Section 88

Purpose of anti-stuffing rule in s

88(1)(c)(v) (p. 942)

Another rule is meant to prevent the parent from transferring property with accrued gains to a subsidiary on a tax-deferred basis before the AOC and eliminating those gains on the wind-up through the 88(1)(d) bump. This ''anti-stuffing'' rule disqualifies any property that the subsidiary acquires (as part of the AOC [acquisition of control] series) from either the parent or a person dealing NAL [not at arm's length] with the parent. That property, as well as any property acquired by the subsidiary in substitution for such property (an issue discussed below), is excluded from being eligible property.

Potential unavailability of “bump and run” where management are expected to retain interest in company (p. 15)

Where Target is a 10(f) corporation, then it is likely a good candidate for a "bump and run" in order to efficiently extract the FAs out of Canada (assuming there is no cross-ownership issue sufficient to trigger the bump denial rule). That last assumption may not always be realistic. As noted above, sponsors generally expect existing management to continue on in the business, and for management's economic incentives to align with theirs. Where management were significant Target shareholders pre-closing, a bump may well be unavailable. [fn 55 to p. 13 discussion of s. 88(1)(c)(vi)(B)(II): Even if management is not co-investing in actual equity, the grant of management incentives as part of employment arrangements may constitute “substituted property’ acquired as part of the series for purposes of the bump denial rules (per paragraph 88(1)(c.3)) and therefore threaten the availability of the bump. See … 2006-0196031C6… .]

Sequencing of steps (p. 13:35)

The steps set out in the plan generally include the repayment of historic Target debt, the cash-out or rollover of Target options and warrants, and the exercise of dissent rights….all of the foregoing actions are typically structured to occur prior to transfer of Target shares to Bidco (and the resulting acquisition of control). This mitigates most concerns that the repaid debt or cashed-out historic securities could be substituted property, thus requiring further analysis.

Covenant of Target shareholders not to acquire additional buyer-group shares (pp. 13:35-36)

Where the ultimate buyer is a public entity or its equity or debt can be acquired without its control, the buyer should consider obtaining a covenant from shareholders of Target, executing a voting support agreement that such shareholders will not acquire any equity or debt of the buyer group for a reasonable period of time after closing.

Such a covenant usually runs from the execution date of the voting agreement until some months after the closing of the transaction. The range varies, but 12 to 24 months afterclosing is typical. This helps guard against the argument that any subsequent acquisition by a former Target shareholder of buyer securities that are substituted property is part of the same series of transactions.

Covenant of Target shareholders not to acquire additional Target shares (p. 13:36)

A buyer will often identify certain former Target shareholders that will (or will likely) acquire substituted property as part of the series, and take comfort in knowing that those shareholders own in aggregate well less than 10 percent of Target's shares. Such shareholders may often have the ability to acquire additional Target shares in the interim period, either because Target is a public company or because the shareholders hold vested options in Target. In this circumstance, the buyer may also look for a covenant from such shareholders that neither they nor NAL persons within their influence will exercise any options or otherwise acquire additional Target securities in the interim period….

Are rights under depositary agreements substituted property? (p. 13:36-37)

The depositary agreement is an escrow-like agreement that governs the treatment of cash and other assets deposited by Bidco, typically a few days before planned closing, which property will be dealt with in accordance with the plan of arrangement….

Thought needs to be given as to whether rights under the depositary agreement constitute substituted property. Stakeholders entitled to the proceeds held by the depositary, including shareholders of Target, as well as option holders and warrant holders, are often not actually paid until after the amalgamation of Bidco and Target.

Once the money is on deposit with the depositary and the transaction closes, the funds are typically held for the benefit of the stakeholders (and not Bidco). Where it is clear that there would be no further recourse to Bidco, the right to the funds on deposit should not be attributable property….

