Section 84

A spin-off butterfly reorganization by DC includes a preliminary step for distributing a small portion of DC's retained business from its immediate subsidiary (Subco 1) to DC. This involves Subco 1 selling that business on a taxable basis for a note, and then setting that note off against amounts that became owing by Subco 1 to DC as a result of a stated capital and dividend distribution.

See summary under s. 55(1) – distribution.

Aco holds 30 common shares of Opco (30% of the common shares) having an ACB and PUC of $30 and an FMV of $300 (the gross and net fair market value of the assets of Opco having an FMV of $1,000). A and Aco deal at arm's length with Opco. A (an individual who is the sole shareholder of Aco) transfers all his common shares of Aco (being 30 common shares having an FMV of $300 and ACB and PUC of $30) to Opco in exchange for 30 Opco shares, realizing a capital gain of $270.

There is no deemed dividend under s. 84(1) by virtue of s. 84(1)(b)(i) because the value of Opco's assets increase by $300 when Opco acquires the Aco common shares.

Where an individual transfers his 5% shareholding in Opco, having a paid-up capital and ACB of $100,000 and a fair market value of $1 million, to Holdco in exchange for shares of Holdo whose stated capital is limited under s. 24(3)(a) of the Business Corporations Act (Ontario) to $100,000 and an election is filed under s. 85(1) to limit the proceeds of disposition to $600,000, RC is of the view that s. 84(1)(c.3)(iii) is not available. In its view, Holdco used s. 24(3)(a) to set the stated capital of Holdco at $100,000, rather than initially setting the stated capital at a higher figure and reducing it.

Where preferred shares having a low paid-up capital are transferred by the shareholder to the corporation in exchange for common shares having a high paid-up capital, s. 84(1) will apply to deem the receipt by the shareholder of a dividend, without any relief under s. 85(2.1).

Background

On the death of B (the surviving spouse of A), B was deemed under s. 70(5)(a) to have disposed of the Class C common shares of the Corporation for their fair market value and the Trust (which had been settled for the exclusive benefit of A and B for their lifetimes, with the beneficiaries on the death of the survivor being their four children), was deemed to have disposed of Class F and I preferred shares of the Corporation under s. 104(4)(a) for their FMV, as well as non-interest bearing demand notes which the Corporation had issued to the Trust as consideration for a previous redemption of preferred shares ("Debt1"). The only assets of the Corporation were marketable securities.

Proposed transactions

1. The estate will transfer its Class C common shares of the Corporation to a newly-incorporated corporation ("Newco") in consideration for a promissory note ("PN") and for non-participating voting common shares of Newco, with a joint election being made under s. 85(1).
2. The Trust will transfer its Class F and I preferred shares of the Corporation to Newco in consideration for a promissory note ("PN1") with a principal equal to the FMV of such shares.
3. The four holding companies ("Holdcos") for the four children (and their spouses) will transfer their respective Class D common shares of the Corporation to Newco in consideration for Class B non-voting participating shares of the Corporation with par value, with a joint election being made under s. 85(1).
4. During the following one year, the Trust will transfer Debt1 to Newco in exchange for a promissory note with the same principal amount and terms.
5. During the one year following 1 to 3, the Corporation will pay part of Debt1 up to a maximum amount of $XX, with Newco, in turn, paying part of the promissory note payable by it to the Trust. Dividends funded out of the earnings of the Corporation will be paid on the Class B common shares of the Holdcos.
6. At least one year after 1 to 4, Newco and the Corporation will amalgamate.
7. The PN and PN1 will be repaid over a period of no less than one year after the amalgamation, and the repayment in any given quarter of the period of one year after the date of the amalgamation will not exceed XX% of the aggregate principal amount of the PN and PN1 when they were issued. The amalgamated corporation ("Amalco") will continue carrying on the investment business with the remaining marketable securities.
8. The Trust and estate will distribute their properties to the four children.

Rulings

Re ss. 84.1 and 84(1) not applying to the Trust or estate, and s. 245(2) not applying.

Background

At death, X was the sole shareholder of Investments (a CCPC, whose shares did not qualify as QSBCs), which held bank balances, shares of public companies and fixed income investments. Although X's spouse was a beneficiary (as well as their adult children), X's estate made the election in s. 70(6.2) for the shares bequeathed to the surviving spouse to be disposed of for their fair market value.

Proposed transactions

1. Investments will redeem preferred shares held by the estate for cash.
2. Investments will purchase for cancellation a portion of its Class A common shares for Note 1 thereby giving rise to a capital loss to be carried back under s. 164(6).
3. The estate will transfer its remaining Class A shares to Newco in consideration for Newco issuing Note 2 (with an amount equal to the ACB of the transferred shares) and a common share, with a joint election being made under s. 85(1).
4. At least one year following 3, Investments will be wound-up into or amalgamated with Newco (thereafter, "Amalco").
5. Amalco will repay the Notes and its other debts, then be liquidated. The Note repayments will occur at a maximum rate of XX% per quarter for the year following the amalgamation.
6. At the opportune time, the estate will distribute the funds to its beneficiaries.

Rulings

Standard ss. 84(2), 84.1 and 245(2) rulings.

Current structure

All the shares of A Co (being Class A voting common shares and Class B non-voting common shares) are held by a spousal trust (the "Trust"), which reported a deemed disposition of its assets at their fair market value on the death of the surviving spouse (Mrs. X). The sole asset of A Co is all the shares of C Co, whose sole asset is all the shares of D Co. D Co carries on a business directly and through four U.S. subsidiaries. The Trust will continue until the X anniversary of Mrs. X's death.

Proposed transactions

1. The Trust will transfer its shares of A Co to its newly-incorporated subsidiary ("Newco") in consideration for a note equal to their combined fair market value and for a preferred share, electing under s. 85(1). A capital loss on the transfer will be suspended under s. 40(3.4).
2. After at least one year, A Co and C Co will be amalgamated with, or wound-up into, Newco.
3. Thereafter, Newco may gradually begin to make payments on the note payable to the Trust and/or to the Beneficiaries and Grandchildren, to whom the note will be distributed on XX. For greater certainty, the amount paid in any quarter of the first year that the note is outstanding after the amalgamation or wind-up in 2 will not exceed XX% of the note' original principal.

