Section 93

Subsection 93(1) - Election re disposition of share of foreign affiliate

Cases

Terrador Investments Ltd. v. Canada, 99 DTC 5358 (FCA)

In connection with the liquidation of a U.S. corporation owned by the two Canadian corporate taxpayers, they received promissory notes owing by another U.S. corporation and cash, and elected under s. 93(1) in respect to the distribution. In finding that this election precluded the taxpayers from subsequently taking a deduction under s. 20(1)(p) when the unpaid balance of the promissory notes proved to be uncollectible, Décary J.A. stated (at p. 5362):

"Once a taxpayer has voluntarily elected, pursuant to subsection 93(1), to treat part of the proceeds of disposition comprised of some cash and of some promissory notes, as a 'deemed dividend received', the cash and parts of the promissory notes at issue lose their identity 'for the purposes of this Act'. When the deemed dividend is included in the taxpayer's income pursuant to paragraph 12(1)(k), it is included as a 'paid' dividend, not as cash and parts of promissory notes ... . The 'deemed dividend' being said by the Act to have been 'paid' and 'received', it cannot at the same time be a 'doubtful debt' or a 'bad debt'. What is deemed to have been paid cannot also be said to be due."

Locations of other summaries Wordcount
Tax Topics - Statutory Interpretation - Interpretation/Definition Provisions reasonable implication of deemed fiction 72

Administrative Policy

5 September 2018 Internal T.I. 2017-0698241I7 - Interpretation of subsection 93(4)

no s. 93 election available where ACB bump under s. 94(3) eliminated gain before application of s. 93(1)

But for s. 94(3), a Canadian corporation (ACo) would have realized a capital loss of $1 million on the liquidation and dissolution of a wholly-owned non-resident subsidiary (FA1) which, in turn, held FA2 and FA3. The Directorate found that s. 94(3) applied to deny the loss and add it to the ACB to ACo of the shares of FA2 and FA3. The FA2 shares were sold by ACo to a third party for cash of $110,000, and ACo under an s. 93(1) election designated $10,000 of the proceeds to be a dividend (based on its view that s. 93(4) did not apply). The Directorate stated:

[U]nder paragraph 93(1)(a), the “elected amount” cannot exceed the amount of the taxpayer’s otherwise determined gain. … ACo has no gain on the disposition of the FA2 shares, in which case ACo’s elected amount would become $ nil.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 93 - Subsection 93(4) FA sub shares acquired “on” disposition of FA parent shares occurring on completion of liquidation and dissolution process 232
Tax Topics - Income Tax Act - Section 93 - Subsection 93(2.01) s. 93(2.01) applied to capital loss resulting from s. 94(3) basis bump 176

14 March 1991 Memorandum (Tax Window, No. 1, p. 21, ¶1143)

RC permits only one election to be made with respect to a particular disposition of shares.

Articles

Paul Dhesi, Korinna Fehrmann, "Integration Across Borders", Canadian Tax Journal, (2015) 63:4, 1049-72

Inefficiency of realization of capital gains by CFA of CCPC (p. 1062, 1064)

[T]he realization of capital gains at the CFA level...is rarely good news… .

[T]he foreign affiliate regime does not contemplate increases to the CCPC's capital dividend account (CDA). The taxable portion of a capital gain on the disposition of non-excluded property gives rise to FAPI. That amount is included in income of the Canadian-resident corporation, and to the extent that the CFA is subject to FAT in respect of the taxable capital gain, an offsetting FAT deduction is available. Where the Canadian-resident corporation is a CCPC that has a net inclusion to taxable income in respect of FAPI (that is, the FAT is less than one-quarter of the FAPI), that amount is AII, which is taxed accordingly at high rates and generates RDTOH. From the perspective of the CFA, that FAPI and the underlying foreign tax paid are respectively included in the CFA's taxable surplus and underlying foreign tax (UFT) balances. ...[T]he non-taxable portion of the capital gain......is included in the exempt surplus pool.

...Exempt surplus dividends...are inherently exempt from further Canadian tax. Because a deduction is available under section 113, the amount is added to a CCPC's GRIP. The CCPC does not receive an addition to its CDA where a CFA has disposed of capital property. In contrast to capital dividends paid from the CDA, eligible dividends paid from the CCPC's GRIP will be subject to further tax in the hands of the ultimate shareholder. The significant difference in the overall effective tax rate stems from this additional tax payable on the non-taxable portion of the capital gain at the individual shareholder level….

