Context: In a sale by a corporate group, options typically arise whether to sell assets at the bottom tier, shares of an operating company, or shares of a holding company. Tax considerations often arise in analyzing these options, not least because the tax basis in assets can easily differ from the tax basis (ACB) in shares. Further, the ACB of shares of a lower-tier company can easily differ from the ACB of shares of a higher-tier holding company. Taking full advantage of these differing tax attributes can present challenges in some cases, as is demonstrated by the case discussed in this Quick Update. 

Tax Court Applies the GAAR to Deny ACB Shift on Shares: In 3295940 Canada Inc. v. The Queen, 2022 DTC 1080 (TCC), a parent company in a corporate group (the Parent) wished to sell shares of a company in the group (A Co). The shares of A Co were indirectly held by a holding company (B Co) owned by the Parent. The ACB of the Parent’s shares of B Co was much higher than the ACB of B Co’s shares of A Co. In a perfect world, the Parent would sell the shares of B Co to take advantage of the higher ACB, but the buyer did not want to purchase B Co because of contingent liabilities in B Co. In order to effectively sell A Co and take advantage of the higher ACB on the shares of B Co, the group took the following steps


1. The Parent’s newly created preferred shares of B Co (representing the Parent’s higher ACB of $31.5M) were transferred to a new company (Newco) in exchange for shares of Newco worth $31.5M. The ACB of these Newco shares issued to Parent was likewise $31.5M.

2. B Co’s shares of A Co – valued at $88.5M and having an ACB of $4M – were then sold to Newco in exchange for preferred shares of Newco (valued at $57M) and common shares of Newco (valued at $31.5M). B Co and Newco filed an election under s. 85(1) with an agreed amount set at $57M (i.e., a partial rollover). This meant that B Co realized a capital gain of $53M ($57M - $4M) on the transfer of its A Co shares, and the ACB of B Co ’s $57M of preferred shares of Newco was equal to the elected amount of $57M under s. 85(1)(g). B Co’s $31.5M common shares of Newco had a nominal ACB under s. 85(1)(h). The $26.5M (50%) tax-free portion of B Co ’s $53M gain was added to B Co’s capital dividend account (CDA), bringing its total CDA at that time to $31.5M.

3. The $31.5M of inter-corporate shareholdings (i.e., Newco’s $31.5M preferred shares of B Co and B Co’s $31.5M common shares of Newco) were then eliminated/redeemed for offsetting promissory notes, giving rise to deemed dividends of $31.5M in both Newco and B Co under s. 84(3). To avoid s. 55(2) converting these deemed dividends into (taxable) capital gains, B Co elected to pay a tax-free capital dividend to Newco out of its $31.5M CDA, Newco added this $31.5M capital dividend to its own CDA, and Newco elected to pay a $31.5M tax-free capital dividend right back to B Co. No tax was therefore paid in B Co (or Newco) as a result of circulating this $31.5M of CDA back to B Co. 

4. Parent then transferred its $31.5M of shares of Newco to B Co in exchange for additional shares of B Co. This had the practical effect of moving (shifting) the Parent’s $31.5M of ACB on its shares of Newco down into B Co’s hands, with the result that B Co ’s shares of Newco now had a total value and ACB equal to $88.5M. As a final step, B Co sold its shares of Newco to the buyer for $88.5M – realizing no gain. 

The Tax Court held that circulating $31.5M of CDA back to B Co represented abusive tax avoidance under the general anti-avoidance rule in s. 245(2) (the GAAR). More specifically, circulating $31.5M of CDA back to B Co abusively circumvented s. 55(2), which was expected to tax the $31.5M of accrued capital gain avoided in B Co on its shares of A Co (see paras. 130 to 132). This was the gain that would have been realized by B Co if it had simply sold it’s A Co shares to the buyer. The above steps also abusively generated a $31.5M ACB “bump” on the shares of A Co (through the use of Newco), which was not permitted under the “bump rules” in s. 88(1)(d) (see paras. 143 and 144). Finally, the fact that the Parent could have sold its shares of B Co to the buyer – with precisely the same tax benefit as achieved in the above steps – was not a valid “alternative transaction” contemplated by the Federal Court of Appeal’s decision in Univar Holdings Canada ULC v. The Queen, 2017 FCA 207, simply because the shares of B Co were not in fact sold to the buyer (see paras. 159 to 161). As a result, B Co was taxed under the GAAR on an additional $31.5M of capital gain – effectively wiping out the benefit of the $31.5M CDA circulated back to B Co in the above steps.

The takeaway: As matters presently stand, circulating CDA to effectively shift ACB on shares within a corporate group down to a lower-tier sub (to reduce a capital gain on sale) can be ignored under the GAAR. It will be interesting to see if the Federal Court of Appeal agrees with the Tax Court, especially in the context of permitted “alternative transactions” contemplated by the decision in Univar Holdings.