Rulings

. For ss. 84.1, 84(2) and 245(2).

Current structure

Since the death of A (who used Investmentco in his professional practice but had Investmentco accumulate investments, Investmentco has been a portfolio investment company holding bank deposits, fixed income investments and shares. On the death of A, his Estate acquired his shares of Investmentco for their fair market value. None of the shares of Investmentco were qualified small business corporation shares at any time, and their adjusted cost base was not based on the tax-free zone. A's Class A common shares of Investmentco were bequeathed to his three adult children (Child 1, 2 and 3) and Child 1 was his executor.

Proposed transactions

1. The Estate of A will subscribe for common shares of newly-incorporated "Newco."
2. The Estate of A will transfer its Class A common shares of Investmentco to Newco in consideration for a demand non-interest bearing note ("Newco Note") and in consideration for Class B non-voting retractable preferred shares of Newco and with a s. 85(1) election made.
3. The preferred shares of Investmentco held by Child 1, 2 and 3 will be redeemed by them.
4. One year after 2, Investmentco will be wound-up into Newco under s. 88(1).
5. Newco then will proceed to repay the Newco Note held by the Estate of A at the rate of 25% at the beginning of each trimester.
6. Newco then will be liquidated, with ss. 88(2) and 84(2) applying.

Standard Rulings

respecting ss. 84.1, 84(2) and 245(2).

Current Holdco structure

Holdco is a portfolio investment company holding bank deposits, certificates of deposit, notes payable and preferred shares of Opco, and some real estate. Its sole liability is demand notes (Notes A to D) payable to its "Shareholders" (Brother 1, Brother 2, Sister, and the Estate of A, who was the fourth child of deceased Father.) Trust 2 holds the Class A voting common shares of Holdco, Brother 1 and 2, and Sister along with the Estate of A, hold its Class B non-voting retractable preferred shares and Trust 1 holds its Class D voting retractable preferred shares, giving Trust 1 de jure control of Holdco.

Trusts 1 and 2, A Estate and Opco

Opco carries on an active business and its Class A common shares are held by Trust 2. Trust 1 is a testamentary trust that came into existence on the death of Father, with the Shareholders (including now the Estate of A) as equal beneficiaries and with Brother 2, Sister and an Opco employee as trustees. Trust 2 is a discretionary inter vivos trust that participated in an estate freeze, and whose beneficiaries are Mother, the Shareholders and their issue or any of their corporations, and an income beneficiary (X). The principal beneficiary of the Estate of A is Trust 3, which, in turn, has A's two children as beneficiaries.

Proposed transactions

1. Trust 1 will subscribe for Class A common shares of newly-incorporated "Newco," so that Holdco will be connected to Newco by virtue of ss. 186(4)(a) and 186(2)
2. The Estate of A will transfer its Class B preferred shares of Holdco (which were stepped up under s. 70(5) on the death of A, without the s. 110.6(2.1) deduction being available) to Newco in consideration for a demand non-interest bearing note ("Note 1").
3. Holdco will subscribe for Class A common shares of newly-incorporated "Investmentco."
4. Holdco will redeem the Class B preferred shares held by Sister, Brother 1 and Brother 2, in consideration for a demand non-interest bearing note, with Holdco making eligible dividend designations.
5. Holdco will transfer its GICs to Investmentco in consideration for Class B non-voting retractable preferred shares, with the sale agreement containing a price adjustment clause, and with a s. 85(1) election made.
6. Holdco will redeem the Class B preferred shares which Newco acquired in 2, in consideration for a demand non-interest bearing note ("Note 2"), with Note 2 containing a price adjustment clause. Newco thereby will realize a capital loss, which will be deemed to be nil by s. 40(3.6).
7. Investmentco will be wound-up into Holdco under s. 88(1).

Subsequent transactions

The Estate of A will demand repayment of Note A by Holdco. At an opportune time, the Estate of A will distribute Note 1 to Trust 3 as described in s. 107(2). At least one year following 2, the Estate of A (or Trust 3, as the case may be) will progressively over various years demand the repayment of Note 1 in order to generate distributions to its beneficiaries. Newco will generate the necessary liquidity to satisfy such demands by making demands for repayments of Note 2 owing by Holdco. It is contemplated that Holdco and Opco will continue their activities in a similar manner as before (including maintaining their separate existence.)

Standard Rulings

respecting ss. 84.1, 84(2) and 245(2).

underline;">: Current structure. The Company is a listed public corporation carrying on the "Business" (comprising resource projects) directly and through subsidiaries and, with the exception of one non-resident individual shareholder, its common shares are widely held. It holds one common share (being all the issued shares) and non-interest-bearing advances (the "Subco1 Loan") of Subco1, which is a holding company for the "investments" (including advances) of the Company (likely foreign resource project subsidiaries held directly or through a further holdco), other than a share and warrant investment in another public company, which is held through Subco2.

Proposed transactions

"The Company proposes to reorganize its Business as follows" pursuant to a Plan of Arrangement:

1. The Company will exchange a portion of the Subco1 Loan for Subco1 treasury common shares (the "Subco1 Distribution Shares") and "Subco1 Warrants," entitling the holder to purchase one common share of Subco1 at an exercise price which will increase after XX months.
2. The Company will distribute the Subco1 Distribution Shares and Subco1 Warrants as a paid-up capital reduction (with the fair market value of each distributed share or warrant being approximately $XX and $XX, respectively), and with the Subco1 common shares thereafter being listed.

Rulings

Ss. 15(1) and 246(1) will not apply to the distribution. S. 84(2) will apply and ss. 84(4.1) and 212(2) will not apply to such distribution. The cost to the Company shareholders of the distributed shares and warrants will be equal to their FMV at that time.

