The Vefghi Holding case: Are you “connected”?

The Federal Court of Appeal (FCA) in Canada v Vefghi Holding Corp recently released a highly anticipated decision regarding the timing for determining when two corporations interposed by a trust, hereinafter referred to as the Paying Corporation and the Corporate Beneficiary, must be “connected” for purposes of applying Part IV tax. While the issue may appear theoretical, it carries significant practical implications in various scenarios involving corporate control and connectivity in transactional contexts and corporate reorganizations.

In its decision, the FCA allowed the appeal brought by the Canada Revenue Agency (CRA), dismissed the taxpayers’ cross-appeal, and confirmed that the relevant time for determining when two corporations are connected is the end of the trust’s taxation year in which the dividend is received.

Summary of facts

• The appeal involved two separate cases – hereinafter referred to as the Vefghi and S.O.N.S. cases – which raised the same legal issue in a transactional context, albeit with slightly different factual backgrounds.
• In both cases, the Paying Corporation and the Corporate Beneficiary were “connected” prior to the proposed sale. The trust had a December 31st year-end. However, in the Vefghi case, the Corporate Beneficiary had a December 31st year-end, whereas in the S.O.N.S. case, the year-end was August 31st.
• Immediately prior to closing, each Paying Corporation declared and paid a dividend to its respective shareholder trust, which then immediately allocated the dividends to its corresponding Corporate Beneficiary.
• On July 1, 2015, the shares of each Paying Corporation were sold to an arm’s length party, resulting in the Paying Corporation to no longer be connected with their respective Corporate Beneficiary.
• In their December 31, 2015, tax returns, each trust designated the allocated dividend under subsection 104(19) of the Income Tax Act (Federal) (ITA). These dividends were subsequently included in the tax returns of the Corporate Beneficiaries for their taxation years ending December 31, 2015, or August 31, 2015, as applicable. 
• The CRA subsequently issued a Part IV tax assessment against each Corporate Beneficiary, arguing that the dividends were received on December 31, 2015 – at a time when the Corporate Beneficiaries were no longer connected with their respective Paying Corporation due to the sale.

Decision of the Tax Court of Canada (2023 TCC 135)

In the Vefghi case, the Tax Court of Canada (TCC) held that the dividend was received by the Corporate Beneficiary at the same time the trust received it – i.e.: prior to the sale of the Paying Corporation’s shares. The Court reasoned that the legal fiction created by subsection 104(19) of the ITA resulted in the Corporate Beneficiary being deemed to have received the “same” dividend as the trust and therefore having received such dividend on the same date.

In the S.O.N.S. case, however, the legal fiction led to the dividend being deemed received in a different taxation year than the year in which the trust actually received it. As a result, the Corporate Beneficiary was deemed to have received the dividend in its taxation year ending August 31, 2016 – at a time the Paying Corporation was no longer connected, thus triggering Part IV tax.

Decision of the FCA (2025 FCA 143)

The FCA found that the TCC erred in finding that the Corporate Beneficiary was deemed to have received “the same” dividend as the trust. According to the FCA, subsection 104(19) of the ITA instead provides that the Corporate Beneficiary is deemed to have received a taxable dividend on the same shares, but not the same dividend. Based on this conclusion, the FCA found that the TCC incorrectly determined the timing of the dividend receipt.

The FCA further emphasized that for subsection 104(19) of the ITA to apply, all its conditions must be met before the Corporate Beneficiary can be deemed to have received the dividend. According to the FCA, since one of its conditions requires the trust to be resident in Canada throughout its taxation year, the deeming provision cannot apply until the end of that year.

Finally, the FCA noted that the position adopted by the TCC creates a conflict in applying the deeming rule of subsection 104(19) of the ITA when the Corporate Beneficiary’s taxation year does not include the last day of the trust’s taxation year (as was the case in S.O.N.S.).

Based on these findings, the FCA concluded that the relevant time for determining whether the Paying Corporation and the Corporate Beneficiary are connected, for purposes of applying Part IV tax, is the end of the trust’s taxation year in which the dividend is received.

Takeaways

In reversing the TCC’s decision, the FCA added a further dimension to over two decades of conflicting authorities¹. 

The FCA’s decision raises many practical concerns in the transactional context, particularly where, for example, a pre-closing dividend is paid to a trust and then allocated to a Corporate Beneficiary, and the Paying Corporation is thereafter sold before the end of the trust’s taxation year. Routine corporate reorganizations may also be affected by this decision, for example, where the Paying Corporation is (i) liquidated and dissolved, or (ii) subject to a horizontal amalgamation, both prior to the end of the trust’s taxation year. 

These practical concerns are troublesome, particularly when compared to a dividend declared and paid directly to a holding company, which would not raise those issues. When a trust is interposed, taxpayers may be required to postpone the closing of a sale transaction or of a corporate reorganization until after the year-end of the trust to avoid the Part IV tax issue. This decision might not always be commercially viable. This lack of neutrality is not warranted, particularly given the wide use of trusts for a plethora of tax and non-tax reasons, such as in the context of estate freezes or the set-up of asset protection structures.