CRA reverses a Code s. 338(h)(10) step-up of goodwill so as to boost exempt earnings of a U.S. foreign affiliate – but finds that there was no corresponding boost to safe income on hand of a Canco shareholder

Where Canco had indirectly purchased the shares of "US-Opcos" with appreciated goodwill, with the U.S. tax basis of the goodwill then being stepped-up under IRC 338(h)(10), the resulting reduction in the gain realized on a subsequent disposition of that goodwill was to be reversed under Reg. 5907(2)(f) in computing the exempt earnings of Canco respecting the US-Opcos – or alternatively (i.e., getting to the same spot), the step-up-related  gain was to be excluded in the first place from the "earnings amount" determined under s. (a)(i) of the Reg. 5907(1) definition, apparently on the basis "that ‘notional’ income or deductions are simply excluded from the earnings amount."

However, the resulting boost in the safe income of Canco (as computed in accordance with s. 55(5)(d)) did not do a shareholder of Canco (PrivateCo) any good as this accrued gain "did not contribute to the gains that accrued on [the relevant U.S.] shares in the Post-acquisition period and, therefore, did not contribute to the gains that accrued on PrivateCo's ... Canco common shares [up to] immediately before their redemption."

Neal Armstrong.   Summaries of 14 March 2014 Memo 2013-0499141I7 under Reg. 5907(2)(f), s. 55(2), Reg. 5907(1) – exempt earnings and Reg. 5907(1) – earnings.