What is the CRA position on Descarries? After noting that the case was not appealed because in the result it was favourable and it was only an informal procedure case, CRA then summarized the facts, stating that the Oka shareholders engaged in "three avoidance transactions" (TaxInterpretations translation) for appropriating the surplus of Oka which, in December 2004, had already "liquidated around 93% of its business assets with the rest…also in the course of liquidation:"

First, on 1 March 2005, they effected an internal transfer ["roulement interne"] of their shares in the capital of Oka in order to crystallize in the adjusted cost base ("ACB") of new shares [of Oka], the excess of the fair market value ("FMV") of the transferred shares over their ACB, thereby realizing a capital gain… .

The second transaction, effected on 15 March 2005, consisted in rolling those new shares in the capital of Oka to…Quebec Inc….in exchange for shares of two classes in the capital of Quebec Inc.: the first…having a low PUC and an ACB equal to their FMV (the "1971 FMV Shares") and the second class having a high PUC (which was the objective of the second transaction) and a high ACB equal to their FMV (the "Stripping Shares").

The third transaction consisted of redeeming for cash on 29 March 2005 all of the Stripping Shares, and part of the 1971 FMV Shares, so as to generate a capital loss sufficient to expunge the capital gain generated in the first transaction.

The CRA continues of the view that ITA subsection 84(2) should have applied in this case especially by reason of …MacDonald… . Furthermore, the CRA is concerned by the approach adopted by the TCC respecting the analysis of the avoidance transactions for purposes of the application of ITA subsection 245(2).

Respecting its s. 84(2) concerns, CRA noted the broad wording of s. 84(2), that the funds received on the redemption of the shares of Quebec Inc. "corresponded closely in dollars to the advance which was provided to Quebec Inc. by Oka," so that , paraphrasing RMM, the funds in the shareholders hands "were actually the funds of Oka, notwithstanding the interposition of Quebec Inc.," and that the "restrictive interpretation" accorded by Hogan J to the word "on" was inconsistent with the meaning of "as a result of" suggested in David, where there was a delay of five months. As for any potential double taxation arising from the applicability of s. 84(3), in practice CRA would avoid double taxation through applying s. 248(28)(a).

After also articulating its concerns about the decision's GAAR analysis, CRA concluded:

CRA will seek a decision of the Federal Court of Appeal or the Supreme Court of Canada…confirming the broad scope of subsection 84(2) recently established….in…MacDonald…and on whether or not there is a specific scheme under the Act for taxing any direct distribution of surplus of a Canadian corporation as a taxable dividend in the hands of individual shareholders; as well as a specific scheme under the Act against indirect surplus stripping.

See also summary under s. 245(4).

underline;">: Current structure. Parent, a public corporation which previously had been spun-off by Subco 2 (also a public corporation, but with Subco 1 holding all its common shares), owns all the common shares of Subco 1, Subco 3, Can Holdco (as well as preferred shares of Subco 1), and a portion of the common shares of FA2. Subco 3 owns the remaining common shares of FA2 and Subco 2 owns all the common shares of FA 1. The assets held in Subco 2 and FA 1 constitute the majority of the assets in the Parent group.

Proposed transactions

1. Parent will transfer to Can Holdco (which currently has nominal assets) all its FA 2 shares in consideration for common shares of Can Holdco having an equal FMV, and elect at the lesser of under s. 85(1)(c.1)(i) and (ii).
2. Subco 3 will transfer all its FA 2 shares to Can Holdco for a purchase price equal to the shares' adjusted cost base (and with a price adjustment clause based only on any adjustment to such ACB), and Can Holdco will issue in consideration therefor redeemable retractable Class B shares having a redemption amount, apid-up capital and FMV equal to such purchase price. Subco 3 and Can Holdco will elect at the lesser of the s. 85(1)(c.1)(i) and (ii) amounts.
3. Similarly, Subco 2 will transfer its FA 1 shares to Can Holdco for Can Holdco Class C preferred shares with a redemption amount, paid-up capital and FMV equal to the ACB of the transferred shares, with a similar s. 85(1) election made.
4. Can Holdco will transfer all its FA 1 shares to FA 2 in consideration for additional FA 2 shares with an equivalent FMV.
5. Can Holdco will redeem its Class C shares held by Subco 2 for demand notes (accepted as full payment, and with their terms acknowledging that their principal amount is subject to adjustment based on the Class C share price adjustment clause).
6. Similarly, Can Holdco will redeem its Class B shares held by Subco 3 for demand notes.
7. Parent will draw down under its credit facility and subscribe for Can Holdco common shares in amounts sufficient to fund the note redemptions in 8 below.
8. Can Holdco will satisfy the notes owing to Subco 2 and 3 in cash.
9. Subco 2 will reduce the stated capital of its common shares by making a single cash distribution, within XX months from the transfer in 3, with the reduction being subject to a price adjustment clause.
10. Subco 1 will make a corresponding stated capital distribution in cash to Parent.
11. Subco 3 will reduce the stated capital of its common shares by making a cash distribution, subject to a price adjustment clause.
12. Parent will repay the advance in 7.

Rulings

Ss. 85(1)(e.2), 15(1), 56(2), 69(4) and 246(1) will not apply to the transfers in 2 and 3. The transfer of FA 1 shares in 4 will not by itself cause those shares to cease to be capital property. S. 84(2) will apply and s. 84(4.1) will not apply to the distribution in 9.

Background

Prior to the death of B (who had been predeceased by her spouse), the Class A common shares of Investmentco, which was a portfolio investment company, were held by Trusts A and B, and its non-voting non-cumulative redeemable retractable Class F shares were held by B and a spousal trust (B2 Trust). Accordingly, the Class F shares were deemed to be disposed of and reacquired under s. 70(5) or 104(4)(a) for their fair market value. The adjusted cost base of the Class F shares was not based on the tax free zone.

