GAAR may apply where the purpose of a s. 55(3)(a) redemption for a note is increasing outside basis, but not where freeze shares are redeemed for personal cash needs

CRA, when asked to comment on the application of s. 55(3)(a) to the redemption of a preferred share that was not supported by safe income (as all the safe income instead supported an accrued capital gain on the common shares), stated that in such a context:

[T]he redemption in question should be analyzed with respect to the purpose of the dividend resulting from the redemption and the GAAR could potentially apply in such a situation. In this regard, see Example 5 in the [“CRA Update on Subsection 55(2) and Safe Income: Where are we Now”].

Example 5 may be summarized as follows:

• Parent, which owns shares of Subco with an ACB of $0 and FMV of $1,000 and no safe income, wishes to increase its cost in the shares of Subco or other property held in Subco, so that shares of Subco are redeemed for a note and the note is either held by Parent or subsequently reinvested back in the shares of Subco held by Parent.
• The redemption for a note has no purpose other than to effect an increase in the cost to Parent of any property, which is a circumvention of the restriction in s. 55(2.1), so that CRA would seek to apply GAAR to the redemption.

CRA then stated:

On the other hand, in the context of a share redemption the purpose of which is ultimately to finance the personal needs of a shareholder-individual, for example in a situation involving a redemption of freeze preferred shares of the capital stock of an operating corporation held by a holding company of the shareholder-individual followed by the payment of that amount by the holding company to the shareholder-individual, the CRA would accept that paragraph 55(3)(a) could apply.

Neal Armstrong. Summaries of 10 October 2024 APFF Roundtable, Q.6 under s. 55(2.1)(c) and s. 55(3)(a).