626468 New Brunswick – Federal Court of Appeal finds that safe income from asset sale was reduced by accrued, but not yet payable, taxes on the gain

An individual rolled his apartment building into a Newco in consideration for a mortgage assumption and shares with nominal paid-up capital, and then rolled those shares into a new Holdco. Following the realization shortly thereafter by Newco of a taxable capital gain and recapture of depreciation on a sale of the building, Newco increased the adjusted cost base to Holdco of its shares by effecting a series of s. 84(1) dividends (including a capital dividend) – following which the individual sold his shares of Holdco to a third party for a sale price based on the amount of cash sitting in Newco.

Webb JA (as did D’Auray J below) agreed with the Deuce Holdings finding that the safe income of Newco was reduced by the amount of corporate income tax ultimately payable by it on its gain on the building sale, notwithstanding that at the time of sale, no income taxes had yet become payable. Webb JA stated:

Both the fair market value of the shares and the portion of the resulting capital gain that would be attributable to the income earned or realized would reflect the tax liability that, although not payable immediately, would eventually have to be paid. …

This tax liability would not disappear if, as contemplated by subsection 55(2) … the shares of Tri-Holdings would have been sold immediately before the dividend in question.

Respecting the mechanics of how the pre-April 20, 2015 version of s. 55(2) operated to generate a capital gain as a result of the denial of safe income, he indicated that:

• The final s. 84(1) dividend in issue was deemed by s. 55(2)(a) to not be a dividend, so that there was no corresponding addition to the adjusted cost base of the shares of Newco for that amount under s. 53(1)(b).
• This s. 53(1)(b) ACB denial resulted in an increased capital gain on the shares’ sale to the third party.
• As this amount was reflected in the amount paid by the third party, no additional amount was to be added to the proceeds under s. 55(2)(b).

Neal Armstrong. Summary of 626468 New Brunswick Inc. v. Canada, 2019 FCA 306 under s. 55(2.1)(c), s. 55(2) and General Concepts - FMV.