The CRA recently published a severed letter in which it considered the applicability of subsection 74.4(2) to two scenarios involving the payment of dividends from a small business corporation to a holding company, for the benefit of “designated persons”. Generally, subsection 74.4(2) applies to a transfer or loan of property made, directly or indirectly, by an individual to a corporation that is not a small business corporation, if it is reasonable to consider that one of the main purposes of the transfer is to reduce the individual’s income and benefit, directly or indirectly, someone who qualifies as a “designated person” in respect of the individual (e.g. a minor child or spouse).
The CRA was asked to consider the following situation:
- Mr. X is the sole shareholder of Opco, a small business corporation.
- Mr. X establishes an estate freeze using his common shares in Opco, in favour of a discretionary family trust (FT).
- Following the freeze, FT owns all of the common shares of Opco.
- FT establishes a new company (Holdco) and subscribes for common shares of Holdco for nominal value. Holdco is not a small business corporation.
- The beneficiaries of FT are Mr. X’s adult children, his wife and Holdco.
- Each year Opco pays a dividend on its common shares equal to the profits generated in the operation of its business.
- FT attributes the dividend to Holdco and pays the amounts received to Holdco.
The CRA concluded that 74.4(2) was unlikely to apply in the aforementioned scenario, commenting as follows:
- 74.4(2) would not apply to the transfer of property from Mr. X to Opco as long as Opco remains a small business corporation.
- Although the payment of a dividend by Opco to Holdco can be considered a transfer of property, subsection 74.4(2) will not generally apply where it is a company, rather than an individual, who has transferred property to a corporation. Here, because the property transferred is generated by Opco’s internal operations, it is considered property originating from Opco.
- The CRA’s comments suggest that, if the funds paid as the dividend were traceable to property transferred to Opco by Mr. X, rather than to profits from the operations of Opco’s business, then 74.4(2) would apply following the attribution of the dividend and the payment of funds received to Holdco. In that case, Mr. X could be considered to have indirectly transferred property to Holdco.
For similar reasons, the CRA commented that 74.4(2) would be unlikely to apply in the following situation, so long as Opco remains a small business corporation. Mr. X rolls his business into Opco in exchange for common shares. The other shareholders of Opco are Holdco (not a small business corporation), Mr. X, Mrs. X and a minor child of Mr. X. Each hold a different class of equity shares in the capital stock of Holdco. Opco has the ability to declare separate discretionary dividends in respect of each class. The shareholders of Holdco are Mr. X, Mrs. X and a minor child of Mr. X. Each year, Opco pays a dividend on its shares held by Holdco equal to the profits generated in the operation of its business.