Non-specified persons in joint bid (p. 13:40)

[J[oint bidder/spin-out… arrangements all include the acquisition of distributed or substituted property by non-specified persons as part of the series. Where there is a majority-interest party in a joint bid, the minority interest investor will be a non-specified person, and both parties will be non-specified persons in a 50/50 arrangement. Similarly, the third party purchaser in a spin-out arrangement will also be a non-specified person. …

On-sale of spun assets to further (prohibited) buyer (p.13:41-42)

Consider the example where Amalco sells one of Target's divisions (Spinco) to a third party (Spinco Buyer). Amalco will presumably have done its diligence to ensure that neither Spinco Buyer nor its shareholders are prohibited persons. However, if Spinco Buyer sells the acquired division (or Spinco Buyer itself is sold, subject to the 10 percent attributed property safe harbour) to a fourth party as part of the series, that sale (which is two degrees removed from the actual acquisition of Target) could taint the bump if the fourth party (or its shareholders, depending on the circumstances) is a prohibited person. … This will be the case even if the transferred division was not part of the bumped property!

Purpose of bump denial rules (p. 276)

…Generally, the bump denial rules were introduced into the Act to prevent so-called back-door butterflies.

…A "purchase butterfly" facilitated the transfer of a portion of the assets of a corporation ("the transferor") to another corporation ("the transferee") in conjunction with the sale of the shares of either the transferor or the transferee without the incidence of corporate-level tax. A similar result could be obtained through a bump transaction pursuant to which a purchaser acquired a target corporation from its shareholder, bumped the tax cost of the target corporation's underlying non-depreciable capital property to its fair market value, and then sold the bumped property back to the shareholder without incurring corporate-level tax.

Policy of bump denial rules (p. 946)

The policy behind the bump denial rule is deceptively simple: The parent should not be able to buy and wind up the subsidiary, claim an 88(1)(d) bump on its property, and then sell some of that property back to the subsidiary's former shareholders….

Prohibited persons/prohibited property (p. 947)

…At a core level:

• prohibited persons are shareholders of the subsidiary at a time that is both before the AOC and during the AOC series; and
• prohibited property is property distributed to the parent on the wind-up (that is, acquired from the subsidiary when it is merged or wound up into the parent).

The basic thrust of the bump denial rule is that property of the subsidiary that is distributed to the parent on the wind-up (herein, distributed property) should not, as part of the AOC series, be acquired by persons who were significant subsidiary shareholders at a time during the AOC series and before the parent acquired control of the subsidiary. The term ''significant'' for this purpose essentially means holding 10 percent or more of a class of the subsidiary's shares, individually or collectively.

Parent relatedness to mooted specifed person from moment of its incorporation if not a shelf corp. (p. 13:22-23)

[A]t the time the parent is incorporated, technically it would not be related to anyone such that no person will be related to the parent throughout the identified period. However, the CRA's administrative practice related to this issue is to consider the incorporating person to control and therefore be related to a corporation on incorporation, even where no shares are issued at that time. [fn 70: ...9700405 and ... 2002-0118145.]…Some care should be taken in certain jurisdictions where normal practice is for the incorporator to be a person unrelated to the buyer group (for example, the buyer's local counsel). While the argument might be made that the incorporator is acting as agent on behalf of the buyer, such an argument may be more difficult when applied to the purchase of an "off the shelf corporation.

Related status before incorporator's share issuance (p. 297)

The joint [CBA/CICA] committee noted in its submission that there are deficiencies in the drafting of clause 88(1)(c.2)(i)(C) in that no person can be related to the parent corporation at the time that it is incorporated; shares of the parent must first be issued in order for a person to become related. On this interpretation, the legislative proposal would never have application. However, there is a principle of statutory interpretation against such a reading of the provision…. [citing Grunwald v. Canada, 2005 FCA 421]

Examples of prohibited persons (pp. 947-8)

The most useful way to illustrate the wide range of potential prohibited persons is by using the example shown in Figure 6, as annotated by the discussion in the text accompanying footnotes 42-47 and 51.

1. Persons Owning (or Deemed to Own) 10-Plus Percent of a Relevant Class of Shares Pre-AOC [acquisition of control]

. The prohibited persons concept centers on persons who are specified shareholders of the subsidiary at a time that is both before the AOC and during the AOC series (herein, a pre-AOC subsidiary specified shareholder)….

