Subsection 55(2) of the Income Tax Act (Canada) is a specific anti-avoidance rule aimed at "capital gain strips" and has been in the Act for over 30 years. Subject to certain exceptions, subsection 55(2) can apply when the purpose test is satisfied, that is, when the purpose of a dividend (other than a dividend arising under subsection 84(3) received as part of a transaction or event or a series of transactions or events is to effect a significant reduction in a capital gain that would otherwise be realized on a fair market value disposition of any share (the "Current CG Purpose Test"). If subsection 55(2) applies, the amount of the dividend is deemed not be a dividend received by the corporate shareholder, and instead is deemed to be either proceeds of disposition or a gain.
This article is divided into three parts. In the first part, we provide an overview of the amendments in the Section 55 Proposals, with a specific emphasis on the changes to the subsection 55(2) exceptions. In the second part, we review the rationale for subsection 55(2) and the guidelines developed by the courts in applying the Current CG Purpose Test. In the third part, we examine the Proposed Purpose Tests and the rationale for these new rules.
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