CRA finds that the surplus recognition rule in Reg. 5907(2.01) for drop-down and sale transactions is not available where any liabilities are assumed

Reg. 5907(2.01) potentially allows the recognition for surplus purposes of unrealized gain on a transfer from one foreign affiliate to another, newly incorporated, foreign affiliate where the shares of the new foreign affiliate are then promptly sold to a third party.  A requirement for this relief is that the "only consideration received in respect of" the drop-down is shares of the new foreign affiliate.

CRA considers that this requirement will not be satisfied if the new foreign affiliate assumes any liabilities of the transferor FA as part of the purchase.  This appears to be technically correct.  However, since any normal business or business division will have related liabilities, this interpretation eviscerates the rule.

Neal Armstrong.  Summary of 22 April 2015 T.I. 2014-0550451E5 under Reg. 5907(2.01).