before the Tax about $35,000, was included in Cousins’ income by virtue of subsection 15(1). Cousins
Court to support the respondent's position that he was not getting the benefit of a personal argued that the benefit was non-taxable under 6(1)(a)(i), as a non-taxable employee
residence paid for by the company. In noting the absence of evidence in support of the benefit.
respondent's position it must be emphasized that the onus was on him throughout to demonstrate
that the Minister's assumptions were wrong. Thus it is significant that counsel for the respondent • On June 1, 2000 the Corporation purchased a “cost plus” insurance policy from Zurich
could direct us to no evidence that anyone in the company other than the respondent and his Life. There was no evidence that the benefits of this policy, or any other similar health
brother ever used this condominium; or that the company indeed had any record of its use for insurance policy were available to any employee other than Cousins. Four or five months
business purposes which one might reasonably expect in relation to a $4 million company asset. after the purchase of the policy, Cousins had the knee surgery performed in San
Francisco. Cousins paid for the surgery, SSI paid the insurance company, and then the
In summary, if the learned Tax Court judge had focussed on the legal test as defined by this insurance company reimbursed Cousins, after deducting an administration fee.
Court in Youngman, namely what did Fobasco do for this shareholder, he would have
concluded that the company had provided the respondent with a luxurious apartment, • The TCC found that the policy would not have been contracted by SSI had Cousins not
chosen by the respondent in a building selected for family reasons, which apartment was been a shareholder, and that Cousins received the reimbursement as a shareholder, not as
renovated and furnished solely at the direction of the respondent or his wife and whose use an employee. There was no evidence that the corporation received any benefit from the
was at the sole control of the respondent and his family. The apartment was used for winter knee surgery.
vacations in the same city, and the same building, where the family had enjoyed winter vacations
for years. It may have been anticipated that the respondent would on occasion entertain business Gillis v. The Queen 2006 DTC 2093
visitors there, just as many people in business or in senior salaried positions are expected because
of their position to entertain business or professional associates. But nothing in the evidence • Taxpayer was the president, majority shareholder an employee of the corporation. The
explains any business need for five bedrooms with ensuite baths or a restaurant-type kitchen, Minister included in his income the value of a golf club membership paid for by the
considering that on only one occasion did a business guest stay at the apartment and the number corporation. The TCC held that the evidence indicated that the corporation received a
of business guests entertained never exceeded five couples. The presence of an "office", a significant benefit from the golf club membership, in that the taxpayer was able to
dressing room fitted with a desk and office equipment amounting to 300 square feet in a 4,600 develop business relationships and promote the corporation while entertaining clients and
square foot apartment, is certainly not supportive of the view that the provision to the respondent potential clients of the corporation at the golf club. Therefore only 40% of the value of
of the apartment as a whole was a normal business transaction. If it were, thousands of private the golf club membership was included in the taxpayer’s income.
homes could be considered business premises. This arrangement therefore cannot be seen as a
 NO.: IT-177R2 (Consolidated) DATE: See Bulletin Revisions section

SUBJECT: INCOME TAX ACT

Permanent Establishment of a Corporation in a Province

REFERENCE: Subsections 124(1) and 124(4) of the Income Tax Act (the “Act”) and subsection 400(2) of the Income Tax
Regulations (the “Regulations”)

Latest Revisions – Title, Reference, Contents, Application This version is only available electronically.
and Summary sections and ¶s 1-4, and 7
Contents
At the Canada Customs and Revenue Agency (CCRA), we
Application
issue income tax interpretation bulletins (ITs) in order to
Summary
provide technical interpretations and positions regarding
Discussion and Interpretation
certain provisions contained in income tax law. Due to their
Definition (¶ 1)
technical nature, ITs are used primarily by our staff, tax
Determination (¶ 2)
specialists, and other individuals who have an interest in tax
Fixed Place of Business (¶ 3)
matters. For those readers who prefer a less technical
Employee or Agent (¶s 4-5)
explanation of the law, we offer other publications, such as
Substantial Usage of Machinery or Equipment (¶ 6)
tax guides and pamphlets.
Rental Operation (¶ 7)
While the comments in a particular paragraph in an IT may Subsidiary of a Corporation (¶ 8)
relate to provisions of the law in force at the time they were Bulletin Revisions
made, such comments are not a substitute for the law. The
reader should, therefore, consider such comments in light of
the relevant provisions of the law in force for the particular
Application
taxation year being considered, taking into account the effect This bulletin is a consolidation of the following:
of any relevant amendments to those provisions or relevant • Interpretation Bulletin IT-177R2 dated May 4, 1984;
court decisions occurring after the date on which the • Special Release to IT-177R2 dated August 25, 1995; and
comments were made.
• subsequent amendments thereto.
Subject to the above, an interpretation or position contained in For further particulars, see the “Bulletin Revision” section
an IT generally applies as of the date on which it was near the end of this bulletin. Unless otherwise stated, all
published, unless otherwise specified. If there is a subsequent statutory references throughout the bulletin are to the Act.
change in that interpretation or position and the change is
beneficial to taxpayers, it is usually effective for future
assessments and reassessments. If, on the other hand, the
Summary
change is not favourable to taxpayers, it will normally be In order for a corporation to have “taxable income earned in
effective for the current and subsequent taxation years or for the year in a province”, it is necessary to determine whether
transactions entered into after the date on which the change is it has a permanent establishment in that province in the year.
published. A corporation will have a permanent establishment in a
province if it has a fixed place of business there. It may also
Most of our publications are available on our Web site at: have a permanent establishment in certain other
www.ccra.gc.ca circumstances, such as when it carries on business through an
employee or agent, or uses substantial machinery or
If you have any comments regarding matters discussed in an
equipment in a province. Where a corporation has a
IT, please send them to:
permanent establishment in a province in a year, 10% of its
Manager, Technical Publications and Projects Section taxable income earned in the year in that province may be
Income Tax Rulings Directorate deducted from its Part I tax otherwise payable.
Policy and Legislation Branch
Canada Customs and Revenue Agency
Ottawa ON K1A 0L5

or by email at the following address: bulletins@ccra.gc.ca

IT-177R2 (Consolidated) IT-177R2 (Consolidated)

Discussion and Interpretation establishment in the province if it satisfies any of the other to the comments in the current version of IT-420, Subsidiary of a Corporation
criteria listed in subsection 400(2) of the Regulations. A Non-Residents −Income Earned in Canada, rental income of
¶ 8. A corporation’s subsidiary in a province or a
Definition corporation is deemed to have a permanent establishment in a a corporation will be considered to constitute income from a
subsidiary engaged in trade or business in a province does
¶ 1. The term “permanent establishment” is defined in particular place if it carries on business through an employee business. If a corporation has rental income from real estate
not in itself constitute a permanent establishment of the
subsection 400(2) of the Regulations in connection with the or agent established in that place with a general authority to that is income from a business, the corporation will have a
corporation. However, the subsidiary may be an agent of the
determination of “taxable income earned in the year in a contract on behalf of the corporation. The fact that a permanent establishment in each province in which it has a
corporation with general authority to contract on its behalf, in
province” (as defined in subsection 124(4)) for purposes of corporation has business dealings in a particular place rental property because each property will be considered a
which case the corporation would be deemed to have a
the deduction under subsection 124(1). through a commission agent, broker or other independent fixed place of business. If a corporation has rental income
permanent establishment in the province (as described
agent is not in itself enough to result in a permanent from other business operations, a permanent establishment
in ¶ 4).
establishment. However, there is nothing in the law which for those operations may or may not exist in accordance with
Determination excludes a commission agent, broker or other independent the rules discussed in this bulletin, depending on the facts of
¶ 2. To determine if a corporation has a permanent agent from the reference to an “agent” in the the case.
establishment in a province, it is necessary to see if the above-mentioned deeming rule. Therefore, a permanent
corporation meets any of the criteria in subsection 400(2) of establishment would be deemed to exist in a particular place
the Regulations. This will often involve questions of fact where a corporation carries on business through such an
which must be answered by the circumstances of each case. agent who is established in that place and has general
An establishment in a province is not a “permanent authority to contract for the corporation.
establishment” as contemplated in the Regulations unless a
business is connected with it. Ownership by the corporation ¶ 5. A corporation will also be deemed to have a
of a farm, timber land, factory or a workshop does not permanent establishment if an employee or agent, established
constitute a permanent establishment of the corporation in a particular place, has a stock of goods owned by the
unless it is used in its business. However, if a corporation corporation from which the employee or agent regularly fills
otherwise has a permanent establishment in Canada and orders. The orders may be received directly from the
owns land in a province, such land is deemed to be a corporation or may come from the customers themselves.
permanent establishment. For the purpose of determining “Regularly” is taken to mean repeatedly according to an
whether a non-resident corporation has a business in a established pattern. A corporation which transacts all its
province, it should be noted that the deeming rules in business from a source outside the province through mail
section 253 apply. order and catalogue sales and does not have a stock of goods
in the province will not usually have a permanent
Fixed Place of Business establishment in that province.
¶ 3. If a corporation has a fixed place of business in a
province, it has a permanent establishment according to the Substantial Usage of Machinery or
Regulations. A fixed place of business may include a place, Equipment
plant or natural resource used in the day-to-day business of ¶ 6. A corporation that uses substantial machinery or
the corporation. It does not mean that the place of business equipment in a particular place in a province will be deemed
must exist for a long time or be located in a durable building; to have a permanent establishment in that province. The
for instance, a temporary field office on a construction site corporation need not own the machinery or equipment that it
could be a fixed place of business. uses. The size, quantity and dollar value of machinery or
equipment used in the particular place are some of the
Examples of fixed places of business are set out in criteria to be considered in the determination of “substantial”.
subsection 400(2) of the Regulations but these are not A comparison of the total or type of machinery or equipment
exclusive nor are they absolute. A public warehouse that is used by the corporation as a whole with that used in the
used by a corporation, but that is neither owned by it nor particular place is not relevant. Another factor that may be
under some measure of its control, does not constitute by taken into account in the determination is whether the said
itself a permanent establishment of that corporation. An machinery or equipment contributes substantially to the
office that is maintained and controlled by an employee of generation of the gross income of the corporation earned at
the corporation at the employee’s choice and expense or an the particular place. The display or demonstration of
office that is maintained solely to purchase merchandise is machinery or equipment by an agent is not a use as
not in itself deemed to be a permanent establishment of the contemplated by subsection 400(2) of the Regulations. A
corporation. Where a corporation does not have any fixed permanent establishment will not be considered to exist in a
place of business (in or outside Canada), it will have a province solely by reason of the fact that a bus or truck
permanent establishment in the principal place in which the travelled through that province.
corporation’s business is conducted.
Rental Operation
Employee or Agent
¶ 7. It is a question of fact whether a rental operation
¶ 4. If a corporation does not have a fixed place of constitutes the carrying on of a business or whether rents
business in a province, it may still have a permanent received constitute income from property. Generally, subject

2 3
 4/12/13 Designated Stock Exchanges
IT-177R2 (Consolidated)

Bulletin Revisions
Home  >  Activities  and  issues  >  Designated  Stock  Exchanges  
Since the issuance of IT-177R2 on May 4, 1984, there have The last sentence of ¶ 2 has been revised to clarify its
been no significant revisions to ¶s 2, 5, 6 and 8. meaning. [November 11, 2003] DESIGNATED  STOCK  EXCHANGES
The reference in the title of the previous bulletin to “a In ¶ 3, a sentence has been added which deals with the
foreign enterprise in Canada” has been deleted in order to situation described in paragraph 400(2)(a) of the
Canada:  Canadian  National  Stock  Exchange  (CNSX)
clarify that this bulletin deals with the determination of Regulations. [November 11, 2003] Canada:  Montreal  Exchange
permanent establishments for provincial allocation purposes Canada:  TSX  Venture  Exchange  (Tiers  1  and  2)
only. [November 11, 2003] ¶s 4 and 7 have been modified by the Special Release to Canada:  Toronto  Stock  Exchange
IT-177R2, dated August 25, 1995. Australia:  Australian  Securities  Exchange
The Reference section has been changed to more accurately Austria:  Vienna  Stock  Exchange
reflect the content of the bulletin. [November 11, 2003] The last sentence of ¶ 4 has been changed in order to clarify Belgium:  Euronext  Brussels
its meaning. [November 11, 2003] Bermuda:  Bermuda  Stock  Exchange
“Content”, “Application” and “Summary” sections have Czech  Republic:  Prague  Stock  Exchange  (Prime  Market)
been added to the bulletin, as well as headings above certain Comments in ¶ 7 have been revised to indicate that they only Denmark:  Copenhagen  Stock  Exchange
apply in determining whether a corporation’s rental Finland:  Helsinki  Stock  Exchange
paragraphs. [November 11, 2003]
operation will constitute a permanent establishment in a France:  Euronext  Paris
Germany:  Frankfurt  Stock  Exchange
¶ 1 has been modified to delete the last sentence because the province. [November 11, 2003]
Germany:  Boerse  Stuttgart  AG  (Stuttgart  Stock  Exchange)
bulletin is not intended to deal with whether a foreign Hong  Kong:  The  Hong  Kong  Stock  Exchange
enterprise has a permanent establishment in Canada. In Throughout the bulletin, we have revised the references to
Ireland:  Irish  Stock  Exchange
addition, a reference to subsection 124(4) of the Act has “Regulation 400” to “subsection 400(2) of the Regulations” Israel:  Tel  Aviv  Stock  Exchange
been added. [November 11, 2003] in order to be more technically precise. Italy:  Milan  Stock  Exchange
[November 11, 2003] Japan:  Tokyo  Stock  Exchange
Luxembourg:  Luxembourg  Stock  Exchange
Mexico:  Mexico  City  Stock  Exchange
Netherlands:  Euronext  Amsterdam
New  Zealand:  New  Zealand  Stock  Exchange
Norway:  Oslo  Stock  Exchange
Poland:  The  main  and  parallel  markets  of  the  Warsaw  Stock  Exchange
Singapore:  Singapore  Stock  Exchange
South  Africa:  Johannesburg  Stock  Exchange
Spain:  Madrid  Stock  Exchange
Sweden:  Stockholm  Stock  Exchange
Switzerland:  SWX  Swiss  Exchange
United  Kingdom:  London  Stock  Exchange
United  States:  American  Stock  Exchange
United  States:  Boston  Stock  Exchange
United  States:  Chicago  Board  of  Options
United  States:  Chicago  Board  of  Trade
United  States:  Chicago  Stock  Exchange
United  States:  National  Association  of  Securities  Dealers  Automated  Quotation  System
United  States:  National  Stock  Exchange
United  States:  New  York  Stock  Exchange
United  States:  NYSE  Arca
United  States:  Philadelphia  Stock  Exchange

Date  Modified:  2011-­10-­31

4
www.fin.gc.ca/act/fim-imf/dse-bvd-eng.asp 1/1
 IT-64R4 (Consolidated)
INCOME TAX GROUP OF PERSONS The essential test in determining whether a corporation is
INTERPRETATION BULLETIN Definition – Paragraph 256(1.2)(a) (¶ 24) associated with another relies on the control of the
Application of Paragraph 256(1.2)(a) (¶ 25) corporation that is exercised “directly or indirectly in any
Simultaneous Control of a Corporation – Paragraph manner whatever.” This expression encompasses:
NO.: IT-64R4 (Consolidated) DATE: See Bulletin Revisions section
256(1.2)(b) (¶ 26) • de jure control (i.e., control in law), the meaning of which
SUBJECT: INCOME TAX ACT CONTROL OF TWO CORPORATIONS BY RELATED has been determined by caselaw; and
Corporations: Association and Control PERSONS OR RELATED GROUPS OF PERSONS –
• de facto control (i.e., control in fact), as determined under
PARAGRAPHS 256(1)(c), (d) AND (e) (¶ 27)
subsection 256(5.1).
REFERENCE: Section 256 (also section 251) ADDITIONAL RULES THAT CAN DETERMINE
OWNERSHIP OF SHARES, OR CONTROL, OF A There are a number of additional rules in section 256,
Latest Revision: ¶ 37 This version is only available electronically. CORPORATION including rules which:
Deemed Control by the Fair Market Value Test – • provide or extend the meaning of certain terms and
At the Canada Customs and Revenue Agency Contents Paragraph 256(1.2)(c) (¶ 28) concepts, such as a “group of persons” and “control by a
(CCRA), we issue income tax interpretation bulletins Deemed Ownership of Shares by the group of persons”;
Application
(ITs) in order to provide technical interpretations and “Look-Through” Rules – Paragraphs 256(1.2)(d)
Summary • can result in deemed control by means of a fair market
positions regarding certain provisions contained in to (f)
Discussion and Interpretation value test;
income tax law. Due to their technical nature, ITs are Introduction (¶ 29)
SOME BASIC RULES • can result in deemed ownership of shares by means of
used primarily by our staff, tax specialists, and other Looking through a corporation – Paragraph
Control of One Corporation by Another “look-through” rules;
individuals who have an interest in tax matters. For 256(1.2)(d) (¶ 30)
Corporation – Paragraph 256(1)(a) (¶ 1)
those readers who prefer a less technical explanation Looking through a partnership – Paragraph • can deem the shares of a child under 18 to be owned by
Control of Two Corporations by Same Person or
of the law, we offer other publications, such as tax 256(1.2)(e) (¶ 31) the child’s parent;
Group of Persons – Paragraph 256(1)(b) (¶ 2)
guides and pamphlets. Looking through a trust – Paragraph • can result in deemed ownership of shares or control by
Anti-Avoidance Provision – Subsection
While the comments in a particular paragraph in an 256(2.1) (¶ 3) 256(1.2)(f) (¶ 32) means of options or rights; and
IT may relate to provisions of the law in force at the Bankrupt Corporation Not Associated – Paragraph Looking through a chain (¶ 33) • allow for simultaneous control by two or more persons or
time they were made, such comments are not a 128(1)(f) (¶ 4) Parent Deemed to Own Shares of Child – Subsection groups of persons.
substitute for the law. The reader should, therefore, Corporations Can Be Related but Not 256(1.3) (¶ 34)
Any statement in this bulletin with respect to the question of
consider such comments in light of the relevant Associated (¶ 5) Options or Rights – Subsection 256(1.4)
whether corporations are associated with each other, or with
provisions of the law in force for the particular Dealings Between Corporations Not Required for Effect of option (¶ 35)
respect to any rule that relates to that question, should
taxation year being considered, taking into account Association (¶ 6) Convertible securities (¶ 36)
implicitly be taken as meaning that such question or rule is
the effect of any relevant amendments to those Corporations With Different Taxation Years (¶ 7) Buy-sell agreements (¶ 37)
being considered at a particular point in time, unless
provisions or relevant court decisions occurring after Two Corporations Associated With the Same Simultaneous control and deemed control (¶ 38)
otherwise stated.
the date on which the comments were made. Corporation – Subsection 256(2) (¶ 8) Simultaneous Control at Different Levels of a
EXCEPTIONS Corporate Chain – Subsections 256(6.1)
Subject to the above, an interpretation or position Situations Involving an Indebtedness or Redeemable and (6.2) (¶ 39) Discussion and Interpretation
contained in an IT generally applies as of the date on Shares Where Association Is Deemed Not to Bulletin Revisions
which it was published, unless otherwise specified. If SOME BASIC RULES
Occur – Subsection 256(3) (¶ 9)
there is a subsequent change in that interpretation or Two Corporations Controlled by Same Executor, Application Control of One Corporation by Another
position and the change is beneficial to taxpayers, it Liquidator of a Succession or Trustee – Subsection
is usually effective for future assessments and This bulletin cancels and replaces Interpretation Bulletin Corporation – Paragraph 256(1)(a)
256(4) (¶ 10)
reassessments. If, on the other hand, the change is not IT-64R3, dated March 9, 1992. ¶ 1. Under paragraph 256(1)(a), two corporations are
Corporation Controlled by Corporate Trustee –
favourable to taxpayers, it will normally be effective Subsection 256(5) (¶ 11) associated with each other if one of them is controlled,
for the current and subsequent taxation years or for Situations Involving an Indebtedness or Redeemable Summary directly or indirectly in any manner whatever, by the other.
transactions entered into after the date on which the Shares Where Control Is Deemed Not to Occur – This bulletin discusses provisions in the Income Tax Act that (For a discussion of the meaning of “controlled” and the
change is published. Subsection 256(6) (¶ 12) contain rules with respect to the association of corporations meaning of “controlled, directly or indirectly in any manner
CONTROL (the “association rules”). There are a number of provisions in whatever,” see ¶s 13 to 18 and ¶s 19 to 23, respectively.)
If you have any comments regarding matters
De Jure Control the Act for which the association rules are relevant (e.g.,
discussed in an IT, please send them to: Control of Two Corporations by Same
The general test (¶ 13) those pertaining to the small business deduction); however, a
Manager, Technical Publications and Projects Section Voting power to wind up the corporation (¶ 14) discussion of such provisions is outside the scope of this Person or Group of Persons – Paragraph
Income Tax Rulings Directorate Beneficial owners of shares (¶ 15) bulletin. 256(1)(b)
Policy and Legislation Branch Effect of casting vote (¶ 16)
Indirect control (¶ 17) Section 256 contains the association rules. Subsections ¶ 2. Under paragraph 256(1)(b), two corporations are
Canada Customs and Revenue Agency
Effect of special provisions (¶ 18) 256(1) and (2) provide the general rules with respect to associated with each other if they are both controlled,
Ottawa ON K1A 0L5
De Facto Control – Subsection 256(5.1) (¶s 19-23) whether one corporation is associated with another. directly or indirectly in any manner whatever, by the same
Most of our publications are available on our Web Subsections 256(3), (4), (5) and (6) provide for certain person or group of persons. (The meaning of “group of
site at: www.ccra.gc.ca exceptional circumstances under which the association of one persons” is discussed in ¶ 24.)
corporation with another does not occur.