• Ownership of Shares in Related Upstream Corporations: a person is deemed to be a specified shareholder of a particular corporation if that person meets the 10 percent share ownership (or deemed share ownership) threshold in any other corporation that both:
  • is related to the first corporation; and
  • has a ''significant direct or indirect interest'' in the first corporation — that is, an ''upstream'' related corporation. [fn 44: …Investor owns 10 percent of the shares of a corporation (ControlCo) that:
    • is related to the subsidiary (since ControlCo has legal control of the subsidiary); and
    • has a significant direct or indirect interest in the subsidiary. NAL [non-arm's length] Person 2 (who deals at NAL with Investor) is deemed to own Investor's shares of ControlCo, and is thus in the same position as Investor.]

2. Other Prohibited Persons

The prohibited person definition goes beyond pre-AOC subsidiary specified shareholders to include the following persons:

(a) any number of persons whose collective share ownership, if aggregated in the hands of one person, would make that one person a pre-AOC subsidiary specified shareholder [fn 45: For example, see A, B, and C collectively in Figure 6 since their shareholdings would, if aggregated, make the holder a specified shareholder of the subsidiary by virtue of owning more than 10 percent of its shares. If A, B, and C all acquired any prohibited property as part of the AOC series, the bump denial rule would apply.]

(b) a corporation, other than the subsidiary, in which a pre-AOC subsidiary specified shareholder is, at any time after the AOC and during the AOC series, a specified shareholder [fn 46: See, e.g., Corp. 1 in Figure 6, which is a corporation more than 10 percent of the shares of which are owned by a pre-AOC subsidiary specified shareholder (Investor) following the AOC.]; or

(c) a corporation, other than the subsidiary, if:

• persons described in (a) above acquired shares as part of the AOC series; and
• those acquired shares would, if aggregated in the hands of one person, make that single notional person a specified shareholder of that corporation at any time after the AOC and during the AOC series. [fn 47: For example, any corporation of which A, B, and C collectively own 10 percent or more of the shares of any class, if they acquired those shares as part of the AOC series.]

Again, in all cases, the parent and anyone dealing at NAL with the parent will not be a prohibited person.

Look-through specified shareholder definition v. s. 88(1)(c.2)(ii) entity approach (p. 288)

As a result of the interaction of subparagraph 88(1)(c.2)(ii) and the definition of "specified shareholder," it is not clear whether or when the bump denial rules may apply in respect of an acquisition by a partnership.

…For example,… if two or more shareholders of the target (other than specified persons) whose shareholdings in the target were at least 10 percent in aggregate were members of a partnership and the fair market value of their aggregate partnership interests was at least 10 percent of the fair market value of all partnership interests, the bump would be precluded as a result of the combined operation of sub-subclause 88(1)(c)(vi)(B)(iii)(2) and subparagraph 88(1)(c.2)(ii). That is, a deemed corporation of which two or more persons (other than specified persons), if treated as one notional person, would constitute a specified shareholder, and would also constitute a specified shareholder of the target, would have acquired prohibited property….

Partnership not qualifying as specified person (p. 289)

[T]he rule in subparagraph 88(1)(c.2)(ii) that deems a partnership to be a corporation is applicable to the definition of "specified person" (subparagraph 88(1)(c.2)(i)). For example, a partnership (such as a private equity fund) that establishes an acquisition corporation should be a specified person because, as a deemed corporation, the fund should be related to the acquisition corporation….[W]here a fund establishes a toehold position in a target of at least 10 percent, causing it to constitute a specified shareholder prior to the acquisition of control of the target… [i]f the fund does not control the acquisition corporation, it likely will not constitute a specified person. Consequently, any acquisition of attributable property (other than specified property) by the fund would preclude the bump.

