Why “connected” timing now matters for Part IV tax in trust structures

Part IV tax is a 38 1/3% refundable tax that can apply when a private Canadian corporation receives a dividend from another Canadian corporation. While most intercorporate dividends aren’t subject to Part I tax, Part IV tax would still generally apply to intercorporate dividends received by a private Canadian corporation. A key exception is where the recipient and payer are “connected corporations.”

Two corporations are typically connected if the recipient controls the payer or owns a sufficient stake (generally more than 10% of votes and value). In common owner manager structures which include a family trust, a dividend may be paid to the trust and then designated to a corporate beneficiary. In such cases, the corporate beneficiary would be “connected” to the dividend paying corporation if both corporations are controlled by the same person.

However, if the shares of the dividend payor are sold during the year, the companies would cease to be connected immediately following the sale. In the context of dividends paid through a trust, the dividend would be considered to be received by the recipient corporation at the trust’s year end and therefore at a time when the corporations may not be connected. 

The basic facts of the Vefghi case are as follows:

• Vefghi Holding Corporation ("Vefghi Holding") was a beneficiary of the Vefghi Family Trust (trustees Rahmatollah Vefghi and Parvin Yavari).

• The Vefghi Family Trust owned all of the Class A voting common shares of R. Vefghi Environmental Consultant Inc. ("Vefghi Environmental"); both the trust and Vefghi Holding had December 31 year ends.

• On July 1, 2015, Vefghi Environmental declared and paid a dividend of $1,363,283 on those shares; later that day, the trust sold its Vefghi Environmental shares to an arm’s length purchaser, breaking the connected status before year end.

• The trust allocated and designated the same amount to Vefghi Holding under subsection 104(19) in its 2015 return, and the CRA assessed Part IV tax to Vefghi Holding—raising the dispute about when to test whether Vefghi Environmental and Vefghi Holding were connected.
  

The Courts concluded as follows:

• At  the Tax Court (2023): On a stated question, the Tax Court held that “connectedness” (for mitigating Part IV tax) is generally checked when the trust actually received the dividend, provided the corporate beneficiary is deemed to receive it in that same year; otherwise, it’s considered received in the beneficiary’s next year. Based on the Tax Court decision, Part IV did not apply to Vefghi.

• On appeal (FCA 2025): The FCA allowed the Crown’s appeal and answered the question differently: when a trust makes a valid s. 104(19) designation, one determines “connectedness” for paragraph 186(1)(a) at the end of the trust’s taxation year in which the trust received the dividend. This aligns with the CRA’s long-standing view about the timing of the designation’s effect. 

Owner-managed groups often use a “trust sandwich”: a private corporation pays a dividend to a family trust, and the trust designates that dividend to a corporate beneficiary. The payment of annual dividends will not put into question the application of Part IV tax since the companies remain connected at the end of the trust’s taxation year. However, in the context of the sale of shares of a private corporation, the dividend payor and recipient will not be connected at the end of the trust taxation year due to a change in control of the dividend payer in favour of a third party purchaser. Under the FCA rule: if the dividend payor and the corporate beneficiary stop being connected before the trust’s year-end (for example, because the dividend payor is sold), the connected-corporation exception won’t apply, and Part IV tax would be applicable to the corporate beneficiary, even if they were connected on the day the dividend was paid. 

Based on the FCA’s decision the timing for purposes of determining connectedness is at the trust’s year-end when a trust designates dividends to a corporate beneficiary. For corporate groups using a family trust with a corporate beneficiary careful attention should be paid to this timing issue, especially in the context of a share sale or reorganization. 

Planning on restructuring with a trust? 

Talk to your Crowe BGK tax advisor. We’ll review your trust year-end, transaction sequencing, and designation mechanics to help manage Part IV exposure.