Proposed transactions

Following capital dividends on the Class A and F shares paid through the issuance of demand promissory notes:

1. Trusts A and B will sell their Class A shares of Investmentco to newly-incorporated Newco for Class A shares of Newco with identical attributes and elect under s. 85 with Newco.
2. B2 Trust and the estate of B will sell their Class F shares of Investmentco to newly-incorporated Newco for shares of Newco with identical attributes and with a paid-up capital equal to the fair market value of the transferred shares (being also their FMV on death).
3. After a period of XX, during which it will continue its portfolio investment activities, Investmentco will amalgamate with Newco.
4. Thereafter, Amalco will proceed with partial seriatim redemptions of its Class F shares held by the Estate of B and by B2 Trust in maximum amounts of $XX per quarter.

Rulings

Respecting non-application of s. 84.1 to the transfer of the Class F shares and non-application of s. 84(2) to B Estate and B2 Trust to deem a dividend on their Class F shares of Investmentco.

Overview

A testamentary spousal trust (the "Spousal Trust") whose basis in pref shares of a portfolio investment company ("Holdco") was stepped up under s. 104(4)(a) on the death of the spouse in question (B), will engage in a "pipeline" transaction under which it will transfer those shares to a Newco for inter alia the "Newco Note," with Newco then amalgamating with Opco (at least one year later) so that marketable securities of "Amalco" may be used to pay down the Newco Note.

Prior to B's death

Following the death of A, the Spousal Trust engaged in an estate freeze transaction under which it received redeemable retractable non-cumulative Class A preferred shares of Holdco under s. 86 in exchange for its common share, and inter vivos trusts for her son (Trust C) and daughter (Trust D) each subscribed for one common shares. Spousal Trust also subscribed cash for redeemable retractable non-cumulative Class B preferred shares of Holdco, and holds debt of Holdco. Holdco's only activity is to hold marketable securities.

B's death and preliminary transactions

On B's death, there was a deemed disposition at fair market value by Spousal Trust under s. 104(4)(a) of its property including its Class A preferred shares. Newco was incorporated with Trusts C and D as nominal common shareholders.

Proposed transactions

:

1. Spousal Trust will transfer its Class A and B preferred shares of Holdco to Newco in consideration for the Newco Note (in the case of the A's) and voting redeemable retractable non-cumulative Class B preferred shares (in the case of the B's).
2. Trusts C and D will each transfer its common share of Holdco to Newco under s. 85(1) for one Newco common share.
3. Holdco and Newco will amalgamate to form Amalco no sooner than one year after the above transfers. Any dividends paid in the interim by Holdco or Newco will not be funded through a disposition of corporate investments. Pursuant to ss. 87(11) and 88(1)(d), Amalco will designate an amount to increase the cost amount of some or all of the Marketable Securities. "The shares of the capital stock of Holdco will not be acquired by a person described in subclauses 88(1)(c)(vi)(B)(I), (II) or (III) as part of the series of transactions or events that includes the amalgamation of Holdco with Newco."
4. The Newco Note "will be gradually repaid over a period of at least one year after the amalgamation date, but the amount of the repayments in any given quarter of that year will not exceed X% of the principal amount of the Newco Note when it was issued. …While Amalco may sell some of the Marketable Securities in order to enable it to make the above-mentioned repayments of the Newco Note, it intends to continue carrying on its investment business with the remaining Marketable Securities left."
5. On completion of its administration, Spousal Trust will transfer its remaining assets to its beneficiaries (C and a testamentary trust for D).

Rulings

:

• S. 84.1 will not apply to the transfer of shares by Spousal Trust to Newco.
• S. 84(2) will not apply to deem Spousal Trust to have received a dividend on the Class A preferred shares.

Background

Pubco (which is a listed Canadian public corporation engaged in the commercialization of innovative products, and is reorganizing to concentrate on XX) and its indirect Canadian subsidiary, Subco, completed an arm's length sale of the X Business. Following the sale, the Board announced an X% reduction in the workforce. No material amount of the PUC of Pubco was the result of its "acquisition of shares of previously unaffiliated corporations for FMV that was significantly less than the aggregate PUC of such corporations or the result of an acquisition that involved non-capital losses…being made available to Pubco" (para. 7).

Proposed transactions

Pubco may effect a distribution (Distribution #1) of its paid-up capital in an amount equal to or less than the proceeds of the sale of its X Business, with Distribution #1 being derived from such sale and occurring within X months thereof.

Within the same time period, Pubco may effect a distribution (Distribution #2) of its paid-up capital which is derived from cash or near cash on hand of it or its subsidiaries.

Rulings

Standard.

X and Y each hold half of the common shares of Opco. X deals at arm's length with Y and Buyer. Buyer incorporates Holdco and subscribes $100,000 for its shares. Opco borrows $500,000 and on-lends at interest to Holdco. Holdco purchases X's shares for $1,000,000, with $600,000 paid on closing, with the deferred $400,000 portion of the purchase price bearing interest.

Holdco and Opco then amalgamate. Buyer and Y each receive 50% of the voting common shares of Amalco, and Amalco preferred shares with a value of $100,000 and $1,000,000 respectively, minus the value of the common shares. Amalco continues to carry on the Opco business.

In response to a query as to whether s. 84(2) applied, CRA stated (TaxInterpretations translation):

…it would be difficult to consider that this business was reorganized by virtue of the amalgamation as the amalgamation would not entail a change to that business. Your request does not provide any other information that would permit us to conclude that there was a winding-up, discontinuance or reorganization of Opco's or Amalco's business.

Two Canadian-resident brothers (Messrs. A and B), who each hold a 50% block of the common shares of a small business corporation (Dividend Payor) having a fair market value of $1.5M and nominal adjusted cost base and paid-up capital, and safe income on hand of perhaps $1M, transfer their respective shareholdings to wholly-owned Newcos (Holdco A and Holdco B), utilizing the s. 85(1) rollover, in consideration for common shares of Holdco A and Holdco B with the same attributes (FMV- $1.5M; nominal ACB and PUC). Each of the two Holdcos then transfers its common shares of Dividend Payor under s. 85(1) to Dividend Payor in consideration for the issuance by Dividend Payor of preferred shares, also with such attributes (FMV- $1.5M; nominal ACB and PUC). Immediately thereafter, A and B subscribe equally for common shares of Dividend Payor.

