Tax shocker in share spin-off: Keep an eye on U.S. holdings

National Post


As investors begin receiving their annual T3 or T5 slips that report the
amount of taxable investment income they received in 2006, those who owned U.S.
equities that "spun off" a subsidiary last year should pay close attention to
the amounts indicated.

A tax case released last November told the story of Peter Allen and the
unfortunate tax treatment of such a transaction. In 2004, he owned 189 shares of
U.S. company FNB Corp. In early 2004, FNB separated its retail banking business
from its insurance and real estate business through a spin-off transaction,
issuing one share of the new corporation -- First National Bankshare -- for each
share held of FNB Corp.

The result was that Mr. Allen received 189 shares of First National Bankshare
-- in addition to the 189 shares of FNB Corp. he already owned. The total fair
market value of both companies' holdings owned by Mr. Allen was approximately
the same as the value of the FNB shares he held prior to the spin-off.

At the end of 2004, Mr. Allen was surprised to receive a T5 slip from TD
Waterhouse, his broker, reporting a foreign stock dividend of slightly more than
US$3,500, which was the value of the First National Bankshare stock he received
from the spin-off.

Mr. Allen did not report this dividend on his Canadian tax return as he felt
he had not received any taxable income on this transaction. Rather, he thought
it should qualify as a tax-deferred transaction under the Income Tax Act.

The Tax Act contains a specific set of rules (introduced in 2001 but
applicable to foreign spin-offs after 1997) that would allow the tax on such a
foreign transaction to be deferred until the shares are sold.

Unfortunately, in order to qualify for this tax deferral, several conditions
must be met, the most important one being that the foreign corporation must
notify the Canada Revenue Agency in writing within six months. The notice must
provide details of the distribution as well as certification that the
transaction was, indeed, tax-deferred under U.S. law.

The FNB did not provide such information to the CRA, and as a result, this
spin-off transaction did not qualify Mr. Allen for tax deferred treatment.

Although the judge was sympathetic to Mr. Allen's pleas, recognizing that the
value of his holdings after the distribution did not increase, he ruled that the
foreign spin-off didn't qualify under the Act. "The result seems unfair to Mr.
Allen. The answer, however, does not lie in ignoring legislative requirements.
It best lies with diligent reporting by U.S. companies with foreign investors."

How do you find out if you can defer tax on a particular 2006 foreign
spinoff? Check the CRA's list of qualifying 2006 spin-offs at topics/spinoffs-e.html#2006, which only lists the
corporations that have given permission to the CRA to publish their names.
Otherwise, you should contact your broker to see if your shares meet the
eligibility requirement for tax deferral.

- Jamie Golombek, CA, CPA, CFP, CLU, TEP is the vice-president, taxation and
estate planning, at AIM Trimark Investments in Toronto.