Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Is GAAR applicable to a situation where a shareholder receives an ACB increase as a result of a corporate reorganization that is exempt under paragraph 55(3)(a)
Reasons: The ACB increase is facilitated by a redemption of shares that is exempt from tax under paragraph 55(3)(a). The scheme of subsection 55(2), as amended in the July 31, 2015 Legislative Proposals, is to prevent the creation or multiplication of ACB with the use of tax-free intercorporate dividends. Furthermore, paragraph 55(3)(a) is restricted in its application to subsection 84(3) dividends in order to facilitate bona fide internal reorganizations and is not intended to provide taxpayers with a tool to create or multiply ACB.
January 13, 2016
Re: ACB increase in paragraph 55(3)(a) reorganization
This is in response to your letter of August 19, 2015 in which you requested our view on the following set of transactions:
Unless otherwise stated, all statutory references herein are to the Income Tax Act (Canada).
Assume that Parentco owns 100% of Holdco which owns 100% of Opco. The group intends to transfer one of Opco’s existing business lines to Newco, a new subsidiary of Holdco, by way of an internal reorganization (“spin-off”) that is exempt under paragraph 55(3)(a). The spin-off can be accomplished using the following steps of 2 separate alternatives:
1) Holdco forms Newco.
2) Holdco transfers shares of Opco (with a value equal to the value of the Opco assets transferred to Newco in step 3) to Newco in exchange for shares of Newco on a tax-deferred basis pursuant to subsection 85(1).
3) Opco transfers the relevant assets to Newco in exchange for preferred shares of Newco on a tax deferred basis pursuant to subsection 85(1).
4) Newco redeems the shares that it issued to Opco in step 3 and issues a note to Opco (the “Newco note”) as a redemption payment for the redeemed shares.
5) Opco redeems the shares that Newco received in step 2, and issues a note to Newco (the “Opco note”) as a redemption payment for the redeemed shares.
6) The Newco note and the Opco note issued in steps 4 and 5 are offset and cancelled.
1) Holdco forms Newco.
2) Opco transfers the relevant assets to Newco in exchange for preferred shares of Newco on a tax deferred basis pursuant to subsection 85(1).
3) Newco redeems the shares transferred to Opco in step 2 in exchange for a note (the “Newco note”).
4) Opco redeems a portion of its shares (with a value equal to the value of the Opco assets transferred to Newco in step 2) and transfers the Newco note to Holdco as a redemption payment.
5) Holdco transfers the Newco note to Newco in exchange for shares or as a capital contribution (thereby cancelling the note).
You assumed that the series of transactions that includes one of the above alternatives will not include a triggering event involving an unrelated person as described in paragraph 55(3)(a).
You requested our view as to whether none of the proposed alternatives would result in the application of subsection 55(2), as amended in the July 31, 2015 Legislative Proposals, or subsection 245(2).
This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6 [Information Circular 70-6R6], Advance Income Tax Rulings and Technical Interpretations.
We assume that, under this alternative, Holdco transfers a proportion of the shares that it had in Opco to Newco such that the amount of the ACB in the shares transferred to Newco is equal to the amount that is obtained by multiplying the aggregate ACB of all the shares held by Holdco in Opco prior to the transfer by the proportion that the FMV of the shares of Opco transferred to Newco is of the FMV of all the shares that Holdco had in Opco prior to the transfer. Such ACB is subsequently eliminated on the redemption of shares of Opco held by Newco.
Under this alternative, Holdco does not seek to increase the ACB of property that it held. The aggregate ACB of the shares of Newco and Opco that are owned by Holdco after the transfer at step 2) is equal to the aggregate ACB of shares of Opco that were owned by Holdco before the transfer.
Newco has received the Opco note on the redemption of shares held in Opco. The receipt of such note may result in an increase in ACB of property held by Newco. Furthermore, Opco has received the Newco note on the redemption of shares held in Newco and the receipt of such note may result in an increase in ACB of property held by Opco. However, both notes are offset and cancelled, eliminating therefore any increase in ACB of property held by either Newco or Opco.
We are of the view that subsection 55(2) would not apply to dividends received by Opco and Newco by virtue of the application of paragraph 55(3)(a), provided that there is no triggering event described in paragraph 55(3)(a) as part of the series. We are also of the view that GAAR does not apply to this alternative.
We assume that, under this alternative, the ACB of the shares of Opco held by Holdco is significantly less than their FMV.
At step 4), Holdco has received the Newco note as consideration for the redemption of the shares held by Holdco in Opco. The ACB of the Newco note is significantly greater than the ACB of the shares of Opco held by Holdco. Holdco has used the Newco note to increase its ACB in the shares held in Newco at step 5).
As a result of this alternative, the aggregate ACB in all the shares held by Holdco in Opco and Newco at the end of step 5) is significantly greater than the ACB of the shares of Opco that were held by Holdco at the beginning of the series.
We are of the view that the increase in the ACB of property held by Holdco as described above is inappropriate considering the following:
- The increase in ACB was facilitated by a redemption of shares held by Holdco in Opco which would be tax-free to Holdco if paragraph 55(3)(a) were to apply.
- The scheme of subsection 55(2), as amended in the July 31, 2015 Legislative Proposals, is to prevent, amongst other things, the creation or multiplication of ACB with the use of tax-free inter-corporate dividends.
- We understand that paragraph 55(3)(a) is restricted in its application to subsection 84(3) dividends in order to facilitate bona fide internal corporate reorganizations and it is not intended to provide taxpayers with a tool to create or multiply ACB as in the present case. The technical note to paragraph 55(3)(a), as amended in the July 31, 2015 Legislative Proposals, reads as follows:
The amended exception in paragraph 55(3)(a) for related-person dividends is intended to facilitate bona fide corporate reorganizations by related persons. It is not intended to be used to accommodate the payment or receipt of dividends or transactions or events that seek to increase, manipulate, manufacture or stream cost base.
In view of the above, we would consider the application of GAAR to Alternative 2. Furthermore, we would consider the possibility of arguing that Alternative 2 is in the same series of transactions that includes an eventual disposition of shares of Newco to a person unrelated to either Opco or Newco, such that paragraph 55(3)(a) would not apply to exempt the dividends received in the reorganization from the application of subsection 55(2).
We have relayed our concerns with respect to Alternative 2 to the Department of Finance.
We trust the above comments to be of assistance.
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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