The proposed revisions to the corporate surplus stripping rules (section 84.1 of the Income Tax Act) will affect the post-mortem pipeline procedure.
On death, shares of OPCO are deemed to be disposed at fair market value, triggering a capital gain if the shares do not vest in a surviving spouse or spousal trust.
The estate acquires the shares at this fair market value. The estate may sell or liquidate OPCO, resulting in corporate tax on the sale or distribution of appreciable corporate assets in addition to tax to the estate on a deemed dividend arising on the redemption of the shares held by the estate. The share redemption also causes a capital loss (assuming certain stop-loss rules are not in play) that may be carried back to the terminal tax return to eliminate the capital gain if this transaction is done within the first taxation year the estate. If the share redemption is done after the first year, then you would have double tax, tax at capital gains rates on the terminal tax return and a second tax at dividend rates to the estate with a combined tax close to 70%.
The commonly used “pipeline procedure” allows the estate to transfer the OPCO shares to NEWCO for a promissory note which would be repaid tax-free to the estate and then to the beneficiaries as a capital distribution, resulting in only capital gains tax on the terminal tax return.
In recent years, CRA has questioned the distribution of the promissory note and has taken the position that the distribution is a deemed dividend under another provision of the Act because it was regarded as a distribution on the winding up or discontinuance of the business carried on by OPCO. However, CRA has issued a number of tax rulings that if OPCO was not wound up for a specific period, they would not assess this deemed dividend. If it was assessed then you could have both capital gains tax on the terminal tax return and tax as a dividend upon the repayment of the promissory note assuming the shares were not redeemed within the first taxation year of the estate.
A transfer after July 17th of OPCO shares by the estate to Newco will regardless of the tax rulings, will cause a deemed dividend to the estate due to the revisions to section 84.1.
To date there has been no comments on the status of potential pipeline transactions that are currently waiting for confirmation of their ruling requests.
At the end of the day, the revisions to section 84.1 will convert taxation at capital gains rates to taxation at dividend tax rates.