Deans Knight – Tax Court of Canada finds that the absence of an acquisition of effective control of a Lossco also demonstrated an absence of s. 245(4) abuse

The “Tax Attributes” of a Lossco (the taxpayer) were effectively sold to arm’s length investors pursuant to transactions under which:

• The existing shareholders of Lossco exchanged their Lossco shares for “Newco” shares under a Plan of Arrangement
• A private company “facilitator” (Matco) acquired a debenture of the Lossco that was convertible into shares representing 79% of its equity shares but only 35% of its voting shares (this occurred before the introduction of s. 256.1). Matco also obligated itself to find a purchaser for the remaining shares of Newco for a pre-agreed price (failing which Matco itself would be required to pay that amount to Newco, without a right ot acquire those shares).
• Lossco transferred it assets to Newco for a note.
• Matco then identified a mutual fund management company who wanted to IPO Lossco and use the IPO proceeds (of $100M) for a new bond trading business to be carried on in Lossco.
• The IPO subscription price for the newly-issued common shares caused the securities of Lossco held by Newco and Matco to appreciate which, in the case of Matco, effectively was its fee.
• Newco sold its remaining shares of Lossco to Matco for the pre-agreed price notwithstanding that this was at a 20% discount to the shares’ current market value.

Paris J rejected the Crown’s technical argument that the parties effectively treated Newco’s right to sell the remaining Lossco shares to a Matco-located purchaser as a right of Matco to acquire those shares, so that s. 256(8) applied by virtue of a s. 251(5)(b) right to deny use of the Tax Attributes, stating that the Crown, contrary to Shell, was effectively seeking to recharacterize the transactions based on their economic substance.

He also found that there was no abuse of the loss-streaming rules (and, in particular, of ss. 256(8) and 251(5)(b)), stating:

I … find that the object, spirit and purpose of subsection 111(5) is to target manipulation of losses of a corporation by a new person or group of persons, through effective control over the corporation’s actions… .

[T]he circumstances referred to by the Respondent do not, in my view, indicate that Matco had effective control over the majority of the voting shares of the Appellant prior to the IPO … .

Neal Armstrong. Summaries of Deans Knight Income Corporation v. The Queen, 2019 TCC 76 under s. 251(5)(b)(i) and s. 245(4).