Charles P. Marquette, "Hybrid Sale of Shares and Assets of a Business", Canadian Tax Journal, (2014) 62:3, 857 – 79.

Summaries
CRA interpretation of specified amount (pp. 877-8)

[I]n a hybrid transaction in in which a redemption of the shares will trigger a deemed dividend, a specific exemption in subsection 191(4) will treat the deemed dividend as an excluded dividend, to exempt the deemed dividend where the specified amount for which the shares are redeemed does not exceed the fair market value of the consideration for which they were issued. In the CRA's view, the specified amount must be a dollar amount and cannot be fixed at a later date, or be subject to a price adjustment clause or described by way of a formula. [fn 55: See…1989 Conference Report…[CTF Roundtable]… and… 59342, May 15, 1990.] However, in a private ruling, the CRA accepted a redemption amount that was subject to a price adjustment clause where a separate specified dollar amount was also provided.

Description of hybrid transaction using external step-up in basis method (pp. 878-9)

[T[he hybrid form of transaction for a corporate business sale utilizes both traditional elements of a business acquisition – the purchase of shares and assets – in order to limit the ultimate tax liability incurred by the vendor and to maximize the cost base of assets for the purchaser….

In our example, the family trust's shares in the target are sold to the purchaser, and the capital gains exemption is claimed by the individual beneficiaries of the trust. This aspect of the transaction may require a purification of the non-qualifyingj assets of the target.

Once the shares of the target have been sold by the family trust, the assets of the target, primarily composed of eligible capital property (goodwill), are sold to the purchaser at fair market value. This allows the purchaser to receive full basis in the assets.

When the target subsequently redeems the shares held by the purchaser, using the proceeds from the sale to pay the redemption price, in order to avoid the applicability of part IV tax (tax on taxable dividends received by a private corporation) the shares must represent more than 10 percent of the votes and value of the target's issued shares. Following the redemption, the parent/freezor owns all of the remaining issued and outstanding shares of the target. The effect is that the target is left with the balance of the proceeds from the sale of goodwill ($20 million in our example),, which will ultimately be distributed to the parent/freezor.

Ultimately, the full CDA of the target is used to reduce the overall tax liability for the parent/freezor.

Utility of hybrid transaction (p. 879)

[T]he hybrid sale has saved many transactions from failing, including in the following circumstances:

  • The purchaser wished to acquire business assets in order (among other reasons) to obtain a step-up in basis of the assets.
  • Certain shareholders preferred selling shares, as opposed to assets, in order to access their capital gains exemption.
  • The majority shareholder ended up with a yield equivalent to that which he would have received on a sale of his shares.
Non-application of s.84(2) to hybrid transaction: sale of some Target shares to purchaser to utilize capital gains exemption, sale of Target assets (mostly goodwill) to purchaser and redemption of Target shares held by purchaser (pp. 869-870)

[T]he CRA seems to accept that subsection 84(2) would not apply to recharacterize the proceeds as dividends from the target corporation where the vendor shareholders and the purchaser are dealing at arm's length and, essentially, the purchaser is using its own funds to purchase the target's shares. [fn 22: … 2003-0029955… See also Geransky v. The Queen, 2001 DTC 243…] The CRA has confirmed that in such a situation, subsection 84(2) or 245(2) would not normally apply provided that (1) the vendors and the purchaser deal at arm's length, (2) the vendor shareholders receive a cash amount from the purchaser's own funds in return for shares of the target, and (3) the target's assets continue to be used in an active business by the target, or by another entity within the purchaser's corporate group. [fn 23: … 2003-0029955…]