Disposition of CFA shares by CCPC (as contrasted to sale by CFA) (pp. 1065, 1067)

[A] Canadian-resident shareholder may have a Canadian holding company ("CCPC 1")…Often interests in foreign subsidiaries will be structured through a dedicated Canadian holding company ("CCPC 2")… .

[T]he overall flow-through tax result can be improved if a purchaser is willing to acquire the shares of the CFA | rather than the asset directly. The disposition of the shares in the CFA would be a taxable transaction. The capital gain to the vendor (CCPC 2) would be determined as the difference between the proceeds of disposition of the CFA shares and the adjusted cost base of the shares. One-half of the capital gain would be included in taxable income while the other half would be included in CCPC 2's CDA.

It should be noted that CCPC 2 could consider making an election under subsection 93(l) to treat the capital gain realized on the disposition as a dividend received from the CFA….While the upfront tax cost associated with the gain in the hands of CCPC 2 could be reduced by such an election, ...the ultimate flow-through rate of tax, once the proceeds on the sale are distributed to the ultimate shareholder, may actually be higher.

...[T]he higher rate is driven by the fact that when the proceeds are distributed to the shareholder, the entire amount of the dividend is subject to tax…

Disposition of CCPC 2 (holding CFA) by CCPC 1 (pp. 1067-8)

The disposition of shares of CCPC 2 should generally yield results similar to those... [immediately] above….

Similar to the subsection 93(1) election above, the safe-income dividend provides the opportunity to convert a taxable capital gain to a dividend that should not give rise to immediate tax….While the dividend would reduce the immediate tax cost of the capital gain, the intimate flow-through tax cost of distributing the proceeds from the sale to the shareholder would likely be higher….

Eric Lockwood, Maria Lopes, "Subsection 88(3): Deferring Gains on Liquidation and Dissolution", Canadian Tax Journal (2013) 61:1, 209-28, p. 209

They provide various examples indicating that a taxpayer (Canco) will realize a capital gain on the disposition of its shares of the disposing affiliate (Foreignco 1) – even where there has been a qualifying liquidation and dissolution (QLAD) election - where the adjusted cost base of Foreignco 1 in the distributed property, being the shares of Foreignco 2 (i.e., the inside basis), exceeds Canco's ACB of its Foreignco 1 shares, i.e., the outside basis. Before turning to the potential relief provided by the suppression election in s. 88(3.3), they make two preliminary observations.

First (at pp. 216-217) respecting accessing exempt surplus of Foreignco 2:

According to the Canada Revenue Agency (CRA), the exempt surplus of Foreignco 2 would not be available to reduce the capital gain realized by Canco. The CRA has expressed the opinion that a liquidation and dissolution of an FA involves a two-step process: the first step is the distribution of the assets of the disposing affiliate, and the second step is the disposition by the taxpayer of its shares of the disposing affiliate. [fn 19: See CRA document no. 2002-0178147, January 9, 2003.] As a result, by the time the taxpayer disposes of its shares of the disposing affiliate, the shares of the underlying FAs are no longer owned by the disposing affiliate and their surplus balances cannot be used to mitigate any capital gain realized by the taxpayer. Consequently, the surplus balances of Fas owned directly or indirectly by the disposing affiliate are not readily accessible to mitigate a capital gain realized by the taxpayer on the disposition of its shares of the disposing affiliate, unless planning is undertaken to use these balances before the liquidation and dissolution begin....

Second (at p. 217) respecting the adverse effect under amended s. 93(1)(a) of the shares of Foreignco 2 being disposed of on a rollover basis under s. 88(3)(a):

Prior to the proposed amendments, one approach to mitigating the gain was for Canco to file two section 93 elections. The first election would be filed in respect of the disposition by Foreignco 1 of the shares of Foreignco 2. This would elevate the exempt surplus of Foreignco 2 to Foreignco 1, making the second election possible. The second election would be in respect of the disposition by Canco of the shares of Foreignco 1. Unfortunately, this approach will no longer be available, as a result of amendments to paragraph 93(1)(a) included in Bill C-48. [fn 20: Paragraph 93(1)(a) is proposed to be revised, effective for dispositions occurring after August 19, 2011, to limit the elected amount to the capital gain.]…

Hetel Kotecha, "The Subsection 93(1) Election - Strategy and Pitfalls", International Tax Planning, 2003, p. 792.

Ron Nobrega, "Technical Bill Amendments Affecting Foreign Affiliate Share Transfers", Taxation Law, Ontario Bar Association, Vol. XIII, No. 3, p. 1.

Schwartz, "Tax-Free Reorganizations of Foreign Affiliates", 1984 Canadian Tax Journal, November-December 1984, p. 1039.

