April 19, 2004
Reductions of Paid-Up Capital by Public Corporations
Introduction
On February 27, 2004, the Minister of Finance released draft technical amendments to the Income Tax Act and the Income Tax Regulations. These draft amendments include the anticipated revision to the package of draft technical amendments released on December 20, 2002. As noted in the accompanying press release, the draft amendments correct a number of technical issues with the legislation, update and revise many previously announced amendments and address situations that the Department of Finance considered in need of a legislative response. The Minister has invited public comments on the draft amendments by April 30, 2004.
The draft amendments and explanatory notes each span over 400 pages. The explanatory notes generally cover only those provisions that are new or have changed from December 2002. The notes for the foreign affiliate changes, however, have essentially been replaced. Tax advisers and taxpayers know all too well that the devil can often be found in technical tax details, and this is certainly true in the case of this package of amendments. Some time will, of course, be required to examine these details and determine the precise implications of the proposed changes. Many of the draft provisions are intended to implement various technical "fixes" that the Department of Finance had promised to introduce in "comfort letters" issued to taxpayers and their advisors in the last several years.
While the bulk of the amendments are technical in nature, there are some substantive gems to be discovered in the mountain of technical changes. The following are some of the more significant highlights.
When a public corporation pays an amount to its shareholders on a reduction of its paid-up capital, except in certain specified transactions, a deemed dividend ordinarily results. An amendment to subsection 84(4.1) of the Income Tax Act , which deals with reductions of a public company's paid-up capital, had been expected since 1998, when the Department of Finance indicated that it would propose a change in a comfort letter released to the public. The proposed amendment has finally been released but, unfortunately, its provisions are much more restrictive than anticipated, which may seriously undermine their usefulness.
In imposing these restrictions, the Department of Finance appears to be primarily concerned about public companies distributing earnings to shareholders on a return of capital as a substitute for regular dividend payments. Accordingly, the amendment requires that, in order to avoid triggering a deemed dividend, the amounts distributed must be derived from proceeds realized by the corporation from a transaction that occurred outside the ordinary course of its business. This also extends to proceeds realized by a person or partnership in which the pubic corporation has a direct or indirect interest. The explanatory notes illustrate this requirement by referring to the sale of a business unit. As a further restriction, the corporation may pay an amount on the reduction of its paid-up capital only once in respect of each such transaction. Moreover, the payment must occur within 24 months of the transaction and the amounts distributed must be derived from the proceeds realized by the corporation.
Due to the restrictions contained in the proposed amendments to subsection 84(4.1), other techniques used to return paid-up capital may continue to be more effective. For example, the same result can often be accomplished (perhaps with fewer restrictions) through a distribution of funds or property on a discontinuance or reorganization of the corporation's business. Nevertheless, proposed subsection 84(4.1) may prove useful in certain circumstances and some may consider that it is at least a step in the right direction.
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