Thereafter, Dividend Payor annually redeems preferred shares held by each of the Holdcos for $150,000. Although $100,000 of the resulting deemed dividend of approximately $150,000 is attributable to safe income on hand, no s. 55(5)(f) designation is made, so that the full amount of such deemed dividend is converted to a capital gain under s. 55(2). Each Holdco then pays a capital dividend of $75,000 to its individual shareholder (A or B).

In indicating that the general anti-avoidance rule could be applied to this and similar transactions involving trusts, CRA stated (TaxInterpretations translation):

[T]he surplus of Dividend Payor is annually stripped in favour of A and B given that annual taxable dividends of $150,000 which otherwise would be paid by Dividend Payor (namely its accumulated surplus) directly to each are, through a series of transactions entailing the insertion of Holdco A and Holdco B, converted in form to capital dividends free of tax (in the amounts of $75,000), through utilizing section 55….

[T]he insertion of Holdco A and Holdco B is part of a stratagem for the surplus-stripping of Dividend Payor with a goal of converting annual taxable dividends paid by Dividend Payor, which dividends would normally be inter-corporate dividends eligible for the subsection 112(1) deduction…, into proceeds of disposition of shares in a manner that abuses subsections 84(3), 55(2) and 83(2).

After referring to the adverse view taken by the GAAR committee of the somewhat similar transactions in 2004-0099201R3, CRA stated that (notwithstanding the decision in Gwartz v. The Queen, 2013 TCC 86) (TaxInterpretations translation):

CRA proposes, at the first favourable occasion, to demonstrate to the Court that there is a specific scheme under the Act for taxing the distribution of surplus of a Canadian corporation as a taxable dividend in the hands of individual shareholders who are the taxpayers; and that there is also an overall scheme of the Act against surplus stripping.

Background

X's Class A, B and C shares of Amalco (a Canadian private corporation that was not a small business corporation) passed on his death to an estate (the Estate) of which two of his sons (Y and Z) were the executors. After giving effect to the immediate bequest of the Class B shares of Amalco to Y and Z, the shares of Amalco were held by the estate (holding Class A and C shares), Y and Z (each holding Class B shares and one common share) and a trust (the Trust) for the children of the other son of X (holding the other common share).

Proposed transactions

:

• The Estate will transfer its Class A and C shares to a newly-incorporated corporation (Newco), whose common shares are owned equally by X, Y and the Trust, in consideration for two Notes
• Y and Z will transfer their common and Class B shares, and the Trust will transfer its common share, of Amalco to Newco in consideration for non-voting preferred shares of Newco
• Amalco will be amalgamated with Newco no sooner than one year after the above transfers
• The Notes "will be gradually repaid over a period of at least one year after the amalgamation date, but the amount of the repayments in any given quarter of that year will not exceed X% of the principal amount of Note 1 and Note 2 when they were issued"

Rulings

:

• S. 84.1 will not apply to the transfer of shares by the Estate to Newco for the Notes, except that it will so apply to the extent of the V-Day value of the Class A shares so transferred by it
• S. 84(2) will not apply to deem the Estate to have received a dividend on the Class A and C shares

CRA would generally not differentiate between a corporation carrying on an active business and a corporation carrying on a business of earning income from property when considering whether funds or property of a corporation resident in Canada have been distributed or otherwise appropriated in any manner whatever to or for the benefit of the shareholders, on the winding-up, discontinuance or reorganization of the corporation's business.

Moreover, the Federal Court of Canada, Trial Division has mentioned in Conrad David v. The Queen, 75 DTC 5136, that the word "on" used in the expression "on the winding-up, discontinuance or reorganization of its business" may possibly mean "as a result of" or "consequential to". Therefore, it could be argued that, even if no business exists at the time of the distribution or appropriation of funds or property, such distribution or appropriation could still occur "on" the winding-up, discontinuance or reorganization of the corporation's business if it happens "as a result of" or is "consequential to" the winding-up, discontinuance or reorganization of the business. For example and depending on the circumstances, subsection 84(2) could apply to the distribution by a corporation to its shareholders of funds or investments resulting from the prior sale of operating assets linked to a former business.

Pubco holds foreign affiliates owning non-core foreign exploration properties through two Canadian holding companies (Canco 1 and Canco 2). After preliminary transactions to capitalize these holdings (which are designed to increase the adjusted cost base of its shares of Canco 1 and Canco 2), Pubco transfers its shares of Canco 1 and 2 to a newly-incorporated Canadian subsidiary (Spinco), utilizing the s. 85(1) election. Spinco then may obtain equity financing from third parties on a private placement basis, thereby diluting Pubco's ownership of Spinco.

Pubco then distributes Spinco to its shareholders as a reduction in the paid-up capital of its common shares (such reduction being equal to the fair market value of the Spinco shares).

Rulings that s. 84(2) will apply, and s. 84(4.1) will not apply, to the distribution; and that subject to s. 47, the cost amount to a Pubco shareholder of the Spinco shares will be equal to their fair market value at the time of distribution.

A CBCA Canadian public company (the "Corporation") transferred Canadian property, which represented substantially all of the assets used by it in an active business, to a CBCA Newco on an s. 85(1) rollover basis in consideration for common shares. It then sold Newco to PurchaseCo (a Canadian public company which was a "capital pool company") in consideration for PurchaseCo common shares and special warrants (apparently in order to qualify the issuance of the related common shares of PurchaseCo for securities law purposes).

Corporation will distribute the PurchaseCo common shares to its shareholders, as a one-time reduction of its paid-up capital.

Ruling that s. 84(2) will apply, and s. 84(4.1) will not apply, to the distribution.

