Gladwin Realty – Tax Court of Canada finds that using the CDA and negative ACB rules to generate “over-integration” was abusive

The taxpayer, a private real estate corporation, rolled a property under s. 97(2) into a newly-formed LP, with the LP then distributing to the taxpayer an amount approximating its capital gain of roughly $24M realized on closing the sale of the property. Such distribution generated a negative ACB gain to the taxpayer of that rough amount under s. 40(3.1) and an addition to its capital dividend account of roughly $12M (as this occurred before a 2013 amendment that eliminated such additions). The taxpayer recognized a further $24M capital gain at the partnership year end, which increased its CDA by a further $12M to $24M. It then promptly paid a $24M capital dividend to its shareholder. Later in the same taxation year, it was permitted to generate a capital loss of $24M under s. 40(3.12) to offset the s. 40(3.1) capital gain previously recognized by it.

Hogan J confirmed CRA’s application of s. 245(2) to reduce the taxpayer’s CDA by ½ the amount of the s. 40(3.1) capital gain, thereby generating Part III tax unless an s. 184(3) election was made.

First, the CDA rule “was adopted to ensure that only one-half of a capital gain would be subject to income tax if the gain was realized indirectly by a private corporation,” whereas here there was “over-integration,” i.e., the taxpayer purported “to pay a capital dividend equal to the entire capital gain realized from the sale of the Property.”

Second, “the purpose and effect of subsection 40(3.1) are to dissuade taxpayers from extracting from a partnership on a tax-free basis funds in excess of their investment in the partnership” - and s. 40(3.1) “and the alleviating rule in subsection 40(3.12) were not enacted to encourage taxpayers to deliberately create offsetting gains and losses for the purpose of inflating their CDA.”

Before recognizing either of the two capital gains, the taxpayer was continued to the BVI in order to cease to be a Canadian-controlled private corporation and to not be subject to additional refundable taxes under s. 123.3. CRA did not challenge this planning.

Neal Armstrong. Summary of Gladwin Realty Corporation v. The Queen, 2019 TCC 62 under s. 245(4).