Bradley, "Foreign Affiliates: A Technical Update", 1990 Conference Report, c. 43

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 91 - Subsection 91(5) 80

Forms

T2107 "Election For A Disposition Of Shares In A Foreign Affiliate"

Separate elections have to be made when a disposition of shares in a foreign affiliate involves shares of different classes or when dispositions are made at different times. ...

Surplus calculations must be filed with the election.. .

Subsection 93(1.11)

Administrative Policy

2017 Ruling 2017-0693751R3 - Transfer of Shares of a Foreign Affiliate

step-up in FA shares transferred into New FA and then sold for note to an affiliated Canco limited to sum of RCB and net surplus
Quite similar transactions in the same corporate group were ruled upon in 2016-0630761R3.

See the diagram for the 2016-0630761R3 transactions.

A Canadian-resident corporation (ACo) wished to transfer its shares of a foreign subsidiary (FA1) to a Canadian subsidiary of ACo (BCo). This was to be accomplished by ACo transferring its FA1 shares on a s. 85.1(3) rollover basis to a newly-formed non-resident subsidiary (New FA), with New FA then transferring its FA1 shares to BCo for a note – which then was to be repaid in cash out of share subscription proceeds from ACo, and with FA1 then distributing such cash to ACo (with a Reg. 5901(2)(b) designation being made). FA1 then is wound up.

In order to satisfy a CRA requirement that the cost to BCo of the FA1 shares (which were excluded property) be limited to the sum of their relevant cost base and the net surplus (being exempt surplus) of FA1 – rather than being stepped up to their higher fair market value, the note equalled such sum. S. 69(1)(c) deemed the proceeds to New FA to be the higher FMV. However, the disposition of the FA1 shares did not give rise to FAPI), their exempt surplus was levitated under s. 93(1.11)(a) to New FA, and the note repayment proceeds were received by ACo out of pre-acquisition surplus and (to the extent of any amount that otherwise would be a negative ACB gain) out of New FA’s exempt surplus pursuant to s. 93(1.11)(b) and Reg. 5902(6).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 69 - Subsection 69(11) - Paragraph 69(11)(b) s. 69(11)(b) inapplicable to transfer of FA to new FA who will use the excluded property exemption 296
Tax Topics - Income Tax Act - Section 9 - Capital Gain vs. Profit - Shares affiliated transfer of shares at gain equal to exempt surplus did not cause loss of capital property status 81

2016 Ruling 2016-0630761R3 - Transfer of Shares

transfer of an FA with exempt earnings by FA Holdco to Can Subco required to occur at less than the shares’ FMV
Quite similar transactions for the same group and with expanded rulings were ruled upon in 2017-0693751R3

Background

ACo wholly-owns BCo, which is a foreign corporation with its central management and control in Canada, and FA1, the fair market value of whose shares exceeds their ACB and the consolidated net surplus of FA1, all of which is exempt surplus. Substantially all the property of FA1 is excluded property.

Subject transactions
  1. ACo transferred all of its FA1 shares to a newly-incorporated foreign affiliate (New FA) for FMV consideration satisfied by the issuance of common shares, and with the stated capital of those shares equalling the principal amount of the BCo Note referenced in 2 below.
  2. New FA transferred to BCo all of its FA1 for a purchase price equalling the “Transfer Amount,” being the sum of the FA1 Shares’ relevant cost base and the consolidated net surplus of FA1 (but not exceeding the shares’ FMV), to be satisfied by the issuance of the BCo Note (whose amount is subject to a price adjustment clause).
  3. ACo subscribed for additional BCo Common Shares for cash in an amount equal to the principal amount of the BCo Note.
  4. BCo repaid the BCo Note.
  5. Such amount was distributed by New FA as a stated capital distribution to ACo, with ACo electing under Reg. 5901(2)(b) to treat the distributions as having come out of New FA’s pre-acquisition surplus.
Proposed transaction

New FA will be liquidated and dissolved, and its property and obligations (principally respecting potential operation of price adjustment clauses respecting 2 and 3) will be distributed to and assumed by ACo.

Purpose

The purpose for the transfer in 2 occurring at the Transfer Amount rather than FMV is “to address certain policy concerns of the CRA by restricting BCo’s aggregate ACB of its FA1 Shares to the Transfer Amount.”

Rulings

Re application of s. 85.1(3) to drop-down in 1.

