Atlantic Packaging - Federal Court of Appeal finds that a drop-down of 68% by value of the assets of a division in a hybrid transaction did not satisfy s. 54.2

The taxpayer, a paper products manufacturer, engaged in a hybrid transaction in which it sold some of the assets of its “Tissue Division” directly to a third-party purchaser (“Cascades”) and rolled the balance of them down to a Newco (“722”) under s. 85(1) for shares of 722 and sold those shares to Cascades. CRA assessed on the basis that the sale of the shares was on income account.

Graham J found that the transferred assets represented about 68% of the fair market value of the assets of the Tissue Division – and perhaps significantly less, given that some of the Tissue Division assets had not been valued. Accordingly, the requirement of s. 54.2 - that all or substantially all of the assets of the business have been transferred to a corporation – had not been met, so that s. 54.2 did not deem the gain on the share sale to be a capital gain.

Webb JA affirmed this finding, stating:

I agree with the Tax Court Judge that conveying 68% of the assets used in the Tissue Division to 722 would not satisfy the requirement that all or substantially all of the assets of the Tissue Division be conveyed to 722.

The taxpayer sought to argue for the first time before the Court of Appeal that the share sale gain was a capital gain on ordinary principles. Webb JA found that it was too late for this issue to be raised. Although the evidence before the Tax Court could have permitted it to address most of the factors that were relevant to the capital account issue, Webb JA noted that one of the relevant factors in this regard was “the frequency or number of other similar transactions completed by the taxpayer,” and stated:

While it would be presumed that Atlantic Packaging would not be frequently selling off an entire division, there is no indication of whether Atlantic Packaging followed a similar pattern or similar transactions in disposing of other depreciable property.

Accordingly, there would have been potential prejudice to the Crown in now addressing that issue.

Neal Armstrong. Summaries of Atlantic Packaging Products Ltd. v. Canada, 2020 FCA 75 under s. 54.2 and s. 9 – capital gain v. profit – machinery and equipment.