Pomerleau – Federal Court of Appeal 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
To simplify the facts somewhat by ignoring transactions in which the taxpayer accessed tax attributes of his sister, the taxpayer wanted to extract $2M from a family corporation, and was willing to do so on a basis that resulted in him receiving a deemed dividend of $1M provided that he was able to extract the other $1M tax free by using the previous step-up of the ACB of the shares of him (and his sister) to $1M using the capital gains deduction. The “hard” ACB and paid-up capital of the shares was nominal, so that the full $2M would have been deemed to be a dividend if he had simply transferred the shares to a new Holdco for cash proceeds of $2M.
Instead, he transferred the shares to a new holding company (P Pom) under s. 85(1) in consideration for high ($1M) basis Class G shares and low basis Class A shares, and redeemed the Class G shares. Most of the proceeds were deemed to be a dividend, and there was a largely matching capital loss that was denied under s. 40(6) and added to the ACB of his Class A shares under s.53(1)(f.2). He now could transfer the bumped Class A shares of P Pom to Holdco, taking back high PUC shares of Holdco, which he promptly redeemed for $2M free of additional tax, or so he thought.
CRA’s assessment of a deemed dividend under s. 245(2) effectively treated the ACB of the shares that were transferred to Holdco as not having been stepped-up under s. 52(1)(f.2). In agreeing with this assessment, Noël CJ stated:
The object and spirit of this provision, or its rationale, is to prevent amounts which have not been subjected to tax to serve in extracting surplus of a corporation free of tax. Subsection 84.1(2) proceeds with this goal in targeting amounts which, while forming part of the ACB of the shares concerned, have not been subjected to tax and have been excluded in the computation of the paid-up capital of new shares. To this end, subparagraph 84.1(2)(a.1)(ii) requires going beyond the ACB of the shares concerned – or of the shares for which they are substituted – and enquiring as to the source of the funds which constituted them in order to ascertain if they were subjected to tax. …
This rationale was circumvented by the plan implemented by the appellant. Of the amount of $1,993,812 that he withdrew, $994,628 represented amounts as to which no income tax had been paid.
After noting that the application of s. 84.1 could have a punitive effect on an inter-generational transfer of a business, he stated:
That situation, if it presented itself in the context of an analysis made under the GAAR, could possibly lead to an interpretation which prevented a punitive application of section 84.1. That situation, however, is not before us.
Neal Armstrong. Summary of Pomerleau v. The Queen, 2018 CAF 129 under s. 84.1(2)(a.1)(ii).