To the extent of any capital gain otherwise realized by New FA from the disposition of its FA1 Shares to BCo in 2:

(a) ss. 93(1), (1.1) and (1.11) and the relevant Regulations applied to cause the amount prescribed under Reg. 5902(6) to be treated as a dividend received by New FA from FA1 immediately before the disposition and not to be proceeds of disposition of such FA1 Shares; and

(b) provided that the FA1 Shares were excluded property of New FA at the time of the disposition, the amount of any capital gain (determined after the application of s. 93(1)) from the disposition of such shares would not have been included in the FAPI of New FA.

The distribution in 5 came first out of pre-acquisition surplus and, to the extent of any amount that otherwise would be a s. 40(3) gain, the Reg. 5902(6) amount was deemed to be a dividend received by ACo from New FA immediately before the time of such distribution (presumably coming out of exempt surplus), with any excess (apparently none) being a s. 93(1) capital gain of ACo.,

Ss. 15(1), 56(2), 69(4) and 246(1) did not apply to the transfer by New FA of all of its FA1 Shares to BCo in 2.

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 5901 - Subsection 5901(2) - Paragraph 5901(2)(b) stated capital distribution from FA treated as pre-acq dividend 184
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1) no conferral of benefit where CRA required sideways transfer to occur at less than FMV 211

Subsection 93(2.01) - Loss limitation on disposition of share of foreign affiliate

Administrative Policy

5 September 2018 Internal T.I. 2017-0698241I7 - Interpretation of subsection 93(4)

s. 93(2.01) applied to capital loss resulting from s. 94(3) basis bump

But for s. 94(3), a Canadian corporation (ACo) would have realized a capital loss of $1 million on the liquidation and dissolution of a wholly-owned non-resident subsidiary (FA1) which, in turn, held FA2 and FA3.After the Directorate found that s. 94(3) applied to deny the loss and add it to the ACB to ACo of the shares of FA2 and FA3, it then considered the question:

If the portion of such denied loss added to the ACB of the FA2 shares under s. 93(4)(b) was $50,000 (resulting in ACo’s ACB of the FA2 shares becoming $100,000 (as otherwise determined under s. 88(3)) + $50,000 = $150,000), would the s. 93(2.01) rules determine ACo’s loss on the disposition of the FA2 shares?

The Directorate responded:

“Yes”. Absent the subsection 93(2.01) loss limitation rule, ACo would have an otherwise determined (capital) loss of $40,000 (i.e. $110,000 - $150,000) arising on its disposition of its FA2 shares … . [P]aragraph 93(2)(a) mandates the application of subsection 93(2.01), and the $40,000 loss is limited by the exempt dividends previously paid on the FA2 shares or on shares for which the FA2 shares were substituted.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 93 - Subsection 93(4) FA sub shares acquired “on” disposition of FA parent shares occurring on completion of liquidation and dissolution process 232
Tax Topics - Income Tax Act - Section 93 - Subsection 93(1) no s. 93 election available where ACB bump under s. 94(3) eliminated gain before application of s. 93(1) 137

22 June 2016 Internal T.I. 2016-0632821I7 F - 93(2.01) & Capital Contribution

a contribution of FA1 shares to FA2 causes the FA2 shares to be substituted property for s. 93(2.01) purposes

A wholly-owned foreign affiliate (“Luxco1”) of Canco held 1/3 of the shares of a corporation ("NRco") resident in a Treaty country. Another wholly-owned affiliate of Canco (“Luxco2”), used the proceeds of an interest-free loan from Canco to make an interest-bearing loan to NRco, with resulting deemed active business income to Luxco2 under s. 95(2)(a)(ii)(B) being paid to Canco as exempt dividends.

Subsequently, the shares of Luxco2 were contributed as capital contribution by Canco to Luxco1 without share consideration, and Canco then sold the shares of Luxco1 to a third party, thereby realizing a capital loss. Luxco1 did not pay any dividends to Canco. Is the capital loss reduced under s. 93(2.01)?

In finding that the shares of Luxco1 were substituted shares for those of Luxco2, so that the loss was so reduced, CRA stated that the s. 92(2.01) rule contains no purpose test and that:

The concept of "substituted share" in subsection 93(2.01) must…be given its ordinary meaning, taking into account inter alia that the interpretive rule in subsection 248(5) does not stipulate a definitive meaning for this concept for the purposes of the Act.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(5) ordinary meaning of “substituted” 113
Tax Topics - Income Tax Act - Section 95 - Subsection 95(2) - Paragraph 95(2)(a) - Subparagraph 95(2)(a)(ii) - Clause 95(2)(a)(ii)(B) inter-affiliate loan generating deemed active business funded out of an interest-free loan from Canco 103