Potential treatment of earnout as substituted property (p. 9: 12)

[T]here can be a denial of the bump where property distributed on the amalgamation or winding up of a target entity or property, other than specified property, acquired in substitution therefor (“substituted property”) was acquired by one or more “specified shareholders” [fn 51: [F]or the purposes of the bump denial rules, in very general terms, each shareholder’s interest in the target is aggregated to form a notional shareholder, such that if a group of persons who collectively own 10 percent or more of the shares of the target (before it is acquired by the parent) acquire the target’s property or substituted property, the bump can be denied.] of the target entity as part of the series that included the windup or amalgamation. Substituted property includes property that, at any time after the acquisition of control of the target entity, derives more than 10 percent of its fair market value from the property distributed to the parent.

An earnout could be interpreted as deriving more than 10 percent of its value from the property of a target entity, depending on its terms. However, the CRA has opined favourably with respect to this issue. In the CRA’s view, if the sole purpose of the earnout is to establish the fair market value of the shares of the subsidiary on closing, then the earnout will not normally be substituted property. [fn 52: 1999-0010965] However, this favourable view would not apply if the earnout were used as a mechanism to distribute additional amounts from the future sale or value of some particular property.

Application of substituted property rules where consideration paid to target (Kodiak) shareholders was over 10% of shares of U.S. acquiror (Whiting) (p. 15:7)

[T]he consideration provided to Kodiak shareholders consisted of shares of a U.S. corporation, which do not qualify as specified property under paragraph 88(1)(c.4) for the purposes of the substituted property rules in paragraph 88(1)(c.3). Kodiak represented more than 10 percent of the value of the combined entity, meaning that more than 10 percent of the value of the Whiting shares issued to the Kodiak shareholders was attributable to the Kodiak shares. Accordingly, the Whiting shares were attributable property for the purposes of subparagraph 88(1)(c.3)(i). Thus, under the plan of arrangement, all of the the Kodiak shareholders acquired substituted property for the purposes of the bump rules, and the conditions in paragraph 88(1)(c) for the bump were not satisfied.

10% attributable property test applied only during the series of transactions (p. 13:12-13)

[W]hen read in a textual, contextual and purposive manner, it would be reasonable to construe the "at any time" wording of the 10 percent test such that the test should not be affected by transactions or events that are not considered part of the series. This construction seems reasonable as a matter of statutory interpretation, and in that respect the absence of an overt series rule in subparagraph 88(l)(c.3)(i) should not be considered to imply otherwise. …

[I]t is for the purpose of determining whether a person has acquired substituted property that subparagraph 88(l)(c.3)(i) extends the meaning of the concept of substituted property contained in subparagraph 88(l)(c)(vi). Accordingly, subparagraph 88(l)(c.3)(i) presumably must be read in the context of subparagraph 88(l)(c)(vi) and take into account the time period, including the series referred to in that subparagraph.

Series for exchangeable shares of Target ending only when final exchange occurs (p.13:15-16)

[A] question has been raised whether the bump might be available where Foreign Parent acquires Target in an exchangeable share transaction...

[O]ne issue is that the initial issuance of exchangeable shares in consideration for Target shares and the final exchange of the exchangeable shares for Foreign Parent shares may be regarded as part of the same series….The final exchanges could be many years after Target is acquired and it would be difficult, if not impossible, to predict or control relative fair market values… .The Joint Committee's submission on this point was not addressed… .

No safe harbour for subsequent conversion of convertible debt (pp. 13:19)

Where the acquisition debt issued is a convertible debt, the subsequent conversion of such debt into shares of the borrower could still cause the application of the bump-denial rule if, at the time of the conversion, the shares derive more than 10 percent of their value from distributed property on the basis that the subsequent conversion is part of the series that includes the winding-up of the subsidiary.

Earnout as potential substituted property (p. 13:41-42)

[T]he concern is that an earnout right could constitute substituted property as the value of the earnout right is based on future performance of the business acquired….

A buyer should therefore be able to utilize an earnout without putting a bump at risk, provided the buyer is comfortable (and can presumably demonstrate to the CRA with evidence if asked) that the earnout is structured solely to provide a mechanism to determine the fair market value of the shares at closing.

