Context: The surplus-stripping rule in s. 84(2) was first adopted in 1924. The rule says that where property of a corporation has been distributed “or otherwise appropriated in any manner whatever” to or for the benefit of the shareholders “on the winding-up, discontinuance, or reorganization of its business”, the shareholders are deemed to receive a dividend unless there is a corresponding reduction in the paid-up capital of the corporation’s shares. Before the decision in Foix et. al. v. The King, 2023 FCA 38, the breath of this provision was unclear. There were two conflicting lines of cases: one line interpreted the provision narrowly (i.e., the specific property distributed had to be that of the corporation itself); the other line interpreted the provision broadly (i.e., indirect distributions of fungible property paid to a shareholder/creditor by a third-party purchaser/facilitator could also be caught). The decision in Foix has now clarified that s. 84(2) must be interpreted broadly.
Federal Court of Appeal (FCA) confirms breadth of s.84(2): The facts in Foix involved a fairly complex “hybrid” sale of a corporation’s assets and its shares to an arm’s length buyer. At the heart of the case was a $19.75 million promissory note received by the corporation as partial consideration for the sale of its assets. The evidence showed that this note was never paid. In the face of the corporation and the shareholders failing to explain why it was never paid, the trial judge found as a fact that the non-payment impoverished the corporation and freed up cash in the purchaser to pay the shareholders for their shares (paras. 65 and 66). The FCA upheld the trial judge’s decision, saying that s. 84(2) is “sufficiently broad to counter this type of distribution when the property being distributed is fungible and a third-party facilitator is involved in the extraction process” (para. 67). In this respect, the words “in any manner whatever” in s. 84(2) are far-reaching and faithfully reflect the anti-avoidance purpose of the provision (para. 68). The FCA likewise noted that the words “winding-up, discontinuance, or reorganization” in s. 84(2) should also be construed broadly rather than narrowly (para. 87). This condition was met here because the corporation’s business had been sold and split into two within the purchaser group (para. 91).
The takeaway: Beware of s. 84(2). It casts a wide net and “necessarily looms over taxpayers who, with the assistance of third-party facilitators, use the sale of their business to extract surpluses without tax or at a reduced rate” (para. 83).