IT-64R4 (Consolidated) IT-64R4 (Consolidated)

Anti-Avoidance Provision – Subsection common shares of Corporation B, the two corporations until the manufacturing corporation has recovered its CONTROL
256(2.1) would not be associated with each other in their respective advances. Another example might be where a corporation
2000 taxation years. This is the case because the date when lends money to another corporation or to a chief shareholder De Jure Control
¶ 3. Subsection 256(2.1) contains an anti-avoidance rule
they first became associated with each other, although within thereof and holds control, directly or indirectly in any
which deems two or more corporations to be associated with The general test
the 2000 taxation year of Corporation B (assuming it retains manner whatever, of the corporation as security.
each other if one of the main reasons for the separate ¶ 13. If the reference to control of a corporation is not
its September 30 year-end after the acquisition of control), is
existence of those corporations is to reduce the amount of accompanied by the words “directly or indirectly in any
not within the 2000 taxation year of Corporation A. If, Two Corporations Controlled by Same
income taxes otherwise payable (or to increase the amount of manner whatever,” such control means de jure control (i.e.,
however, the date when Corporation A acquired the shares of
refundable investment tax credits available under section Executor, Liquidator of a Succession or control in law).
Corporation B was February 28, 2000, the two corporations
127.1). Subsection 256(2.1) could apply, for example, where
would be associated with each other in their respective 2000 Trustee – Subsection 256(4) The general test for de jure control was established by the
two parts of what could reasonably be considered to be one
taxation years since that date is within the 2000 taxation year ¶ 10. Subsection 256(4) ensures that when two or more Exchequer Court of Canada in Buckerfield’s Limited et al. v.
business, such as the manufacturing and sales activities of a
of each of them. corporations, not previously associated with each other, have MNR, 64 DTC 5301, [1964] CTC 504, to be whether the
single business, are carried on by two corporations each of
come under the control of the same executor, liquidator of a shareholder enjoys “effective control” over the affairs and
which is controlled by different persons. In such a case, if it
Two Corporations Associated With the succession or trustee (either a corporation or an individual) fortunes of the corporation, as manifested in the ownership of
is reasonable to conclude that the separate existence of the
through the deaths of their respective controlling such a number of shares as carries with it the right to a
corporations is mainly tax-motivated, the corporations will Same Corporation – Subsection 256(2) majority of the votes in the election of the board of directors.
shareholders, the corporations will not, for that reason alone,
be deemed to be associated with each other. ¶ 8. If two otherwise unassociated corporations are become associated with each other. This relieving provision The test in Buckerfield’s was confirmed by the Supreme
associated with the same third corporation, subsection 256(2) does not apply if the executor, liquidator or trustee acquired Court of Canada in Duha Printers (Western) Ltd. v. The
Bankrupt Corporation Not Associated – deems the two corporations to be associated with each other. control of the corporations as a result of one or more estates Queen, 98 DTC 6334, [1998] 3 CTC 303. In Duha Printers,
Paragraph 128(1)(f) (There are exceptions—where subsection 256(2) will not or trusts created by the same individual or two or more the court stated that in determining whether effective control
apply for the purposes of the small business deduction. For individuals not dealing with each other at arm’s length. exists, one must consider:
¶ 4. Paragraph 128(1)(f) deems a corporation not to be
further particulars, see subsection 256(2).)
associated with any other corporation in a taxation year (a) the corporation’s governing statute;
ending in the period when it is bankrupt. Corporation Controlled by Corporate (b) the share register of the corporation; and
EXCEPTIONS Trustee – Subsection 256(5) (c) any specific or unique limitation on either the majority
Corporations Can Be Related but Not Situations Involving an Indebtedness or ¶ 11. Subsection 256(5) provides that, if one corporation— shareholder’s power to control the election of the board
Associated Redeemable Shares Where Association Is acting as a trustee—controls another corporation through a or the board's power to manage the business and affairs
trust, the two corporations are deemed not to be associated of the company, as manifested in either:
¶ 5. Two corporations can be “related persons” as defined Deemed Not to Occur – Subsection 256(3)
in subsection 251(2) and still not be associated with each with each other. This does not apply if a settlor of the trust (i) the constating documents of the corporation; or
¶ 9. Subsection 256(3) provides an exception, in particular controls or is a member of a related group that controls the
other under subsection 256(1). As an example, if 65 per cent (ii) any unanimous shareholder agreement.
circumstances, to the general rules that two corporations will corporation that is the trustee. (The term “related group” is
of the voting shares of Corporation A are owned by Mr. A
be associated with each other when: defined in subsection 251(4)—see ¶ 27.)
and 60 per cent of the voting shares of Corporation B are Voting power to wind up the corporation
owned by his brother, Mr. B, the corporations are “related • one corporation controls, directly or indirectly in any
manner whatever, the other corporation (see ¶ 1); or Situations Involving an Indebtedness or ¶ 14. A refinement of the meaning of de jure control can be
persons” pursuant to subparagraph 251(2)(c)(ii); however,
• the two corporations are controlled, directly or indirectly found in Oakfield Developments (Toronto) Limited v. MNR,
the two corporations would not be associated with each other Redeemable Shares Where Control Is 71 DTC 5175, [1971] CTC 283. In that case, an “inside
unless the cross-ownership test in paragraph 256(1)(c), as in any manner whatever, by the same person (see ¶ 2).
Deemed Not to Occur – Subsection 256(6) group” of shareholders owned all the corporation’s common
discussed in ¶ 27, were met. Pursuant to subsection 256(3), the two corporations will be
¶ 12. As is the case with subsection 256(3) (see ¶ 9), shares and another group owned all the corporation’s
deemed not to be associated with each other when such preferred shares with each group holding, in aggregate, an
subsection 256(6) deals with certain situations involving an
Dealings Between Corporations Not control exists for the purpose of safeguarding the rights or
indebtedness or redeemable shares. The rules in subsection equal number of votes. The preferred shares were issued after
Required for Association interests of the corporation that controls the other corporation the common shares and were entitled on winding up only to
256(6) are similar to the rules in subsection 256(3), except
or the person who controls the two corporations (referred to the amount paid to acquire the shares plus a 10% premium.
¶ 6. Two corporations may be associated with each other that the controlled corporation is deemed not to be controlled
in this paragraph as the “controller”) in respect of: The Supreme Court of Canada held in Oakfield that control
even if those corporations and their shareholders do not have by the person or partnership which controls, directly or
any dealings with each other. Association depends solely (a) any indebtedness owing to the controller; or indirectly in any manner whatever, the corporation (referred of the corporation remained with the common shareholders
upon the fulfilment of the control and share ownership (b) any redeemable shares owned by the controller in the to in this paragraph as “the controller”) rather than deemed who had the power to wind up the corporation and to receive
requirements set out in subsection 256(1). controlled corporation (in this paragraph and in ¶ 12, not to be associated (as is the case in subsection 256(3)) with all the capital and surplus except the fixed amount payable to
“redeemable shares” means shares to be redeemed by the controller. Subsection 256(6) could apply, for example, the preferred shareholders. (See also the Supreme Court of
Corporations With Different Taxation the controlled corporation or shares to be purchased by where a manufacturing corporation establishes a dealership Canada’s decision in The Queen v. Imperial General
a person or group of persons with whom the controller in another corporation and, under the terms of the financing Properties Limited, 85 DTC 5500, [1985] 2 CTC 299.)
Years deals at arm’s length). arrangement, the operator or dealer will not acquire active
¶ 7. If two corporations have taxation years ending at control of the dealership corporation until certain financial Beneficial owners of shares
There must also be an enforceable agreement in place
different times in the calendar year, such corporations are not obligations to the manufacturing corporation are met. In
providing that control will pass, upon the occurrence of an ¶ 15. The owners of shares of a corporation are considered
associated with each other in a particular taxation year these circumstances, and assuming that the other
event that is likely to occur, to a person or group with whom to be those persons who are the beneficial owners of such
unless, on some day which is within that particular taxation requirements of subsection 256(6) are met, this subsection
the controller was dealing at arm’s length. An example of a shares. This is the case even if the shares are registered in the
year for each of them, they are associated with each other. deems the dealership corporation not to be controlled by the
situation where subsection 256(3) applies might be one corporation’s share register in the name of another person or
For example, assume that Corporation A and Corporation B manufacturing corporation, which results in the corporations
involving a manufacturing corporation that has financed a persons such as a nominee or bare trustee. (See also ¶ 32
have year-ends of March 31 and September 30, respectively. not being associated with each other by reason of the
dealer corporation and has retained control, directly or concerning a share held by a trustee.)
If, on July 31, 2000, Corporation A acquires all the issued arrangement.
indirectly in any manner whatever, of that dealer corporation,

3 4
 IT-64R4 (Consolidated) IT-64R4 (Consolidated)
Effect of casting vote De Facto Control – Subsection 256(5.1) (a) the percentage of ownership of voting shares (when Application of Paragraph 256(1.2)(a)
¶ 16. Where the voting shares of a corporation are divided ¶ 19. If the reference to control of a corporation is such ownership is not more than 50 per cent) in relation ¶ 25. The existence of de facto control under
evenly between two persons, the fact that the chairperson of a accompanied by the words “directly or indirectly in any to the holdings of other shareholders; subsection 256(5.1), as discussed in ¶s 19-23, does not
shareholder’s meeting may have the right to cast a deciding manner whatever,” such control encompasses both de jure (b) ownership of a large debt of a corporation which may require that the controller own any shares in the corporation
vote does not give that person de jure control of the control (as discussed in ¶s 13 to 18) and de facto control (i.e., become payable on demand (unless exempted by being considered. Therefore, the definition of “group of
corporation where the deciding vote is conferred on that control in fact). For the purposes of the Act, a corporation is subsection 256(3) or (6)) or a substantial investment in persons” in paragraph 256(1.2)(a) is restricted in its
person as chairperson of the meeting and not by ownership of considered by subsection 256(5.1) to be “controlled, directly retractable preferred shares; application to subsections 256(1) to (5) and does not apply
voting shares (see Aaron’s (Prince Albert) Ltd. et al. v. MNR, or indirectly in any manner whatever,” where another (c) shareholder agreements including the holding of a for the purposes of subsection 256(5.1).
also known as Allied Business Supervisions Ltd. v. MNR, 66 corporation, person or group of persons (referred to in this casting vote;
DTC 5244, [1966] CTC 330 (Ex.Ct.)—confirmed in MNR v. paragraph, ¶s 20 and 25 as the “controller”) has any direct or Simultaneous Control of a Corporation –
(d) commercial or contractual relationships of the
Dworkin Furs (Pembroke) Ltd., 67 DTC 5035, [1967] CTC indirect influence that, if exercised, would result in control in
50 (S.C.C.)). (However, the holding of a “casting vote” in the
corporation, e.g., economic dependence on a single Paragraph 256(1.2)(b)
fact of the corporation.
supplier or customer; ¶ 26. Paragraph 256(1.2)(b) provides that a corporation can
above circumstances may constitute de facto control as
defined in subsection 256(5.1).) ¶ 20. Subsection 256(5.1) further provides, however, that (e) possession of a unique expertise that is required to be considered to be controlled by a person or particular group
the corporation shall not be considered to be controlled, operate the business; and of persons notwithstanding that the corporation is also
Indirect control directly or indirectly in any manner whatever, by the (f) the influence that a family member, who is a controlled or deemed to be controlled by another person or
controller where the corporation and the controller are shareholder, creditor, supplier, etc., of a corporation, group of persons. Thus, if Mr. X controls a corporation de
¶ 17. It is possible for a person to have de jure control over dealing at arm’s length and the controller’s influence is jure and Mr. Y controls the same corporation de facto, the
may have over another family member who is a
a corporation without ownership of any of its shares if that derived from an agreement or arrangement such as a corporation is considered, by virtue of paragraph 256(1.2)(b),
shareholder of the corporation.
person controls one or more other corporations which, singly franchise, licence, lease, distribution, supply or management to be controlled by each of Mr. X and Mr. Y. Paragraph
or among them, have voting control of the first-mentioned Although the degree of influence in (f) is always a question
agreement—i.e., a business agreement or arrangement—the 256(1.2)(b) also provides that if a group of persons owns
corporation. For example, if Y controls Corporation A which of fact, close family ties (between parents and children or
main purpose of which is to govern the relationship between shares of the capital stock of a corporation, the fact that an
in turn controls Corporation B, then Y also controls between spouses) especially lend themselves to the
the parties regarding the manner in which a business carried individual member of the group, alone, owns enough shares
Corporation B. Similarly, if Corporation P controls development of significant influences. Generally, these
on by the corporation is to be conducted. Thus, for example, to control the corporation will not alter the fact that the group
Corporations M and N which, between them, own more than persons must demonstrate their economic independence and
a franchise agreement or lease which provides to the also controls the corporation.
50 per cent of the voting shares of Corporation X, then autonomy before escaping presumptions of fact which apply
franchiser or lessor a measure of control over the products
Corporation P controls Corporation X, and all four of the to related persons. However, with respect to siblings, unless
sold by the corporation or the hours during which it conducts Example
corporations are associated with each other. See Vineland the facts indicate otherwise, generally one sibling would not
its business, would not by itself result in the franchiser or
Quarries and Crushed Stone Limited v. MNR, 66 DTC 5092, be considered to have influence over another.
lessor having de facto control of the corporation.
[1966] CTC 69 (affirmed from the bench without written In addition to the general factors described above, the
reasons by the Supreme Court of Canada, 67 DTC 5283). ¶ 21. De facto control goes beyond de jure control and composition of the board of directors and the control of
(Depending on the facts in the particular situation, paragraph includes the ability to control “in fact” by any direct or day-to-day management and operation of the business would
256(1.2)(d) may also result in the corporations being indirect influence. De facto control may exist even without be considered.
associated with each other—see ¶ 30.) the ownership of any shares. It can take many forms, e.g., the
ability of a person to change the board of directors or reverse GROUP OF PERSONS
Effect of special provisions its decisions, to make alternative decisions concerning the
¶ 18. As indicated in ¶ 13, it is also necessary to take into actions of the corporation in the short, medium or long term, Definition – Paragraph 256(1.2)(a)
to directly or indirectly terminate the corporation or its ¶ 24. By virtue of paragraph 256(1.2)(a), the expression Mr. A and Mr. B constitute a group that controls both
consideration the following:
business, or to appropriate its profits and property. The “group of persons” used in subsection 256(1) refers to any Corporation A and Corporation B by virtue of paragraph
• special provisions in the constating documents of a 256(1.2)(b), even though each corporation is also controlled
existence of any such influence, even if it is not actually two or more persons each of whom owns shares of the capital
corporation, such as its letters patent, articles of by one person. Therefore, the corporations are associated
exercised, would be sufficient to result in de facto control. stock of the corporation. Once it is established that a group of
incorporation or by-laws; or with each other under paragraph 256(1)(b) because they are
persons owns a majority of the voting shares of a corporation
• unanimous shareholder agreements sanctioned by the ¶ 22. The moment when the influence must exist, for the controlled by the same group of persons.
(even though one person in the group may alone control the
relevant legislation. purposes of the de facto control test, depends upon the
corporation as discussed in ¶ 26) and that the same group
For example, the articles of incorporation of a corporation context in which the notion of control is applied. For
also owns a majority of the voting shares of a second
may provide that a motion put before a meeting of the example, in the case of the small business deduction, where CONTROL OF TWO CORPORATIONS
corporation, that fact is sufficient to make the two
shareholders will fail unless it receives the unanimous the status of “Canadian-controlled private corporation”
corporations associated with each other. This is the case BY RELATED PERSONS OR RELATED
consent of all the owners of voting shares. In these (subsection 125(7)) must be maintained throughout the year, GROUPS OF PERSONS – PARAGRAPHS
whether or not other combinations of shareholders also could
circumstances, the person or persons holding the majority of control will be examined for the whole year for which the
own a majority of voting shares in either corporation (see the 256(1)(c), (d) AND (e)
the voting shares can be said to have de jure control over the deduction is claimed. In the case of the investment tax credit
Supreme Court of Canada’s decision in Vina-Rug (Canada)
corporation only if that person or persons own all the voting (section 127.1), the reference period will be restricted to the ¶ 27. Paragraphs 256(1)(c), (d), and (e) contain rules that
limited v. MNR, 68 DTC 5021, [1968] CTC 1). Therefore, for
shares. (However, even if the majority shareholder or year in which the allowable expenses are incurred. cause corporations to be associated with each other if they
the purposes of applying the provisions of subsection 256(1),
shareholders in the above example did not own all the voting are controlled, directly or indirectly in any manner whatever,
¶ 23. Whether a person or group of persons can be said to any two or more persons, related or unrelated, may be
shares, they could still be deemed to control the corporation by related persons or related groups of persons and certain
have de facto control of a corporation, notwithstanding that identified as a group of persons, without considering whether
by means of the fair market value test in paragraph cross-ownership tests are met. For the meaning of “related
they do not legally control more than 50 per cent of its voting the members of the group act in concert to control the
256(1.2)(c), as discussed in ¶ 28.) persons”, see subsection 251(2). The term “related group” is
shares, will depend on each factual situation. The following corporation.
defined in subsection 251(4) to mean a group of persons each
are some general factors that may be used in determining member of which is related to every other member of the
whether de facto control exists: group.
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IT-64R4 (Consolidated) IT-64R4 (Consolidated)

Two corporations are associated with each other under • Each member of one related group is related to all the
paragraph 256(1)(c) if the following conditions exist: members of the other related group.
ADDITIONAL RULES THAT CAN Example
• Each corporation is controlled, directly or indirectly in • One or more persons who are members of both related
DETERMINE OWNERSHIP OF SHARES,
any manner whatever, by a person. groups own, in total, at least 25 per cent of the issued OR CONTROL, OF A CORPORATION
• The person controlling one of the corporations is related shares of any class—other than a “specified class”
(discussed below after the example)—of the capital stock
Deemed Control by the Fair Market Value
to the person controlling the other corporation.
of each corporation. Test – Paragraph 256(1.2)(c)
• Either of those two persons owns at least 25 per cent of
¶ 28. For the purposes of the association rules in
the issued shares of any class—other than a “specified
class” (this term is discussed immediately after the final
Example subsections 256(1) to (5), paragraph 256(1.2)(c) deems a
person or group of persons to control a corporation where the
example in this paragraph)—of the capital stock of each
person or group:
corporation.
(a) owns shares representing more than 50 per cent of the
Example fair market value of all the issued and outstanding Paragraph 256(1.2)(d) deems Mr. A to own 25 per cent of
shares of the capital stock of a corporation; or Opco 2. As a result, Opco 1 and Opco 2 are associated with
(b) owns common shares representing more than 50 per each other under paragraph 256(1)(c) (see ¶ 27).
cent of the fair market value of all the issued and
outstanding common shares of the capital stock of the
corporation. Looking through a partnership – Paragraph
Shares of a “specified class” as discussed above are defined For purposes of making this valuation, paragraph 256(1.2)(g)
256(1.2)(e)
in subsection 256(1.1) and must have all the following provides that voting rights shall be ignored. As well, ¶ 31. Similarly, where shares of a corporation are the
characteristics: subsection 256(1.6) provides that shares described (and property of (or are deemed by subsection 256(1.2) to be
(a) The shares are not convertible or exchangeable. during the applicable time referred to) in paragraph (e) of the owned by) a partnership, paragraph 256(1.2)(e) looks
(b) The shares are non-voting. definition of “term preferred shares” in subsection 248(1), through the partnership and deems the shares to be owned by
Paragraph 256(1)(d) provides a rule that is similar to the and shares of a “specified class” as defined in subsection the partnership’s members in proportion to their respective
(c) The dividends are calculated as a fixed amount or by income interests in the partnership. If both the income and
above-mentioned rule under paragraph 256(1)(c). Under reference to a fixed percentage of the fair market value 256(1.1) (see ¶ 27), shall be disregarded.
paragraph 256(1)(d), two corporations are associated with loss of the partnership in a fiscal period are nil, so that a
of the consideration for which the shares were issued. member’s income interest cannot be determined, paragraph
each other if the following conditions exist:
(d) The annual dividend rate cannot in any event exceed the
Deemed Ownership of Shares by the
256(1.2)(e) further provides that the member’s proportionate
• One of the corporations is controlled, directly or indirectly following: “Look-Through” Rules – Paragraphs income interest is to be determined as if the partnership had
in any manner whatever, by a person. 256(1.2)(d) to (f) income of $1,000,000 in that period.
(i) where the shares were issued after 1983, the
• That person: prescribed rate of interest at the time the shares
− is related to each member of a group of persons
Introduction
were issued; and
¶ 29. Paragraphs 256(1.2)(d), (e), and (f) provide rules that Example
which controls, directly or indirectly in any manner (ii) where the shares were issued before 1984, the rate
whatever, the other corporation; and apply to “look through” corporations, partnerships and trusts.
of interest prescribed for the purposes of
The rules deem shares owned by a corporation, partnership
− owns at least 25 per cent of the issued shares of any subsection 161(1) at the time the shares were
or trust to be owned by the shareholders of the corporation
class—other than a “specified class” (discussed issued.
(see ¶ 30), the members of the partnership (see ¶ 31) or
below after the final example)—of the capital stock (e) The shares cannot be redeemed, cancelled or acquired beneficiaries of the trust (see ¶ 32), respectively.
of that other corporation. for more than the fair market value of the consideration
for which the shares were issued plus any unpaid Looking through a corporation – Paragraph
Example dividends on such shares.
256(1.2)(d)
The dividends on shares of a specified class need not be
cumulative. Furthermore, if the dividends are cumulative, the ¶ 30. Where a corporation owns (or is deemed by
Assuming Mr. A, B, C and D are equal partners in ABCD
fact that the shareholders forfeit their entitlement to a subsection 256(1.2) to own) shares of a second corporation,
Partnership, each will be deemed by paragraph 256(1.2)(e) to
particular dividend—e.g., because of corporate law paragraph 256(1.2)(d) deems those shares to be owned by
own 10 per cent of the shares of Corporation B. Therefore,
constraints or because of insufficient profits or cash flow— any shareholder of the first corporation in proportion to the
Corporation A and Corporation B will be associated with
will not prevent the shares from qualifying as a specified fair market value of their shareholding in the first
each other under paragraph 256(1)(e) because both
class of shares. corporation. In determining the fair market value of shares of
corporations are controlled by Mr. A.
a corporation for purposes of applying the look-through
Since a share that is issued as a stock dividend is issued for rules, all issued and outstanding shares of the capital stock of
no consideration, it cannot qualify as a share of a specified the corporation are deemed by paragraph 256(1.2)(g) to be Looking through a trust – Paragraph 256(1.2)(f)
Paragraph 256(1)(e) provides another similar rule to those class because it cannot satisfy characteristic (e) above. non-voting.
discussed above. Under paragraph 256(1)(e), two ¶ 32. Paragraph 256(1.2)(f) provides the look-through rule
corporations are associated with each other if the following for shares of a corporation that are owned (or deemed by
conditions exist: subsection 256(1.2) to be owned) by a trust. It deems the
• Each corporation is controlled, directly or indirectly in
any manner whatever, by a related group.