Upstream equity or debt as substituted property (p. 280)

Any upstream equity interests (such as shares of the parent or other upper-tier corporate or partnership interests) or debt of any upstream entities owned after the acquisition of control will constitute substituted property since the value of such property will be considered wholly or partly attributable to distributed property.

10%-plus properties as prohibited property (p. 951)

2. Property Deriving More Than 10 Percent of Its FMV From Distributed Property Post-AOC [acquisition of control]. Typically, the main concern with the scope of prohibited property is property that derives more than 10 percent of its FMV from distributed property at a time following the AOC and when owned by the prohibited person (herein, 10 percent-plus property). One of the most common examples of 10 percent-plus property is shares of an acquirer of the subsidiary (or of that acquirer's own controlling shareholder)….

Exclusions in s. 88(1)(c.3)

Some properties specified in the ITA that are 10 percent-plus property are excluded from being deemed substituted property. …

These are important exceptions, since they allow, for example, the parent to issue shares or debt in exchange for money in order to finance an acquisition of the subsidiary, without having to worry about whether the persons acquiring the shares or debt are prohibited persons. They also allow a taxable Canadian corporation to issue shares of itself directly in exchange for shares of the subsidiary, which permits Canadian acquirers to use their shares as currency to acquire the subsidiary without creating prohibited property. [fn 57: Moreover, since for these purposes a ''share'' includes a right to acquire a share (paragraph 88(1)(c.9) of the ITA), employee stock options to acquire subsidiary shares can be exchanged for employee stock options to acquire parent shares. Note, however, that this exception does not extend to stock options issued for other consideration — for example, options issued to subsidiary employees as an incentive to remain with the company post-AOC [acquisition of control].]

Exceptions do not extend to foreign securities (p. 953)

Unfortunately, none of these exceptions apply to shares or debt issued by non-Canadian corporations (other than the exception for debt issued solely for money). As such, securities of a foreign entity that is the direct or indirect acquirer of the subsidiary will generally constitute deemed substituted property, unless either:

• the securities are debt issued in exchange for money; or
• the foreign entity is so much larger than the Canadian target subsidiary that the foreign entity's securities cannot be said to derive more than 10 percent of their value from the Canadian target subsidiary's assets (that is, distributed property).

The result is that Canadian acquirers have an advantage over foreign acquirers in that they can use their shares and debt to pay for the shares of Canadian targets and still be able to claim the 88(1)(d) bump. If Canadian target shareholders who collectively hold 10 percent or more of the Canadian target's shares receive shares or debt of a foreign acquirer for their Canadian target shares, and if those foreign acquirer shares or debt derive more than 10 percent of their value from the Canadian target's properties, persons who in aggregate constitute a pre-AOC subsidiary specified shareholder will have received prohibited property, and the bump denial rule will apply. Hence, a foreign acquirer can generally use the 88(1)(d) bump only if it pays cash or if it acquires a Canadian corporation representing less than 10 percent of the acquirer's own value.

Example of problems arising on foreign acquisition (pp. 953-4)

Figure 9 illustrates some of the typical problems that can arise when a foreign acquirer (Foreign Parent) acquires a public Canadian target (CanCo) in exchange for Foreign Parent shares, using a Canadian corporation (CanAcquireCo):