26 May 2016 IFA Roundtable Q. 7, 2016-0642121C6 - 93(2.01) & Capital Contribution

contribution of shares to a subsidiary caused the subsidiary shares to be substituted property

CRA considered that the s. 93(2.01) stop loss rule applied where Canco made a contribution of capital to a foreign subsidiary (FA2) of its shares of a non-resident Finco subsidiary (FA1) which had paid dividends out of its deemed active business income to Canco – so that s. 93(2.01) denied a subsequent capital loss realized on an arm’s length sale of the FA2 shares to the extent of such dividends. This was so even though the contribution did not entail any exchange of property and even though the FA1 shares likely would never have generated an accrued loss (with CRA observing in its oral comments that “there is no purpose test inherent in subsections 93(2) and (2.01), and other similar rules.)

CRA stated:

[W]e may be prepared to develop administrative solutions to the extent this could result in double-counting, or the same dividends being counted, or producing two or more losses.

Words and Phrases
substituted

15 August 2014 Internal T.I. 2014-0538591I7 - FX losses on CFA wind-up

no reduction under s. 93(2.01)(a) if no exempt dividend

A Canadian-resident corporation did not elect under s. 88(3.1) for the winding-up of its wholly-owned controlled foreign affiliate (CFA) to be a qualifying liquidation and dissolution. Would s. 93(2.01) limit the loss on the disposition of CFA shares disposed of in a wind-up where the loss is primarily due to FX fluctuations and no exempt dividends had been paid on the shares or substituted shares? CRA stated:

If no exempt dividends had been paid on the CFA shares or shares for which the CFA shares were substituted, then the amount determined under paragraph 93(2.01)(a) will not be less than the particular loss determined without reference to the subsection [i.e., per the Summary, "without the payment of exempt dividends, paragraph 93(2.01)(a) will not operate to reduce the loss.]

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 40 - Subsection 40(3.6) s. 40(3.6) does not apply to winding-up 153

24 November 2013 CTF Roundtable, 2013-0508161C6 - Loss on disposition of shares

loss preservation transactions which did not satisfy the s. 93(2.01) requirements

A shareholder having an accrued foreign exchange loss on common shares of an FA and an accrued foreign exchange gain on a related party debt used to acquire those shares acquires a separate class of the FA's shares and pays dividends thereon with a view to such dividends not reducing a loss to be realized on the a sale of the original FA shares owned - in order that such loss can offset the FX gain on settlement of the debt. Would the conclusion at the 2013 IFA conference (see below) that GAAR would apply change if the funds used to acquire the original FA shares had been borrowed from an arm's length party more than 30 days before the acquisition of the shares?

In responding "no," CRA indicated that a loss would be denied "unless the related debt is a debt described in subparagraph 93(2.01)(b)(ii), a provision which precisely specifies which gains are intended to have an effect on the computation of the amount of a loss to be denied on the disposition of FA shares," and that one such requirement was that an "arm's length foreign currency debt… was entered into within 30 days of the acquisition of the FA share."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 112 - Subsection 112(3) loss preservation transactions which avoid s. 112(3) stop-loss rule 263
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) loss preservation transactions which did not satisfy the s. 93(2.01) requirements 201

25 September 2013 Internal T.I. 2013-0476311I7 F - 93(2), 93(2.01) - Share substituted

concept of substituted share in s. 93(2.01) is subject to the exchanged-for limitation in s. 248(5)(a)

Tower 1

Under a Tower structure (Structure 1) a taxable Canadian corporation (Parent), all of whose shares were held directly or indirectly by a Canadian public company (Publico), was partner together with its subsidiary (Canco1) in a limited partnership (LP1), which had borrowed from banks and which held all the shares of a ULC (Canco2), which was the member of an LLC (LLC1). Interest received by LLC1 on a loan to a US Opco (USCO2, held by USCO1, held in turn by Parent) was deemed to be active business income by s. 95(2)(a)(ii), so that dividends paid by it to Canco2 were exempt dividends. Dividends received in turn by Parent and Canco1 through LP1 were deducted under s. 112(1).

