Tax Court applies GAAR to deny transfer of ACB


The context: In a sale by a group of companies, options usually arise, whether to sell assets at the lower level, shares of an operating company or shares of a holding company . Tax considerations often arise when analyzing these options, particularly because the tax basis of assets can easily differ from the tax basis (ACB) of stocks. Also, the ACB of shares of a lower-tier company can easily differ from the ACB of shares of an upper-tier holding company. Taking full advantage of these different tax attributes can present challenges in some cases, as the case discussed in this quick update shows.

Tax Court applies GAAR to deny ACB change on shares: In 3295940 Canada Inc. c. The Queen, 2022 DTC 1080 (TCC), a parent company of a group of companies (the Parent Company) wished to sell shares of a group company (A Co). The shares of A Co were indirectly held by a holding company (B Co) owned by the parent company. The ACB of B Co’s parent company stock was much higher than the ACB of A Co’s B Co stock. In a perfect world, the parent company would sell B Co’s stock to take advantage of the higher ACB, but l buyer did not want to buy B Co due to contingent liabilities in B Co. In order to effectively sell A Co and take advantage of the higher ACB on B Co shares, the group took the following actions

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

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

3. The $31.5 million of intercompany equity (i.e., the $31.5 million Newco preferred shares of B Co and the $31.5 million B Co common shares of Newco) were then were eliminated/redeemed to offset the promissory notes, resulting in deemed dividends of $31.5M in Newco and B Co under s. 84(3). To avoid art. 55(2) converting these deemed dividends into (taxable) capital gains, B Co elected to pay a tax-free capital dividend to Newco on its CDA of $31.5 million, Newco added this capital dividend of $31.5 million to its own CDC, and Newco elected to pay a tax-free capital dividend of $31.5 million directly to B Co. No tax was therefore paid to B Co (or Newco ) following the remittance of this $31.5 million from CDC to B Co.

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

The Tax Court held that CDC’s remittance of $31.5 million to B Co constituted abusive tax avoidance under the general anti-avoidance rule in s. 245(2) (the GAAR). Specifically, CDC’s $31.5 million remittance to B Co improperly circumvented s. 55(2), which was to tax the $31.5 million accrued capital gain avoided in B Co on its A Co shares (see paras. 130-132). This is the gain that would have been realized by B Co if it had simply sold its A Co shares to the buyer. The above steps also improperly generated a $31.5 million ACB “mark-up” on A Co’s stock (through the use of Newco), which was not permitted under the increase rules” of art. 88(1)(d) (see paras. 143 and 144). Finally, the fact that the parent company could have sold its shares of B Co to the purchaser – with precisely the same tax benefit obtained in the steps above – was not a valid “alternative transaction” contemplated by the decision of the Federal Court of Appeal in Univar Holdings Canada ULC c. La Reine, 2017 FCA 207, simply because the B Co shares were not in fact sold to the buyer (see paras. 159-161). As a result, B Co was taxed under GAAR on an additional capital gain of $31.5 million, thereby reversing the CDC profit of $31.5 million redistributed to B Co in the steps above. .

The take-out sale: As it stands, the circulation of CDA to effectively transfer the ACB of shares of a group of companies to a lower level sub-group (to reduce a capital gain on sale) can be ignored under of the GAAR. It will be interesting to see whether the Federal Court of Appeal agrees with the Tax Court, particularly in the context of the permitted “alternative transactions” contemplated by the decision in Univar Holdings.


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