• Foreign Parent shares would be prohibited property if more than 10 percent of their post-AOC FMV is attributable to CanCo's property. [fn 63: In ''exchangeable share'' transactions, CanCo shareholders receive exchangeable shares of CanAcquireCo that track the value of, and will ultimately be exchanged for, Foreign Parent shares. In such circumstances, while CanAcquireCo exchangeable shares may be ''specified property'' and thereby excepted from being prohibited property, the ultimate exchange of exchangeable shares for Foreign Parent shares would generally trigger the application of the bump denial rule if those Foreign Parent shares are 10 percent-plus property so as to be prohibited property….]
• Holders of CanCo employee stock options who exchange their options for Foreign Parent stock options will have acquired deemed substituted property (and thus prohibited property) if more than 10 percent of the options' post-AOC FMV is attributable to CanCo's property.
• A Foreign Parent receivable acquired by a lender as part of the AOC series would be a prohibited property if more than 10 percent of its post-AOC FMV is attributable to CanCo's property, unless it was issued solely for money.
• If after the wind-up, Foreign Parent disposes of SubCo 1 (a distributed property) to Buyer, it is important that Buyer not be a prohibited person. Buyer's own securities will also become prohibited property if they derive more than 10 percent of their FMV from the SubCo 1 shares (which are distributed property), creating the need to determine if Buyer's shareholders include former CanCo shareholders (prohibited persons). [fn 64: If Buyer securities are acquired as part of the AOC series by a single pre-AOC CanCo specified shareholder (a prohibited person) or by a number of smaller pre-AOC CanCo shareholders whose collective shareholdings would make a single holder of them a pre-AOC CanCo specified shareholder, the 88(1)(d) bump will be tainted. As described in Section VII.A.2, Buyer will itself be a prohibited person (tainting the bump if the purchase of SubCo 1 is part of the AOC series) if either:
  • a single pre-AOC CanCo specified shareholder is also a post-AOC specified shareholder of Buyer (regardless of whether that shareholder acquired its Buyer shares as part of the AOC series); or
  • as part of the AOC series, a number of smaller pre-AOC CanCo shareholders whose collective shareholdings would make a single holder of them a pre-AOC CanCo specified shareholder acquire enough Buyer securities to make a single holder of them a specified shareholder of Buyer following the AOC.] This is an important issue since one of the primary uses of the 88(1)(d) bump is on the post-wind-up sale of distributed property to third parties.

… where a foreign purchaser ("Forco") sets up a Canadian acquisition corporation ("Bidco") to acquire a Canadian target company ("Canco"), and the consideration to be paid for the Canco shares includes Forco shares, the tax cost bump will not be precluded provided that not more than 10% of the value of the Forco shares is attributable to Canco's property. … From a practical perspective, the Bump Amendment favours larger foreign purchasers (which are substantially more valuable than the Canadian target company) over smaller foreign purchasers.

… It is not entirely clear, however, how the timing in the Bump Amendment is intended to apply. The draft provision refers to property owned at any time after the acquisition of control where more than 10% of the fair market value of that property is, at that time, attributable to the target's property. If the consideration paid for the Canco shares includes Forco shares, and less than 10% of the value of those Forco shares is attributable to Canco's property at the time of the acquisition, does it matter if values fluctuate and, at a later point in time, more than 10% of the value of the Forco shares is attributable to Canco's property? The Bump Amendment does not even appear to have a same series concept in respect of this valuation issue. In order to preclude the bump, the Substituted Property must be acquired as part of the same series of transactions or events that includes the winding-up of Canco (the Forco shares issued as consideration for the Canco shares would clearly satisfy this series requirement where they are the actual deal consideration). The question as to whether the Forco shares constitute Substituted Property is governed by paragraph 88(1)(c.3), which does not include a series concept. It is not known whether post-closing value fluctuations over an unlimited time can determine whether the bump was available on a retroactive basis. In many situations, the bumped property will be transferred out of Canada quickly following the acquisition of control and winding-up (or amalgamation).

Where a public corporation ("Smallco") makes a successful takeover bid for another corporation ("Bigco"), RC is prepared to rule that shares of Smallco issued to shareholders of Bigco will not be considered to be substituted property by virtue of s. 88(1)(c.3)(ii) if the fair market value of the gross assets of Smallco prior to the completion of the bid is greater than 10%, but less than 50%, of the fair market value of the gross assets of Smallco after the wind-up of Bigco.

Is debt of Target non-specified property after it is amalgamated with Bidco? (pp. 13:16-19)

On a literal reading of old paragraph 88(1)(c.3), indebtedness of the subsidiary, the parent, and anyone up the chain of ownership is attributable property. Therefore, any loans made to finance the acquisition would constitute substituted property acquired as part of the series. A more technical concern arose with respect to historical debt of the subsidiary in that upon the winding-up or amalgamation, the creditors arguably acquired new property, presumably as part of the series. Therefore, there was a concern that the bump could be denied if lenders to the buyer group or the subsidiary were prohibited persons.

