Foix – Tax Court of Canada finds that s. 84(2) applied to a hybrid sale transaction

The shareholders of a private Canadian company (“W4N”) exploiting a valuable item of software had agreed in principle to sell W4N to a U.S. public company (“EMC”) for U.S.$50 million. However, EMC was amenable to a reorganization being implemented to permit the shareholders to extract the excess cash and investment type assets of W4N.

What was implemented was a hybrid transaction in which there was both a sale of the software, goodwill and other business assets of W4N to EMC and a sale of shares of W4N by its shareholders to a Canadian subsidiary (“EMC Canada”) of EMC.

The steps included s. 84(1) safe income dividends by W4N to personal holding companies for the two principals (Souty and Foix) so as to step up the ACB of their shares under s. 53(1)(b), dirty s. 85(1) exchanges by Souty and Foix of W4N shares held by them personally so as to realize capital gains of $750K each, for which the s. 110.6 deduction was claimed, a sale by family trusts of W4N shares to EMC Canada for notes of EMC Canada, with the resulting capital gains being ultimately distributed to beneficiaries who claimed the s. 110.6 deduction, a sale by W4N of its business assets for notes of EMC, with the resulting s. 14 gain and $22 million addition to W4N's capital dividend account being distributed to the two respective personal holding companies as capital dividends that were satisfied through distributions of some of the notes received, a sale of the balance of the shares of W4N to EMC Canada for at reduced gains that reflected the previous basis step-up transactions, an amalgamation of EMC Canada, W4N and a personal holding company for Foix, and repayment of the notes. Although the sales by the two trusts and then the sale by the remaining shareholders of their W4N shares resulted in the receipt of a total of $20 million in share sale proceeds, CRA applied s. 84(2) only to the sale by Souty and Foix of their personally held shares for $0.8 million each and to the sale by the Souty family trust of its shars for $2.5 million (for a total of $4.1), which was less than the cash and near-cash assets of W4N of $4.5 million.

In confirming this application of s. 84(2), Boyle J first determined that “funds or property” of W4N had been “distributed or otherwise appropriated in any manner whatever to or for the benefit of the shareholders.” He stated:

As in RMM Equilease, EMC and EMC Canada, by virtue of their purchase of the business assets and shares of W4N, were the vehicles and intermediaries through which the distribution of W4N's funds or property to or for the benefit of its shareholders took place as a result of the earlier reorganization. … It does not matter that EMC and EMC Canada had other very significant interests in the share and asset purchase agreement. This does not preclude them from being recognized and treated as instrumentalities for the purposes of the indirect distribution or appropriation.

In finding that there also had been a reorganization of the business of W4N, he noted that the amalgamated company no longer owned the software and was required to operate whatever was left of its business in a very different manner.

Neal Armstrong. Summary of Foix v. The Queen, 2021 CCI 52 under s. 84(2).