7 8
 IT-64R4 (Consolidated) IT-64R4 (Consolidated)
shares to be owned by beneficiaries of the trust (and possibly Corporation A has only common shares, 75% of which are to redeem, acquire or cancel shares of its capital stock owned
also by a person from whom property was received by the Example owned by Mr. A. Under paragraph 256(1.2)(d), Mr. A is by other shareholders, the person or partnership is deemed to
trust). The percentage of the shares that a particular deemed to own 60.91875% (i.e., 75% × 81.225%) of the have the same position in relation to control of the
beneficiary is deemed to own depends on the type of trust. shares of Corporation Y. corporation and ownership of shares of its capital stock as if
The general rules are as follows: Therefore, in accordance with the principle discussed in ¶ 17, the shares were redeemed, acquired or cancelled by the
(a) Where a beneficiary’s share of income or capital of the Mr. A has de jure control of Corporation Y. corporation.
trust is subject to any discretionary power (such a trust Neither paragraph 256(1.4)(a) nor 256(1.4)(b) applies,
being referred to hereafter as a “discretionary” trust), however, with respect to a right that is not exercisable until
each such beneficiary is deemed to own all the shares Parent Deemed to Own Shares of Child – the death, bankruptcy or permanent disability of an
held by the trust. Subsection 256(1.3) individual. For example, paragraph 256(1.4)(a) would not
(b) Where the trust is not a discretionary trust, each ¶ 34. Subsection 256(1.3) provides that shares of a apply to a right that the person or partnership has under a
beneficiary is deemed to own shares in proportion to the corporation owned by a child under the age of 18 shall be survivorship agreement to acquire shares of a corporation.
fair market value of that beneficiary’s beneficial interest deemed to be owned by a parent of the child for the purposes
in the trust. Since X’s children are the beneficiaries of the discretionary of determining whether the corporation is associated with Convertible securities
(c) An exception to the rules in (a) and (b) occurs where: trust, they are each deemed by subparagraph 256(1.2)(f)(ii) to any other corporation that is controlled, directly or indirectly ¶ 36. If bonds, debentures or preferred stock of a
own all of the shares of Corporation B that are owned by the in any manner whatever, by that parent or a group that corporation are convertible into voting shares, subsection
• the trust is a testamentary trust; trust. Therefore, since each one of X’s children controls includes that parent. An exception to subsection 256(1.3) is 256(1.4) may apply because of the “right” of the owners of
• one or more of its beneficiaries (referred to hereafter Corporation B, Corporation A and Corporation B are provided where the child manages the business and affairs of those securities to make the conversion. However, whether it
as the “initial income beneficiaries”) are entitled to associated with each other under paragraph 256(1)(c) the corporation without a significant degree of influence by will be applied can depend upon their distribution. Thus, if
receive all the income of the trust before the date on (see ¶ 27). Also, since X’s uncle is the sole trustee of the the parent. such securities have been issued to the general public and
which the death of one or all of them has occurred trust, he will control Corporation B. Therefore,
The following example illustrates the operation of the look- have wide distribution, they may usually be ignored.
(the “distribution date”); and Corporation B and Corporation C will be associated with
through rules in paragraph 256(1.2)(f) (see ¶ 32) in However, if large numbers of them are concentrated in the
• prior to that date no other person (e.g., a beneficiary each other under paragraph 256(1)(b). Corporation A and hands of, say, four or five persons, the situation will be
conjunction with the rules in subsection 256(1.3).
who is solely a capital beneficiary, or a person who Corporation C will also be associated with each other by examined because they may be used as a device so that the
will become an income beneficiary only upon the virtue of subsection 256(2) (assuming one of the two real control of the corporation will not be apparent simply
occurrence of the distribution date) can receive or exceptions described in ¶ 8 does not apply). Example from an examination of the shareholdings. A similar situation
obtain the use of the income or capital of the trust. Corporation A is controlled by Mr. X and Corporation B is can exist, also, when a person has a right in some other form
If all these conditions exist, shares held by the trust are Looking through a chain controlled by an inter vivos trust for the benefit of his two to subscribe for voting shares.
deemed to be owned only by the initial income children who are under 18 years of age. The children are
¶ 33. A person at the top of a chain can be deemed to own a income and capital beneficiaries of the trust. The provisions
beneficiaries before the distribution date. Whether any Buy-sell agreements
particular initial income beneficiary is deemed to own proportion of the shares of a corporation at the bottom of the of paragraph 256(1.2)(f) will apply to deem the children to
chain, by applying the rules in subsection 256(1.2) ¶ 37. Although the wording in subsection 256(1.4) may be
all, or only a proportion of, the shares will depend on own the shares of Corporation B. Since the provisions of broad enough to include almost any buy-sell agreement, this
whether the trust is discretionary or not discretionary as sequentially from one level of the chain to the next. paragraph 256(1.2)(f) are applicable for the purposes of
Furthermore, there will be simultaneous ownership or subsection will not normally be applied solely because of:
described in (a) and (b), respectively. After the subsections 256(1) to (5), subsection 256(1.3) would then
deemed ownership of some shares (or some percentage of apply to deem Mr. X to own those shares deemed to be • a “right of first refusal”; or
distribution date, the rule in (a) or (b), as the case may
be, applies with respect to all the beneficiaries, shares) of the corporation at the bottom of the chain by owned by the children and thus Corporation A and • a “shotgun arrangement” (i.e. an arrangement under which
including those that are solely capital beneficiaries. different individuals, corporations, partnerships or trusts at Corporation B would be associated with each other under a shareholder offers to purchase the shares of another
different levels of the chain. paragraph 256(1)(b) because they are controlled by the same shareholder and the other shareholder must either accept
(d) Where a trust is one referred to in subsection 75(2) of
person, Mr. X. the offer or purchase the shares owned by the offering
the Act, such as a “reversionary” trust, the person from
Example party)
whom property of the trust was received is also deemed
to own the shares. Corporation Y has only common shares, 95% of which are contained in a shareholder agreement.
owned by Corporation X. Options or Rights – Subsection 256(1.4)
The result of the application of paragraph 256(1.2)(f) is that
more than one person can be deemed to own the same shares Corporation X has only common shares, 95% of which are Effect of option Simultaneous control and deemed control
at the same time. In addition, paragraph 256(1.2)(f) does not owned by Partnership AB. Under paragraph 256(1.2)(d), ¶ 38. If subsection 256(1.4) does apply, it is possible for
¶ 35. Subsection 256(1.4) provides two special rules, for
negate the fact that the shares are actually held by the trustees Partnership AB is deemed to own 90.25% (i.e., 95% × 95%) each of two separate and unrelated persons to be regarded,
the purposes of the association rules, which deem a person,
of the trust. Thus, control of a corporation, the majority of of the shares of Corporation Y. for the purposes of the Act, as having control of the same
or a partnership in which the person has an interest (the
whose voting shares are owned by a trust, will rest with the Trust A is a member of Partnership AB and is entitled to “partnership”), to own shares of a corporation in which the corporation at the same time. For example, one person could
trustee or group of trustees that can bind the trust (see MNR 90% of its income. Under paragraph 256(1.2)(e), Trust A is person or partnership holds certain options or rights. have control by means of direct ownership of shares and the
v. Consolidated Holding Company Limited, 72 DTC 6007, deemed to own 81.225% (i.e., 90% × 90.25%) of the shares other could have control as a result of the application of one
Under the first rule—which is in paragraph 256(1.4)(a)—if
[1972] CTC 18 (S.C.C.)). of Corporation Y. of the rules in subsection 256(1.4). This provision prevents a
the person or partnership has a right, under a contract, in
Corporation A is the sole beneficiary of Trust A. Under person who really controls a corporation from giving the
equity or otherwise, to acquire shares in a corporation or to
paragraph 256(1.2)(f), Corporation A is deemed to own appearance of divesting control by “selling” the controlling
control the voting rights of shares in a corporation, the shares
81.225% (i.e., 100% × 81.225%) of the shares of shares to some other person while retaining an option to
are deemed to be issued and outstanding and to be owned by
Corporation Y. repurchase them.
the person or partnership.
Subsection 256(1.4) does not deny that actual control is held
Under the second rule—which is in paragraph 256(1.4)(b)—
by the person who holds it. If it did so, it would be possible
if the person or partnership has a right to cause a corporation
for a person or other entity which controls a corporation to
9 10

IT-64R4 (Consolidated) IT-64R4 (Consolidated)

give the appearance of divesting itself of control by giving to In addition, in a situation involving a corporate chain (e.g.,
some other person or other entity an option that will never be where the shares of a corporation are held by one or more Bulletin Revisions
exercised. other corporations the shares of which, in turn, are held by
one or more other corporations), there can be simultaneous Since the issuance of IT-64R4 on August 14, 2001, there has
ownership of the same shares of the corporation at the been no revision to ¶s 1 to 36 or ¶s 38 and 39.
Example bottom of the chain by different entities at different levels of
Mr. S has actual control of Corporations A and X. ¶ 37 was modified to reflect the revised wording adopted in
the chain in the manner described in ¶ 33. Furthermore, de
¶ 17 of IT-419R2. ¶ 37 deals with subsection 256(1.4) which
Mr. J, who controls Corporation Y, has an option to purchase jure control can exist at the top of the chain (see ¶ 17 and the
is almost identical to paragraph 251(5)(b) as discussed in
from Mr. S, during his lifetime or from his estate, the reference therein to the Vineland Quarries case). However,
¶ 17 of IT-419R2. [October 13, 2004]
controlling shares in Corporation A. in Parthenon Investments Limited v. MNR, 97 DTC 5343,
In these circumstances, subsection 256(1.4) deems Mr. J to [1997] 3 CTC 152, the Federal Court of Appeal held that a
have control of Corporation A but does not deny Mr. S the particular corporation at the bottom of a corporate chain was
actual control of it. controlled by the corporation at the top of the chain and not
by any intermediate corporation for the purposes of
As a result:
determining whether the particular corporation was a
• Corporations A and X are related (see subparagraph Canadian-controlled private corporation.
251(2)(c)(i)) and are deemed not to deal with each other at
Subsections 256(6.1) and (6.2), which took effect for taxation
arm’s length (see paragraph 251(1)(c));
years beginning after November 1999, reverse the principle
• Corporations A and Y are related (see subparagraph in the Parthenon case described above. Although subsections
251(2)(c)(i)) and are deemed not to deal with each other at 256(6.1) and (6.2) apply for purposes of the association rules
arm’s length (see paragraph 251(1)(a)); in section 256, the existing rules in subsection 256(1.2) are
• Corporations X and Y are related (see subsection 251(3)) sufficient, in most cases, to establish control by one or more
and are deemed not to deal with each other at arm’s length persons or groups of persons, thus ensuring the proper
(see paragraph 251(1)(a)); and application of the association rules. However, in determining
• all three corporations are associated with each other under control of a corporation for the purposes of the association
the provisions of section 256 (see ¶s 2 and 8). rules, subsection 256(1.2) and subsections 256(6.1) and (6.2)
should be considered.
If, however, Mr. J’s option had been exercisable only after
Mr. S’s death, bankruptcy or permanent disability, Mr. J
would not be deemed to have control of Corporation A,
because of the exceptions in subsection 256(1.4), in which
case only Corporations A and X would be associated with
each other.

Simultaneous Control at Different Levels of

a Corporate Chain – Subsections 256(6.1)
and (6.2)
¶ 39. It is possible for there to be simultaneous ownership
of the same shares of a corporation, or simultaneous control
of the corporation, by different persons or groups of persons
in the manner described in ¶ 26, 34 or 38.

11 12
 IT-419R2
the Act, the Act does not contain any precise definition of the ¶ 5. Paragraph 252(2)(b) provides that an individual’s
term. Section 251, which is the statutory provision for “brother” includes the brother of the individual’s spouse or
determining arm’s length relationships, refers to three common-law partner and the spouse or common-law partner
categories of persons. This bulletin deals with each category of the individual’s sister. It does not include the spouse or
NO.: IT-419R2 DATE: June 8, 2004
separately. The first category of persons is “related persons”, common-law partner of the sister or of the brother of the
SUBJECT: INCOME TAX ACT the second category involves personal trusts and their individual’s spouse or common-law partner. Similarly,
Meaning of Arm’s Length beneficiaries, while the third category includes “persons not paragraph 252(2)(c) provides that an individual’s “sister”
related to each other”. Persons described in the second and includes the sister of the individual’s spouse or common-law
REFERENCE: Section 251 (and section 252) third categories are referred to as “unrelated persons” in this partner and the spouse or common-law partner of the
bulletin. individual’s brother. It does not include the spouse or
This version is only available electronically. common-law partner of the brother or sister of the
At the Canada Revenue Agency (CRA), we issue income
Discussion and Interpretation individual’s spouse or common-law partner. Therefore, if
tax interpretation bulletins (ITs) in order to provide Contents Mr. A and Mr. B are otherwise unrelated, and they have each
technical interpretations and positions regarding certain
provisions contained in income tax law. Due to their Application RELATED PERSONS married one of two sisters, they are not related by blood
Summary according to paragraph 251(6)(a). Similarly, if Mr. X and
technical nature, ITs are used primarily by our staff, tax ¶ 1. Paragraph 251(1)(a) deems that related persons do
Discussion and Interpretation Mrs. Y are brother and sister, Mrs. X and Mr. Y are not
specialists, and other individuals who have an interest in not deal with each other at arm’s length. This is the case
RELATED PERSONS (¶ 1) related by blood. However, Mr. A and Mr. B, and Mrs. X and
tax matters. For those readers who prefer a less technical regardless of how they actually conduct their mutual business
Related Individuals (¶ 2) Mr. Y, in the respective examples, are connected by marriage
explanation of the law, we offer other publications, such as transactions. Subsection 251(2) defines related persons for
Blood relationship (¶s 3-5) according to paragraph 251(6)(b).
tax guides and pamphlets. the purposes of the Act. Subsections 251(3) to 251(6) clarify
Marriage (¶ 6) and expand on the definitions in subsection 251(2).
While the comments in a particular paragraph in an IT may Common-law partnership (¶s 7-8) Marriage
relate to provisions of the law in force at the time they Other relatives (¶ 9) ¶ 6. According to paragraph 251(6)(b), two persons are
Related Individuals
were made, such comments are not a substitute for the law. Adoption (¶ 10) “connected by marriage” if one person is married to the other
The reader should, therefore, consider such comments in Corporations and Other Persons (¶s 11-13) ¶ 2. According to paragraph 251(2)(a), individuals
person or to an individual who is connected by blood
light of the relevant provisions of the law in force for the Special Rules (¶ 14) connected by blood relationship, marriage, common-law
relationship to that other person. For example, an individual
particular taxation year being considered, taking into Options and Rights partnership (see ¶ 7) or adoption are related persons.
will be connected by marriage to the parents and any siblings
account the effect of any relevant amendments to those Effect of option (¶ 15) of the individual’s spouse. However, where an individual’s
provisions or relevant court decisions occurring after the Convertible securities (¶ 16) Blood relationship marriage is dissolved by either divorce or the death of the
date on which the comments were made. Buy-sell agreements (¶ 17) ¶ 3. Paragraph 251(6)(a) refers to a blood relationship as individual’s spouse, the individual will cease to be
Simultaneous control and deemed control (¶ 18) being that of a parent and a child (or other descendant, such “connected by marriage” or to be “connected by blood
Subject to the above, an interpretation or position
UNRELATED PERSONS as a grandchild or a great-grandchild) or that of a brother and relationship” to the parents and any siblings of the
contained in an IT generally applies as of the date on
Personal Trusts (¶s 19-21) a sister. Section 252 extends the meaning of those terms to individual’s former spouse.
which it was published, unless otherwise specified. If there
Other Unrelated Persons (¶ 22-26) encompass other individuals who might otherwise not be
is a subsequent change in that interpretation or position and
Partnerships (¶s 27-28) considered to fit the normal use of the term. Common-law partnership
the change is beneficial to taxpayers, it is usually effective
Trusts (¶s 29-31)
for future assessments and reassessments. If, on the other ¶ 4. In addition to a natural child and an adopted child, ¶ 7. Paragraph 251(6)(b.1) provides that two individuals
Shareholders and Corporations (¶s 32-33)
hand, the change is not favourable to taxpayers, it will subsection 252(1) provides that a child of an individual are “connected by common-law partnership” if one
Explanation of Changes
normally be effective for the current and subsequent includes: individual is in a common-law partnership with the other or
taxation years or for transactions entered into after the date with a person who is connected by blood relationship to that
(a) a person who is wholly dependant on that individual for
on which the change is published. Application support if the person is or was, before reaching 19 years
other person. Subsection 248(1) defines a common-law
This bulletin cancels and replaces IT-419R dated August 24, partnership as the relationship between two persons who are
Most of our publications are available on our Web site at: of age, in law or in fact, under the individual’s custody
1995. The effective date of a particular legislative provision common-law partners of each other. The expression
www.cra.gc.ca and control;
discussed in the bulletin may be indicated in the Explanation “common-law partner” is also defined in subsection 248(1)
(b) a child of the individual’s spouse, (e.g., a stepchild) or and means a person of the opposite or same sex who, at that
If you have any comments regarding matters discussed in of Changes section (or, in some cases, in the Discussion and common-law partner (see ¶ 7); and
an IT, please send them to: Interpretation section) of the bulletin. However, where the time, lives with and has a conjugal relationship with the
bulletin is silent with respect to the effective date of a (c) a spouse or common-law partner of the individual’s individual. In addition, one of the following conditions must
Income Tax Rulings Directorate particular provision, such date can be obtained from the child, e.g., a son-in-law or a daughter-in-law, as well as be satisfied:
Policy and Planning Branch legislation itself. Unless otherwise stated, all statutory the spouse or common-law partner of a stepchild, of an (a) the person has been living in a conjugal relationship
Canada Revenue Agency references throughout the bulletin are to the Income Tax Act adopted child or of an individual considered to be the with the individual for a continuous period of at least
Ottawa ON K1A 0L5 (the Act). taxpayer’s child as described in (a) above. one year; or
On the divorce of an individual’s child (whether a natural (b) the person is the natural or adoptive parent (whether
or by email at the following address: bulletins@cra.gc.ca
child, an adopted child, a stepchild, or an individual
Summary considered to be a child by reason of paragraph (a) above),
legally or in fact) of the individual’s child (see ¶4).
This bulletin discusses the criteria used to determine whether Where an individual and another person have been living
the child’s former spouse ceases to be the child’s spouse and
or not persons deal with each other at arm’s length under the together in a conjugal relationship, they will be considered, at
is no longer a child of the individual.
Act. Although the term “at arm’s length” is used throughout any time thereafter, to be living together in a conjugal
relationship unless the couple have been living apart for a
period of at least 90 days that includes the particular time

IT-419R2 IT-419R2
because of a breakdown of their conjugal relationship. Once because of the extended meaning of child (as described in of an unrelated group that controls the other shareholders, none of which individually controls the
a common-law partnership has been established, it will ¶ 4), or is the spouse or common-law partner of the other corporation (see Example 1 below); corporation) the CRA considers that there is a presumption
continue to exist unless the parties are living apart and have one’s brother or sister. However, under certain (v) any member of a related group that controls one that the shareholders of such a closely-held corporation will
been doing so for a continuous period of 90 days due to a circumstances, cousins may be related by marriage, of the corporations is related to each member of act together to control the corporation. In order to rebut this
breakdown in the relationship. For example, Ms X and Mr. Y common-law partnership, or adoption. an unrelated group that controls the other presumption, it would be necessary to show that no one is
have been living together in a conjugal relationship corporation (see Example 2 below); or controlling the corporation and that the decision-making
beginning in 1997. On January 15, 2001, they begin to live Adoption process in the corporation is effectively deadlocked.
(vi) each member of an unrelated group that controls
separate and apart as a result of a breakdown in their
¶ 10. According to paragraph 251(6)(c), two individuals are one of the corporations is related to at least one ¶13. Subsection 251(3) provides that where two
relationship. On June 30, 2002, they reconcile and resume
“connected by adoption” if one individual is the adopted member of an unrelated group that controls the corporations are each related to a third corporation, they will
living together in a conjugal relationship. Ms X and Mr. Y
child of the other. “Adoption” includes a legal adoption and other corporation (see Example 3 below). be considered to be related to each other for the purposes of
will be common-law partners beginning June 30, 2002
an adoption in fact. In addition, an individual who is related For the purposes of subsection 251(2), control means de jure subsections 251(1) and (2). For example, A and B are sisters
because they have previously lived together in a conjugal
by blood (except a brother or sister) to another individual control, which generally means the right of control that rests and each has an adult child, being C and D, respectively.
relationship for a continuous period of one year.
will be related by adoption to that person’s adopted child. in ownership of such number of shares as carries with it the Each of A, B, C and D owns all of the issued shares of a
Note 1: On December 20, 2002, the Minister of Finance Therefore, individuals are connected by adoption to their right to a majority of the votes in the election of the board of corporation, Aco, Bco, Cco and Dco, respectively. In this
released Legislative Proposals and Explanatory Notes adoptive children, parents and grandparents. Whether a directors of the corporation. For a detailed discussion of de situation, Aco and Bco are related to each other by virtue of
Relating to Income Tax, a package of draft technical factual adoption has occurred at a particular time is a jure control of a corporation, see the current version of subparagraph 251(2)(c)(ii). Also, Aco and Cco are related to
amendments to the Income Tax Act. One of the proposals is question of fact and has to be determined based on a IT-64, Corporations: Association and Control. each other and Bco and Dco are related to each other by
to amend the definition of “common-law partner” in consideration of the particular circumstances. The fact that an virtue of subparagraph 251(2)(c)(ii). Therefore, Aco and Dco
subsection 248(1) to provide that an individual will be individual is appointed guardian of a child does not, in and of will be related to each other by virtue of subsection 251(3)
considered a common-law partner of another person at a itself, constitute adoption in fact. For a de facto adoption to Example 1 because each of them is related to Bco. Similarly, Bco and
particular time only where they have lived together in a exist, generally the “adoptive” parent must exercise parental A has two adult children, C and D. C has two children, X and Cco will be related under subsection 251(3) because each of
conjugal relationship throughout the 12-month period that care and guidance on a continuing basis. The factors to look Y, and D has one child, Z. A owns all of the issued and them is related to Aco. However, since subsection 251(3)
ends at the particular time. In the example referred to above, for in determining whether a certain relationship between an outstanding shares of Aco, consequently, A controls Aco. does not apply for the purposes of a subsequent application
this would have the effect that Ms X and Mr. Y will not be individual person and a child constitutes an adoption in fact Each of Y and Z owns 50% of the common shares of Opco. of subsection 251(3), Cco will not be related to Dco.
considered common-law partners until June 30, 2003. If are actual control and custody, an exercise of parental care Since Y and Z are cousins, they will, for purposes of the Act,
enacted as proposed, this amendment will apply for the 2001 and responsibility on a continuing basis, dependency, and be an unrelated group that controls Opco. As A is related to
and subsequent taxation years. proximity to each other.
Special Rules
each of Y and Z (i.e. A is their grandparent), Aco and Opco
will be related pursuant to subparagraph 251(2)(c)(iv). ¶ 14. The provisions of paragraphs 251(5)(a), (b), and (c)
¶ 8. In determining whether an individual is a parent of apply in the determination of control of a corporation for the
their partner’s child, paragraph (b) of the definition of Corporations and Other Persons
Example 2 purposes of identifying related persons within the meaning
“common-law partner” does not restrict such a determination ¶ 11. Paragraphs 251(2)(b) and (c) set out the statutory assigned by subsection 251(2) and for the purpose of the
to the natural child of the partner. Consequently, subsection rules for determining when a corporation and another person Same facts as in Example 1, except that each of A, C and D
definition of a Canadian-controlled private corporation in
252(1) characterizes each individual as a parent of a child will be considered to be “related persons” (or persons related owns 33 1/3% of the common shares of Bco. A, C and D are
subsection 125(7). When a related group is in a position to
when there is a legal or factual adoption of that child. When to each other) for purposes of the Act. Under paragraph a related group that controls Bco. Since A is related to each
control a corporation, paragraph 251(5)(a) deems the
the facts substantiate that an individual is the adoptive (see 251(2)(b), a corporation will be related to another person of Y and Z (i.e. A is their grandparent), Bco and Opco will
corporation to be controlled by the related group even though
¶ 10) parent of the child of an individual with whom the (including another corporation) where: be related pursuant to subparagraph 251(2)(c)(v).
it may be part of a larger group that in fact controls the
individual is living together in a conjugal relationship, both (a) that person controls the corporation; corporation. In determining whether two corporations are
individuals would be considered to be the parents of the child Example 3 related, paragraph 251(5)(c) provides that a person who owns
(b) that person is a member of a related group that controls
and a common-law partnership will be considered to have Mr. X, Mr. Y and Mr. Z are an unrelated group that controls shares of more than one corporation shall be deemed, as
the corporation; or
begun at that time, which could be at the time that the couple XYZ Co. Their spouses, Mrs. X, Mrs. Y and Mrs. Z are an shareholder of the corporations to be related to himself,
began to live together conjugally, or it could be after that (c) that person is a person who is related to a person unrelated group that controls ZYX Co. As Mr. X is related to herself, or itself.
time. described in (a) or (b) above. Mrs. X, Mr. Y is related to Mrs. Y and Mr. Z is related to
For the purposes of paragraph (b) of the definition of In addition, paragraph 251(2)(c) provides that two Mrs. Z, XYZ Co will be related to ZYX Co pursuant to
corporations will be related if:
Options and Rights
“common-law partner”, a child does not generally include a subparagraph 251(2)(c)(vi).
son-in-law or a daughter-in-law. Therefore, for example, a (i) the two corporations are controlled by the same Effect of option
woman who begins to live together in a conjugal relationship person or group of persons; ¶12. The expression “related group” is defined in ¶ 15. Paragraph 251(5)(b) deems a person to be in the same
with her son-in-law’s father would not be the common law (ii) each of the corporations is controlled by one subsection 251(4) and means a group of persons each position, relative to the control of a corporation when, under
partner of her son-in-law’s father until they have lived person and the person who controls one member of which is related to every other member of the a contract, in equity or otherwise, that person has the right:
together for a continuous 12-month period. corporation is related to the person who controls group. For example, a group consisting of two common-law (a) to acquire shares (or control voting rights of shares) as if
the other corporation; partners and their children would be a related group. An that person actually owned the shares;
Other relatives (iii) one of the corporations is controlled by one unrelated group refers to a group of persons that is not a
(b) to cause the corporation to redeem, acquire, or cancel
¶ 9. For purposes of the Act, an individual’s niece, person and that person is related to any member related group. For a group of unrelated persons to constitute a
any shares of its capital stock owned by other
nephew, aunt, or uncle is not related by blood, marriage, of a related group that controls the other group of persons which controls a corporation, there must be
shareholders as if the shares were redeemed, acquired,
common-law partnership or adoption to the individual unless corporation; a common link or interest between the persons (which must
or cancelled by the corporation;
such person is also the individual’s child or parent because of involve more than their mere status as shareholders) or there
(iv) one of the corporations is controlled by one (c) to (or to acquire or control) voting rights of a
the extended meaning of child as described in ¶ 4. Cousins must be evidence that those shareholders act together to exert
person and that person is related to each member corporation’s shares as if that person could exercise
are not related by blood unless one is the child of the other control over the corporation. In the case of a closely-held
corporation (i.e. where there are two or three unrelated those voting rights at that time; or