Dismantling of Tower 1

Parent subscribed for preferred shares (A Shares) of USCO1 (1), with USCO1 lending the funds at interest to USCO2 (2), which repaid the loan from LLC1 (as well as a loan from LP1) (3). Parent acquired the shares of Canco2 for a note (4), LLC1 distributed the loan repayment funds to Canco2 as a capital reduction (5) with Canco2, in turn, making a matching capital distribution to Parent (6). Parent repaid the note (7), with LP1 using such proceeds to make an interest-bearing loan to Parent (8). LLC2 was continued under the CBCA (9), Canco2 was wound-up into Parent under s. 88(1) (10), LLC1 was wound-up into Parent and Canco1 under s. 88(2), with Parent claiming a capital loss on its shares of LLC1 (11). Such capital loss "technically" was not reduced under s 112(1) or 93(2) but CRA denied the loss under s. 245(2).

Realization of capital loss at issue

In connection with transactions described in 2007-023929, Parent transferred its A Shares to an affiliated company (Canco4) (12), which was wound-up into Parent under s. 88(1) (13). There then was an acquisition of control of Parent (14), so that it reported a capital loss under s. 40(3.4)(b)(iii).

Question 1

Was the membership interest in LLC1 a share for which the A Shares were substituted for purposes of s. 93(2)?

CRA response

In indicating "no", CRA stated (TaxInterpretations translation):

Paragraph 248(5)(a) circumscribes this concept [of substituted property] by providing that it refers to a property acquired in a disposition or exchange of a particular property, so that the latter property is the subject of a legal transaction. The second part of paragraph 248(5)(a) expands the scope of this concept in envisaging an indeterminate number of substitutions, establishing a link between the initial property under consideration and the property acquired in the final substitution. It should be noted that it is not necessary for a particular expression to be reproduced in a particular provision of the Act in order to apply the rules of interpretation governing the concept of substituted property in subsection 248(5). In this context, the use of the terms "action de remplacement" and "share for which the affiliate share was substituted" in the French and English versions of paragraph 93(2.01)(a) refer to the concept governed by paragraph 248(5) in respect of property that is shares.

In this case, the XXXXXXXXX A Shares of USCO1 were issued in the course of a legal transaction which did not involve in any way the interest in LLC1 or a property acquired in replacement for such interest. Accordingly ... the interest in LLC1 cannot be considered as a share for which XXXXXXXXXX A Shares of USCo1 were substituted for the purpose of determining Element B.

Tower 2

Publico and Parent were the partners of LP2, which held all the shares of a ULC (Canco3). Canco3 held preferred shares of a limited liability company (LLC2) and LP2 held the remainder shares. Interest received by LLC2 on a loan to a US Opco (USCO3, held by USCO2) was deemed to be active business income by s. 95(2)(a)(ii), so that dividends paid by it to Canco3 were exempt dividends. Dividends received in turn by Parent and Canco1 through LP2 were deducted under s. 112(1). No dividends were paid on the remainder shares of LP2.

Dismantling of Tower 2

Parent used borrowed money to lend US dollars to Publico at interest (1), which Publico used to make a capital contribution to LP2 (thereby changing their relative partnership interests) (2). LP2 repaid its 3rd party loan (3) before being wound-up into Publico and Parent under s. 98(3) (4). Parent transferred its undivided interest in the shares of Canco3, as well as the remainder shares of LLC2, to Publico in consideration for a note (5). As a result, Parent claimed a capital loss which was not reduced by s. 112(3). Publico transferred such properties, in turn, to USCO1 in consideration for the issue of preferred shares (B Shares) (6). As a result, Publico claimed a capital loss which also was not reduced by s. 112(3). Publico transferred the B Shares to Parent in repayment of a portion of the note (7). Canco3 effected a stated capital distribution of a portion of its preferred shares of LLC2 to USCO1 as a capital distribution (8). Canco3 was wound-up into USCO1 (9), and USCO3 and LLC2 were merged (10).

Realization of capital loss at issue

In connection with transactions described in 2007-023929, Parent transferred its B Shares to an affiliated company (Canco4) (11), which was wound-up into Parent under s. 88(1) (12). There then was an acquisition of control of Parent (13), so that it reported a capital loss under s. 40(3.4)(b)(iii).

Question 2

Did the preferred shares of LLC2 represent shares for which the B Shares held by parent were substituted for purposes of s. 93(2)?

CRA response

In indicating "no", CRA stated (TaxInterpretations translation):

[T]he loss realized ... by Parent respecting the ... B Shares of USCO1 was attributable entirely to a fluctuation in the exchange rate for the Canadian dollar over the course of the period ... .

[T]he ... B Shares of USCO1 held by Parent were issued in the course of a legal transaction which did not directly involve the Preferred Interest in LLC2 or a property acquired in replacement of such interest. ... [T]he Preferred Interest in LLC2 cannot be considered as a share for which USCo1's XXXXXXXXXX Class B Shares were substituted for the purpose of the application of Element B. Those shares instead were acquired by Parent in replacement of shares of Canco3, and no Exempt Dividend was paid in respect of the latter shares. Furthermore ... the wording of element B does not support the amounts of the dividends received by Canco3 in respect of the Preferred Interest it held in LLC2 being indirectly considered for purposes of the application of the rules.

