In most years, the days before and after New Year are occasions for a fair amount of tax news.  Although year end was less frantic than usual in this regard, there are a couple of developments – both of which relate to the taxation of dividends - that are worthy of discussion. 

 The first pertains to an article I wrote in October in this newsletter about “leaky pipelines”[1] – that the dividend-strip provisions of subsection 84(2) may potentially apply to a post mortem “pipeline” procedure.  As a reminder, a “pipeline” involves the estate swapping shares of an Opco to a Holdco for Holdco debt in order to extract corporate-level assets equivalent to the cost base on the Opco shares - which is bumped up when the shares pass on death to another generation.  The application of subsection 84(2) would “transmogrify” the normally tax-free Holdco debt repayment into a taxable dividend[2]. 

 Briefly speaking, the CRA’s position has appeared to be that subsection 84(2) can override the normal results of a “pipeline” if funds or property of the corporation in question (the “Opco” in my example) have been distributed or otherwise appropriated in any manner whatever to or for the benefit of the estate on the “winding-up, discontinuance or reorganization of its business”.  If so, Opco would be deemed to have paid a dividend to the estate.

 A few weeks after my article appeared, the potential application of subsection 84(2) in this situation was canvassed in the December Canadian Tax Foundation CRA Round Table in Vancouver.  The CRA’s slides themselves, while delineating its general views (as above), are relatively non-committal, indicating that it could not confirm that subsection 84(2) would not apply in the context of a pipeline, and that the potential application of subsection 84(2) requires a review of the facts and circumstances relating to a particular situation (i.e., focusing on the wording above).

 More interesting were the verbal remarks at the session made by a senior CRA official[3].  They pertained to a specific question from the 2009 APFF Conference CRA Round Table,[4] which relates to the application of subsection 84(2) to a pipeline to extract cash balances sequestered in a corporation which seemed to have discontinued its business prior to the death of the shareholder.  The remarks were to the effect that if such a corporation is now nothing but a pot of cash, this is the sort of situation to which dividend rather than capital gain taxation should be applicable, i.e., so that subsection 84(2) would apply to the apparent fact situation in the APFF question.[5]

 Central to the application of subsection 84(2) is the issue of whether there has been a “winding-up, discontinuance or reorganization”.[6]  This terminology refers to the business, rather than the corporation itself.  As noted by the CRA in the Vancouver Round Table question, circumstances falling short of a dissolution of a corporation may still result in the application of subsection 84(2). 

 While the meaning of winding-up and discontinuance are fairly straightforward, “reorganization” of a business may be perceived to have a wider reach.  But in Kennedy v. MNR[7], the Court observed that:

 . . . the word "reorganization" is used in association with the words "winding-up" and discontinuance". Both of those words contain an element of finality. The company is ended. It is therefore logical to assume that the word "reorganization" presupposes the conclusion of the conduct of the business in one form and its continuance in a different form.   

Thus, cases have generally held that section 84(2) does not apply in situations where substantial business assets have been sold but the business continues on in a similar manner as prior to the transaction[8].  However, commentators have criticized some of these cases as having an overly narrow view of the term “reorganization”.[9]

 Coming back to the “pipeline” itself, assuming that a ruling is not obtained, it may be prudent to ensure that if cash or other assets are to be distributed, it is not necessary to liquidate sufficient amounts of assets to fund the distribution(s) that the CRA could possibly take the position that there has been a winding-up, discontinuance or reorganization of the business.  It may be prudent to withdraw funds only as needed and preferably over extended periods of time.[10]

 The CRA remarks above have significance beyond the realm of post-mortem planning.  Although at one point there was little difference between the tax rate on dividends and capital gains, the differential has increased[11].  The remarks are a reminder that the difference has become sufficiently large that the CRA may be motivated to take an adverse position on structures that convert tax on dividends to tax on capital gains.  As discussed in my October article, the potential application of subsection 84(2) itself is not confined to post-mortem tax planning situations and pertains to a variety of structures where the proceeds of a realization of corporate-level assets end up in the hands of shareholders on a tax-efficient basis.[12] 