Subparagraph 88(1)(c.4)(ii) was amended to extend to indebtedness issued for consideration that consists solely of money….

Generally, if the borrower is at a level anywhere above Bidco, no further issues should arise provided no reorganization is undertaken that involves the borrower as part of the series. However, if the debt is borrowed by Bidco itself, a technical concern arises on the subsequent amalgamation of Bidco and Target: has the holder of the Bidco debt acquired attributable property that is not specified property-- namely, a debt of Amalco acquired as a result of the amalgamation (rather than debt issued for money)?

[P]aragraph 87(2)(a) deems Amalco to be a new corporation for the purposes of the lTA, and the cost rule in subsection 87(6) appears to presume that there is a disposition by a holder of debt of a predecessor upon an amalgamation. The deemed acquisition of the Amalco debt on the amalgamation does not appear to fit squarely into the definition of specified property because the Amalco debt is not issued as consideration for the acquisition of the Target shares, and it is not clear whether it continues to be issued solely for money. The same issue arises where the existing debt of Target or any vendor-take-back notes issued by Bidco to shareholders of Target become debt of Amalco as a result of the amalgamation.

Does paragraph 88(4)(b) resolve this potential issue?...

The Joint Committee made a submission on this point; however, no changes were made by Finance in response. It stands to reason that Finance believes that no changes are needed…

We also note that CRA has ruled favourably [fn 63: document no. 2006-0205771R3, 2007] in the context of a short-form amalgamation dealing with the Amalco shares. The CRA states that the Bidco shares issued to Target shareholders and which became Amalco shares on the Amalgamation did not constitute substituted property….

[W]e submit that paragraph 88(4)(b), when read in context, should reasonably be considered to have the effect of deeming the securities of Amalco to be the same as the securities of the predecessor corporation….

Alternatively, it may be argued that debt of a predecessor becoming debt of Amalco does not constitute an issuance of the debt. If the original debt was issued only for money, the new debt (representing the same obligation) may be debt acquired for something other than money, but it continues to be debt issued solely for money.

Is debt of Target non-specified property after it is wound-up into Bidco? (p. 13:19)

A similar issue could arise with respect to historic debt of the subsidiary assumed by the parent on the winding-up of the subsidiary. By virtue of paragraph 88(l)(e.2), subsection 87(6) is applicable to the substitution of the parent's obligation for that of the subsidiary. However, the above argument with respect to paragraph 88(4)(b) would not apply to debt of the subsidiary assumed by parent on the winding up because paragraph 88(4)(b) only applies to amalgamations, not windings up….

No safe harbour for subsequent conversion of convertible debt (p. 13:19)

Where the acquisition debt issued is a convertible debt, the subsequent conversion of such debt into shares of the borrower could still cause the application of the bump-denial rule if, at the time of the conversion, the shares derive more than 10 percent of their value from distributed property on the basis that the subsequent conversion is part of the series that includes the winding up of the subsidiary.

Dissent payment rights under a plan of arrangemnt as indebtedness (p. 292)

If the plan of arrangement ultimately receives shareholder approval, dissenting shareholders will be entitled to receive fair value for their shares at a later date. The dissent right represents indebtedness the value of which would be attributable to distributed property. If the plan of arrangement provides that the shares held by dissenting shareholders are to be acquired by the acquiror in exchange for payment, such indebtedness will constitute specified property since it will be issued by the parent as consideration for the acquisition of the shares of the subsidiary. In contrast, if the plan of arrangement provides that the shares held by dissenting shareholders are to be cancelled for payment, while such indebtedness will constitute substituted property, it will not be specified property. Thus, in the latter example, the acquisition of such substituted property (being the right of dissenting shareholders to receive fair value for their shares) will have to be taken into account in determining whether prohibited persons have acquired property….

Convertible debt as specified/determinable property (p. 293)

Proposed clause 88(1)(c.4)(ii)(B) provides that indebtedness that was issued for consideration that consists solely of money will be specified property. Thus, acquisition financing, assuming that it is issued solely for money, will constitute specified property. On its face, this proposal includes convertible debt or other participating debt issued solely for money as specified property. However, consideration should be given to whether such debt may constitute determinable property. [described in s.88(1)(c.3)(ii)] In such case, it may be prohibited property.

