Pomerleau – Tax Court of Canada finds that GAAR applied to converting soft ACB (generated from crystallizing the capital gains deduction) into pseudo-hard ACB under s. 53(1)(f.2) for use in extracting surplus

An individual taxpayer engaged in a surplus-stripping transaction similar to transactions in a ruling which CRA had resiled from following Descarries. He held shares of a holding company whose adjusted cost base reflected the step-up of predecessor shares’ ACB in capital gains crystallization transactions by him and other family members. Such additional “soft” ACB would have been ignored under s. 84.1 if those shares had been transferred to a personal holding company in exchange for the issuance of shares with a purported paid-up capital equal to the transferred shares’ soft ACB.

Instead, he retracted his own soft ACB shares (as well as soft ACB shares that had been gifted to him by family members), which resulted in a capital loss under s. 40(3.6) that was added to the ACB of his common shares of the corporation under s. 53(1)(f.2). This s. 53(1)(f.2) bump was not caught by s. 84.1(2), so that he could transfer the bumped common shares to a personal holding company, taking back high PUC shares which he promptly redeemed.

Favreau J agreed with CRA that this conversion of soft ACB into hard ACB, in order to receive a tax-free return of capital, contravened GAAR, stating:

This series of transactions permitted the appellant, on the redemption of the Class G shares of [his new holding company], to extract as a tax-free return of capital, $994,628 derived from the surplus of his corporation by virtue of utilizing his capital gains deduction and that of his mother and sister. …

Neal Armstrong. Summary of Pomerlau v. The Queen, 2016 CCI 228 under s. 84.1(2)(a.1).