3 4
 IT-419R2 IT-419R2
(d) to cause the reduction of voting rights of a corporation’s for a person or other entity which controls a corporation to • a particular person or partnership who is not otherwise deceased will be acquired from a person with whom the
shares owned by other shareholders as if the voting give the appearance of divesting itself of control by giving to beneficially interested in a trust at a particular time but beneficiary is not dealing at arm’s length. In addition,
rights were reduced at that time. some other person an option that will never be exercised. may, by reason of the exercise of discretion by any person paragraph 251(1)(b) will deem two or more specified
However, the provisions of paragraph 251(5)(b) will not or partnership, subsequently become beneficially personal trusts not to be dealing at arm’s length where,
apply to the extent that one or more of the rights described interested in the trust where any property has been among other things,
Example acquired, directly or indirectly in any manner, by the trust
above is not exercisable at that time because the exercise of • the same person is a beneficiary of each trust; or
S owns a majority of the voting shares in each of from the particular person or partnership;
the right is contingent on: • a person who is a beneficiary of one trust does not deal at
Corporations A and B and, therefore, has actual control of
• the death, • a member of a partnership that is beneficially interested in arm’s length with a person who is a beneficiary of the
Corporations A and B.
the trust. other trust(s).
• the bankruptcy, or J, who controls Corporation C, has an option to purchase
The following are examples of situations where an individual
• permanent disability, from S or from S’s estate, the controlling shares in
is beneficially interested in a trust: Other Unrelated Persons
of an individual. Corporation A.
(a) trust income is payable to the individual; ¶ 22. Paragraph 251(1)(c) provides that, at a particular
S and J are not related.
Convertible securities (b) income is held in trust and will be paid upon the time, it is a question of fact whether unrelated persons (other
In these circumstances, paragraph 251(5)(b) deems J to have
individual’s attainment of a certain age; than persons described in ¶s 19 and 20) are dealing with each
¶ 16. If bonds, debentures or non-voting shares of a control of Corporation A, but does not deny that S has the
(c) the individual is one for whom a preferred beneficiary other at arm’s length. Sometimes unrelated persons may deal
corporation are convertible into voting shares, paragraph actual control of it.
election may be made; with each other at arm’s length, sometimes they may not,
251(5)(b) may apply because of the “right” of the owners of As a result: depending on all the circumstances. By providing general
those securities to make the conversion. However, whether it (d) the individual is one of a class who has a remainder
• Corporations A and B are related (see subparagraph criteria to determine whether there is an arm’s length
will be applicable can depend upon the distribution of such interest under the trust;
251(2)(c)(i)) and are deemed not to deal with each other at relationship between unrelated persons for a given
convertible securities. If such securities have been issued to arm’s length (see paragraph 251(1)(a)); (e) the individual has contributed property to the trust (e.g. transaction, it must be recognized that all-encompassing
the general public and have wide distribution, they may the settlor of the trust) and may, by virtue of the guidelines to cover every situation cannot be supplied. Each
usually be ignored since it is unlikely that the exercise of • Corporations A and B are each related to S (see
existence of a power of appointment, be added as a particular transaction or series of transactions must be
such rights will result in any person or group of persons subparagraph 251(2)(b)(i)) and are deemed not to deal
beneficiary of the trust at a later date. examined on its own merits. The following paragraphs set
acquiring control of the corporation as a result of the with S at arm’s length (see paragraph 251(1)(a));
The individual is beneficially interested in the trust in (b) forth the CRA’s general guidelines with some specific
conversion of such securities. However, if large numbers of • Corporations A and C are related (see subparagraph
even if the individual’s right to receive income ceases if the comments about certain relationships.
such securities are concentrated in the hands of a small group 251(2)(c)(i)) and are deemed not to deal with each other at
individual should die before attaining the specified age.
of people, their impact will need to be considered. A similar arm’s length (see paragraph 251(1)(a)); ¶ 23. The following criteria have generally been used by
Similarly, the individual is beneficially interested in the trust
situation can exist, also, when a person has a right in some • Corporations A and C are each related to J (see in (c) even if the trustees have full discretionary powers the courts in determining whether parties to a transaction are
other form to subscribe for voting shares of a corporation. subparagraph 251(2)(b)(i)) and are deemed not to deal concerning the distribution of the capital or income of the not dealing at “arm’s length”:
with J at arm’s length (see paragraph 251(1)(a)); and trust so that the individual may in fact receive nothing from • was there a common mind which directs the bargaining
Buy-sell agreements • Corporations B and C are related (see subsection 251(3)) the trust. for both parties to a transaction;
¶ 17. Although the wording in paragraph 251(5)(b) may be and are deemed not to deal with each other at arm’s length • were the parties to a transaction acting in concert without
broad enough to include almost any buy-sell agreement, this (see paragraph 251(1)(a)). ¶ 20. A personal trust, as defined in subsection 248(1), is
separate interests; and
paragraph will not normally be applied solely because of: either a testamentary trust or an inter vivos trust in which no
If, however, J’s option had been exercisable only after the • was there “de facto” control.
beneficial interest was acquired for consideration payable to
(a) a “right of first refusal”; or death, bankruptcy or permanent disability of S, J would not
the trust or to a person who has made a contribution to the
(b) a “shotgun arrangement” (i.e. an arrangement under be deemed to have control of Corporation A, because of the ¶ 24. The courts have held that when one person (or a
trust. Subsection 108(7) provides that a person (or two or
which a shareholder offers to purchase the shares of exceptions in paragraph 251(5)(b), in which case group of persons) is, in fact, the bargaining agent, or the
more persons who are considered to be related for the
another shareholder and the other shareholder must Corporations A and B would not be related to Corporation C mind by which the bargaining is directed, on behalf of both
purposes of that subsection) may make a contribution of
either accept the offer or purchase the shares owned by and J would not be related to Corporation A. (or all) parties to a transaction, then the parties cannot be
property to a trust and retain an interest in the trust without
the offering party) dealing at arm’s length. The courts have expanded this
causing the trust to lose its status as a personal trust. A
principle to include the concept of “acting in concert” with
contained in a shareholder agreement. UNRELATED PERSONS specified personal trust as used in ¶ 19 is a personal trust
respect to an element of common interest. Therefore, even
other than an amateur athlete trust, an employee trust, a
Personal Trusts when there are two distinct parties (or minds) to a
Simultaneous control and deemed control master trust, a trust governed by a deferred profit sharing
transaction, but these parties act in a highly interdependent
¶ 19. Paragraph 251(1)(b) provides that a taxpayer and a plan, an employee benefit plan, an employees profit sharing
18. If paragraph 251(5)(b) does apply, it is possible for manner (in respect of a transaction of mutual interest), then it
specified personal trust (see ¶ 20) will be deemed not to deal plan, a foreign retirement arrangement, a registered education
each of two unrelated persons to be regarded, for the can be assumed that the parties are acting in concert and
with each other at arm’s length if the taxpayer, or any person savings plan, a registered pension plan, a registered
purposes of subsection 251(2), as having control of the same therefore are not dealing with each other at arm’s length.
not dealing at arm’s length with the taxpayer, is beneficially retirement income fund, a registered retirement savings plan
corporation at the same time. For example, one person could When a common purpose exists, a transaction is not
interested in the trust. Pursuant to subsection 248(25), a or a registered supplementary unemployment benefit plan, a
have control by means of direct ownership of shares and the necessarily a non-arm’s-length one when different interests
person who is beneficially interested in a trust includes: related segregated fund trust, a retirement compensation
other could have control as a result of the application of one (or independent parties) are also present. In this context,
arrangement trust, a trust whose direct beneficiaries are one
of the rules in paragraph 251(5)(b). This provision prevents a • a person who has any right (whether immediate or future, different interests are considered to exist when each party has
of the aforementioned trusts, a health and welfare trust, a
person who really controls a corporation from giving the whether absolute or contingent or whether conditional on an independent interest from the other parties to a
trust governed by an eligible funeral arrangement or a
appearance of divesting control by “selling” the controlling or subject to the exercise of any discretion by any person transaction, notwithstanding the fact that each party may
cemetery care trust, and a communal organization.
shares to some other person while retaining an option to or partnership) as a beneficiary to receive any of the have the same purpose, such as economic gain.
repurchase them. income or capital of the trust either directly from the trust ¶ 21. Pursuant to paragraph 251(1)(b), property acquired by
Paragraph 251(5)(b) does not deny that actual control is held or indirectly through one or more trusts or partnerships; a person (i.e. beneficiary) as a consequence of the death of an
by the person who holds it. If it did so, it would be possible individual and in accordance with the terms of the will of the
5 6

IT-419R2 IT-419R2
¶ 25. The courts have also held, in certain cases, that arm’s length with its beneficiaries or with any person who Explanation of Changes
excessive or constant advantage, authority or influence can does not deal at arm’s length with any such beneficiary. In
constitute de facto control (i.e., effective without legal any other case, it is a question of fact whether or not a trust ¶11 (former ¶ 10) has been expanded to include a discussion
control). This situation can bring parties into a non-arm’s and a particular person or group of persons are dealing at
Introduction
of when two corporations will be related by virtue of
length-relationship. It is important to note that this advantage arm’s length. The purpose of the Explanation of Changes is to give the
paragraph 251(2)(c).
need not be exercised to be a factor; the mere ability to do so reasons for the revisions to an interpretation bulletin. It
is sufficient. ¶ 30. Unless the facts indicate otherwise, a trust is outlines revisions that we have made as a result of changes ¶ 12 is a new paragraph which discusses the meaning of the
considered not to be dealing at arm’s length with its settlor; to the law, as well as changes reflecting new or revised expressions “related group” and “unrelated group”.
¶ 26. Failure to carry out a transaction at fair market value however, unless the settlor has maintained some degree of interpretations of the CRA.
may be indicative of a non-arm’s length transaction. influence over the trustee this general presumption may be ¶ 13 is a new paragraph which discusses subsection 251(3)
However, such failure is not conclusive and, conversely, a ignored when the trustee of the trust is a professional trustee, Overview which deems two corporations to be related in certain
transaction between unrelated persons at fair market value (e.g., a public trust company); or if property is settled on a circumstances.
We have revised this bulletin primarily to reflect
does not necessarily indicate an arm’s length situation. The trust and, as a result, the settlor has transferred all of the
amendments to the Income Tax Act enacted by: S.C. 1998, Former ¶ 11 has been renumbered as ¶ 14.
key factor is whether there are separate economic interests usual rights of ownership of the property, the settlor might be
c. 19 (formerly Bill C-28), S.C. 2000, c. 12 (formerly Bill
which reflect ordinary commercial dealing between parties considered to deal at arm’s length with the trust provided that ¶ 15 (former ¶ 12) has been revised to reflect that the draft
C-23) and S.C. 2001, c. 17 (formerly Bill C-22).
acting in their separate interests. The situation where one the trustee of the trust is free of any influence exercised by legislation referred to in the Note thereto has been enacted as
party to a transaction is merely accommodating the other the settlor. However, the CRA generally considers that a S.C. 1998, c. 19, subsections 242(2) and (3), applicable after
party in an attempt to obtain a certain tax result may be a transfer of property from a deceased to the estate of the Legislative and Other Changes
April 26, 1995.
situation where the parties are not dealing at arm’s length deceased or to a trust created by the will of the deceased is The Summary has been revised to include a reference to
because they do not have separate economic interests which not an arm’s length transaction. personal trusts and their beneficiaries as a result of the ¶ 16 is a new paragraph which discusses paragraph 251(5)(b)
reflect ordinary commercial dealings between parties acting amendments made to paragraph 251(1)(b) as enacted by S.C. in the context of convertible securities. These comments
in their own separate interests. ¶ 31. According to subsection 104(2), a trust is deemed to 2001, c. 17, s. 192, applicable after December 23, 1998. have been added since the current version of IT-64
be an individual in respect of trust property and, pursuant to Corporations: Association and Control, which was referred
the definition in subsection 248(1), an “individual” is a ¶ 2 has been revised to include a reference to individuals to in former ¶ 13, no longer discusses paragraph 251(5)(b).
Partnerships connected by “common-law partnership” as a result of the
person. Therefore, in section 251, a reference to the word
¶ 27. In circumstances where a partnership owns a majority “person” includes a trust. amendment to paragraph 251(2)(a) enacted by S.C. 2000, ¶ 17 (former ¶ 13) has been revised to delete the reference to
of the issued voting shares of a corporation, the partnership c. 12, Sch. 2, s. 10, applicable after 2000. IT-64 Corporations: Association and Control which no
will not be considered to deal at arm’s length with the longer discusses paragraph 251(5)(b).
Shareholders and Corporations Former ¶ 4 has been subdivided into two paragraphs, ¶s 4
corporation. In situations when one partner is in a position to
control a partnership, either through ownership of a ¶ 32. If, by the rules in paragraph 251(2)(b), a shareholder and 5. ¶s 4 and 5 have also been revised to change the ¶ 18 is a new paragraph which discusses the simultaneous
controlling interest or through a mandate vested in that does not control a corporation or is not otherwise related to references to spouse to include a “common-law partner” control which may occur where paragraph 251(5)(b) is
partner by the other partners, that partner is not considered to the corporation, there is a general presumption that the effective after 2000. applicable.
be dealing at arm’s length with the partnership. However, shareholder deals at arm’s length with the corporation in
which the shareholder holds shares. However, if a sufficient ¶ 6 (former ¶ 5) has been revised to delete the references to ¶s 19, 20 and 21 are new paragraphs which discuss the
when a partner is not in a position to control a partnership in
number of minority shareholders act in concert in order to paragraphs 252(4)(a) and (b) which were repealed by S.C. amendment to paragraph 251(1)(b) as enacted by S.C. 2001,
which the partner has an interest, and that partner has little or 2000, c. 12, s. 141(2), applicable after 2000.
direct the affairs of a corporation, they may be considered not c. 17, s. 192, applicable after December 23, 1998. Amended
no say in directing the operations of the partnership, it is
to be dealing at arm’s length with the corporation. Acting in paragraph 251(1)(b) deems certain personal trusts not to deal
generally recognized that the partner is dealing at arm’s ¶ 7 is a new paragraph which describes the new definitions
concert generally means a predetermined agreement to act in at arm’s length with any person who is beneficially
length with the partnership. Where a related group of of “common-law partner” and “common-law partnership”
a certain manner. In a widely held corporation, the fact that a interested in the trust or with persons who do not deal at
partners owns a controlling interest in a partnership, each which were added to subsection 248(1) by S.C. 2000, c. 12, arm’s length with such beneficiaries.
member of that related group will not be considered to deal at majority of shareholders vote collectively to take some s. 139(2), applicable after 2000. It also describes a proposal
arm’s length with the partnership. business action will not, by itself, indicate that those to amend the definition of “common-law partner” in ¶ 22 (former ¶ 15) has been amended to change the reference
shareholders are acting in concert and therefore not dealing at subsection 248(1) which is described in Legislative to former paragraph 251(1)(b) to paragraph 251(1)(c).
¶ 28. As a general rule, it is presumed that partners, who arm’s length with each other and the corporation. Also, the Proposals and Explanatory Notes Relating to Income Tax, a
are not related persons, deal with each other on an direct management voice of any minority shareholder who package of draft technical amendments to the Income Tax ¶s 23, 24, 25 and 26 (former ¶s 16, 17, 18 and 19) have been
arm’s-length basis in transactions outside of their partnership holds an officer’s position with a corporation may be relevant Act which was released by the Minister of Finance on renumbered.
activity, although their partnership in business would be a in assessing that shareholder’s relationship with that December 20, 2002.
factor to be considered in any other transaction between corporation. ¶s 27 and 28 (former ¶s 20 and 21) have been revised to
them. ¶ 8 (former ¶s 6 and 7) have been revised to delete the include additional comments with respect to when a
¶ 33. There may be situations when closely held private references to paragraphs 252(4)(a) and (b) which were partnership will not be dealing at arm’s length with another
corporations (with, in some cases, intercorporate share repealed and replaced by the definition of “common-law person.
Trusts
ownership which is insufficient to create legal control) partner” in S.C. 2000, c. 12, applicable after 2000.
¶ 29. In the situation where a trust owns a majority of the ¶s 29 to 31 (former ¶s 22 and 23) have been revised as a
employ some of the same personnel, occupy the same
voting shares of a corporation such that the trustees of the ¶ 9 (former ¶ 8) has been revised to include references to consequence of the new deeming rule applicable to certain
premises, and to the public eye, appear to be one enterprise.
trust control the corporation, the trust and the corporation “common-law partnership” and “common-law partner”. personal trusts.
In such situations, the corporations may be considered not to
will be related persons by virtue of subparagraph 251(2)(b)(i) be dealing with each other on an arm’s length basis.
¶ 10 (former ¶ 9) has been revised to provide additional ¶s 32 and 33 (former ¶s 24 and 25) have been renumbered.
and will, pursuant to paragraph 251(1)(a) be considered not
to be dealing at arm’s length. Also, as discussed in ¶s 19 and comments on de facto adoption. Throughout the bulletin we have revised some of the
20, a specified personal trust will be deemed not to deal at wording in order to improve readability without altering the
substance.

7 8
256(1.1)(“Specified(Class”( Small Business Deduction Provisions

Dividends(on(shares(of(a(specified(class(may(not(exceed(the(prescribed(rate(in(relation(to(the(issue(price( (See also the ITA provisions on classification of corporations)

at(the(time(they(were(issued.(
125. (1) Small business deduction
Regulation(4301.((
There may be deducted from the tax otherwise payable under this Part for a taxation year by a
Subject(to(section(4302,(for(the(purposes(of( corporation that was, throughout the taxation year, a Canadian-controlled private corporation, an
amount equal to the corporation's small business deduction rate for the taxation year multiplied
(a)(every(provision(of(the(Act(that(requires(interest(at(a(prescribed(rate(to(be(paid(to(the(Receiver(
by the least of
General,(the(prescribed(rate(in(effect(during(any(particular(quarter(is(the(total(of(
(a) the amount, if any, by which the total of
(i)(the(rate(that(is(the(simple(arithmetic(mean,(expressed(as(a(percentage(per(year(and(rounded(to(the(
next(higher(whole(percentage(where(the(mean(is(not(a(whole(percentage,(of(all(amounts(each(of(which( (i) the total of all amounts each of which is the income of the corporation for the
is(the(average(equivalent(yield,(expressed(as(a(percentage(per(year,(of(Government(of(Canada(Treasury( year from an active business carried on in Canada (other than the income of the
Bills(that(mature(approximately(three(months(after(their(date(of(issue(and(that(are(sold(at(auctions(of( corporation for the year from a business carried on by it as a member of a
Government(of(Canada(Treasury(Bills(during(the(first(month(of(the(quarter(preceding(the(particular( partnership), and
quarter,(and(
(ii) the specified partnership income of the corporation for the year
(ii)(4(per(cent;(
exceeds the total of
(b)(every(provision(of(the(Act(that(requires(interest(at(a(prescribed(rate(to(be(paid(or(applied(on(an(
amount(payable(by(the(Minister(to(a(taxpayer,(the(prescribed(rate(in(effect(during(any(particular(quarter( (iii) the total of all amounts each of which is a loss of the corporation for the year
is(the(total(of( from an active business carried on in Canada (other than a loss of the corporation
for the year from a business carried on by it as a member of a partnership), and
(i)(the(rate(determined(under(subparagraph((a)(i)(in(respect(of(the(particular(quarter,(and(
(iv) the specified partnership loss of the corporation for the year,
(ii)(if(the(taxpayer(is(a(corporation,(zero(per(cent,(and(in(any(other(case,(2(per(cent;(and(
(b) the amount, if any, by which the corporation's taxable income for the year exceeds the
(c)(every(other(provision(of(the(Act(in(which(reference(is(made(to(a(prescribed(rate(of(interest(or(to(
total of
interest(at(a(prescribed(rate,(the(prescribed(rate(in(effect(during(any(particular(quarter(is(the(rate(
determined(under(subparagraph((a)(i)(in(respect(of(the(particular(quarter.( (i) 10/3 [100/281] of the total of the amounts that would be deductible under
subsection 126(1) from the tax for the year otherwise payable under this Part by it
The prescribed rate is announced two to three weeks before the commencement of each calendar if those amounts were determined without reference to sections 123.3 and 123.4,
quarter. The rate under 4301(a)(i) for January – March 2013 is 1%.
(ii) [the amount determined by multiplying the total] 10/4 of the total of the
See also CRA’s site: http://www.cra-arc.gc.ca/tx/fq/ntrst_rts/menu-eng.html amounts that would be deductible under subsection 126(2) from the tax for the
(
year otherwise payable under this Part by it if those amounts were determined
without reference to section 123.4 [by the relevant factor for the year], and

(iii) the amount, if any, of the corporation's taxable income for the year that is not,
because of an Act of Parliament, subject to tax under this Part, and
"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""
1
"Words"in"square"brackets"represent"proposed"amendments"that"will"be"in"force"for"the"2012"year,"and"will"be"
pro<rated"for"corporations"with"tax"years"that"end"before"December"31.""However,"the"technical"application"of"(b)"
is"beyond"the"scope"of"Law"346A."

