CRA rules that a s. 85(1)(e.2) does not apply to transfers of property at less than FMV to sister corps

Two sister Canadian subsidiaries (Subco 2 and Subco 3) of Canadian parent (Parent) wish to consolidate ownership of their two foreign affiliate subsidiaries (FA 1 and FA 2) in another newly-formed subsidiary of Parent (Can Holdco – which already has acquired ownership of a portion of FA 2 from Parent).  Accordingly, they transfer their FA shares to Can Holdco (their sister) on a purported s. 85 rollover basis in consideration for Can Holdco prefs with a fair market value equal to the ACB of the transferred shares (rather than their higher FMV).  Can Holdco then redeems the prefs with cash subscriptions received from Parent and the redemption proceeds received by Subco 2 and 3 are distributed as PUC distributions back to Parent.

The effect of doing the FA transfers at ACB rather than FMV is to reduce the basis reduction to Parent’s investments in Subco 2 and 3, which have other important assets.  CRA ruled that s. 85(1)(e.2) (and s. 15(1)) would not apply, stating that it would not be reasonable to regard any part of the excess of the FMV of the transferred shares over their ACB "as a benefit that Subco 2 or Subco 3 desired to have conferred on a person related to [them]."  This sounds right - as the prefs are vapourized, the cash is completely circled and Parent retains its 100% indirect ownership of the FAs.  However, it took CRA three years to so conclude.

Neal Armstrong.  Summary of 2014 Ruling 2011-0415811R3 under s. 85(1)(e.2).