CRA requires that there be no basis step-up in FA shares above their relevant cost base and net surplus

A Canadian-resident corporation (ACo) wished to transfer its shares of a foreign subsidiary (FA1) to a Canadian subsidiary of ACo (BCo). This was to be accomplished by ACo transferring its FA1 shares on a s. 85.1(3) rollover basis to a newly-formed non-resident subsidiary (New FA), with New FA then transferring its FA1 shares to BCo for a note – which then was to be repaid in cash out of share subscription proceeds from ACo, and with FA1 then distributing such cash to ACo (with a Reg. 5901(2)(b) designation being made).

CRA wished to restrict the cost to BCo of the FA1 shares (which were excluded property) to the sum of their relevant cost base and the net surplus (being exempt surplus) of FA1 – rather than letting such cost be stepped up to the shares’ higher fair market value. Accordingly, it required that the note equal such sum. S. 69(1)(c) deemed the proceeds to New FA to be the higher FMV, but apparently this did not matter, as the disposition of the FA1 shares did not give rise to FAPI, their exempt surplus was levitated under s. 93(1.11)(a) to New FA, and the note repayment proceeds were received by ACo out of pre-acquisition surplus and (to the extent of any amount that otherwise would be a negative ACB gain) out of New FA’s exempt surplus pursuant to s. 93(1.11)(b) and Reg. 5902(6).

These transactions in their essential features were the same as transactions implemented by the same corporate group in 2016-0630761R3f. One difference from the earlier ruling letter is that a ruling was requested and given that s. 69(11)(b) would not apply to deem ACo’s proceeds of disposition on the s. 85.1(3) drop-down of FA1 Shares to New FA to be equal to the FMV of the FA1 Shares. Although it clearly would have been contemplated that the transferee (New FA) would “obtain the benefit of an exemption available to” it for excluded shares, CRA concluded (as per its summary) that the “one of the main purposes” test in s. 69(11) was not satisfied.

Neal Armstrong. Summaries of 2017-0693751R3 under s. 69(11)(b), s. 9 – capital gain v. profit – shares and s. 93(1.11).