1"
"

(c) the corporation's business limit for the year. taxation year straddles December 31, 2008). Provincial small business limits may vary from the limit specified in
s. 125(2).
CCH Editorial note: The small business deduction is computed by applying the “small business deduction rate”
(per s. 125(1.1)) to the least of the corporation's: (3) Associated corporations

1. non-partnership income from an active business carried on in Canada and “specified partnership income” (see Notwithstanding subsection (2), if all the Canadian-controlled private corporations that are
the editorial note in s. 125(7)), less non-partnership Canadian-active-business losses and “specified partnership associated with each other in a taxation year file with the Minister in prescribed form an
losses” (see the editorial note in s. 125(7)) (see paragraph (a));
agreement that assigns for the purpose of this section a percentage to one or more of them for the
2. Small business limit — As amended by the 2009 Federal Budget (S.C. 2009, c. 2) (s. 125(2)), this is normally year, the business limit for the year of each of the corporations is
$500,000 for the 2009 and subsequent taxation years (prorated where the 2009 taxation year straddles
December 31, 2008). This may be reduced where it the corporation is associated in the year with one or more (a) if the total of the percentages assigned in the agreement does not exceed 100%,
corporations (see paragraph (c)); $500,000 multiplied by the percentage assigned to that corporation in the agreement; and
3. A general limitation based on the corporation's taxable income, reduced by amounts designed to estimate the (b) in any other case, nil.
extent to which the corporation's taxable income is effectively sheltered by foreign tax credits, or is tax-exempt (see
paragraph (b)). CCH Editorial note: Associated CCPCs have a business limit of nil unless they file an allocation agreement
(Schedule 23). Subsection 125(4) requires the CRA to make an allocation if any associated corporation fails to file
While a corporation must be a CCPC throughout the year to qualify for the small business deduction, s. 249(3.1) or
an agreement within 30 days after notice in writing that such an agreement is required.
(4) provides a deemed year end when CCPC status is lost. The small business deduction is phased-out (per
s. 125(5.1)), based on taxable capital employed in Canada of between $10M–$15M. Special rules in s. 125(5) may (4) Failure to file agreement
apply for short taxation years, as well as where a corporation has two or more taxation years which end in the same
calendar year. If any of the Canadian-controlled private corporations that are associated with each other in a
(1.1) Small business deduction rate taxation year has failed to file with the Minister an agreement as contemplated by subsection (3)
within 30 days after notice in writing by the Minister has been forwarded to any of them that
For the purpose of subsection (1), a corporation's small business deduction rate for a taxation such an agreement is required for the purpose of any assessment of tax under this Part, the
year is the total of Minister shall, for the purpose of this section, allocate an amount to one or more of them for the
taxation year. The total amount so allocated must equal the least of the amounts that would, if
(a) that proportion of 16% that the number of days in the taxation year that are before none of the corporations were associated with any other corporation during the year and if this
2008 is of the number of days in the taxation year, Act were read without reference to subsections (5) and (5.1), be the business limits of the
(b) that proportion of 17% that the number of days in the taxation year that are after 2007 corporations for the year.
is of the number of days in the taxation year. (5) Special rules for business limit
CCH Editorial note: Income eligible for the small business deduction is excluded from “full rate taxable income”
per paragraph (b) of the definition in s. 123.4(1) and will therefore not qualify for the “general rate reduction”
Notwithstanding subsections (2) to (4),
applicable to business income, per s. 123.4(1) and 123.4(2). Thus, the effective benefit of the small business
deduction is net of the general rate reduction.
(a) where a Canadian-controlled private corporation (in this paragraph referred to as the
“first corporation”) has more than one taxation year ending in the same calendar year and
(2) Business limit it is associated in 2 or more of those taxation years with another Canadian-controlled
private corporation that has a taxation year ending in that calendar year, the business limit
For the purpose of this section, a corporation's business limit for a taxation year is $500,000
of the first corporation for each taxation year ending in the calendar year in which it is
unless the corporation is associated in the taxation year with one or more other Canadian-
associated with the other corporation that ends after the first such taxation year ending in
controlled private corporations, in which case, except as otherwise provided in this section, its
that calendar year is, subject to the application of paragraph (b), an amount equal to the
business limit is nil.
lesser of
CCH Editorial note: See the editorial note to s. 125(1). The 2009 Federal Budget (S.C. 2009, c. 2) raised the small
business limit from $400,000 to $500,000 for the 2009 and subsequent taxation years (prorated where the 2009

2" 3"
" "
 (i) its business limit determined under subsection (3) or (4) for the first such (b) where the corporation is associated with one or more other corporations in the particular year,
taxation year ending in the calendar year, and (ii) its business limit determined the total of all amounts each of which would, but for subsections 181.1(2) and (4), be the tax
under subsection (3) or (4) for the particular taxation year ending in the calendar payable under Part I.3 by the corporation or any such other corporation for its last taxation year
year; and ending in the preceding calendar year.

(b) where a Canadian-controlled private corporation has a taxation year that is less than [¶19,612] Editorial Comment: Reduction of small business deduction for certain large
51 weeks, its business limit for the year is that proportion of its business limit for the year corporations
determined without reference to this paragraph that the number of days in the year is of
365. Subsection 125(5.1) phases out the small business deduction for a corporation in a taxation year
where it or an associated corporation was subject to the Part I.3 large corporations capital tax
CCH Editorial note: Paragraph 125(5)(b) pro-rates the business limit for a taxation year of less than 51 weeks, in the preceding taxation year, or would have been subject to the Part I.3 tax but for its repeal
based on the number of days in the taxation year, divided by 365. (which occurred in 2006).
Paragraph 125(5)(a) is applicable where a corporation has two or more taxation years which end in the same
The phase out begins if the corporation and its associated corporations have $10 million in
calendar year, and is associated in at least two of those years with another CCPC that has a taxation year ending in
the particular calendar year. The business limit of the corporation for the second and subsequent taxation years is taxable capital employed in Canada (as defined in the former Part I.3) and the small business
the business limit allocated to the corporation for the first taxation year, or that of the particular year, if less. limit is reduced to nil when the amount of taxable capital employed in Canada reaches $15
(Paragraph (a) is then subject to the application of paragraph (b); for an example of the interaction of paragraphs million.
(a) and (b), see paragraph 28 of Interpretation Bulletin IT-73R6.) The provision could apply when there is a deemed
year end, such as a change of status to/from a CCPC or an acquisition of control. (6) Corporate partnerships [not part of Law 346A course content]
(5.1) Business limit reduction Where in a taxation year a corporation is a member of a particular partnership and in the year the
corporation or a corporation with which it is associated in the year is a member of one or more
Notwithstanding subsections (2) to (5), a Canadian-controlled private corporation's business limit
other partnerships and it may reasonably be considered that one of the main reasons for the
for a particular taxation year ending in a calendar year is the amount, if any, by which its
separate existence of the partnerships is to increase the amount of a deduction of any corporation
business limit otherwise determined for the particular year exceeds the amount determined by the
under subsection (1), the specified partnership income of the corporation for the year shall, for
formula
the purposes of this section, be computed in respect of those partnerships as if all amounts each
of which is the income of one of the partnerships for a fiscal period ending in the year from an
active business carried on in Canada were nil except for the greatest of those amounts.
A X B___
CCH Editorial note: Subsections 125(6) to (6.3) are anti-avoidance rules directed against the use of partnerships to
11,250 increase entitlement to the small business deduction. Per subsection 125(6), where a corporation or associated
corporation is a member of a number of partnerships and it may reasonably be considered that one of the main
reasons for the separate existence of the partnerships is to increase the small business deduction, the specified
partnership income is limited to the greatest income of one of the partnerships, with the remaining partnership
where income ignored.

A is the amount that would, but for this subsection, be the corporation's business limit for the (6.1) Corporation deemed member of partnership [not part of Law 346A course content]
particular year; and
For the purposes of this section, a corporation that is a member, or is deemed by this subsection
B is to be a member, of a partnership that is a member of another partnership shall be deemed to be a
member of the other partnership and the corporation's share of the income of the other
(a) where the corporation is not associated with any other corporation in the particular year, the partnership for a fiscal period shall be deemed to be equal to the amount of that income to which
amount that would, but for subsections 181.1(2) and (4), be the corporation's tax payable under the corporation was directly or indirectly entitled.
Part I.3 for its preceding taxation year, and

4" 5"
" "

CCH Editorial note: Subsection 125(6.1), which is part of the anti-avoidance rules in subsections 125(6) to (6.3) (a) a corporation controlled, directly or indirectly in any manner whatever, by one or
pertaining to partnerships and the small business deduction, is a look-through rule for tiered partnerships, such that more non-resident persons, by one or more public corporations (other than a prescribed
lower-tier income is considered to be that of the upper-tier partnership.
venture capital corporation), by one or more corporations described in paragraph (c), or
(6.2) Specified partnership income deemed nil by any combination of them,

Notwithstanding any other provision of this section, where a corporation is a member of a (b) a corporation that would, if each share of the capital stock of a corporation that is
partnership that was controlled, directly or indirectly in any manner whatever, by one or more owned by a non-resident person, by a public corporation (other than a prescribed venture
non-resident persons, by one or more public corporations (other than a prescribed venture capital capital corporation), or by a corporation described in paragraph (c) were owned by a
corporation) or by any combination thereof at any time in its fiscal period ending in a taxation particular person, be controlled by the particular person,
year of the corporation, the income of the partnership for that fiscal period from an active
(c) a corporation a class of the shares of the capital stock of which is listed on a
business carried on in Canada shall, for the purposes of computing the specified partnership
designated stock exchange, or
income of a corporation for the year, be deemed to be nil.
(d) in applying subsection (1), paragraphs 87(2)(vv) and (ww) (including, for greater
CCH Editorial note: Subsections 125(6.2) and (6.3) — part of the anti-avoidance rules in subsections 125(6) to
(6.3) pertaining to partnerships and the small business deduction — are designed to impose a requirement at the certainty, in applying those paragraphs as provided under paragraph 88(1)(e.2)), the
partnership level which is similar to Canadian-controlled corporation status. Per subsection 125(6.2), where a definitions “excessive eligible dividend designation”, “general rate income pool” and
corporation is a member of a partnership that is controlled by non-residents and/or public corporations at any time “low rate income pool” in subsection 89(1) and subsections 89(4) to (6), (8) to (10) and
in its fiscal period, Canadian active business income for the purpose of computing specified partnership income 249(3.1), a corporation that has made an election under subsection 89(11) and that has
(i.e., income eligible for the small business deduction) is generally deemed to be nil. (It is not clear that the control
not revoked the election under subsection 89(12);
test is necessarily based on 265(5.1) (de facto control).) Subsection 125(6.3) deems a partnership to be controlled
by one or more persons if the total share of the partnership income from any source for the fiscal period exceeds CCH Editorial note: CCPC status is based on being both a “Canadian corporation” and a “private corporation”,
50% of the income from that source.
per subsection 89(1). Further, the corporation must not be controlled, (effectively or legally) by any combination of
non-resident persons or public corporations (other than a prescribed venture capital corporation). Finally, no class
(6.3) Partnership deemed to be controlled
of its shares can be listed on a designated stock exchange (whether Canadian or foreign). Because control is defined
in the negative, a deadlock will not disqualify a corporation. If the control requirements are broken anywhere in a
For the purposes of subsection (6.2), a partnership shall be deemed to be controlled by one or
corporate chain, downstream companies will not be Canadian-controlled private corporations. Per paragraph (b)
more persons at any time if the total of the shares of that person or those persons of the income of the definition, non-residents' and public corporations' shareholdings must be notionally attributed to one
of the partnership from any source for the fiscal period of the partnership that includes that time hypothetical person. If that person would control the corporation, then the corporation is not a CCPC (paragraph
exceeds 1/2 of the income of the partnership from that source for that period. (a) on its own would require a common connection between non-residents and/or public companies).

(7) Definitions Paragraph (d) relates to the eligible dividend regime, providing that, if the corporation has elected not to be a
CCPC pursuant to subsection 89(11) (so that it can pay eligible dividends “by default” — see the editorial note to
In this section, subsection 89(11)), CCPC status will not apply, but only for the specific provisions listed (e.g., the small business
deduction per subsection 125(1) will not be available, but the RDTOH regime will continue to apply).
“active business carried on by a corporation”
“income of the corporation for the year from an active business”
“active business carried on by a corporation” means any business carried on by the corporation
“income of the corporation for the year from an active business” means the total of
other than a specified investment business or a personal services business and includes an
adventure or concern in the nature of trade; (a) the corporation's income for the year from an active business carried on by it
including any income for the year pertaining to or incident to that business, other than
“Canadian-controlled private corporation”
income for the year from a source in Canada that is a property (within the meaning
“Canadian-controlled private corporation” means a private corporation that is a Canadian assigned by subsection 129(4)), and
corporation other than
(b) the amount, if any, included under subsection 12(10.2) in computing the corporation's
income for the year;

6" 7"
" "
 “personal services business” other similar services to the corporation in the year and the corporation could reasonably
be expected to require more than 5 full-time employees if those services had not been
“personal services business” carried on by a corporation in a taxation year means a business of provided;
providing services where
CCH Editorial note: Income from a “specified investment business” is not eligible for the small business deduction
(a) an individual who performs services on behalf of the corporation (in this definition but instead attracts “investment rates”/refundable tax treatment if earned by a CCPC. This refers to a business
and paragraph 18(1)(p) referred to as an “incorporated employee”), or whose principal purpose is to derive income from property, including interest, dividends, rents or royalties, but
excluding non-real-estate leasing. Two ordinarily-applicable exceptions arise where the corporation employs
(b) any person related to the incorporated employee throughout the year more than five full-time employees (see Cases below), or where an associated corporation
provides managerial administrative, financial, maintenance or other services, but for which the corporation could
is a specified shareholder of the corporation and the incorporated employee would reasonably be reasonably be expected to require more than five full-time employees.
regarded as an officer or employee of the person or partnership to whom or to which the services
129.(4) Definitions
were provided but for the existence of the corporation, unless
The definitions in this subsection apply in this section.
(c) the corporation employs in the business throughout the year more than five full-time “aggregate investment income”
employees, or
“aggregate investment income” of a corporation for a taxation year means the amount, if any, by
(d) the amount paid or payable to the corporation in the year for the services is received which the total of all amounts, each of which is
or receivable by it from a corporation with which it was associated in the year;
(a) the amount, if any, by which
CCH Editorial note: A personal services business is denied the small business rate, and deductions are severely
curtailed (see paragraph 18(1)(p)). It involves an individual providing services through his or her corporation to a (i) the eligible portion of the corporation's taxable capital gains for the year
would-be employer. If, but for the service company, the individual would reasonably have employee status, the
provision applies, provided that the individual or a related person is a “specified shareholder” (per subsection exceeds the total of
248(1)) of the service company. (Basically, this requires at least 10% of any class of shares counting those held by
non-arm's length persons.) Exceptions apply if throughout the year the corporation employs more than five full-time (ii) the eligible portion of its allowable capital losses for the year, and
employees or if the services are provided to an associated corporation. See 489599 B.C. Ltd. v. The Queen in
“Cases” below. (iii) the amount, if any, deducted under paragraph 111(1)(b) in computing its
taxable income for the year, or
The applicable corporate tax rate should be the general business rate rather than the higher corporate rate applying
to investment-type income. A CCPC would generate a GRIP account and could thus pay eligible dividends.
(b) the corporation's income for the year from a source that is a property, other than
“specified investment business” (i) exempt income,
“specified investment business” carried on by a corporation in a taxation year means a business
(ii) an amount included under subsection 12(10.2) in computing the corporation's
(other than a business carried on by a credit union or a business of leasing property other than income for the year,
real property) the principal purpose of which is to derive income (including interest, dividends,
rents and royalties) from property but, except where the corporation was a prescribed labour- (iii) the portion of any dividend that was deductible in computing the
sponsored venture capital corporation at any time in the year, does not include a business carried corporation's taxable income for the year, and
on by the corporation in the year where
(iv) income that, but for paragraph 108(5)(a), would not be income from a
(a) the corporation employs in the business throughout the year more than 5 full-time property,
employees, or
exceeds the total of all amounts, each of which is the corporation's loss for the year from a source
(b) any other corporation associated with the corporation provides, in the course of that is a property.
carrying on an active business, managerial, administrative, financial, maintenance or
8" 9"
" "

CCH Editorial note: The calculation of a corporation's aggregate investment income is made by determining the (i) the deductible portion shall be deemed to be income of the recipient
total of: (a) the eligible portion of taxable capital gains — basically, that have accrued while the corporation was a corporation for the particular year from an active business carried on by it in
CCPC or certain other specialty corporations (see the editorial note for the definition of “eligible portion”); and
Canada, and
(b) income from property (with certain exceptions, including exempt income and deductible dividends) — this
includes “specified investment business” income. (Note: The eligible portion of taxable capital gains is net of the
(ii) any outlay or expense, to the extent described in subparagraph (a)(ii), shall be
eligible portion of allowable capital losses, and capital loss carryovers.)
deemed to have been made or incurred by the recipient corporation for the
“income” or “loss” purpose of gaining or producing that income.

“income”or“loss” of a corporation for a taxation year from a source that is a property CCH Editorial note: This provision expands the concept of active business income to include Canadian-source
payments from associated corporations which, when viewed in isolation, would not qualify as active business
(a) includes the income or loss from a specified investment business carried on by it in income (e.g., interest and rent), but which are deductible in computing the payor corporation's active business
Canada other than income or loss from a source outside Canada, but income. The recipient does not include the income as from property (and related outlays are not sourced to income
from property); instead, the amount is deemed to be active business income (with related outlays sourced to active
(b) does not include the income or loss from any property business income). This rule does not depend on either CCPC status, or whether the income qualifies for the small
business deduction. While the income would not generate refundable tax treatment to a CCPC, its effects may be
(i) that is incident to or pertains to an active business carried on by it, or advantageous even if the small business deduction is not available, since the income would attract the general
corporate “business rate” rather than the “investment rate”, and would normally generate eligible dividends.
(ii) that is used or held principally for the purpose of gaining or producing income
from an active business carried on by it.

129.(6) Investment income from associated corporation deemed to be active business income

Where any particular amount paid or payable to a corporation (in this subsection referred to as
the “recipient corporation”) by another corporation (in this subsection referred to as the
“associated corporation”) with which the recipient corporation was associated in any particular
taxation year commencing after 1972, would otherwise be included in computing the income of
the recipient corporation for the particular year from a source in Canada that is a property, the
following rules apply:

(a) for the purposes of subsection (4), in computing the recipient corporation's income for
the year from a source in Canada that is a property,

(i) there shall not be included any portion (in this subsection referred to as the
“deductible portion”) of the particular amount that was or may be deductible in
computing the income of the associated corporation for any taxation year from an
active business carried on by it in Canada, and

(ii) no deduction shall be made in respect of any outlay or expense, to the extent
that that outlay or expense may reasonably be regarded as having been made or
incurred by the recipient corporation for the purpose of gaining or producing the
deductible portion; and

(b) for the purposes of this subsection and section 125,

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" "
 Personal Services Business: Associated Corporation Exception Taxation of Dividends Provisions
12. (1) Income inclusions
There shall be included in computing the income of a taxpayer for a taxation year as
income from a business or property such of the following amounts as are applicable:
(j) Dividends from resident corporations
Bill Barb • Real estate sales any amount required by subdivision h [sections 82-89.1] to be included in
• 6 FT employees computing the taxpayer's income for the year in respect of a dividend paid by a
• Bill used to be an corporation resident in Canada on a share of its capital stock;
25% employee before (k) Dividends from other corporations
100% 75% Billco was any amount required by subdivision i [section 90-95 shareholders of corporations
incorporated not resident in Canada] to be included in computing the taxpayer's income for the
year in respect of a dividend paid by a corporation not resident in Canada on a
share of its capital stock or in respect of a share owned by the taxpayer of the
fees capital stock of a foreign affiliate of the taxpayer;

82. (1) Taxable dividends received

Billco Barbco
In computing the income of a taxpayer for a taxation year, there shall be included the
photography total of the following amounts:
services (a) the amount, if any, by which
(i) the total of all amounts, other than eligible dividends and amounts
described in paragraph (c), (d) or (e), received by the taxpayer in the
taxation year from corporations resident in Canada as, on account of, in
• Bill and Barb are common law partners. Billco’s only client is Barbco. lieu of payment of or in satisfaction of, taxable dividends,
• Billco’s only employee is Bill. He provides all the photography and related exceeds
services to Barbco in respect of Barbco’s real estate marketing, but he does not (ii) if the taxpayer is an individual, the total of all amounts paid by the
participate in selling properties or negotiating contracts. taxpayer in the taxation year that are deemed by subsection 260(5)
• Billco has photography and related computer equipment, but no other assets. Bill [securities lending arrangements] to have been received by another
usually gets a ride with Barb or a Barbco employee to the property, and he takes person as taxable dividends (other than eligible dividends);
pictures under a degree of direction from the selling agent, the same as when he (a.1) [eligible dividends] the amount, if any, by which
was an employee of Barbco. (i) the total of all amounts, other than amounts included in computing the
• Billco claims CCA on the photography equipment and the interest on the loan to income of the taxpayer because of paragraph (c), (d) or (e), received by
acquire the equipment. the taxpayer in the taxation year from corporations resident in Canada as,
• Billco would be carrying on a PSB but for the fact that Billco provides services to on account of, in lieu of payment of or in satisfaction of, eligible dividends,
exceeds
an associated corporation, Barbco (see definition of PSB in 125(7)). This means
(ii) if the taxpayer is an individual, the total of all amounts paid by the
Billco is not restricted in the deductions it can claim under 18(1)(p), and its
taxpayer in the taxation year that are deemed by subsection 260(5) to
profits are eligible for the SBD, though the business limit will be shared with
have been received by another person as eligible dividends; and
Barbco. (b) if the taxpayer is an individual, other than a trust that is a registered charity,
the total of
(i) 25% of the amount determined under paragraph (a) in respect of
the taxpayer for the taxation year, and
(ii) the product of the amount determined under paragraph (a.1) in respect
of the taxpayer for the taxation year multiplied by
(A) for the 2009 taxation year, 45%,
(B) for the 2010 taxation year, 44%,
(C) for the 2011 taxation year, 41%, and
(D) for taxation years after 2011, 38%; (…)
CCH Editorial note: The amount under paragraph 82(1)(b) is the so-called gross-up in respect of
taxable dividends received by individuals from Canadian resident corporations. For “eligible

