CRA finds that the avoidance of s. 100(1.5) through paying down partner debt rather than making a dilutive partnership distribution is subject to GAAR

The published CRA responses to questions at the 2014 Annual CTF Conference include a discussion of the GAAR Committee approach to a situation where (using a simplified example) a building with accrued recapture of depreciation of $50,000 is transferred by a Canadian corporation on a s. 97(2) rollover basis to a subsidiary partnership in exchange for a note equal to the building’s undepreciated capital cost and units for the balance of the consideration. As the building is used in a business which is carried on outside (rather than inside) Canada, s. 100(1) would have applied, on a sale of half the resident’s partnership interest to a non-resident purchaser, to produce a fully taxable gain (of $25,000) on that sale – thereby producing a result comparable to realization of the accrued recapture of depreciation on half of the building. What occurs instead is that the non-resident subscribes $50,000 for a half interest in the partnership with that cash used to pay off the note – so that no immediate gain is recognized. CRA indicated that it "will challenge such an arrangement by applying the GAAR," given that there is "a misuse or abuse… having regard to the 2012 amendments to subsection 100(1) that extend its application to acquisitions by non-residents and the addition of the anti-avoidance dilution provisions contained in new subsections 100(1.4) and (1.5)."

The CRA analysis appears to be informed by two, or perhaps three, alternative transactions:

1. a sale of ½ of the resident’s partnership interest (along with half of the note) to the non-resident, which would give rise to a fully taxable gain of $25,000 under s. 100(1);
2. the $50,000 cash subscription from the non-resident (applied as to $25,000 for partnership units and a partnership note, respectively) is used to make a capital distribution of $25,000 to the resident so that its partnership interest is reduced in value from $50,000 to $25,000 (with the other $25,000 used to pay off ½ of the resident's note), in which case s. 100(1.5) would apply to deem the resident to realize a fully taxable gain under s. 100(1) of $25,000; and
3. a direct sale of a ½ interest in the building for $50,000, which would result in the resident’s UCC being reduced from $50,000 to nil (so that the UCC of $25,000 relating to the resident’s retained ½ interest would be eliminated).

The first (and a fortiori the third) transaction appear to not have a lot of GAAR traction since (leaving aside whatever one might make of Stursberg) there appears to be a fundamental distinction between sales and subscriptions, and "where it can be shown that an anti-avoidance provision has been carefully crafted to include some situations and exclude others, it is reasonable to infer that Parliament chose to limit their scope accordingly" (Landrus – see also Inter-Leasing).

The second comparative transaction is more interesting. Immediately receivable partnership distributions following a s. 97(2) roll have been characterized as boot, i.e., as an obligation (see Haro, Vantem, MDS). If a right to an almost immediate capital distribution is effectively characterized in some contexts as cognate with partner debt (assuming that the partner debt is not recharacterized as equity under general principles – see Skingle), can this somehow be turned on its head so that a repayment of partnership debt should be characterized for purposes of applying the policy of s. 100(1.5) for GAAR purposes as if it were an obligation to make a dilutive capital distribution?

Neal Armstrong. Summary of 2 December 2014 CTF Roundtable, Q. 6 under s. 100(1).