GAAR review status

Finally, the subject facts have also been provided to the specialized audit team of your Tax Services Office in order that they can decide as to the possible application of the general anti-avoidance provision of the Act ("GAAR") regarding an avoidance transaction. We have received confirmation from a member of that team that the analysis has not been concluded and that a referral to the Abusive Tax Planning Division at National Headquarters has not been made in this file.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(5) s. 248(5) requirement for a legal exchange is engaged by a reference to a substituted share 187

23 May 2013 IFA Round Table Q. 3

What is the CRA's position on the application of the GAAR to a series of transactions undertaken for the purpose of avoiding the application of s. 93(2) so as to preserve the portion of the loss on the disposition of FA shares that is attributable to foreign exchange, such that it remains available to effectively offset a foreign exchange gain related to the investment in the FA shares?

Response

: Given that proposed s. 93(2.01)(b)(ii) specifies "precisely which related foreign exchange gains realized by a taxpayer are intended to affect the computation of the amount of the loss to be denied on the disposition of an FA share," it follows that except in these narrow circumstances s. 93(2) and proposed s. 93(2.01) are intended to deny a loss on the disposition of an FA share to the extent that exempt dividends had been received on that share, or on a share for which that share had been substituted, prior to the disposition, "even in circumstances where the loss is arguably due to foreign exchange fluctuations rather than the extraction of earnings from the FA."

Consider a case where a corporation resident in Canada ("Canco") uses borrows U.S. dollar proceeds of a related party borrowing to acquire common shares of an FA, which then generates a large exempt surplus balance from its active business, but with a large FX gain accruing on Canco's borrowing. Canco acquires preferred shares of FA for nominal consideration, and receives thereon a distribution of FA's exempt earnings - in order that on the subsequent sale of the FA common shares, Canco can realize a loss which will offset a FX gain on repayment of Canco's debt. Given that a foreign exchange gain realized on the repayment of a non-arm's-length debt is not a gain described in proposed s. 93(2.01)(b)(ii), it was not intended that it should affect the computation of the loss denied under s. 93(2). "Therefore the issuance of the FA preferred shares and the payment of the dividends thereon result in an abuse having regard to subsection 93(2) such that the GAAR would apply." CRA's opinion would be the same if, for the purpose of avoiding the application of s. 93(2), the preferred shares were issued on the initial incorporation of FA.

10 May 2013 Internal T.I. 2012-0464901I7 - 93(2), 93(2.01) - Share substituted

Canco owns all the shares of Forco1, which it transfers to Forco2 for a promissory note payable in U.S. dollars, and then transfers the note to Forco3 in exchange for shares of Forco3. In finding that such shares of Forco3 were substituted for the shares of Forco1, CRA indicated that the concept of "share substituted" was not restricted "to a chain of substitutions in which only shares are substituted."

Articles

Didier Fréchette, Ryan Rabinovitch, "Current Issues Involving Foreign Exchange", 2015 CTF Annual Conference paper

Narrowness of 30-day rule/exclusion for related party debt (pp. 26:46)

Despite the promising comments made in the 2001 comfort letter, the loss preservation rules that have ultimately been enacted are, unfortunately, very restrictive. The 30-day window will, in practice, be very difficult to satisfy, since it is not unusual for the repayment schedule of the third-party debt to not coincide with the disposition of the shares of the financing foreign affiliate. It is also common for the external debt to be incurred by a related entity within the group (such as the parent company), and not necessarily by the entity holding the shares of the foreign affiliate. Similarly, there does not seem to be a clear policy rationale for the exclusion of debt from related parties or debt arising as part of legitimate corporate reorganizations that may occur between the time a debt is incurred and the time it is repaid. …

Nikolakakis, "Foreign Exchange Fluctuations: Comprehensive Rules are Needed", Corporate Finance, Vol. V, No. 1, 1997.

Subsection 93(2.1)

Articles

Didier Fréchette, Ryan Rabinovitch, "Current Issues Involving Foreign Exchange", 2015 CTF Annual Conference paper

Whether substitutions for s. 93(2.1) purposes are not limited to share-for-share transactions (p. 26:47)

The CRA has taken an expansive view of the concept of substituted property. In particular, it has taken the view that substitutions are not limited to share-for-share transactions, [fn 135: See for example, CRA document no. 2012-046490117, May 10, 2013.] such that subsection 93(2.1) can apply where shares of a foreign affiliate have been disposed of on a fully taxable basis for cash or a promissory note and the proceeds are ultimately reinvested in a new foreign affiliate. Whether this position is correct at law is debatable.

