Brent Carlson Family Trust – Federal Court finds that CRA had been confused by the rectification jurisprudence in rejecting an amended s. 85(1) election

In implementing a plan to maximize the utilization by family members of the capital gains exemption (“CGE”) on the sale to an arm’s length purchaser of an operating company that was indirectly held by family trusts, the trusts engaged in a dirty s. 85(1) exchange of existing low-basis common shares of a subsidiary for new shares of that subsidiary that included Class F preferred shares, with a joint s. 85 election being filed at an agreed amount that resulted in recognition of a capital gain equaling the aggregate CGE available to the trust’s beneficiaries. The Class F preferred shares were then sold at the closing for an amount equaling their stepped-up ACB to the arm’s length purchaser.

CRA subsequently reassessed on the basis that, since the capital gain had been realized by the trusts in a non-arm’s length transaction and some of the family beneficiaries had not yet attained 17 years, s. 120.4(5) of the “kiddie tax” rules applied to deem the capital gains distributed to those minor beneficiaries to be taxable dividends. To avoid this result, the trusts requested that CRA accept an amended election (beyond the three-year period set out in s. 85(7)) pursuant to s. 85(7.1) for the preliminary exchange for the Class F preferred shares to have occurred on a rollover basis, so that the capital gain was instead realized on the subsequent arm’s length sale of the Class F preferred shares such that s. 120.4(5) ceased to apply.

This request was rejected by CRA on the grounds that it represented “retroactive tax planning,” which was not permissible having regard to the jurisprudence (Canada Life) on rectification.

Before setting aside and remitted to the Minister for redetermination, Walker J stated:

… The Minister’s delegate … imports equitable requirements specific to rectification and rescission without acknowledging any difference in the remedies sought. … They requested only the amendment of the Original Elections, as contemplated in subsection 85(7.1). The Minister’s delegate erred when he stated, “[y]our request is similar to the request Canada Life put forward, in which [the] ONCA said, ‘The court cannot substitute one series of transactions for another to avoid an unintended tax result’”.

The first-level CRA review had been conducted by the immediate CRA supervisor of the auditor who had proposed the reassessments, and the second level review was conducted by the Assistant Director further up the same audit chain. Walker directed that the redetermination be made by CRA personnel who had had no audit involvement.

Neal Armstrong. Summary of Brent Carlson Family Trust v. Canada (National Revenue), 2021 FC 506 under s. 85(7.1).