They use the facts in the example below (set out at p. 215) to illustrate in various scenarios that a taxpayer (Canco) will realize a capital gain on the disposition of its shares of the disposing affiliate (Foreignco 1) – even where there has been a qualifying liquidation and dissolution (QLAD) election - where the adjusted cost base of Foreignco 1 in the distributed property, i.e., the inside basis, exceeds Canco's ACB of its Foreignco 1 shares, i.e., the outside basis:
Assumptions
Canco is a company incorporated and resident in Canada for the purposes of the Act. Foreignco 1 is a wholly owned FA of Canco. Canco's ACB in the shares of Foreignco 1 is $1,000. Foreignco 1 is a holding company whose only asset is the shares of Foreignco 2. Foreignco 1 acquired the shares of Foreignco 2 for $2,500. Foreignco 2 has exempt surplus of $1,500. The FMV of the shares of Foreignco 2 exceeds $4,000. Foreignco 1 has no liabilities. Canco wishes to liquidate Foreignco 1. In the course of the liquidation and dissolution, Foreignco 1 distributes the shares of Foreignco 1 to Canco….
They then turn (at p. 220) to the potential relief provided by the suppression election:
… Canco can elect under proposed subsection 88(3.3) for Foreignco 1 to have disposed of its shares of Foreignco 2 for PD equal to a claimed amount of $1,000. The consequences under proposed subsection 88(3) are then as follows:
1. Foreignco 1 is deemed to have disposed of its shares of Foreignco 2 for PD [proceeds of disposition] equal to the claimed amount of $1,000. Foreignco 1 realizes a capital loss of $1,500 on the disposition of its shares of Foreignco 2. If the shares of Foreignco 2 are not excluded property, the loss will be suspended pursuant to the proposed amendment to subsection 40(3.3) and paragraph 40(3.4)(a). Because the liquidation and dissolution is elected to be a QLAD, the loss would not be released under proposed subparagraph 40(3.4)(b)(v). Furthermore, the suppression consequences are ignored under paragraph (a) of the amended description of E in the FAPI definition in subsection 95(1). Thus, it does not appear that a suppression election could be used to generate a foreign accrual property loss. [fn 26: See the proposed amendment to the definition of "foreign accrual property loss" in regulation 5903(3).]
If the shares of Foreignco 2 are excluded property, the stop-loss rules do not apply to suspend the loss….
2. Canco is deemed to have disposed of its shares of Foreignco 1 for PD equal to the NDA in respect of the distribution of the shares of Foreignco 2 ($1,000). Therefore, Canco does not realize a capital gain or loss on the disposition of its shares of Foreignco 1.
Consequently, the suppression election under proposed subsection 88(3.3) enables Canco to fully eliminate the capital gain that it would otherwise realize on the disposition of its shares of Foreignco 1. This alternative also preserves Foreignco 2's exempt surplus balance of $1,500….
They provide various examples indicating that a taxpayer (Canco) will realize a capital gain on the disposition of its shares of the disposing affiliate (Foreignco 1) – even where there has been a qualifying liquidation and dissolution (QLAD) election - where the adjusted cost base of Foreignco 1 in the distributed property, being the shares of Foreignco 2 (i.e., the inside basis), exceeds Canco's ACB of its Foreignco 1 shares, i.e., the outside basis. Before turning to the potential relief provided by the suppression election in s. 88(3.3), they make two preliminary observations.
First (at pp. 216-217) respecting accessing exempt surplus of Foreignco 2:
According to the Canada Revenue Agency (CRA), the exempt surplus of Foreignco 2 would not be available to reduce the capital gain realized by Canco. The CRA has expressed the opinion that a liquidation and dissolution of an FA involves a two-step process: the first step is the distribution of the assets of the disposing affiliate, and the second step is the disposition by the taxpayer of its shares of the disposing affiliate. [fn 19: See CRA document no. 2002-0178147, January 9, 2003.] As a result, by the time the taxpayer disposes of its shares of the disposing affiliate, the shares of the underlying FAs are no longer owned by the disposing affiliate and their surplus balances cannot be used to mitigate any capital gain realized by the taxpayer. Consequently, the surplus balances of Fas owned directly or indirectly by the disposing affiliate are not readily accessible to mitigate a capital gain realized by the taxpayer on the disposition of its shares of the disposing affiliate, unless planning is undertaken to use these balances before the liquidation and dissolution begin....
