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Foreign Spin Off Transactions and Dividend in Kind - Conflicting Rulings that Reinforce an Earlier Precedent


On 29 June 2007, Tyco International Ltd underwent a corporate reorganisation that involved spinning off Tyco Electronics Ltd and Covidien Ltd and a stock consolidation. This simple and common place corporate reorganisation spawned a series of separate cases in the Tax Court of Canada that examined whether the shares of Electronics and Covidien distributed to Tyco's shareholders, pursuant to the reorganisation, are taxable dividends in kind.

Taxand Canada discusses the decision of the Tax Court of Canada in regards to share distributions from foreign spin off transactions and subsequent tax implications.

At trial, the taxpayers argued that they did not receive any net economic benefit from the shares distributed. In their view, the shares in Tyco were simply replaced by shares in Electronics and Covidien and the value of their overall shareholdings did not change. Thus, they argued that there is no increase in income on which to levy a tax. Conversely, CRA argued that the shares were taxable dividends in kind by virtue of section 90, of the ITA.

A more in-depth look at the facts of the case is discussed by Taxand Canada

Taxand's Take

Even though the outcomes differ, all the cases support the precedent set that shares distributed pursuant to a foreign spin off transaction is a dividend in kind only if the parent corporation owned the shares prior to the distribution. Therefore, where a particular business or division of a corporation is spun off into a newly created corporation, the shares of which were not owned by the distributing corporation, the shareholders of the distributing corporation who acquire shares of the new corporation will likely not be taxed in Canada. It is unclear how wide the scope of this exception will be in practice as it will depend on the structuring of spin-offs under foreign tax and corporate law. For instance, under the US tax regime, one of the requirements of a tax free spin off in the US is that the corporation being spun off is controlled by the distributing corporation. Thus, Canadian shareholders of a US corporation who receive shares pursuant to a tax free spin off transaction in the US will likely not benefit from the aforementioned Tax Court of Canada rulings.

While subsequent courts do not need to follow judgments from cases heard under the informal procedure, these decisions still carry persuasive authority. Regardless, taxpayers should still be mindful of the risk that subsequent courts may depart from the precedent set in the above cases, especially if engaging in tax planning activities.

Your Taxand contact for further queries is:
Eric Koh
T. +1 613 786 0121

Taxand's Take Author