Ruling that s. 84(2) will apply to the distribution by a resource public company of a resource subsidiary as a reduction of stated capital, in order that the former can focus on its more promising projects.

At the time of death of Mr X, he held common and preferred shares of (and controlled) Holdco, which carried on an investing business and held a wholly-owned subsidiary carrying on a business (Opco). Mrs X held common shares and preferred shares of Holdco of a different class.

A testamentary trust created by Mr X will transfers the estate shares to a Canadian corporation (Newco) which is jointly owned by the trust and Mrs X and controlled by the trust in consideration for two promissory notes equal to the fair market value of such common and preferred shares at the death of Mr X, and for preferred shares having a redemption amount equal to any appreciation in the fair market value of the common shares subsequent to such death (and having a nominal paid-up capital so as not to engage s. 84.1). A s. 85(1) election is filed in due course. Mrs X effects a similar transfer of her Holdco shares to Newco.

After at least one year has elapsed since the transfer of the shares of the capital stock of Holdco to Newco, Holdco will be amalgamated with or wound-up into Newco. Pursuant to paragraph 88(1)(d) and within the limits of this provision, Newco will designate an amount to increase the ACB of the shares of the capital stock of Opco that will be distributed or acquired on the amalgamation/winding-up.

Subsequently to such amalgamation or winding-up, Newco may gradually begin to make payments on the notes owing by it to the testamentary trust in order to fund distributions to beneficiaries in accordance with the terms of the trust.

Ruling that s. 84(2) will not apply to deem Holdco to have paid a dividend to the testamentary trust.

An estate engages in a "pipeline" strategy in which it disposes of its shares of ACo (having a stepped-up adjusted cost base under s. 70(5)) to a newly-incorporated holdco ("AHoldco") in consideration for a promissory note, and AHoldco applies an intercorporate dividend from ACo to repay the promissory note. CRA stated that the circumstances which "could" lead to the application of s. 84(2) included: the funds or property of ACO being distributed in a short time frame following the death of the deceased; and ACo having no business and instead holding mostly cash.

Given that the Tremblay decision contained a strong dissent based on the Smythe decision and given that the general anti-avoidance rule was not invoked in that case, CRA will continue to challenge abusive surplus stripping arrangements including those taking the form of "tuck under" transactions. However, it maintains its position that ss. 84(2) and 245(2) should not apply to "tuck under" transactions carried out in the context of "safe income extraction" scenarios.

Mr. A is the sole shareholder of Aco, which generates an annual profit from its operations of more than $100,000. His Aco shares have a significant fair market value and nominal paid-up capital and adjusted cost base.

In a given year, A transfers a portion of his shares of Aco, having a FMV of $100,000, to Aco in consideration for preferred shares of Aco having a redemption amount of $100,000 and a nominal PUC. As s. 84(5) applies, there is no deemed dividend and A realizes a capital gain of $100,000.

In the same year, A transfers his $100,000 preferred shares of Aco to a Newco formed by him (Bco) in consideration for a demand promissory note of $100,000. As his preferred shares had an ACB for purposes of s. 84.1(2)(a.1) of $100,000, no deemed dividend arises. Aco then redeems the $100,000 of preferred shares (giving rise to a deemed dividend to Bco of that amount – which is not subject to s. 55(2) as Bco had full ACB in those shares), and BCo uses the redemption proceeds to discharge the note owing to A.

CRA stated (TaxInterpretations translation):

The goal of the series of transactions which you presented to us was to convert an annual dividend, which otherwise would have been paid by your corporation, into a taxable capital gain, by the annual conversion, in a taxable transaction, of participating shares in your corporation into preferred shares and the transfer of such preferred shares to a holding company controlled by you….[This] series of transactions constitutes a mechanism for the stripping of surplus of your corporation so that all the conditions for the application of the GAAR are satisfied.

An indirect foreign subsidiary ("Forco 1") of a Canadian public company ("Opco 1" - likely, BCE Emergis Inc.) sold a foreign subsidiary of Forco 1 ("Forco 2" - likely BCE Emergis Corporation) in an arm's length sale to a purchaser. As a condition to the sale of Forco 2, a loan owing by Forco 2 to another indirect foreign subsidiary of Opco 1 ("Forco 3") was required to be paid off. Accordingly, Opco 1 used money borrowed by it from a Canadian bank to contribute, through a series of transactions, capital to Forco 2, in order that Forco 2 could pay off the loan owing by it to Forco 3. Upon completion of the sale of Forco 2, the sale proceeds were distributed, through winding-up of Forco 1 and its immediate parent to Opco 1 ,which used a portion of the proceeds so received by it to pay off the bank loan. Thereafter, Forco 3 uses the loan repayment proceeds received by it to effect a capital distribution to its immediate Canadian parent ("Sub 2") which, in turn, will effect a capital distribution directly (and through another intermediate corporation) to Opco 1, which will then effect a stated capital distribution of a portion of such cash proceeds on its shares.

CRA gave a favourable s. 84(2) ruling.

U.S.-resident shareholders of a Canadian investment company ("Canco") sell their shares of Canco to an unrelated Canadian purchaser ("Holdco"), and Holdco winds-up Canco, "bumps" the investments of Canco under s. 88(1)(d) and sells some of those investments to persons other than those described in s. 88(1)(c)(vi)(B)(I), (II) and (III). S.84(2) does not apply to the transactions as Holdco is not a special purpose corporation and has been an investment holding company since the 1970s, and sales by it of the bumped assets will be in the ordinary course of its business. "Therefore it cannot be said that Holdco is an instrumentality designed to facilitate these proposed transactions."

After negotiations with a purchaser, who is interested in the assets of the business of Opco, it is agreed that the Opco shareholders will sell their Opco shares after Opco has transferred all its assets in a taxable transaction to a newly-incorporated subsidiary ("Subco"). The capital dividend account of Opco is distributed to the vendor shareholders of Opco immediately after the taxation year end resulting from the amalgamation of Opco and Subco and the acquisition of control of Opco. The sale price for the shares is adjusted to reflect the income tax payable on the asset drop-down and the funds distributed on payment of the capital dividend. The vendors utilize their capital gains exemption on the sale.

