CRA rules on a self-cancelling circular transaction to convert net capital losses into stepped-up UCC

Aco, and its subsidiary Bco, have available capital losses that they wish to use in stepping up the undepreciated capital cost of trademarks (Class 14.1 properties, presumably having a nominal or modest capital cost) which Bco uses in the course of carrying on its business. In broad terms, this is accomplished by Bco using up its losses in spinning the trademarks off to Aco on a partial rollover basis, and by Aco dropping the trademarks down to Bco to also use up its losses. More specifically:

1. Aco establishes a new sister to Bco (Newco) to which Aco does an s. 85(1) drop-down of preferred shares of Bco having a fair market value equaling that of the trademarks;
2. Bco spins-off the trademarks to Newco on a partial rollover basis in consideration for prefs of Newco, thereby using Bco’s net capital losses to effect a ½ step-up of the UCC of the trademarks under s. 13(7)(e)(ii) – and with Newco licensing the trademarks back to Bco for royalties;
3. The prefs in 1 and 2 above are cross-redeemed (with reliance on the s. 55(3)(a) exception to s. 55(2));
4. Newco is wound-up under s. 88(1);
5. Aco does an s. 85(1) drop-down of the trademarks back to Bco, but choosing an elected amount so as to uses up its net capital losses and to effect a further ½ step-up of the trademarks' UCC under s. 13(7)(e)(ii).

The CRA summary of this transaction emphasizes that Reg. 1102(14) deems the trademarks to have the same (Class 14.1) class to Newco, Aco and Bco in succession. It is unclear whether this reflects someone’s sensitivity to a Mara Properties issue (property retaining its character as it is bounced around in the group) or a Hickman Motors/Reg 1102(1)(c) issue (transitory income-producing purpose).

Neal Armstrong. Summary of 2019 Ruling 2018-0772921R3 under s. 13(7)(e)(ii).