dividends” (see the definition in subsection 89(1)) received after 2005 and before 2010, the gross- “general rate income pool” (GRIP)
up is 45%, reducing to 44% for 2010, 41% for 2011, and 38% thereafter. The gross-up for non- “general rate income pool” at the end of a particular taxation year, of a taxable Canadian
eligible dividends is 25%. The dividend tax credit under section 121 equals 11/18 of the gross-up corporation that is a Canadian-controlled private corporation or a deposit insurance
for eligible dividends received before 2010, 10/17 for those received in 2010, 13/23 in 2011, and corporation in the particular taxation year, is the positive or negative amount determined
6/11 thereafter. The dividend tax credit for non-eligible dividends is two-thirds of the gross-up.
by the formula
The 2008 Federal Budget, which implemented these changes, noted that these changes were
necessary as a result of the reduction in the general corporate tax rate, in order to more closely
A–B
resemble full integration. where
A is the positive or negative amount that would, before taking into consideration the
89(1) specified future tax consequences for the particular taxation year, be determined by the
“taxable dividend” means a dividend other than formula
(a) a dividend in respect of which the corporation paying the dividend has elected C+D+E+F–G
in accordance with subsection 83(1) as it read prior to 1979 or in accordance with where
subsection 83(2), and C is the corporation's general rate income pool at the end of its preceding taxation year,
(b) a qualifying dividend paid by a public corporation to shareholders of a D is the amount, if any, that is the product of the corporation's general rate factor for the
prescribed class of tax-deferred preferred shares of the corporation within the particular taxation year multiplied by its adjusted taxable income for the particular
meaning of subsection 83(1). taxation year,
E is the total of all amounts each of which is
“eligible dividend” (a) an eligible dividend received by the corporation in the particular taxation year,
“eligible dividend” means or
(a) a taxable dividend that is received by a person resident in Canada, paid after (b) an amount deductible under section 113 in computing the taxable income of
2005 by a corporation resident in Canada and designated, as provided under the corporation for the particular taxation year,
subsection (14), to be an eligible dividend, and F is the total of all amounts determined under subsections (4) to (6) in respect of the
(b) in respect of a person resident in Canada, an amount that is deemed by corporation for the particular taxation year, and
subsection 96(1.11) or 104(16) to be a taxable dividend that is received by the G is
person; (a) unless paragraph (b) applies, the amount, if any, by which
CCH Editorial note: Eligible dividends will qualify for a 38% gross-up and a dividend tax credit of (i) the total of all amounts each of which is the amount of an eligible
6/11 of that amount, when the gross-up/credit rates are phased-in in 2012. Prior to this, more dividend paid by the corporation in its preceding taxation year
generous gross-up and tax credit rates will apply (see s. 82(1) and s. 121). CCPCs can pay exceeds
eligible dividends without potential penalties to the extent that post-2005-taxation-year income is (ii) the total of all amounts each of which is an excessive eligible dividend
taxed at the general (business) corporate tax rate, as such income enlarges a CCPC's general designation made by the corporation in its preceding taxation year, or
rate income pool (GRIP); a special GRIP addition may apply to taxation years ending after 2000 (b) if subsection (4) applies to the corporation in the particular taxation year, nil,
and before 2006. Non-CCPCs (as well as SIFT partnerships and trusts) can pay eligible
and
dividends without potential penalties, after they have exhausted their low rate income pool (LRIP)
B is the amount determined by the formula
by paying ineligible dividends. Eligible dividends must be designated, per s. 89(14), and received
by a Canadian resident. See also the editorial notes to s. 89(1), “excessive eligible dividend H × (I – J)
designation”, “general rate income pool”, “low rate income pool”, ss. 89(7) and 89(11), s. 185.1 where
and s. 249(3.1) (regarding a change of status to/from a CCPC). H is the corporation's general rate factor for the particular taxation year,
I is the total of the corporation's full rate taxable incomes (as would be defined in the
definition “full rate taxable income” in subsection 123.4(1), if that definition were read
without reference to its subparagraphs (a)(i) to (iii)) for the corporation's preceding three
taxation years, determined without taking into consideration the specified future tax
consequences, for those preceding taxation years, that arise in respect of the particular
taxation year, and
J is the total of the corporation's full rate taxable incomes (as would be defined in the
definition “full rate taxable income” in subsection 123.4(1), if that definition were read
without reference to its subparagraphs (a)(i) to (iii)) for those preceding taxation years;
CCH Editorial note: This tax account is relevant to eligible dividends paid by CCPCs. If dividends
exceed the corporation's GRIP, the “excessive eligible dividend designation” penalty regime will
apply. GRIP is a year-end calculation, where dividends can be paid without potential penalties at
a time when there is no GRIP, provided that by year-end, there is enough GRIP to cover the
 dividend. Generally, and in simplified form, the following are components of the GRIP account of (a) if the non-CCPC was not a Canadian-controlled private corporation in its
a CCPC (applicable to taxation years after 2005): preceding taxation year, 80% of the amount determined by multiplying the
The description of A: amount, if any, deducted by the corporation under subsection 125(1) for that
GRIP at the end of the preceding taxation year (the description of C). preceding taxation year by the quotient obtained by dividing 100 by the rate of
Add 68% of taxable income (paragraph (a) of the description of D), less income subject to the
the deduction provided under that subsection for that preceding taxation year,
small business deduction (the description of E) and investment income (the description of F).
Add eligible dividends received by the corporation (paragraph (a) of the description of G),
and
dividends which are deductible under section 113 (e.g., dividends from exempt surplus[ of a (b) in any other case, nil,
foreign affiliate]) (paragraph (b) of the description of G), and GRIP additions on becoming a F is
CCPC or in respect of amalgamation or winding-up (the description of H). (a) if the non-CCPC was an investment corporation in its preceding taxation year,
Less eligible dividends paid in the preceding taxation year (net of excessive eligible dividend four times the amount, if any, deducted by it under subsection 130(1) for its
designations) (the description of I). preceding taxation year, and
Subsequent years' losses that are carried back to a particular year (and other “specified future tax (b) in any other case, nil,
consequences”), do not reduce that year's GRIP, but instead reduce GRIP at the end of the year G is the total of all amounts each of which is a taxable dividend (other than an eligible
in which the loss arises (the description of B). A CCPC may qualify for an addition to GRIP in dividend, a capital gains dividend within the meaning assigned by subsection 130.1(4) or
respect of years prior to its 2006 taxation year, by virtue of subsection 89(7). Separate
131(1) or a taxable dividend deductible by the non-CCPC under subsection 130.1(1) in
calculations apply upon becoming a CCPC (subsection 89(4)), to amalgamations, and to
windings-up (subsections 89(5) and (6)). Dividends subject to subsection 55(2) as deemed capital
computing its income for the particular taxation year or for its preceding taxation year)
gains to the recipient nonetheless deplete the GRIP of the payor — see CRA Document No. that became payable, in the particular taxation year but before the particular time, by the
2007-0233771C6. non-CCPC, and
To account for lower corporate tax rates, Bill C-10 will change the 68% amount (above) to 69% H is the total of all amounts each of which is an excessive eligible dividend designation
for 2010, 70% for 2011, and 72% for subsequent years (see the definition of “general rate factor” made by the non-CCPC in the particular taxation year but before the particular time;
in subsection 89(1)). In addition, a number of mainly-clerical changes to the formula will be made: CCH Editorial note: This tax account, which generally applies to non-CCPCs, must be “cleared-
The descriptions of D, E and F will be moved to the definition of “adjusted taxable income” in out” before such corporations can pay eligible dividends without potential penalties under the
subsection 89(1), so that the description of D is based on “general rate factor” multiplied by “excessive eligible dividend designation” regime. Unlike GRIP, which is a year-end calculation
“adjusted taxable income”, which cannot be negative. Corresponding changes to the lettering of applying to CCPCs, LRIP is a point-in-time calculation.
subsequent descriptions will be made. The formula in B will refer to the “general rate factor” (the Generally, and in simplified form, the following are the components of LRIP (applicable to taxation
description of H), with descriptions in paragraphs (a) and (b) thereof redesignated as I and J but years after 2005):
otherwise unchanged. LRIP at the end of the preceding taxation year (the description of A).
Add ineligible dividends payable before the particular time to the non-CCPC from a corporation
“low rate income pool” (LRIP) resident in Canada (the description of B).
“low rate income pool” , at any particular time in a particular taxation year, of a Add LRIP additions on ceasing to be a CCPC or in respect of an amalgamation or winding-up
corporation (in this definition referred to as the “non-CCPC”) that is resident in Canada (the description of C).
Add 80% of investment income if the corporation would be a CCPC but for a change-of-status
and is in the particular taxation year neither a Canadian-controlled private corporation
election (paragraph (a) of the description of D).
nor a deposit insurance corporation, is the amount determined by the formula Less eligible dividends payable in the taxation year before the particular time (net of excessive
(A + B + C + D + E + F) – (G + H) eligible dividend designations) (the descriptions of G and H — the descriptions of E and F apply
where to special status corporations).
A is the non-CCPC's low rate income pool at the end of its preceding taxation year, Separate calculations apply upon ceasing to be a CCPC (s. 89(8)), to amalgamations, and to
B is the total of all amounts each of which is an amount deductible under section 112 in windings-up (ss. 89(9) and 89(10)).
computing the non-CCPC's taxable income for the year in respect of a taxable dividend
(other than an eligible dividend) that became payable, in the particular taxation year but 121. Deduction for taxable dividends
before the particular time, to the non-CCPC by a corporation resident in Canada, There may be deducted from the tax otherwise payable under this Part by an individual
C is the total of all amounts determined under subsections (8) to (10) in respect of the for a taxation year the total of
non-CCPC for the particular taxation year, (a) 2/3 of the amount, if any, that is required by subparagraph 82(1)(b)(i) to be included
D is in computing the individual's income for the year; and
(a) if the non-CCPC would, but for paragraph (d) of the definition “Canadian- (b) the product of the amount, if any, that is required by subparagraph 82(1)(b)(ii) to be
controlled private corporation” in subsection 125(7), be a Canadian-controlled included in computing the individual's income for the year multiplied by
private corporation in its preceding taxation year, 80% of its aggregate (i) for the 2009 taxation year, 11/18,
investment income for its preceding taxation year, and (ii) for the 2010 taxation year, 10/17,
(b) in any other case, nil, (iii) for the 2011 taxation year, 13/23, and
E is (iv) for taxation years after 2011, 6/11.

GRIP and LRIP and Eligible Dividends A corporation must designate each eligible dividend it pays as such. An excessive eligible
dividend designation (EEDD) attracts a penalty tax under Part III.1 of the Act of 20%.
Law 346A
" To calculate GRIP and LRIP, we will use formulas that have been simplified from those
Since 2006, the dividend integration regime has been extended so that full integration applies to provided in the definitions in 89(1). These pools are kept for accounting purposes, on a year on
both dividends paid by CCPCs out of active business income, and to taxable dividends paid by year basis. You will not be expected to be able to do a GRIP or LRIP calculation, only to
non-CCPCs out of corporate income taxed at the normal corporate rates. The change was a recognize an amount that would be added to either pool, to the extent covered in the course.
response to the increasing use of income trusts, instead of corporations, to avoid one level of
taxation. The goal of bringing in full integration was to align the taxation of distributions of GRIP starts with “C” in the formula, the GRIP balance (positive or negative) at the end of the
Canadian corporations other than CCPCs with the taxation of income trust distributions. previous tax year before deducting eligible dividends paid in that previous year. To that is added
Announced in November 2005 by the Liberals, the proposal was carried through by the “D” the corporation’s income subject to the general corporate rate (“adjusted taxable income” in
Conservatives in 2006. It should be noted that these measures proved insufficient to stop the tide 89(1)), multiplied by the general rate factor. [This excludes (a) income subject to the small
of conversions of large corporations to income trust structures. This resulted in the business deduction and (b) aggregate investment income.]
announcement on October 31 2006 (“The Hallowe’en Massacre”) of the specified investment
flow-through or “SIFT” rules that effectively force income trusts other than REITs and some The general rate factor is currently .72 (2012) and we will assume that it is and has been constant
limited partnerships to convert to corporations by the end of 2011, or their distributions become for the purposes of this course. (In reality, it was .68 from 2006 to 2009, .69 in 2010, and
subject to taxation equivalent to corporate dividends. increased to .70 in 2011 and .72 in 2012, as the general corporate tax rate decreased.)

CCH’s Canadian Tax Reporter covers this very well, but again with more complexity than we Thus D adds to GRIP an amount approximating the income of the corporation after tax at the
will. Most of the definitions are in subsection 89(1). The dual regime for dividend taxation is general corporate rate.
another important distinction between the tax treatment of CCPCs and other Canadian
corporations. Eligible dividends received from other corporations are added to the GRIP by E(a) in the
formula. (Ignore E(b), as this deals with dividends from foreign corporations.)
The system is actually pretty simple. Dividends paid out of income of a corporation that has
been taxed at the small business rate is subject to a lower gross-up, and the Canadian resident From this is subtracted the properly designated eligible dividends paid by the corporation in the
individual who receives the dividend is entitled to a lesser dividend tax credit, than for dividends preceding year - G. We will not get into the details of the adjustments that must be made to GRIP
paid out of income of a Canadian corporation that has been taxed at the normal corporate rate. and LRIP due to reorganizations or changes in status.
The overall system is intended to ensure that business income earned through a corporation is
subject to about the same tax burden as income earned directly. Many CCPCs will have no GRIP, but those with income in excess of the small business limit that
has been taxed at the general rate will have a positive GRIP and be able to designate eligible
The provinces have all responded with varying rates of gross-ups and credits based on their dividends to that extent.
corporate tax rates and policies. We will only study BC’s rules, but the provinces have all
responded in similar fashion. LRIP

An “eligible dividend”, properly designated as such by the distributing corporation, receives the A non-CCPC must calculate its LRIP to ensure that it does not make Excessive Eligible
more favourable treatment from the recipient shareholder’s perspective. Dividend Designations “EEDDs”. As noted, a non-CCPC can only designate a dividend as an
eligible dividend to the extent it exceeds its LRIP. Again, the formula in 89(1) is more complex
A CCPC must calculate its “general rate income pool” (GRIP) each year. To the extent that a than we can cover.
CCPC has a positive GRIP, it can pay eligible dividends. (We will not cover this topic in
relation to DICs, deposit insurance corporations.) The first inclusion (A) in calculating LRIP is the LRIP at the end of its preceding tax year (which
excludes dividends that were not eligible dividends paid in that year) plus any EEDDs made in
A non-CCPC must calculate its “low rate income pool” (LRIP), as it must have eliminated any that preceding year. To that is added the total of all non-eligible dividends received by the
balance in this pool before it can pay an eligible dividend. A non-CCPC may have LRIP if it has corporation (B) and deductible under 112(1).
previously been a CCPC, or if it has a received a dividend from a CCPC.

1" 2"
" "
From this is deducted G, the amount of non-eligible dividends paid by the non-CCPC in the year, (ii)"the"amount"claimed"by"the"corporation"in"the"election"not"exceeding"the"
but before the time the LRIP is being calculated. Also deducted are (H) the total EEDDs in the excessive"eligible"dividend"designation,"determined"without"reference"to"this"
year up to the time of calculation of LRIP. subsection;"
(b)"an"amount"equal"to"the"amount"claimed"by"the"corporation"in"the"election"is"
Many non-CCPCs will have no LRIP, as all of their income will have been subject to tax at the deemed"to"be"a"separate"taxable"dividend"(other"than"an"eligible"dividend)"that"was"
normal corporate rate. However, if they have received dividends from CCPCs, or were formerly paid"by"the"corporation"immediately"before"the"particular"time;"
CCPCs, they may have an LRIP balance. (c)"each"shareholder"of"the"corporation"who"at"the"particular"time"held"any"of"the"issued"
shares"of"the"class"of"shares"in"respect"of"which"the"original"dividend"was"paid"is"
Eligible Dividends
deemed""
In order to pay an eligible dividend, a Canadian corporation must pay a taxable dividend and
designate it as an eligible dividend as provided by 89(14). We are not concerned with the (i)"not"to"have"received"the"original"dividend,"and"
administrative requirements for designation. Note that capital dividends are not eligible (ii)"to"have"received"at"the"particular"time""
dividends, because they are excluded from the definition of taxable dividends in 89(1). (A)"as"an"eligible"dividend,"the"shareholder's"pro"rata"portion"of"the"
amount"of"any"dividend"determined"under"paragraph"(a),"and"
If a corporation makes an excessive eligible dividend designation, it may be subject to additional (B)"as"a"taxable"dividend"(other"than"an"eligible"dividend)"the"
tax under Part III.1. The EEDD does not affect the recipient unless the distributing corporation shareholder's"pro"rata"portion"of"the"amount"of"any"dividend"determined"
seeks to revoke the EEDD. under"paragraph"(b);"and"
(d)"a"shareholder's"pro"rata"portion"of"a"dividend"paid"at"any"time"on"a"class"of"the"
Part III.1 shares"of"the"capital"stock"of"a"corporation"is"that"proportion"of"the"dividend"that"the"
185.1."(1)"Tax$on$excessive$eligible$dividend$designations" number"of"shares"of"that"class"held"by"the"shareholder"at"that"time"is"of"the"number"of"
A"corporation"that"has"made"an"excessive"eligible"dividend"designation"in"respect"of"an"eligible" shares"of"that"class"outstanding"at"that"time."
dividend"paid"by"it"at"any"time"in"a"taxation"year"shall,"on"or"before"the"corporation's"balanceA "
due"day"for"the"taxation"year,"pay"a"tax"under"this"Part"for"the"taxation"year"equal"to"the"total" (3)"Concurrence$with$election"
of" An"election"under"subsection"(2)"in"respect"of"an"original"dividend"is"valid"only"if""
(a)"20%"of"the"excessive"eligible"dividend"designation,"and" (a)"it"is"made"with"the"concurrence"of"the"corporation"and"all"its"shareholders""
(b)"if"the"excessive"eligible"dividend"designation"arises"because"of"the"application"of" (i)"who"received"or"were"entitled"to"receive"all"or"any"portion"of"the"original"
paragraph"(c)"of"the"definition"“excessive"eligible"dividend"designation”"in"subsection" dividend,"and"
89(1),"10%"of"the"excessive"eligible"dividend"designation." (ii)"whose"addresses"were"known"to"the"corporation;"and"
" (b)"either""
(2)"Election$to$treat$excessive$eligible$dividend$designation$as$an$ordinary$dividend$ (i)"it"is"made"on"or"before"the"day"that"is"30"months"after"the"day"on"which"the"
If,"in"respect"of"an"excessive"eligible"dividend"designation"that"is"not"described"in"paragraph" original"dividend"was"paid,"or"
(1)(b)"and"that"is"made"by"a"corporation"in"respect"of"an"eligible"dividend"(in"this"subsection"and" (ii)"each"shareholder"described"in"subparagraph"(a)(i)"concurs"with"the"election,"
subsection"(3)"referred"to"as"the"“original"dividend”)"paid"by"it"at"a"particular"time,"the" in"which"case,"notwithstanding"subsections"152(4)"to"(5),"any"assessment"of"the"
corporation"would,"if"this"Act"were"read"without"reference"to"this"subsection,"be"required"to" tax,"interest"and"penalties"payable"by"each"of"those"shareholders"for"any"
pay"a"tax"under"subsection"(1),"and"it"elects"in"prescribed"manner"on"or"before"the"day"that"is" taxation"year"shall"be"made"that"is"necessary"to"take"the"corporation's"election"
90"days"after"the"day"of"sending"the"notice"of"assessment"in"respect"of"that"tax"that"would" into"account."
otherwise"be"payable"under"subsection"(1),"the"following"rules"apply:"" "
(a)"notwithstanding"the"definition"“eligible"dividend”"in"subsection"89(1),"the"amount"of" CCH"Editorial"note:"Elections"to"treat"a"part"of"the"excess"eligible"dividend"designation"as"a"separate"nonAeligible"
dividend"must"generally"be"made"either:"(a)"within"30"months"of"the"original"payment"with"the"consent"of"all"
the"original"dividend"paid"by"the"corporation"is"deemed"to"be"the"amount,"if"any,"by"
shareholders"entitled"to"receive"any"portion"of"the"dividend"whose"names"and"addresses"are"known"to"the"
which"" corporation;"or"(b)"if"later,"with"the"consent"of"all"shareholders"so"entitled."
(i)"the"amount"of"the"original"dividend,"determined"without"reference"to"this" "
subsection" (4)"Exception$for$non:taxable$shareholders"
"exceeds"" If"each"shareholder"who,"in"respect"of"an"election"made"under"subsection"(2),"is"deemed"by"
subsection"(2)"to"have"received"a"dividend"at"a"particular"time"is"also,"at"the"particular"time,"a"
person"all"of"whose"taxable"income"is"exempt"from"tax"under"Part"I,""
3" 4"
" "

(a)"subsection"(3)"does"not"apply"to"the"election;"and" Law 346A

(b)"the"election"is"valid"only"if"it"is"made"on"or"before"the"day"that"is"30"months"after"the"
day"on"which"the"original"dividend"was"paid."
" Capital dividends and the capital dividend account
Stop loss rules in respect of capital losses on certain shares

1. Capital dividends and the capital dividend account

Optional background reading: Materials 14th pp. 692-693

89(1) : relevant definitions

“taxable dividends” paragraph (a) – exception for a dividend in respect of which the
corporation has elected in accordance with subsection 83(2).

“capital dividend account” – a formula comprising numerous elements is set out in s.

89(1). For our purposes, it consists of (a) non-taxable portion of capital gains minus non-
allowable portion of capital losses accrued while the corporation is a private corporation;
and (b) capital dividends received by the corporation from other private corporations.
When a capital dividend is paid, it reduces the CDA.

83(2) Capital dividend

Where at any particular time after 1971 a dividend becomes payable by a private
corporation to shareholders of any class of shares of its capital stock and the corporation
so elects in respect of the full amount of the dividend, in prescribed manner and
prescribed form and at or before the particular time or the first day on which any part of
the dividend was paid if that day is earlier than the particular time, the following rules
apply:
(a) the dividend shall be deemed to be a capital dividend to the extent of the
corporation's capital dividend account immediately before the particular time; and
(b) no part of the dividend shall be included in computing the income of any
shareholder of the corporation.

CCH Editorial note: The full amount of the elected dividend is excluded from the income
of each resident shareholder, even if the total dividend exceeds the corporation's “capital
dividend account” (subsection 89(1)) such that the excess is not a capital dividend.
However, the corporation may be subject to a penalty tax in respect of the excess under
subsection 184(2); alternatively, the corporation can elect under subsection 184(3) to
have the excess treated as a separate taxable dividend. A capital dividend paid to a non-
resident is subject to withholding tax under subsection 212(2).

- applies only to private corporations

- election must apply to full amount of dividend
- election must be filed at earlier of day dividend became payable or any part of it is
paid

5"
" 1
- dividend is deemed a “capital dividend” to extent of capital dividend account
- dividend is exempt – not included in recipient shareholder’s income (2) Tax on excessive elections
Where a corporation has elected in accordance with subsection 83(2), […] in respect of
Example the full amount of any dividend payable by it on shares of any class of its capital stock
and the full amount of the dividend exceeds the portion thereof deemed by that
Canco is a CCPC. It has a nil balance in its capital dividend account. It then sells subsection to be a capital dividend […], the corporation shall, at the time of the election,
shares of a public corporation, and realizes a capital gain of $50,000. It has allowable pay a tax under this Part equal to 3/4 of the excess. [Under proposed amendments in Bill
capital losses from other dispositions of capital property in previous of $15,000. C-10 of 2006, effective as of 2000, the tax will be reduced to 3/5 of the excess.]

What is Canco’s tax liability in respect of the sale of the shares? CCH Editorial note: The penalty tax will apply if the full amount of an elected dividend
under subsection 83(2) exceeds the corporation's “capital dividend account” (subsection
What is Canco’s capital dividend account, from the above facts? 89(1)) such that the excess is not a capital dividend. As an alternative to the penalty tax,
the corporation may elect under subsection 184(3) to have the excess treated as a
How is the portion of the net taxable capital gain that is not included in the CDA taxed? separate taxable dividend.