Would s. 84(2) (which was invoked in Geransky) be applied? Given that tax was paid on the asset sale, would s. 245(2) be applied? CRA responded:

[W]here none of Opco's funds or property are distributed or otherwise appropriated in any manner whatever to or for the benefit of the selling shareholders of Opco in the Given Situation, subsection 84(2) of the ITA would not be applicable. This could be the case where the selling shareholders and the purchaser are dealing at arm's length, the selling shareholders would receive a cash amount from the purchaser's own funds in return for their Opco shares, and Opco's assets would continue to be used in an active business by Opco or by another entity within the purchaser's corporate group.

Respecting the application of subsection 245(2)…it is possible to confirm that in a situation of the type described in the preceding paragraph, subsection 245(2) would not normally apply to the selling shareholders to redetermine the tax consequences arising from the sale of their shares.

…[I]t is not possible to comment definitively on the application of subsection 84.1 in the Given Situation given…the brief description [respecting facts relevant to arm's length dealing].

…[However] where the proposed transaction is a business transaction and is supported by bona fide business purposes (other than obtaining a tax benefit), where a purchaser is interested in the assets of an unrelated person (the "Target Corporation"), and where the purchaser and the shareholders of the Target Corporation are unrelated persons with distinct and different interests, the sole fact that the parties have finally agreed that the purchaser would acquire the Target Corporation's assets by purchasing shares of its capital stock would not be sufficient, in and by itself, to consider that the purchaser and the vendors are not dealing at arm's length, with respect to the disposition of the shares of the capital stock of the Target Corporation. …

Ruling that a transfer by a Canadian public company in a taxable transaction of all the assets of a business to a Newco, followed by a distribution of Newco shares to its shareholders would give rise to a dividend only to the extent that the fair market value of the distributed shares exceeded the paid-up capital reduction associated with the distribution.

Description of reorganization of a public corporation in which the paid-up capital of its issued and outstanding common shares are reduced through the distribution of the common shares of Newco to the shareholders, with s. 84(4.1) not applying because of the application of s. 84(2).

Where Mr. A effectively wishes to withdraw cash from a corporation of which he is the sole shareholder and accomplishes this by selling the shares of the corporation to another unrelated corporation which then winds-up the purchased corporation, s. 84(2) may possibly apply to Mr. A.

A price adjustent clause in the share provisions for preferred shares issued by Opco to the taxpayer in Year 1 in consideration for the transfer of property to Opco provide that the redemption value of the shares issued will be changed if the FMV of the consideration for the shares is determined by CRA to be different than the determination at the time of the transaction (or an additional amount will be paid if the change is upward and the preferred shares issued are redeemed before the determination by CRA).

In year 5, Opco redeems all the preferred shares, in year 7, CRA determines that the FMV of the property and the redemption value of the preferred shares should have been higher, and "pursuant to the price adjustment clause" the taxpayer receives an additional payment from Opco in year 8.

When would the taxpayer have to include the additional payment as income? CRA stated:

[I]f the price adjustment… is valid…CRA's longstanding position is that the additional payment will be treated as a dividend that will be included in the taxpayer's income in the year of receipt under subsection 84(3) of the Act. …

However, as the additional payment is not determined at the time of the redemption of the shares… it should not be included in the income of the taxpayer in the year of the redemption as part of the amount paid under subsection 84(3)… .Rather, the CRA…[will] tax the additional payment pursuant to the general rules with respect to the dividends, that is, to tax such amount at the time it is received. …

[T]here would be no interest with respect to the income tax computed on that additional amount if the income tax is paid in a timely manner pursuant to the Act and if any instalment computed under the Act with respect to the income tax for the year of the receipt was remitted on time.

A CCPC ("Opco"), whose voting common shares were owned by two individuals (B and R) and by a Canadian-controlled private corporation ("Management M") wholly owned by a third individual ("M"), purchased for cancellation all of its shares (having nominal paid-up capital and adjusted cost base) held by Management M. This was a non-arm's length transaction. The safe income on hand was in excess of the purchase price, so that all of the purchase for cancellation was reported as giving rise to a deemed dividend under s. 84(3) that was not subject to s. 55(2). CRA determined that the purchase price for the shares was less than their fair market value, and that a price adjustment clause was invalid as there was no intention at the time for the transaction to occur at the shares' fair market value.

The Directorate indicated that the shares were deemed by s. 69(1)(a) to be disposed of for their fair market value. Such proceeds were reduced by the deemed dividend arising under s. 84(3), which was based on the actual amount paid rather than being modified by the application of s. 69(1)(b). Accordingly, none of the unutilized safe income on hand attributable to the shares could be utilized.

if preferred shares with a redemption amount which is subject to a price adjustment clause are redeemed before there is an upward adjustment to the redemption amount pursuant to that clause, a payment of the resulting additional amount will be included in the shareholder's income in the year of receipt under s 84(3).

Where Parentco owns preferred shares of a subsidiary wholly-owned corporation (Subco) denominated in U.S. dollars and Subco purchases the preferred shares for cancellation in consideration for the issuance of preferred shares denominated in Canadian dollars, there is a good argument that Subco has not sustained a loss for purposes of s. 39(2) given that its patrimony is unaffected by the transaction. The only effect of the transaction is to change the claims of various classes of shareholders on its assets.

Confirmation of a previous position that in light of the McMillan Bloedel decision, CRA intends to assess any redemption of foreign-currency-denominated redeemable and retractable preferred shares on the basis that s. 39(2) applies to the issuer corporation.

Respecting the situation where a subsidiary purchases for cancellation a portion of the common shares in its capital held by its wholly-owning parent, CRA noted that s. 69(1)(b) would apply only for capital gains purposes and not for purposes of determining the amount of a deemed dividend under s. 84(3), given that the presumption in s. 69(1)(b) applied only with respect to the person disposing of property.

