CRA rules on using Treaty step-up to avoid the application of s. 55(2) to a spin-off made to effect an arm’s length sale

The U.S. parent of a Canadian corporation (Amalco) is indirectly selling the "XYZ" business, carried on through subsidiaries of Amalco, to an arm’s length purchaser (Buyer).  This will be accomplished through a spin-off transaction in which the shares of Amalco are split on a s. 86 reorg into "Keep" pref and new common shares, the U.S. parent transfers its Keep pref to its newo subsidiary ("Canco") on a Treaty-exempt basis in consideration for common shares of Canco, Amalco sells the "Keep" assets to Canco on a taxable basis for a note, and Amalco redeems the Keep pref by way of set-off against the note it received for the Keep assets (and, contrary to the usual Rulings practice, not first issuing a redemption note).  As Amalco now only holds the XYZ business, it can be sold by the U.S. parent on a Treaty-exempt basis to Buyer.

This is the opposite of the purchase butterflies of yesteryear: there is no outside gains tax (under the Treaty); but there is inside gain on the spin-off of the Keep assets.  S. 55(2) does not apply to the deemed dividend arising on the redemption of the Keep pref as their basis was stepped up under the Treaty.

Neal Armstrong.  Summary of 2012 Ruling 2011-0403291R3 under s. 55(2) and s. 248(1) – disposition.