Second (at p. 217) respecting the adverse effect under amended s. 93(1)(a) of the shares of Foreignco 2 being disposed of on a rollover basis under s. 88(3)(a):
Prior to the proposed amendments, one approach to mitigating the gain was for Canco to file two section 93 elections. The first election would be filed in respect of the disposition by Foreignco 1 of the shares of Foreignco 2. This would elevate the exempt surplus of Foreignco 2 to Foreignco 1, making the second election possible. The second election would be in respect of the disposition by Canco of the shares of Foreignco 1. Unfortunately, this approach will no longer be available, as a result of amendments to paragraph 93(1)(a) included in Bill C-48. [fn 20: Paragraph 93(1)(a) is proposed to be revised, effective for dispositions occurring after August 19, 2011, to limit the elected amount to the capital gain.]…
They use the facts in various scenarios to illustrate that a taxpayer (Canco) will realize a capital gain on the disposition of its shares of the disposing affiliate (Foreignco 1) – even where there has been a qualifying liquidation and dissolution (QLAD) election - where the adjusted cost base of Foreignco 1 in the distributed property, i.e., the inside basis, exceeds Canco's ACB of its Foreignco 1 shares.
The authors then provide an example illustrating how, on the liquidation of a foreign affiliate (Foreignco 2), with a "blocking deficit," into Foreignco 1, followed by a "QLAD" liquidation of Foreignco 1 into Canco, the application of the fill-the-hole rule in proposed Reg. 5905(7.2) can give rise to situation where the inside basis is greater than the outside basis – thereby necessitating a suppression election by Canco under s. 88(3.3) in order to avoid a capital gain as a result of this difference.
The starting facts are described at p. 222:
Assumptions
Canco is a company incorporated and resident in Canada for the purposes of the Act. Canco incorporated Foreignco 1, Foreignco 1 incorporated Foreignco 2, and Foreignco 2 incorporated Foreignco 3, all for nominal amounts. Foreignco 1's only asset is the shares of Foreignco 2, and Foreignco 2's only asset is the shares of Foreignco 3. Foreignco 1 has no exempt surplus, Foreignco 2 has an exempt deficit of $50, and Foreignco 3 has exempt surplus of $100. Foreignco 1 and Foreignco 2 have no liabilities….
After describing the fill-in-the-hole rule, they proceed (at pp. 223-224) with the example:
The liquidation of Foreignco 2 will trigger the application of proposed regulation 5905(7.2)(a), Foreignco 3's exempt surplus of $100 will be reduced by Foreignco 2's exempt deficit of $50. Under proposed regulation 5905(7.2)(b), Foreignco 2's exempt deficit will be eliminated. The result achieved is thus comparable to Foreignco 3's having paid a notional exempt surplus dividend to Foreignco 2, immediately before the liquidation and dissolution of Foreignco 2, to the extent necessary to fill Foreignco 2's exempt deficit. By virtue of proposed regulation 5905(7.5), proposed regulation 5905(7.6) will further apply to increase Foreignco 2's ACB in the shares of Foreignco 3 by $50, following the analogy that the notional exempt surplus dividend paid by Foreignco 3 to Foreignco 2 was reinvested by Foreignco 2 before the time of its liquidation and dissolution.
The liquidation and dissolution of Foreignco 2 occurs on a rollover basis under proposed paragraph 95(2)(3).…
Foreignco 1's ACB in the shares of Foreignco 3 (the inside basis) is now greater than Canco's ACB in the shares of Foreignco 1 (the outside basis) by $50 as a result of the application of the fill-the-hole rule in proposed regulation 5905(7.2). As permitted, Canco elects for the liquidation and dissolution of Foreignco 1 to be a QLAD, and realizes a capital gain of $50 on the disposition of its shares of Foreignco 1 under proposed subsection 88(3).
Because the liquidation and dissolution of Foreignco 1 is an elected QLAD, and assuming that the shares of Foreignco 3 are the capital property of Foreignco 1 immediately before the time of the distribution, Canco can elect under proposed subsection 88(3.3) for Foreignco 1 to have disposed of its shares of Foreignco 3 for PD [proceeds of disposition] equal to a claimed amount of nil. As previously discussed, the suppression election will enable Cano to fully defer the capital gain that it would otherwise realize on the disposition of its shares of Foreignco 1. Foreignco 3's exempt surplus balance of $50 will be preserved. We suspect that the suppression election was specifically intended to apply to circumstances such as these, where capital gains would arise on the liquidation and dissolution of top-tier FAs by reason of the prior application of the fill-the-hole rule in proposed regulation 5905(7.2).
Email this Content