In a situation where preferred shares were redeemed for an amount less than the fair market value, the Directorate stated that "where, in a non-arm's length situation, the fair market value of the shares exceeds the redemption amount, the difference will be taxed as a capital gain rather than as a deemed dividend. Paragraph 84(3)(a) speaks only of the 'amount paid' where shares are redeemed. It does not stipulate fair market value payment or the lack of fair market value payment or even the necessity for one as opposed to the other ... ."

A purchaser is interested in purchasing an operating subsidiary ("Opco") of a management corporation ("Managementco") and not Managementco. Accordingly, the individual shareholder of Managementco transfers his shares of Managementco to Opco in consideration for shares of Opco and Managementco is wound-up into Opco. The individual then sells all his shares of Opco utilizing the capital gains deduction.

No dividends will be deemed to have been paid by Opco at the time the shares in its capital stock held by Managementco are cancelled because no amount would have been paid by Opco at the time of this cancellation.

Where employees of Opco (who as a group, own 14% of its issued common shares) are terminated, they are required to sell their Opco common shares for cash consideration to a new corporation ("Newco") equal to the shares' fair market value; and Newco finances the purchase with a non-interest bearing loan from Opco and, shortly after the purchase, transfers the common shares to Opco for fair market value consideration.

Ss.84.1 and 84(3) do not apply "as long the employees and the corporations are dealing with each other at arm's length and Newco is not purchasing the Opco shares as agent for Opco"; and s. 245(2) would generally not be applied.

A foreign subsidiary ("Holdco") which is making a takeover bid for a public corporation in the same foreign jurisdiction ("Targetco'), acquires (without obtaining beneficial ownership) common shares of the taxpayer in order to provide such treasury shares to the public shareholders of Targetco as consideration for the acquisition of shares of Targetco. Any shares of the taxpayer that are subscribed for by Holdco and which are not delivered by Holdco to Targetco shareholders are returned by Holdco to the taxpayer and cancelled in accordance with section 38 of the Canada Business Corporation Act regulations, with the subscription proceeds previously paid for the shares also being returned.

S.84(3) would not apply to deem a dividend to be received by Holdco or the Targetco shareholders as a result of the return and cancellation of such shares.

"Where an employee has income from employment under paragraph 7(1)(a) related to the disposition, by virtue of subsection 7(1.1), of shares and a deemed dividend under subsection 84(3) of the Act related to the redemption of shares in the same or a different year, we are of the view that subsection 248(28) of the Act will apply so that there will be no income inclusion under subsection 84(3) of the same amount as a deemed dividend resulting on the redemption of the shares."

Where shares held by a financial institution are redeemed, s. 84(3) will be considered to take precedence over s. 142.5(1), and s. 248(28) will apply to allow the financial institution to reduce its proceeds of disposition by the amount of the deemed dividend. The financial institution may claim a loss on the redemption.

S.142.5(1) takes precedence over s. 84(3). To the extent that an amount has been included in computing income under s. 142.5(1), such amount will not be taken into account again for purposes of s. 84(3), by virtue of s. 248(28).

In response to a proposal that a payment be made to a separated wife of a husband by her dissenting to the amalgamation of a corporation controlled by her husband and in which he had a minority interest with another corporation wholly-owned by her husband, RC stated that "where a payment to a shareholder pursuant to his/her right of dissent arises as a result of transactions the primary purpose of which is to realize a distribution of corporate surplus that is taxed as a capital gain rather than a dividend and the capital gains are taxed at a lower rate, it is our view that it would constitute an avoidance transaction and subsection 245(2) would be applicable unless it is not considered to result in an abuse ... . Transactions contrived to avoid the application of section 84.1 would be considered to result in an abuse for the purposes of subsection 245(4) of the Act".

Where there is a wind-up of a wholly-owned subsidiary that also owns shares of its parent, s. 84(3) will not apply to the subsidiary because the parent will not pay any amount to the subsidiary on the cancellation of its shares.

On the redemption of shares held as inventory, a deemed dividend will arise pursuant to s. 84(3) and, to the extent that the paid-up capital of the share exceeds its cost to the shareholder, the excess will be included as business income of the recipient under s. 9(1). Because s. 54(h)(x) is not applicable, any deemed dividend arising under s. 84(3) cannot result in the realization by the recipient of any loss.

S.84(3) does not apply to deem a dividend to have been paid when shares of a corporation owned by its wholly-owned subsidiary are cancelled on the winding-up of the subsidiary.

S.84(3) does not apply to an amalgamation to which s. 87 applies.

With respect to an argument that where a corporation purchases for cancellation only some of the shares of a given class and pays an amount greater than the average paid-up capital of each share, the paid-up capital of the class should be reduced by the entire amount paid, RCT indicated that a deemed dividend will arise under s. 84(3) where the amount paid for each share exceeds its paid-up capital.

On the transfer by Mr. A of 1/2 of the common shares of Opco to Opco in exchange for preferred shares of Opco having 1/2 the paid-up capital of the old common shares of Opco, s. 84(3) would not deem Opco to have paid a dividend to Mr. A because the amount paid by Opco by issuing preferred shares would be equal to the amount by which the paid-up capital in respect of the preferred shares increased by virtue of the issue of preferred shares to Mr. A.

A normal course issuer bid would not give rise to deemed dividends.

The purchase by the issuer of common shares held by a majority holding company would not taint the application of s. 84(6) with respect to its purchase of common shares of minority shareholders pursuant to a normal course issuer bid.

Where a corporation is wound up and the shares are cancelled as a result of the winding-up, s. 84(9) does not apply.

Under Canadian corporate law, the shares of a corporation which is being wound-up or liquidated are not disposed of "to a person" as a result of the liquidation. Consequently, the shareholders' shares of the corporation have not been redeemed, acquired or cancelled as a result of the liquidation and s. 84(9) would not apply to the disposition.