 TIEAs and International Business Structures

 On January 4th, the first bilateral Tax Information Exchange Agreement (TIEA) – between Canada and the Netherlands Antilles – came into effect.  Actually, this is the first of many such agreements.  You can check out the status of the agreements at www.fin.gc.ca/treaties-conventions/tieaaerf-eng.asp.  You will see that there are over a dozen TIEAs signed but not yet in force, with almost another dozen others under negotiation.  For many taxpayers, the notion of exchange of tax information is not exactly a welcome idea, what with the tax haven status of most or all of the jurisdictions involved.  In fact, many comments from authorities in affected jurisdictions have been crafted to ease angst about loss of confidentiality.

 But the cloud has a big silver lining.  When a TIEA comes into effect, companies resident and carrying on businesses in the TIEA jurisdiction will potentially be entitled to Canadian-exempt surplus treatment.  This means that active business profits can be distributed as dividends to a Canadian holding company without Canadian tax.  Under former rules, active business income would escape Canadian tax only to the extent that earnings were not distributed to Canada.  (Note that, contrary to what some believe, qualifying active business income carried on in a non-treaty/TIEA country is not immediately taxable in Canada.  However, under current tax rules, FAPI treatment will apply if Canada does not enter into a TIEA with a country within five years following the initiation of such negotiations.)

 These provisions extend the favourable tax treatment which, in recent years, has been exemplified in treaties with such  countries as Ireland and Cyprus, but most notably, the Canada-Barbados tax treaty. 

 But besides favourable tax treatment, the ability to successfully implement international tax planning structures may depend upon the infrastructure in the particular jurisdiction – including the availability of sophisticated professionals.

 The “B” Words

 While some of the countries currently entering into TIEAs are comparative backwaters, a number of them have quite sophisticated financial and legal advisors.  One such jurisdiction is Bermuda, where the morning flight from Toronto pulls in nearly two and a half hours earlier than the flight to Bridgetown.  (At time of writing the Canada-Bermuda TIEA is signed, but not yet in effect.)

 A release by a major Bermuda law firm pulls no punches about the two jurisdictions:

 While Canada has had a long standing relationship with Barbados pursuant to the Barbados-Canada tax treaty, as a result of the TIEAs being entered into by Canada, we expect Bermuda to play a significantly greater role in the international structuring by Canadian companies.

. . .

When the Canada-Bermuda TIEA becomes effective, Bermuda will become a “designated treaty country” as a consequence of the 2007 Canadian Budget. With this designation, income earned by a Bermuda subsidiary and distributed to its Canadian parent is not subject to certain taxes. This designation has been afforded to foreign affiliates in countries who share a double-tax treaty with Canada (including Barbados, Ireland and Cyprus). However, unlike these countries, Bermuda does not impose any corporate income tax, capital gains tax or withholding tax. Thus by establishing a Bermuda subsidiary, a Canadian corporation may benefit from the tax savings available to it. With the Canada-Bermuda TIEA, Bermuda may be even more attractive than such double taxation treaty partners, by offering Canadian groups an international financial centre with a favourable tax regime and advanced business infrastructure.[13]

 So if “set up an IBC” is the first thing that may pop out of your mouth in an international tax planning session, bite your tongue.  I don’t expect that established enterprises will pull out of Barbados over its 2 1/2% tax rate, but for new international initiatives, this may be one of a number of considerations in making a choice of jurisdiction[14].  

David Louis, tax partner, Minden Gross LLP, a member of MERITAS law firms worldwide. David's practice focuses on tax and estate planning for entrepreneurs and their corporations (dlouis@mindengross.com).  Thanks to my tax partners Joan Jung and Michael Goldberg, and to articling student Daniel Wiener, who researched case law on “winding-up, discontinuance or reorganization” of a business.