The Income Tax Act (Canada) (the "Tax Act") generally permits a corporation to deduct the amount of a dividend received from another corporation resident in Canada when computing its taxable income, subject to certain limitations (a "Dividend Received Deduction").
Among the applicable limitations, the Tax Act contains certain specific anti-avoidance rules that preclude a corporation from claiming a Dividend Received Deduction where the dividend arises as part of a "synthetic equity arrangement". Synthetic equity arrangements include arrangements that involve share transactions where all or substantially all of the risk of loss or opportunity for gain or profit in respect of the shares are retained by the transferor (the Canada Revenue Agency typically interprets the phrase "all or substantially all" to represent 90% or more of a particular amount.). Under a classical synthetic equity arrangement in respect of a share, a taxable Canadian corporation enters into a forward share sale agreement with a tax-exempt counterparty and agrees to compensate the counterparty for the amount of any dividends received on the share prior to the ultimate sale. The corporate taxpayer seeks to claim tax deductions in respect of the dividend compensation payments made to the counterparty in addition to the Dividend Received Deduction in respect of any dividends received on the share. Absent the "synthetic equity arrangement" anti-avoidance rule, the corporate taxpayer would effectively be entitled to claim two deductions in respect of the same dividend.
The Tax Act currently provides certain exceptions to the application of the "synthetic equity arrangement" anti-avoidance rule, including where the taxpayer can establish that no "tax-indifferent investor" bore all or substantially all of the economic exposure in respect of the share upon which the subject dividend is paid. (A "tax indifferent investor" includes persons that are exempt from taxation under the Tax Act.) A related exception also applies to synthetic equity arrangements traded on a derivatives exchange.
Budget 2024 proposes to tighten the "synthetic equity arrangement" anti-avoidance rule by eliminating the no "tax-indifferent investor" exception (including the exchange traded exception). The Government asserts that such amendments will simplify the anti-avoidance rule and ostensibly prevent taxpayers from claiming the Dividend Received Deduction in unwarranted circumstances.
It is curious that the Government has concluded that the motivations for originally enacting the exceptions to the "synthetic equity arrangement" anti-avoidance rule in the first instance are no longer operative. It is also interesting that the financial figures that accompanied Budget 2024 indicate that no material, incremental revenue is expected to be collected by the Government as a consequence of tightening the anti-avoidance rule.
The proposed amendments to the "synthetic equity arrangement" anti-avoidance rule will apply to dividends received on or after January 1, 2025.
The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.
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