1245989 Alberta – Tax Court of Canada finds that the use of class PUC-averaging to bump the PUC of personally-held shares was abusive under s. 245(4)

An individual (Mr. Wild) stepped up the adjusted cost base of his investment in a small business corporation (PWR) by transferring his PWR common shares to two new Holdcos for him and his wife in exchange for preferred shares of the Holdcos, and electing under s. 85 at the right deemed proceeds amount to use up his capital gains exemption. However, the paid-up capital of those preferred shares was ground down to essentially nil under s. 84.1.

The solution was for PWR to then transfer high basis assets to the Holdcos in consideration for preferred shares of the same class, so that the PUC of the preferred shares held by Mr. Wild personally could be bumped due to the class-averaging rule in s. 89(1). It didn’t matter that there was a corresponding shifting of PUC away from the prefs taken back by PWR, because those prefs were then redeemed for a note in reliance on the s. 55(3)(a) exception (and their relatively high basis anyway).

Lyons J, in finding that there was an abuse under s. 245(4), so that CRA’s assessment taking away the stepped-up PUC in the personally held prefs was confirmed, stated:

[T]he…transactions…achieved a result (extraction of corporate surplus indirectly and use of his [capital gains] exemption) that section 84.1 was intended to prevent and defeats its underlying rationale and did so by misusing the PUC computation in subsection 89(1) to trigger the share averaging thus artificially inflated the PUC in The Shares held by Mr. Wild without any new capital contribution made by him.

Neal Armstrong. Summaries of 1245989 Alberta Ltd. v. The Queen, 2017 TCC 51 under s. 84.1(1) and s. 245(4).