Posted on July 8th, 2016 by Don Knechtel in Domestic Tax, General Business

Latest Ruling on the Pipeline Strategy


Over the last number of years dividend rates have gone up such that they are significantly higher than capital gains rates.  For taxable income greater than $150,000 taxpayers will pay from 23.98% to 26.77% on realized capital gains.  On the other hand, taxpayers with income greater than $150,000 will pay from 31.67% to 39.34% on eligible dividends and from 38.8% to 45.3% on other dividends.  Therefore, taxpayers want to structure their affairs such that they receive capital gains rather than dividends, if at all possible.

If an individual holds shares of a Canadian Controlled Private Corporation (CCPC), he will deemed to dispose of these shares on his death at fair market value.  His estate will be liable for capital gains tax on the deemed disposition.   This assumes that he has no spouse to transfer the shares to on his death and the capital gains exemption is not available to him.  For simplicity sake we will assume also that the capital gains exemption wasn’t used in the past and there are no V-day (December 31, 1971) issues to be concerned with.  If the estate wishes to windup the company, after the company assets are liquidated, the remaining cash will be paid out to the estate.  At the time the cash is distributed there is a second tax in the form of a deemed dividend to the estate, assuming the cash can’t come out of the notional tax free Capital Dividend Account.  The mechanics of the deemed dividend create a capital loss in the estate.  If the windup was completed in the first year of the estate the Income Tax Act allows the estate to carry the capital loss back to the final tax year of the deceased.  This loss is used to offset the capital gain realized on the final return of the deceased thus eliminating one level of tax.   The net result is the capital gains tax has been replaced by a dividend tax.  However, as noted above dividend tax rates are significantly higher than capital gains rates.

To preserve the capital gains tax often a “Pipeline” strategy is employed.  Under such a strategy the estate will incorporate a new company (Newco).  The estate will then transfer the shares of the existing company to Newco.  The estate will receive a note for substantially all of the value of the shares held at death plus some share capital of Newco.  There is no gain on this transaction for two reasons:

  • The cost base of the shares was increased by the capital gain that was realized on death.
  • If there has been an increase in the share value since the time of death, the estate and Newco can jointly elect under section 85(1) to defer the recognition of this gain.

The corporate structure that results from the above is the estate holds all of the Newco shares which in turns holds all of the existing company shares forming a parent / subsidiary relationship.

In the past Canadian Revenue Agency (CRA) ruled that if this structure was maintained for a year and the existing company continued to operate its business, then after such time the two companies could be amalgamated before windup.   After assets of the amalgamated company are liquidated, the cash would be used to pay off the note to the estate tax free.  The funds would be used to distribute to the beneficiaries.  Therefore, there will be no dividend tax.  The original capital gains tax would remain.

If the waiting period is not followed then CRA will tax the repayment of the note as a dividend thus negating the effectiveness of the tax plan.

A key element in past CRA rulings was the continual carrying on of the business for a period of one year.  CRA noted in the 2011 STEP Conference that the pipeline strategy would not work if the original corporation had no business assets, holding mostly cash.  There is considerable amount of correspondence from CRA in the past that would indicate that portfolio investments are not considered business assets.  This is a problem for many taxpayers, because they may have had an active business inside their corporation at one time, but since retired and sold their business assets.  They have replaced their business inside their corporation with an investment portfolio to support their retirement.

There is recent good news from the CRA in a recent ruling.  On January 20, 2016, the CRA gave a favorable ruling to a taxpayer.  In the pipeline proposal put before the CRA, the CRA ruled that the company was “engaged in the business of managing and trading an active investment portfolio”.  This situation was a little unique in that there were four beneficiaries of the estate, one of which lived in the United States.  The company first redeemed the desired amount of shares representing the U.S. beneficiary’s portion.  This transaction was treated as a deemed dividend to the U.S. individual.  After that transaction, the typical pipeline was carried out similar to that discussed above.  CRA gave its blessing to the transactions.  We hope that CRA will treat future pipeline plans involving investment companies in a similar manner.



Reorganizations and Resources Division: Income Tax Rulings Directorate, January 20, 2016.

About the Author

Don KnechtelPartner | CPA, CA

Don has over 25 years practicing in the area of taxation for both individual and corporate clients, including estate tax, corporate reorganizations, estate planning, and succession planning.
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