Penalty for late filed capital dividend election (3) Election to treat excess as separate dividend
If, in respect of a dividend payable at a particular time after 1971, a corporation would,
83(3) Late filed elections but for this subsection, be required to pay a tax under this Part equal to all or a portion of
Where at any particular time after 1974 a dividend has become payable by a corporation an excess referred to in subsection (2) […] it may elect in prescribed manner on or
to shareholders of any class of shares of its capital stock, and subsection (1) or (2) would before a day that is not later than 90 days after […] the day of sending of the notice of
have applied to the dividend except that the election referred to therein was not made on assessment in respect of the tax that would otherwise be payable under this Part, and on
or before the day on or before which the election was required by that subsection to be such an election being made, subject to subsection (4), the following rules apply:
made, the election shall be deemed to have been made at the particular time or on the (a) the amount by which the full amount of the dividend exceeds the amount of
first day on which any part of the dividend was paid, whichever is the earlier, if the excess shall be deemed for the purposes of the election that the corporation
(a) the election is made in prescribed manner and prescribed form; made in respect of the dividend under subsection 83(2), […] and for all other
(b) an estimate of the penalty in respect of that election is paid by the corporation purposes of this Act to be the full amount of a separate dividend that became
when that election is made; and payable at the particular time;
(c) the directors or other person or persons legally entitled to administer the (b) such part of the excess as the corporation may claim shall, for the purposes of
affairs of the corporation have, before the time the election is made, authorized any election in respect thereof under subsection 83(2), […] where the corporation
the election to be made. has so elected, for all purposes of this Act, be deemed to be the full amount of a
separate dividend that became payable immediately after the particular time;
(4) Penalty for late filed election (c) the amount by which the excess exceeds any portion deemed by paragraph (b)
For the purposes of this section, the penalty in respect of an election referred to in to be a separate dividend for all purposes of this Act shall be deemed to be a
paragraph (3)(a) is an amount equal to the lesser of separate dividend that is a taxable dividend that became payable at the particular
(a) 1% per annum of the amount of the dividend referred to in the election for time; and
each month or part of a month during the period commencing with the time that (d) each person who held any of the issued shares of the class of shares of the
the dividend became payable, or the first day on which any part of the dividend capital stock of the corporation in respect of which the full amount of the dividend
was paid if that day is earlier, and ending with the day on which that election was was paid shall be deemed
made, and (i) not to have received any portion of the dividend, and
(b) the product obtained when $500 is multiplied by the proportion that the (ii) to have received at the time the dividend was paid the proportion of any
number of months or parts of months during the period referred to in paragraph separate dividend, determined under paragraph (a), (b) or (c), that the
(a) bears to 12. number of shares of that class held by the person at the time the dividend
was paid is of the number of shares of that class outstanding at that time
except that, for the purpose of Part XIII, a separate dividend that is a
taxable dividend, a capital dividend or a life insurance capital dividend
Excess election penalty tax: Part III, subsections 184(2) and (3)

2 3

shall be deemed to have been paid on the day that the election in respect of (i) the total of all amounts each of which is a dividend received by the
this subsection is made. taxpayer on the share in respect of which an election was made under
subsection 83(2) where subsection 83(2.1) does not deem the dividend to
(4) Concurrence with election be a taxable dividend, and
An election under subsection (3) is not valid unless (ii) the loss determined without reference to this subsection minus all
(a) it is made with the concurrence of the corporation and all its shareholders taxable dividends received by the taxpayer on the share; and
(i) who received or were entitled to receive all or any portion of the (b) where the taxpayer is a corporation, the total of all amounts received by the
dividend in respect of which a tax would, but for subsection (3), be payable taxpayer on the share each of which is
under this Part, and (i) a taxable dividend, to the extent of the amount of the dividend that was
(ii) whose addresses were known to the corporation; and deductible under this section or subsection 115(1) or 138(6) in computing
(b) either the taxpayer's taxable income or taxable income earned in Canada for any
(i) it is made on or before the day that is 30 months after the day on which taxation year,
the dividend became payable, or (ii) a dividend in respect of which an election was made under subsection
(ii) each shareholder described in subparagraph (a)(i) concurs with the election, in 83(2) where subsection 83(2.1) does not deem the dividend to be a taxable
which case, notwithstanding subsections 152(4) to (5), such assessment of the tax, dividend, or […]
interest and penalties payable by each such shareholder for any taxation year may
be made as is necessary to take the corporation's election into account. (3.01) Loss on share that is capital property — excluded dividends
A dividend shall not be included in the total determined under subparagraph (3)(a)(i) or
2. Stop-loss rules for capital losses realized on shares where capital dividends paragraph (3)(b) where the taxpayer establishes that
have been received on the shares. (a) it was received when the taxpayer and persons with whom the taxpayer was not
dealing at arm's length did not own in total more than 5% of the issued shares of any
112(3) provides a “stop-loss” rule to limit capital losses on shares on which capital class of the capital stock of the corporation from which the dividend was received; and
dividends or other exempt dividends have been received. (b) it was received on a share that the taxpayer owned throughout the 365-day period that
ended immediately before the disposition.
This restriction prevents a taxpayer from realizing a capital loss on the disposition of a
share held as capital property to the extent of the lesser of: (a)(i) tax free capital CCH Editorial note: S. 112(3) is a stop-loss rule which may deny a portion of a capital
dividends received on the share and (ii) taxable dividends received on the share (where loss on the disposition of a share of a corporation by a natural person (i.e., an individual
the shareholder is an individual). Subsection 112(3.01) restricts the stop-loss rule to other than a trust, to which separate provisions apply), or by a corporation, as a result of
instances where the taxpayer and non-arm’s length persons hold 5% or more of the issued the receipt of tax-advantaged dividends (including by virtue of deemed dividends on a
shares or have not held the shares for at least 365 days. share redemption, which may trigger the loss itself).
In the case of a natural person, the loss is reduced by the total amount of capital
112. (1) Deduction of taxable dividends received by corporation resident in Canada dividends received on the share (more precisely, a dividend on which a capital dividend
Where a corporation in a taxation year has received a taxable dividend from election has been made including excessive elections, but not including a separate
(a) a taxable Canadian corporation, or taxable dividend per a s. 184(3) election or a would-be capital dividend subject to the
(b) a corporation resident in Canada (other than a non-resident-owned investment capital dividend anti-avoidance rules in s. 83(2.1)). However, the amount subject to the
corporation or a corporation exempt from tax under this Part) and controlled by it, stop-loss is reduced if the loss otherwise determined, less taxable dividends received on
an amount equal to the dividend may be deducted from the income of the receiving the share, is less than this amount; in other words, taxable dividends can enlarge the loss
corporation for the year for the purpose of computing its taxable income. that can be claimed (s. 112(3)(a)).
In the case of a corporation, the capital loss on a disposition of a share in another
(3) Loss on share that is capital property corporation is reduced by: (i) tax-free intercorporate dividends (e.g., dividends
Subject to subsections (5.5) and (5.6), the amount of any loss of a taxpayer (other than a deductible under s. 112, but not under s. 113); (ii) capital dividends (as described
trust) from the disposition of a share that is capital property of the taxpayer (other than a above); and (iii) life insurance capital dividends received on the share (s. 112(3)(b)).
share that is property of a partnership) is deemed to be the amount of the loss determined Dividends which would otherwise enlarge the disallowed loss are ignored in computing
without reference to this subsection minus, the amount of the denied losses, per a “5/365 exception” (per s. 112(3.01)), which
(a) where the taxpayer is an individual, the lesser of applies if the dividend was received when the shareholder and non-arm's length persons
did not own more than 5% of the shares of any class (or series) in the corporation, and

4 5
the shares were owned throughout the 365-day period before the disposition Law 346A
(s. 112(3.01)). This means that the stop-loss rules will not apply if a taxpayer and non-
arm's length persons did not hold more than 5% of the class (or series) of shares, if held
for the 365 day period. Deemed Dividends and Paid Up Capital

Optional background reading: Materials on Canadian Income Tax (14th ed.) pp. 693-698,
starting with 2. Dividends in Kind and Stock Dividends.

I. Definition of Dividend

The Act provides only: 248(1) “dividend” includes a stock dividend

Dividends are, as a matter of corporate law, normally paid out of after-tax profits or
retained earnings. The portion of any amount paid to a shareholder which represents a
return of capital contributed by the shareholder is generally exempt of tax, as it was
already subject to tax before being contributed as an investment in shares of the
corporation. This is an important concept in the taxation of “deemed dividends”.

Corporate law restricts the payment of dividends where the payment would render the
corporation insolvent or reduce its assets to less than its liabilities and stated capital.

Canada Business Corporations Act

s. 42 Dividends - A corporation shall not declare or pay a dividend if there are reasonable
grounds for believing that
(a) the corporation is, or would after the payment be, unable to pay its liabilities as they
become due; or,
(b) the realizable value of the corporation’s assets would thereby be less than the
aggregate of its liabilities and stated capital of all classes.

Other Canadian corporate statutes contain similar restrictions on the payment of

dividends.

Dividends in kind are paid when instead of distributing cash, the corporation distributes
assets, such as shares of other corporations, to its shareholders in proportion to their
shareholdings. A dividend in kind is treated the same way as a cash dividend for the
recipient individual shareholder – the fair market value (FMV) of the asset received is
included in income, grossed up and credited under s. 82 and 121 as either an eligible or
ineligible dividend. A corporation receiving a dividend in kind is able to claim the
112(1) deduction and is subject to Part IV tax on the same basis as for a cash dividend.

From the distributing corporation’s point of view, the asset distributed as a dividend is
considered to have been disposed of at FMV, with resulting (capital or non-capital) gain
or loss to the corporation. The shareholder is deemed to have acquired the asset at FMV
(52(2)).

6 1

Stock dividend means any dividend paid by issuing shares of any class of the distributing - to the extent the amount paid for the shares on the redemption, repurchase or retraction
corporation’s own shares to shareholders in proportion to the shares they hold of a exceeds the PUC of the shares, the shareholder is deemed to have received a dividend,
particular class of the corporation. The “amount” of a stock dividend is determined under and the corporation is deemed to have paid a dividend.
the definition of “amount” in 248(1). In general (i.e. where the special circumstances in
paragraph (a) and (b) of the definition do not apply), the amount of a stock dividend is the - The redemption etc. is a disposition of the shares under 248(1), but the proceeds of
amount by which the paid up capital (or “PUC”) of the distributing corporation is disposition will exclude the amount of the deemed dividend (54(j) “proceeds of
increased by the stock dividend. See 52(3) for the cost of a stock dividend. disposition”). Note that 84(9) specifically clarifies that redemption, cancellation or
acquisition by a corporation of its shares results in a disposition of the shares by the
II. Paid Up Capital shareholder.

PUC vs. Stated Capital - 84(6)(b) provides that 84(3) does not apply if the corporation acquired those shares in
the manner in which shares would normally be purchased by any member of the public in
89(1)(a) definition of paid up capital of a share the open market. This does not extend, obviously, to a regulated buy-back offer to
shareholders.
89(1)(b) PUC of a class of shares
84(6): 84(3) does not apply where 84(1) applies, or where the corporation purchases its
89(1)(c) PUC of a corporation shares on the open market in the same manner in which shares would normally be
purchased by any member of the public in the open market.
note definition in 248(1) – common share

248(6) – class includes series

III. Deemed Dividends: section 84

There are a number of transactions that are deemed to result in a dividend for tax
purposes. We will only discuss two of them that are most commonly encountered in tax
practice. Understanding these will help you understand the others when you encounter
them.

84(1): capitalization of surplus

- CBCA 26(5) – requires special resolution of shareholders.

- the increase in PUC (unless one of the exceptions in 84(1) applies) is treated as a
dividend paid by the corporation and received pro-rata by each shareholder of the
affected class of shares.

- 53(1)(b) adds the amount of the deemed dividend to the ACB of the shares to prevent
the dividend resulting from 84(1) from being taxed for a second time when the shares are
disposed of.

84(3): deemed dividend on redemption, acquisition or cancellation of shares

- CBCA 39(1) is the applicable corporate law.

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Business Associations Law 315
Stated Capital Example – relevant to sections 42 and 118 CBCA Common share rights and restrictions

The common shares have one vote per share, and are entitled to receive dividends in the
580957 CANADA LIMITEE has authorized capital of (a) unlimited Common shares and (b) discretion of the directors, subject to the priority of the cumulative dividend payable on the
unlimited Preferred shares. preferred shares. On dissolution, the common shareholders will receive, pro-rata, all the
remaining assets of 580957 CANADA LIMITEE after all of its debts and obligations have been
The articles of incorporation of 580957 CANADA LIMITEE provide: paid and the preferred shareholders have received their capital, plus any unpaid dividends.

The corporation is authorized to issue an unlimited number of Common and Preferred Stated capital
shares with the following rights, privileges, restrictions and conditions:
1. Common shares, without nominal or par value, the holders of which are entitled: 580957 CANADA LIMITEE has issued 5 million Class A shares for $1 per share = $5 million
a. to vote at all meetings of shareholders except meetings at which only holders of a
specified class of shares are entitled to vote; and 580957 CANADA LIMITEE has issued 1 million preferred shares for $3 per share = $3 million
b. to receive the remaining property of the corporation upon dissolution; and
c. subject to the rights and privileges attaching to the Preferred shares, to receive 580957 CANADA LIMITEE’s total stated capital is therefore $8 million.
dividends as and when declared by the board of directors of the corporation.
Application of section 42 CBCA
2. Preferred shares, which shall carry the right:
a. to a cumulative annual dividend equal to $.15 per share before any distribution may Assume 580957 CANADA LIMITEE has liabilities of $2 million, and assets of $11 million. Can
be made to any other class of shares, and shall not be entitled to any additional it pay a dividend of $.25 per common share? Note that the cash 580957 CANADA LIMITEE
dividends; and would use to pay dividends is accounted for in the assets of $11 million.
b. upon the liquidation or winding-up of the corporation, to repayment of the amount of
capital contributed for such share (plus any declared and unpaid dividends) in priority to
the Common shares, but they shall not confer a right to any further participation in profits
or assets.

The Preferred shares shall be redeemable by the corporation as and when determined
by the board of directors, for the amount of capital contributed on each such share at the
time of original issue.

The holders of Preferred shares shall not be entitled to vote at meetings of shareholders
except as otherwise specifically provided in the Canada Business Corporations Act.

Accordingly, the Preferred shares are entitled to a preferential cumulative dividend of $.15 per
share, and are not entitled to any further dividends. This means that a dividend of $.15 per
preferred share is payable every year before any dividend may be paid to the common
shareholders. If the corporation does not have sufficient after-tax profits or retained earnings to
pay the cumulative dividend, the dividend is considered an amount owing to the preferred
shareholders to be paid when the corporation is able to do so. A non-cumulative dividend is
declared and paid when the directors determine.

580957 CANADA LIMITEE may redeem any or all of the Preferred shares for $3 per share, plus
any unpaid dividends.

On dissolution, the Preferred shareholders are entitled to a return of the capital paid in up on their
shares (i.e. $3 per share) together with any unpaid dividends, before the common shareholders are
entitled to receive any of the remaining assets of 580957 CANADA LIMITEE. The preferred
shareholders are not entitled to share in the surplus assets beyond return of their capital with
dividends.

ITA Provisions related to PUC and deemed dividends (j) any amount that would otherwise be proceeds of disposition of a share to the extent
that the amount is deemed by subsection 84(2) or (3) to be a dividend received and is not
52. (2) Cost of property received as dividend in kind deemed by paragraph 55(2)(a) or subparagraph 88(2)(b)(ii) not to be a dividend, (…)
Where any property has, after 1971, been received by a shareholder of a corporation at
any time as, on account or in lieu of payment of, or in satisfaction of, a dividend payable 84. (1) Deemed dividend
in kind (other than a stock dividend) in respect of a share owned by the shareholder of the Where a corporation resident in Canada has at any time after 1971 increased the paid-up
capital stock of the corporation, the shareholder shall be deemed to have acquired the capital in respect of the shares of any particular class of its capital stock, otherwise than
property at a cost to the shareholder equal to its fair market value at that time, and the by
corporation shall be deemed to have disposed of the property at that time for proceeds (a) payment of a stock dividend,
equal to that fair market value. (b) a transaction by which
(i) the value of its assets less its liabilities has been increased, or
CCH Editorial note: The fair market value of the dividend will also be the amount of the (ii) its liabilities less the value of its assets have been decreased,
dividend included in the shareholder's income. S. 52(3), rather than s. 52(2), applies to a by an amount not less than the amount of the increase in the paid-up
stock dividend. capital in respect of the shares of the particular class,
(c) a transaction by which the paid-up capital in respect of the shares of all other
52.(3) Cost of stock dividend classes of its capital stock has been reduced by an amount not less than the
Where a shareholder of a corporation has, after 1971, received a stock dividend in respect amount of the increase in the paid-up capital in respect of the shares of the
of a share owned by the shareholder of the capital stock of the corporation, the particular class, (…)
shareholder shall be deemed to have acquired the share or shares received by the (c.3) where the corporation is neither an insurance corporation nor a bank, any
shareholder as a stock dividend at a cost to the shareholder equal to the total of action by which it converts into paid-up capital in respect of a class of shares of
(a) where the stock dividend is a dividend, the amount of the stock dividend, its capital stock any of its contributed surplus that arose after March 31, 1977
(a.1) where the stock dividend is not a dividend, nil, and (i) on the issuance of shares of that class or shares of another class for
(b) where an amount is included in the shareholder's income in respect of the which the shares of that class were substituted (other than an issuance to
stock dividend under subsection 15(1.1), the amount so included. which section 51, 66.3, 84.1, 85, 85.1, 86 or 87, subsection 192(4.1) or
194(4.1) or section 212.1 applied),
CCH Editorial note: The “amount of the stock dividend” is the amount by which the (ii) on the acquisition of property by the corporation from a person who at
corporation's paid-up capital is increased by reason of the payment of the dividend the time of the acquisition held any of the issued shares of that class or
(s. 248(1), "amount"). If s. 15(1.1) applies to the stock dividend, the fair market value of shares of another class for which shares of that class were substituted for
the stock dividend in excess of the amount of the stock dividend is also added to the cost no consideration or for consideration that did not include shares of the
of the share. capital stock of the corporation, or
(iii) as a result of any action by which the paid-up capital in respect of that
53. (1) Adjustments to cost base class of shares or in respect of shares of another class for which shares of
In computing the adjusted cost base to a taxpayer of property at any time, there shall be that class were substituted was reduced by the corporation, to the extent of
added to the cost to the taxpayer of the property such of the following amounts in respect the reduction in paid-up capital that resulted from the action,
of the property as are applicable: the corporation shall be deemed to have paid at that time a dividend on the issued
shares of the particular class equal to the amount, if any, by which the amount of
(b) [Adjustments to cost base — Deemed dividend] the increase in the paid-up capital exceeds the total of
where the property is a share of the capital stock of a corporation resident in Canada, the (d) the amount, if any, of the increase referred to in subparagraph (b)(i) or the
amount of any dividend on the share deemed by subsection 84(1) to have been received decrease referred to in subparagraph (b)(ii), as the case may be,
by the taxpayer before that time; (e) the amount, if any, of the reduction referred to in paragraph (c), and
(f) the amount, if any, of the increase in the paid-up capital that resulted from a
54. “proceeds of disposition” conversion referred to in paragraph (c.1), (c.2) or (c.3),
“proceeds of disposition” of property includes, (…) and a dividend shall be deemed to have been received at that time by each person who
but notwithstanding any other provision of this Part, does not include held any of the issued shares of the particular class immediately after that time equal to
that proportion of the dividend so deemed to have been paid by the corporation that the

1 2
number of the shares of the particular class held by the person immediately after that time Subsection (3) does not apply to deem a dividend to have been received by a shareholder
is of the number of the issued shares of that class outstanding immediately after that time. of a public corporation where the shareholder is an individual resident in Canada who
deals at arm's length with the corporation and the shares redeemed, acquired or cancelled
CCH Editorial note: Deemed dividends under subsection 84(1) in respect of a share are are prescribed shares of the capital stock of the corporation.
added in computing the adjusted cost base of the share under paragraph 53(1)(b). This
ensures that the increases in paid-up capital referred to in subsection 84(1) are not (9) Shares disposed of on redemptions, etc
subsequently taxed in the form of capital gains. For greater certainty it is declared that where a shareholder of a corporation has disposed
of a share of the capital stock of the corporation as a result of the redemption, acquisition
(3) Redemption, etc or cancellation of the share by the corporation, the shareholder shall, for the purposes of
Where at any time after December 31, 1977 a corporation resident in Canada has this Act, be deemed to have disposed of the share to the corporation.
redeemed, acquired or cancelled in any manner whatever (otherwise than by way of a
transaction described in subsection (2)) any of the shares of any class of its capital stock, CCH Editorial note: The main purpose of subsection 84(9) is to ensure that where the
shareholder and corporation do not deal at arm's length, the various provisions of the
(a) the corporation shall be deemed to have paid at that time a dividend on a Act that deal with dispositions between non-arm's length persons will apply. See also the
separate class of shares comprising the shares so redeemed, acquired or cancelled stop-loss rule in subsection 40(3.6) where the shareholder and corporation are affiliated
equal to the amount, if any, by which the amount paid by the corporation on the immediately after the disposition. Subsection 84(9) does not expressly deem the
redemption, acquisition or cancellation, as the case may be, of those shares corporation to have purchased or acquired the share; this issue may be relevant, for
exceeds the paid-up capital in respect of those shares immediately before that example, in respect of the potential application of subsection 116(5) to the corporation.
time; and
(b) a dividend shall be deemed to have been received at that time by each person 89(1) “paid-up capital”
who held any of the shares of that separate class at that time equal to that portion “paid-up capital” at any particular time means,
of the amount of the excess determined under paragraph (a) that the number of (a) in respect of a share of any class of the capital stock of a corporation, an
those shares held by the person immediately before that time is of the total amount equal to the paid-up capital at that time, in respect of the class of shares of
number of shares of that separate class that the corporation has redeemed, the capital stock of the corporation to which that share belongs, divided by the
acquired or cancelled, at that time. number of issued shares of that class outstanding at that time,
(b) in respect of a class of shares of the capital stock of a corporation, (…)
CCH Editorial note: The amount of a deemed dividend arising under subsection 84(2) or (iii) where the particular time is after March 31, 1977, an amount equal to
(3) on a redemption, acquisition, or cancellation of a shareholder's share is excluded the paid-up capital in respect of that class of shares at the particular time,
from the proceeds of disposition of the share; see paragraph (j) of the definition of computed without reference to the provisions of this Act except
“proceeds of disposition” in section 54. Thus, if the shareholder's adjusted cost base of subsections 51(3) and 66.3(2) and (4), sections 84.1 and 84.2, subsections
the share exceeds the paid-up capital in respect of the share, the deemed dividend will 85(2.1), 85.1(2.1) and (8), 86(2.1), 87(3) and (9), 128.1(2) and (3),
generally be accompanied by a capital loss on the disposition of the share. But see the 138(11.7), 139.1(6) and (7), 192(4.1) and 194(4.1) and section 212.1,
stop-loss rule of subsection 40(3.6) (shareholder and corporation affiliated immediately except that, where the corporation is a cooperative corporation (within the meaning
after disposition), and the loss reduction rules of subsections 112(3) through (3.2) (loss assigned by subsection 136(2)) or a credit union and the statute by or under which it was
reduced generally by tax-free dividends received). incorporated does not provide for paid-up capital in respect of a class of shares, the paid-
up capital in respect of that class of shares at the particular time, computed without
(6) Where s. (2) or (3) does not apply reference to the provisions of this Act, shall be deemed to be the amount, if any, by which
Subsection (2) or (3), as the case may be, is not applicable (iv) the total of the amounts received by the corporation in respect of
(a) in respect of any transaction or event, to the extent that subsection (1) is applicable in shares of that class issued and outstanding at that time
respect of that transaction or event; and exceeds
(b) in respect of any purchase by a corporation of any of its shares in the open market, if (v) the total of all amounts each of which is an amount or part thereof
the corporation acquired those shares in the manner in which shares would normally be described in subparagraph (iv) repaid by the corporation to persons who
purchased by any member of the public in the open market. held any of the issued shares of that class before that time, and
(c) in respect of all the shares of the capital stock of a corporation, an amount
(8) Where s. (3) does not apply equal to the total of all amounts each of which is an amount equal to the paid-up

3 4

capital in respect of any class of shares of the capital stock of the corporation at
the particular time; (ii) shares of, or another interest in, a body corporate that immediately
before the exchange, or that because of the exchange, did not deal with the
CCH Editorial note: The paid-up capital of a class of shares is initially computed corporation at arm’s length within the meaning of that expression in the
“without reference to the provisions of this Act”, which is understood to mean the Income Tax Act, or
amount determined for corporate law purposes (the amount determined under corporate
law is often referred to as the “stated capital” of the class of shares). The paid-up capital (iii) property of a person who, immediately before the exchange, dealt
of the class of shares is then subject to adjustments under specific provisions of the Act as with the corporation at arm’s length within the meaning of that expression
set out in paragraph (b) of the definition. in the Income Tax Act, if the person, the corporation and all the holders of
shares in the class or series of shares so issued consent to the exchange; or
248(1)
“amount” (b) pursuant to an agreement referred to in subsection 182(1) [amalgamation] or
“amount” means money, rights or things expressed in terms of the amount of money or an arrangement referred to in paragraph 192(1)(b) or (c) [arrangement amounting
the value in terms of money of the right or thing, except that, (…) and to amalgamation] or to shareholders of an amalgamating body corporate who
receive the shares in addition to or instead of securities of the amalgamated body
(c) in any other case, the “amount” of any stock dividend is the amount by which the corporate.
paid-up capital of the corporation that paid the dividend is increased by reason of the
payment of the dividend; 26(4) – On the issue of a share a corporation shall not add to a stated capital account in
respect of the share it issues an amount greater than the amount of the consideration it
“common share” received for the share.
“common share” means a share the holder of which is not precluded on the reduction or
redemption of the capital stock from participating in the assets of the corporation beyond 26(5) – Where a corporation proposes to add any amount to a stated capital account it
the amount paid up on that share plus a fixed premium and a defined rate of dividend; maintains in respect of a class or series of shares, if

“preferred share” (a) the amount to be added was not received by the corporation as consideration
“preferred share” means a share other than a common share; for the issue of shares, and

(b) the corporation has issued any outstanding shares of more than one class or
Canada Business Corporations Act provisions affecting stated capital account. series,

the addition to the stated capital account must be approved by special resolution unless all
26(1) – A corporation shall maintain a separate stated capital account for each class and the issued and outstanding shares are shares of not more than two classes of convertible
series of shares it issues. shares referred to in subsection 39(5).

