The proposed version of s. 85.1(4) is overly broad
The current version of s. 85.1(4) avoids deferral of the capital gain that would otherwise be realized on the outright sale of a directly held FA (the first affiliate) through transferring it under s. 85.1(3) to a second affiliate, which then sells the first affiliate shares to a subsequent acquiror – where the first affiliate shares are excluded property so that such sale occurs on a deferred basis.
Under the proposed expanded version of s. 85.1(4) released on August 9, 2022, its application will extend to a subsequent disposition of any property that is substituted for the share of the first affiliate, as well as any other property any of the FMV of which is derived, directly or indirectly, from the first affiliate shares is inappropriately broad.
For example, the transfer of the first affiliate from a Canadian corporation to a second affiliate followed by an outright sale of the second affiliate by the Canadian corporation is caught, even where such subsequent disposition is fully taxable in Canada.
Second, the transfer of the first affiliate by a Canadian corporation to a second affiliate, followed by an outright sale of the Canadian corporation by its shareholders, is caught because the FMV of the Canadian corporation’s shares is derived, in part, from that of the first affiliate shares.
Third, if all of the first affiliate shares are transferred to the second affiliate for 100 shares of the second affiliate, and then to the third affiliate for 100 shares of the third affiliate, following which only one share of the second affiliate is sold to a subsequent acquiror, rollover treatment would be denied for all (rather than only 1/100) of the first affiliate shares because the single share derived a portion of its FMV from each first affiliate share.
The current purpose test is eliminated under proposed s. 85.1(4). Instead, there is simply a requirement that the initial transfer be part of a series of transactions that includes another disposition of the first affiliate shares (or certain other properties that derive a portion of their value from such shares.) This means that reference must now be made to the fraught concept of a series under Copthorne.
Neal Armstrong. Summary of David Bunn and Mark Dumalski, “Proposed Amendments to Subsection 85.1(4),” International Tax Highlights, Vol. 1, No. 2 November 2022, p. 6 under s. 85.1(4).