A matter of time: Part 2

On August 11, 2025, the Federal Court of Appeal (“FCA”) released its decision in The King v. Vefghi Holding Corp., 2025 FCA 143, reversing the previous decision of the Tax Court of Canada (“Tax Court”). The FCA determined when two corporations in a so-called “trust sandwich” are considered connected, such that a dividend paid to the corporation at the top of the sandwich will not attract Part IV tax under the Income Tax Act (the “Act”). All statutory references in this commentary are to the Act.

This article is Part 2 of KPMG Law’s A matter of time series. Part 1, which covers the facts and the Tax Court decision.

For ease of reference, the sandwich structure is depicted in the diagram below.

Subsection 104(19) applies where a dividend received by a trust is designated to a beneficiary of a trust, and deems the beneficiary as having received a dividend on the same shares.

Subsection 186(1) imposes Part IV tax on private corporations that receive dividends. However, this tax does not apply to dividends received by a private corporation from another corporation with which it is connected.

The Crown argued that when subsections 104(19) and 186 are interpreted in light of their text, context and purpose, connectedness is to be tested when the deemed dividend is crystallized by the deeming provision in subsection 104(19), which only occurs upon designation at the trust’s year end.

The Crown highlighted that the conditions under subsection 104(19) (e.g., designation in the income tax return, Canadian residency throughout the year) can only be met to crystallize the dividend at the trust’s taxation year-end. The Crown argued that when Parliament amended subsection 104(19), it made it clear that the timing of the dividend’s inclusion in the beneficiary’s income is dictated not by when the designation is made, but when the trust’s particular taxation year ends.

The Crown also argued that, until crystallized when all of the conditions in subsection 104(19) are met, the taxable dividend is not yet an “assessable dividend” subject to Part IV tax.

The Crown contended that the Tax Court misinterpreted subsection 104(19), arguing that deeming the beneficiary to have received the same dividend as the trust constitutes an improper rewriting of the statutory provision. In other words, the Crown argued that the deeming rule in subsection 104(19) does not go so far as to deem the beneficiary corporation to have received the same dividend received by the trust.

The taxpayers argued that connectedness for the purpose of Part IV tax should be tested when the dividend is declared and paid by the payer corporation. They argued that declaration and payment of dividends are actions that are closely tied to control or significant influence. In contrast, the time at which a dividend is deemed to be received by a beneficiary of a trust is not an action of a payer corporation and is governed by provisions (i.e. subsection 104(19)) that do not share the same purpose as Part IV.

Unlike the Crown, which began its argument with subsection 104(19), the taxpayers began their analysis with section 186 and Part IV tax imposed on dividends received from unconnected corporations. The taxpayers argued that section 186 does not specify a time in which the determination of connectedness must take place, beyond that it is made at a specific point. Instead, the word “received” in section 186 refers to the year that Part IV is payable, and not the time at which the connectedness is tested.

Finally, the taxpayers referred to the purpose of Part IV tax, highlighting that it was intended to reduce or eliminate tax deferrals on portfolio investments, and that connectedness is used to distinguish a portfolio from a non-portfolio investment. This line is drawn, in part, by asking whether a recipient had at least a substantial influence over whether a dividend is declared or not.

In the alternative, the taxpayers argued that if connectedness is to be tested at the time of receipt, as the Tax Court concluded, connectedness should be tested when the trust, not the beneficiary corporation, receives the dividend.

The FCA adopted the Crown’s interpretation. It concluded that the connectedness test for the purposes of Part IV tax is conducted at the end of the trust’s taxation year, as shown in the diagram below.

The FCA did not follow the taxpayers’ approach of beginning the analysis with section 186, and found that the deeming provision in subsection 104(19) forms “the heart of this appeal.” The FCA disagreed with the Tax Court’s finding that subsection 104(19) deems the dividend received by the beneficiary to be the same dividend that was received by the trust. Instead, the portion designated by the trust is deemed to be a dividend on the same share. The deeming provision only applies once the appropriate designation is made by the trust (which is deemed to be an individual) and the conditions of subsection 104(19) are satisfied. The beneficiary is not considered to have received the deemed dividend on the same date the trust received it. Instead, the deemed dividend is regarded as received by the beneficiary in the taxation year in which the trust’s taxation year ends.

Since all of the conditions in subsection 104(19) must be satisfied before the corporate beneficiary is deemed to receive a dividend, it cannot be made before the trust’s year end. Therefore, it is only once the designation is made and the beneficiary corporation is deemed to receive a dividend that the determination of whether the beneficiary corporation is connected with the payer corporation can be made.

The FCA also noted that using the date that the trust received the dividend could conflict with the requirements that dividends be included in the taxation year of the beneficiary corporation as noted in subsection 104(19). The only date that a dividend could be deemed to be received by a beneficiary corporation without resulting in a potential conflict between the date of deemed receipt and the requirements under subsection 104(19) is the last day of the trust’s taxation year.

The FCA also rejected the taxpayers’ purposive argument, noting that the purpose of Part IV cannot override the clear language of subsection 104(19) that the dividend is deemed to be received in the taxation year of the beneficiary in which the trust’s taxation year ends.

Unless the taxpayers are granted leave to appeal to the Supreme Court of Canada, this is the final decision on an unclear area of the Act. The conclusion aligns with the CRA’s interpretative position in technical interpretation 2020-0845821C6 – Part IV tax and trust, published on October 7, 2020.

The differing interpretations of the parties and both courts underscore the challenge of defining where deeming rules begin and end. The taxpayers pointed out that the implications here could extend beyond Part IV tax: where a taxable Canadian corporation pays a dividend and then is wound up before the trust’s taxation year, the beneficiary corporation would be denied the dividend deduction under subsection 112(1) because the payer corporation is no longer a taxable Canadian corporation when the dividend is received. The FCA addressed this concern in obiter stating that the dividend is deemed to be paid on the same share, which preserves its status as a dividend on a share of a taxable Canadian corporation. It is not immediately clear that the deeming provision preserves the status of the payer corporation at the time of declaring the dividend but not the connected relationship between the payer and beneficiary corporations at that time.

The outcome flowed from the FCA’s finding that the issue turned on identifying a specific date that the beneficiary corporation received the dividend. Although the FCA recognized that the deeming rule does not state that date, the FCA found that the effect of the deeming rule was to deem that receipt to occur at the trust’s year end because that was the only date that would work in all factual circumstances.