• Indebtedness issued for money is specified property – this rule now confirms, from and after 2001, that indebtedness issued solely for consideration consisting of money will not generally cause a bump problem if acquired by restricted persons. This alleviates much of the concern when acquisition financing is provided by a bank (or banking syndicate) and the lender's related entities may have been shareholders of a public Target. This also alleviates concerns regarding the need to obtain historic Target ownership information from bondholders in a public debt offering.

Buy, bump and sell transactions of foreign acquirer (p. 937)

The introduction of the foreign affiliate dumping (FAD) rules in 2012 makes the 88(1)(d) bump more important than ever to foreign purchasers. The FAD rules create significant adverse (and ongoing) Canadian tax consequences for foreign-controlled Canadian corporations with foreign subsidiaries, and they effectively encourage Canadian group members to dispose of existing foreign affiliates whenever possible. Amendments made to the version of the FAD rules enacted in late 2012 facilitate the use of the 88(1)(d) bump in these circumstances, and when the 88(1)(d) bump is available to reduce or eliminate Canadian CGT [capital gains tax] on shares of foreign affiliates (and there are no tax impediments in the foreign affiliate's home country), it will generally be the primary tool used by foreign purchasers of a Canadian corporation that owns foreign subsidiaries to avoid having to contend with the FAD rules on an ongoing basis.

General summary of surplus carve-out rule (p. 945)

…When control is acquired of a Canadian corporation that owns shares of a foreign affiliate, Canadian tax authorities perceive it as being duplicative to allow (in very general terms) the sum of the tax cost of the Canadian corporation's shares of the foreign affiliate and the amount of this ''good'' surplus the Canadian corporation has in the foreign affiliate to exceed the FMV of the Canadian corporation's shares of the foreign affiliate.

Accordingly, when the subsidiary owns shares of a foreign affiliate, an 88(1)(d) bump is not permitted to result in the sum of (1) the parent's tax cost of those shares and (2) the good surplus of the foreign affiliate at the time of the AOC [acquisition of control] exceeding the FMV of those shares. A comparable rule applies when the subsidiary owns shares of a foreign affiliate through a partnership….

Summary of s. 88(1)(d)(ii.1)

… Expressed conceptually, the FMV of the partnership interest is deemed to be reduced by an amount representing that portion of the subsidiary's accrued gain on the partnership interest that is attributable to the sum of:

• the FMV of Canadian or foreign resource property owned by the partnership (directly or through other partnerships); and
• the difference between the FMV and cost amount of other forms of non-eligible property (for example, depreciable property or inventory) owned by the partnership, either directly or through other partnerships. [fn 29: The Department of Finance explanatory notes accompanying the relevant provisions of the ITA make clear that this rule does not reduce the amount of an 88(1)(d) bump regarding an interest in a partnership that owns shares of a corporation simply because the corporation owns non-eligible property.]

Example: bump reduction for ineligible appreciation (p. 944)

For example, consider the case of a partnership interest held by the subsidiary at a tax cost of $70 and whose FMV is $100 (that is, a $30 accrued gain). If the partnership itself owns an eligible property with a tax cost of $5 and an FMV of $10, and a non-eligible property with a cost amount of $65 and an FMV of $90, for purposes of the general limitation in Section VI.A.1 above, the FMV of the partnership interest would be deemed to be $75 instead of $100. [fn 30: The reduction in the FMV of the partnership interest is computed as the portion of the accrued gain on that property that is attributable to the notional gains on non-eligible property. Since the notional gains on the non-eligible property represent five-sixths ($25 / ($5 + $25)) of the total accrued gain ($30), for this purpose the FMV of the partnership interest ($100) is reduced by $25 (five-sixths of the $30 accrued gain on the partnership interest)] This means that the maximum s. 88(1)(d) bump on such partnership interest would be $5 ($75-$70).