26(2) – A corporation shall add to the appropriate stated capital account the full amount 36(1) … a corporation may purchase or redeem any redeemable shares issued by it at
of any consideration it receives for any shares it issues. prices not exceeding the redemption price thereof stated in the articles or calculated
according to a formula stated in the articles.
26(3) – Despite subsection (2) a corporation may, subject to subsection (4) add to the
stated capital accounts maintained for the shares of classes or series the whole or any part 39(1) – On a purchase, redemption or other acquisition by a corporation under section 34,
of the amount of the consideration that it receives in an exchange if the corporation issues 35, 36, 45 or 190 or paragraph 241(3)(f), of shares or fractions thereof issued by it, the
shares corporation shall deduct from the stated capital account maintained for the class or series
(a) in exchange for of shares of which the shares purchased, redeemed or otherwise acquired form a part an
amount equal to the result obtained by multiplying the stated capital of the shares of that
(i) property of a person who immediately before the exchange did not deal class or series by the number of shares of that class or series or fractions thereof
with the corporation at arm’s length within the meaning of that expression purchased, redeemed or otherwise acquired, divided by the number of issued shares of
in the Income Tax Act, that class or series immediately before the purchase, redemption or other acquisition.

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 ITA Provisions: 245. [General anti-avoidance rule]
42. Dividends – A corporation shall not declare or pay a dividend if there are reasonable
grounds for believing that (1) Definitions
(a) the corporation is, or would after the payment be, unable to pay its liabilities as they
become due; or In this section,
(b) the realizable value of the corporation’s assets would thereby be less than the
CCH Editorial note: S. 245 sets out the general anti-avoidance rule (the “GAAR”). The GAAR was enacted in 1987
aggregate of its liabilities and stated capital of all classes.
partially in response to the Supreme Court of Canada's decision in Stubart (84 DTC 6305), and more generally for
the purpose of combating abusive tax avoidance transactions and arrangements which technically comply with the
43. (1) Form of dividend – A corporation may pay a dividend by issuing fully paid provisions of the Act.
shares of the corporation and, subject to section 42, a corporation may pay a dividend in
money or property. [stock and in-kind dividends] The GAAR applies to any transaction that is an “avoidance transaction”. An “avoidance transaction” is defined in
s. 245(3) as a transaction that results in a tax benefit or a transaction that is part of a series of transactions that results
(2) Adjustment of stated capital account – If shares of a corporation are issued in in a tax benefit. However, it does not include a transaction arranged primarily for bona fide purposes other than to
payment of a dividend, the declared amount of the dividend stated as an amount of obtain a tax benefit. A tax benefit is defined in s. 245(1) as a reduction, avoidance or deferral of tax, an increase in a
money shall be added to the stated capital account maintained or to be maintained for the deferral of tax or an increase in a refund of tax, under the Act or under a tax treaty. In addition, the GAAR only
shares of the class or series issued in payment of the dividend. applies to a transaction that results directly or indirectly in a misuse of the provisions of the Act, the Regulations, or
a tax treaty or an abuse of those provisions other than s. 245 read as a whole. Therefore, a transaction which
otherwise is subject to the GAAR, will not be subject to the GAAR if it does not involve such a misuse or abuse. In
Canada Trustco Mortgage Company 2005 DTC 5523, the SCC stated that the “misuse” and “abuse” requirement is
determined having regard to the text, context and purpose of the relevant provisions of the Act and whether the
transaction frustrates or defeats the object, spirit and purpose of the relevant provisions.

If the GAAR applies under s. 245(5), the tax consequences of the transaction will be determined, as is reasonable in
the circumstances, to deny the tax benefit resulting from the transaction.

It should be noted that the Act contains numerous specific anti-avoidance provisions such as s. 69 which deals with
property transferred to a person not at arm's length, s. 74.1 to 74.5 which deals with transfers of property or income
between spouses or between a parent and a minor child, s. 15 which deals with benefits conferred by a corporation,
s.110.6 which deals with the capital gains exemption and s. 40(3.3) and 54 which prohibit certain losses from being
realized. The GAAR supplements the anti-avoidance provisions in the Act and normally is a provision of “last
resort”.

It should also be noted that there are a large number of court decisions, including three Supreme Court of Canada
decisions which have considered the GAAR. Despite these decisions, the applicability of the GAAR to a specific
fact pattern is difficult to predict because in many cases, it is not clear whether a tax benefit realized by a taxpayer is
inconsistent with the object, spirit and purpose of a provision of the Act, or the Act read as a whole.

“tax benefit”

“tax benefit” means a reduction, avoidance or deferral of tax or other amount payable under this
Act or an increase in a refund of tax or other amount under this Act, and includes a reduction,
avoidance or deferral of tax or other amount that would be payable under this Act but for a tax
treaty or an increase in a refund of tax or other amount under this Act as a result of a tax treaty;

“tax consequences”

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“tax consequences” to a person means the amount of income, taxable income, or taxable income (v) any other enactment that is relevant in computing tax or any other amount
earned in Canada of, tax or other amount payable by or refundable to the person under this Act, payable by or refundable to a person under this Act or in determining any amount
or any other amount that is relevant for the purposes of computing that amount; that is relevant for the purposes of that computation; or

“transaction” (b) would result directly or indirectly in an abuse having regard to those
provisions, other than this section, read as a whole.
“transaction” includes an arrangement or event.
Historical*version,*replaced*by*S.C.*2005,*c.*19*s.*52(2)*applicable*with*respect*to*transactions*entered*
(1.1) Idem [Repealed] into*after*September*12,*1988:*
(2) General anti-avoidance provision (4)*[Where*s.*(2)*does*not*apply]*For*greater*certainty,*subsection*(2)*does*not*apply*to*a*transaction*
where*it*may*reasonably*be*considered*that*the*transaction*would*not*result*directly*or*indirectly*in*a*
Where a transaction is an avoidance transaction, the tax consequences to a person shall be
misuse*of*the*provisions*of*this*Act*or*an*abuse*having*regard*to*the*provisions*of*this*Act,*other*than*this*
determined as is reasonable in the circumstances in order to deny a tax benefit that, but for this
section,*read*as*a*whole.*
section, would result, directly or indirectly, from that transaction or from a series of transactions
that includes that transaction. (5) Determination of tax consequences
(3) Avoidance transaction Without restricting the generality of subsection (2), and notwithstanding any other enactment,
An avoidance transaction means any transaction (a) any deduction, exemption or exclusion in computing income, taxable income, taxable
income earned in Canada or tax payable or any part thereof may be allowed or disallowed
(a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the
in whole or in part,
transaction may reasonably be considered to have been undertaken or arranged primarily
for bona fide purposes other than to obtain the tax benefit; or (b) any such deduction, exemption or exclusion, any income, loss or other amount or part
thereof may be allocated to any person,
(b) that is part of a series of transactions, which series, but for this section, would result,
directly or indirectly, in a tax benefit, unless the transaction may reasonably be (c) the nature of any payment or other amount may be recharacterized, and
considered to have been undertaken or arranged primarily for bona fide purposes other
than to obtain the tax benefit. (d) the tax effects that would otherwise result from the application of other provisions of
this Act may be ignored,
(4) Application of subsection (2)
in determining the tax consequences to a person as is reasonable in the circumstances in order to
Subsection (2) applies to a transaction only if it may reasonably be considered that the deny a tax benefit that would, but for this section, result, directly or indirectly, from an avoidance
transaction transaction.
(a) would, if this Act were read without reference to this section, result directly or (6) Request for adjustments
indirectly in a misuse of the provisions of any one or more of
Where with respect to a transaction
(i) this Act,
(a) a notice of assessment, reassessment or additional assessment involving the
(ii) the Income Tax Regulations, application of subsection (2) with respect to the transaction has been sent to a person, or
(iii) the Income Tax Application Rules, (b) a notice of determination pursuant to subsection 152(1.11) has been sent to a person
with respect to the transaction,
(iv) a tax treaty, or

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any person (other than a person referred to in paragraph (a) or (b)) shall be entitled, within 180 ITA provisions re Acquisition of Control
days after the day of sending of the notice, to request in writing that the Minister make an
assessment, reassessment or additional assessment applying subsection (2) or make a 111.(4) Acquisition of control
determination applying subsection 152(1.11) with respect to that transaction. Notwithstanding subsection (1), where, at any time (in this subsection referred to as “that time”),
control of a corporation has been acquired by a person or group of persons
(7) Exception (a) no amount in respect of a net capital loss for a taxation year ending before that time is
deductible in computing the corporation's taxable income for a taxation year ending after
Notwithstanding any other provision of this Act, the tax consequences to any person, following that time, and
the application of this section, shall only be determined through a notice of assessment, (b) no amount in respect of a net capital loss for a taxation year ending after that time is
deductible in computing the corporation's taxable income for a taxation year ending
reassessment, additional assessment or determination pursuant to subsection 152(1.11) involving
before that time,
the application of this section. and where, at that time, the corporation neither became nor ceased to be exempt from tax under
this Part on its taxable income,
(8) Duties of Minister
(c) in computing the adjusted cost base to the corporation at and after that time of each
On receipt of a request by a person under subsection (6), the Minister shall, with all due dispatch, capital property, other than a depreciable property, owned by the corporation
immediately before that time, there shall be deducted the amount, if any, by which the
consider the request and, notwithstanding subsection 152(4), assess, reassess or make an
adjusted cost base to the corporation of the property immediately before that time
additional assessment or determination pursuant to subsection 152(1.11) with respect to that exceeds its fair market value immediately before that time,
person, except that an assessment, reassessment, additional assessment or determination may be (d) each amount required by paragraph (c) to be deducted in computing the adjusted cost
made under this subsection only to the extent that it may reasonably be regarded as relating to base to the corporation of a property shall be deemed to be a capital loss of the
the transaction referred to in subsection (6). corporation for the taxation year that ended immediately before that time from the
disposition of the property,
248.(10) Series of transactions (e) each capital property owned by the corporation immediately before that time (other
than a property in respect of which an amount would, but for this paragraph, be required
For the purposes of this Act, where there is a reference to a series of transactions or events, the by paragraph (c) to be deducted in computing its adjusted cost base to the corporation or
series shall be deemed to include any related transactions or events completed in contemplation a depreciable property of a prescribed class to which, but for this paragraph, subsection
of the series. (5.1) would apply) as is designated by the corporation in its return of income under this
Part for the taxation year that ended immediately before that time or in a prescribed form
filed with the Minister on or before the day that is 90 days after the day on which a notice
of assessment of tax payable for the year or notification that no tax is payable for the year
is mailed to the corporation, shall be deemed to have been disposed of by the corporation
immediately before the time that is immediately before that time for proceeds of
disposition equal to the lesser of
(i) the fair market value of the property immediately before that time, and
(ii) the greater of the adjusted cost base to the corporation of the property
immediately before the disposition and such amount as is designated by the
corporation in respect of the property,
and shall be deemed to have been reacquired by it at that time at a cost equal to the
proceeds of disposition thereof, except that, where the property is depreciable property of
the corporation the capital cost of which to the corporation immediately before the
disposition time exceeds those proceeds of disposition, for the purposes of sections 13
and 20 and any regulations made for the purpose of paragraph 20(1)(a),
(iii) the capital cost of the property to the corporation at that time shall be deemed
to be the amount that was its capital cost immediately before the disposition, and

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(iv) the excess shall be deemed to have been allowed to the corporation in respect income for the year is deductible by the corporation for a particular year ending before
of the property under regulations made for the purpose of paragraph 20(1)(a) in that time
computing its income for taxation years ending before that time, and (i) only if throughout the taxation year and in the particular year that business was
(f) each amount that by virtue of paragraph (d) or (e) is a capital loss or gain of the carried on by the corporation for profit or with a reasonable expectation of profit,
corporation from a disposition of a property for the taxation year that ended immediately and
before that time shall, for the purposes of the definition “capital dividend account” in (ii) only to the extent of the corporation's income for the particular year from that
subsection 89(1), be deemed to be a capital loss or gain, as the case may be, of the business and, where properties were sold, leased, rented or developed or services
corporation from the disposition of the property immediately before the time that a rendered in the course of carrying on that business before that time, from any
capital property of the corporation in respect of which paragraph (e) would be applicable other business substantially all the income of which was derived from the sale,
would be deemed by that paragraph to have been disposed of by the corporation. leasing, rental or development, as the case may be, of similar properties or the
rendering of similar services.
CCH Editorial note: S. 111(4) ensures that net capital losses of a corporation cannot be carried forward
or back after a change of control of the corporation. Similarly, accrued capital losses cannot be utilized CCH Editorial note: S. 111(5) prohibits the carryforward or carryback of non-capital losses and farm
beyond the change of control, owing to the “write-down” of cost to fair market value under s. 111(4)(c). losses of a corporation after a change in the control of the corporation. An exception is made under the
This write-down will generate capital losses in the year ending immediately before the change of control “streaming rules” under paragraphs (a) and (b), which can apply to allow the losses if the corporation
(paragraph (d)). The corporation can elect under paragraph (e) to generate a deemed disposition of continues to carry on the pre-change of control business for profit or with a reasonable expectation of
other capital property — for example, for the purpose of generating capital gains that can be offset by the profit, and generally to the extent of income from that business and similar businesses in the year in
capital losses triggered by the write-down. See s. 111(5.1) regarding accrued terminal losses in respect of which the loss is claimed.
depreciable property.
(5.1) Computation of undepreciated capital cost [will not be examinable]
(5) Idem Where, at any time, control of a corporation (other than a corporation that at that time became or
Where, at any time, control of a corporation has been acquired by a person or group of persons, ceased to be exempt from tax under this Part on its taxable income) has been acquired by a
no amount in respect of its non-capital loss or farm loss for a taxation year ending before that person or group of persons and, if this Act were read without reference to subsection 13(24), the
time is deductible by the corporation for a taxation year ending after that time and no amount in undepreciated capital cost to the corporation of depreciable property of a prescribed class
respect of its non-capital loss or farm loss for a taxation year ending after that time is deductible immediately before that time would have exceeded the total of
by the corporation for a taxation year ending before that time except that (a) the fair market value of all the property of that class immediately before that time, and
(a) such portion of the corporation's non-capital loss or farm loss, as the case may be, for (b) the amount in respect of property of that class otherwise allowed under regulations made
a taxation year ending before that time as may reasonably be regarded as its loss from under paragraph 20(1)(a) or deductible under subsection 20(16) in computing the corporation's
carrying on a business and, where a business was carried on by the corporation in that income for the taxation year ending immediately before that time,
year, such portion of the non-capital loss as may reasonably be regarded as being in the excess shall be deducted in computing the income of the corporation for the taxation year
respect of an amount deductible under paragraph 110(1)(k) in computing its taxable ending immediately before that time and shall be deemed to have been allowed in respect of
income for the year is deductible by the corporation for a particular taxation year ending property of that class under regulations made under paragraph 20(1)(a).
after that time
(i) only if that business was carried on by the corporation for profit or with a CCH Editorial note: S. 111(4)(e) allows an elective "write-up" for depreciable property, generally where
reasonable expectation of profit throughout the particular year, and the fair market value of the property exceeds the cost amount of the property. The election could be
(ii) only to the extent of the total of the corporation's income for the particular advisable if any resulting recapture could be offset by the deduction in respect of accrued losses under
year from that business and, where properties were sold, leased, rented or s. 111(5.1).
developed or services rendered in the course of carrying on that business before
that time, from any other business substantially all the income of which was 249. (1) Definition of “taxation year”
derived from the sale, leasing, rental or development, as the case may be, of For the purpose of this Act, a “taxation year” is
similar properties or the rendering of similar services; and (a) in the case of a corporation or Canadian resident partnership, a fiscal period, and
(b) such portion of the corporation's non-capital loss or farm loss, as the case may be, for (b) in the case of an individual, a calendar year,
a taxation year ending after that time as may reasonably be regarded as its loss from and when a taxation year is referred to by reference to a calendar year, the reference is to the
carrying on a business and, where a business was carried on by the corporation in that taxation year or years coinciding with, or ending in, that year.
year, such portion of the non-capital loss as may reasonably be regarded as being in
respect of an amount deductible under paragraph 110(1)(k) in computing its taxable (3.1) Year end on status change

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If at any time a corporation becomes or ceases to be a Canadian-controlled private corporation, before that time would, but for this paragraph, have ended within the 7-day period that
otherwise than because of an acquisition of control to which subsection (4) would, if this Act ended immediately before that time, that taxation year shall, except where control of the
were read without reference to this subsection, apply, corporation was acquired by a person or group of persons within that period, be deemed
(a) subject to paragraph (c), the corporation's taxation year that would, if this Act were to end immediately before that time where the corporation so elects in its return of
read without reference to this subsection, include that time is deemed to end immediately income under Part I for that taxation year; and
before that time; (d) for the purpose of determining the corporation's fiscal period after that time, the
(b) a new taxation year of the corporation is deemed to begin at that time; corporation shall be deemed not to have established a fiscal period before that time.
(c) notwithstanding subsections (1) and (3), the corporation's taxation year that would, if
this Act were read without reference to this subsection, have been its last taxation year 256.(7) Acquiring control
that ended before that time is deemed instead to end immediately before that time if For the purposes of subsections 10(10), 13(21.2) and (24), 14(12) and 18(15), sections 18.1 and 37,
(i) were this Act read without reference to this paragraph, that taxation year subsection 40(3.4), the definition “superficial loss” in section 54, section 55, subsections 66(11), (11.4)
and (11.5), 66.5(3) and 66.7(10) and (11), section 80, paragraph 80.04(4)(h), subsections 85(1.2), 88(1.1)
would, otherwise than because of paragraph 128(1)(d), section 128.1 and
and (1.2) and 110.1(1.2), sections 111 and 127, subsection 249(4) and this subsection,
paragraphs 142.6(1)(a) or 149(10)(a), have ended within the 7-day period that (a) control of a particular corporation shall be deemed not to have been acquired solely because of
ended immediately before that time, (i) the acquisition at any time of shares of any corporation by
(ii) within that 7-day period no person or group of persons acquired control of the (A) a particular person who acquired the shares from a person to whom the
corporation, and the corporation did not become or cease to be a Canadian- particular person was related (otherwise than because of a right referred to in
controlled private corporation, and paragraph 251(5)(b)) immediately before that time,
(iii) the corporation elects, in its return of income under Part I for that taxation (B) a particular person who was related to the particular corporation (otherwise
year to have this paragraph apply; and than because of a right referred to in paragraph 251(5)(b)) immediately before
(d) for the purpose of determining the corporation's fiscal period after that time, the that time, (…)
corporation is deemed not to have established a fiscal period before that time.

CCH Editorial note: This provision deems a year-end immediately before a change of status to/from a
CCPC, after which the corporation can then set a new year-end. Situations include where there is an
agreement to acquire control of the corporation by a public company and/or a non-resident (see
paragraph 251(5)(b)), the corporation becomes public, or the controlling shareholder becomes non-
resident. This permits the small business deduction and RDTOH build-up for the stub taxation year
preceding the change of status, since CCPC status would be maintained throughout that year. Opening
GRIP/LRIP accounts (re: eligible dividends) are calculated (using a “tax balance sheet” approach)
immediately before the end of the stub taxation year (see subsections 89(4) and (8)). Subsection 249(3.1)
does not apply where subsection 249(4) (providing a separate deemed year end on an acquisition of de
jure control) applies, nor does it apply to “change of status” elections/revocations re: subsections 89(11)
or (12).

(4) Year end on change of control

Where at any time control of a corporation (other than a corporation that is a foreign affiliate of a
taxpayer resident in Canada and that did not carry on a business in Canada at any time in its last
taxation year beginning before that time) is acquired by a person or group of persons, for the
purposes of this Act,
(a) subject to paragraph (c), the taxation year of the corporation that would, but for this
paragraph, have included that time shall be deemed to have ended immediately before
that time;
(b) a new taxation year of the corporation shall be deemed to have commenced at that
time;
(c) subject to paragraph 128(1)(d), section 128.1, and paragraphs 142.6(1)(a) and
149(10)(a), and notwithstanding subsections (1) and (3), where the taxation year of the
corporation that would, but for this subsection, have been its last taxation year that ended

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