Having regard to the text, context, and purpose of subsection 93(2.1), there seems to be a reasonable interpretation that a taxable disposition of the shares for cash (or a promissory note) should break the chain of substitutions, such that dividends paid on the original shares should no longer be relevant. The French version of subsection 93(2.1) specifically refers to share substitutions ("actions de remplacement"). The English version of subsection 93(2.1) refers to "the affiliate share or a share for which the affiliate share was substituted." The word "share" in the provision must be given the meaning ascribed by subsection 248(1). Other forms of property (such as cash or a promissory note) would not be viewed as a "share." Other provisions of the Act clearly refer to "substituted property," [fn 136: See, for example, the attribution rule in subsection 74.1(1), which refers "to any income or loss, as the case may be, of that person for a taxation year from the property or from property substituted therefor." See also subsection 149.1(1), which refers to "substituted shares.] supporting the view that the different language in subsection 93(2.1) should have a different meaning. …

Streaming of dividends on preferred shares (MRPS) for non-93(2.1) avoidance reasons (p. 26:49-50)

Consider the example of a financing structure commonly implemented by Canadian-based multinationals, which was the subject of an advance tax ruling issued by the CRA in 2011. [fn 145: …2010-0375111R3, 2011….] The structure described in the ruling involved the formation of a financing foreign affiliate in a third country to finance, by way of loans denominated in US dollars, the operations of another foreign affiliate in the United States. The financing affiliate was capitalized with "zero percent" mandatory redeemable preferred shares (MRPS) with no dividend entitlement, and common shares. Typically, to comply with the tax rules in the foreign country, approximately 99 percent of the capital would be contributed in exchange for MRPS, and the remaining 1 percent would be contributed in exchange for common shares. As the financing foreign affiliate earned interest income, dividends would be paid on the common shares, and not on the preferred shares. In the event that the US dollar declined in value, a loss would ultimately be realized on the windup of the financing affiliate. The loss would be driven exclusively by the decrease in value of the US dollar. Because the financing affiliate was capitalized almost exclusively with preferred shares but the dividends would be paid only on the common shares, the loss realized on the disposition of the preferred shares would not be reduced pursuant to subsection 93(2.1). Would the CRA seek to invoke GAAR to deny the loss? In this fact pattern, the use of the preferred shares was dictated by foreign tax reasons.

Subsection 93(4)

Administrative Policy

5 September 2018 Internal T.I. 2017-0698241I7 - Interpretation of subsection 93(4)

FA sub shares acquired “on” disposition of FA parent shares occurring on completion of liquidation and dissolution process

On a liquidation and dissolution (“L&D”) of FA1, it distributed to its parent (ACo) its shares of (wholly-owned) FA2 and FA3 and other property. Ss. 88(3) to (3.5) applied to the L&D. As it was not a “qualifying liquidation and dissolution,” the FA1 properties were disposed of at their fair market value. Prior to the L&D, FA2 and FA1 had paid exempt dividends to FA1 and ACo, respectively. But for s. 93(4), Canco realized a capital loss of $1 million (after the application of s. 93(2.01) to reduce such capital loss by the exempt dividends previously paid by FA1) on its disposition of the FA1 shares. Since the FA2 and FA3 shares were acquired by ACo prior to FA1’s dissolution, did s. 93(4) apply? The Directorate responded:

ACo acquired the shares of FA2 and FA3 as part of the process of liquidating and dissolving FA1, which included ACo disposing of its shares of FA1. In our view, the distribution of the property of FA1 to ACo was “on” the disposition of the shares of FA1.

Consequently, ACo’s otherwise determined capital loss of $1 million on the disposition of its FA1 shares is deemed by paragraph 93(4)(a) to be nil. The denied capital loss is added by paragraph 93(4)(b) to the ACB to ACo of the shares of FA2 and FA3 that ACo acquired on the disposition in proportion to their respective fair market values.

Words and Phrases
on
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 93 - Subsection 93(2.01) s. 93(2.01) applied to capital loss resulting from s. 94(3) basis bump 176
Tax Topics - Income Tax Act - Section 93 - Subsection 93(1) no s. 93 election available where ACB bump under s. 94(3) eliminated gain before application of s. 93(1) 137