CRA rules on plan marrying a US beneficiary’s objective of realizing a Code s. 331 capital gain on a redemption of bequeathed Canco shares (coupled with estate loss carried back under ITA s. 164(6)) and Canadian beneficiaries’ objective of a pipeline strip of Canco

CRA has often ruled that s. 84(2) will not apply to "pipeline" transactions in which shares of a private company (say, “A Co”), which have been stepped up on death without using the capital gains exemption, are sold by the estate to a new estate subsidiary (Newco) for a promissory note of Newco, Newco and A Co amalgamate a year later, the promissory note is repaid out of the Amalco assets over the following year and the proceeds thereof distributed by the estate to its resident beneficiaries.

A ruling dealt with the complications arising when one of the beneficiaries (“Child 2”) was a U.S. resident and A Co (a portfolio trading company) was a PFIC. The transactions contemplated that A Co redeems a portion of its shares held by the estate, thereby giving rise to a deemed dividend and to a capital loss which can be carried back under s. 164(6) to partially offset some of the terminal year capital gain on the A Co shares – and that such redemption proceeds are allocated and paid (less Part XIII withholding) by the estate to Child 2 through the issuance of a promissory note. The estate then engages in a conventional pipeline transaction (as described above) for the benefit of its resident beneficiaries.

The ruling letter indicates that an objective of the transactions “is to remove Child 2 as a shareholder of A Co in a manner that will ensure that he can receive any distribution from A Co as a capital gain for United States income tax purposes and avoid the complications and negative tax consequences resulting from being a United States resident shareholder of a PFIC.” (The estate acquired its A Co shares with a stepped up basis and they could then be disposed of with no gain being recognized, provided that dividend treatment was avoided through receiving Code s. 331 liquidation treatment.) Accordingly, all the transactions are being undertaken for Code purposes as a “Plan of Liquidation” of A Co, so that Child 2 can enjoy capital gains treatment under s. 331 on his distributions. Among other things, this is stated to depend on Amalco being “dissolved within a reasonable time” following the share repurchase by A Co – so that the transactions contemplate that Amalco will be dissolved fairly soon after the two-year period mandated by CRA for implementing pipeline transactions.

Rather curiously, the CRA ruling summary indicates that the principal issue is "whether estate can elect under subsection 164(6) where there is a non-resident beneficiary" – but no s. 164(6) ruling was given.

Neal Armstrong and Abe Leitner. Summaries of 2015 Ruling 2015-0569891R3 under s. 84(2) and s. 164(6).