CRA indicates that GAAR may apply to the use of a “Midco” to step up the tax basis of a target investment on a triangular amalgamation

In a conventional domestic triangular amalgamation, in which the shareholders of Targetco receive shares of Parentco, and Parentco receives shares of the Amalco resulting from the amalgamation of Targetco and Subco (a wholly-owned subsidiary of Parentco), ss. 87(9)(a.4) and (c) limit the cost of such Amalco shares to Parentco. Some ancient technical interpretations of CRA indicated that Parentco could achieve a step-up of its investment to fair market value if it inserted a “Midco” between it and Subco. On the amalgamation, Parentco receives additional shares of Midco (having an FMV equaling the FMV of the shares of Parentco issued to the former shareholders of Targetco and to compensate it for such issuance (and Midco receives compensatory shares of Amalco).

CRA continues to acknowledge that as a purely technical matter, the “compensatory” shares issued by Midco to Parentco have full (FMV) basis (although of course the cost of the shares issued by Amalco to Subco continues to be limited by ss. 87(9)(a.4) and (c).) However, CRA indicated that if an amalgamation is subject to the application of s. 87(9), and is structured in a manner to frustrate the application of ss. 87(9)(a.4) and (c), it will potentially be subject to the application of GAAR.

Accordingly, for transactions implemented after the Conference date of December 3, 2019 (or for amalgamations implemented before March 31, 2020 as part of a series of transactions or an arrangement that were substantially advanced, as evidenced in writing, before December 3, 2019) taxpayers should not rely on the old technical interpretations.

CRA has now provided its official written responses to the Canadian Tax Foundation, which are available to those who attended the conference. In its oral comments, CRA queried whether giving FMV tax basis to Parentco for the shares issued by Midco, which would be in excess of the basis described in ss. 87(9)(a.4) and (c), would be in accordance with the scheme of such provisions, and the scheme of the Act’s rollover provisions in general.

Neal Armstrong. Summary of 3 December 2019 CTF Roundtable, Q.13 under s. 87(9)(a.4).