An estate freeze was implemented for the benefit of X’s child under which, in the course of a capital reorganization of Opco, Holdco (held by X) and 3rd-Party Holdco exchanged 60% and 40% of the Opco Class A common shares (having a safe income on hand of $2,000,000) for 60% and 40% of a newly-created class of (Class B) preferred shares (whose redemption amount of $5,000,000 well exceeded the safe income on hand attributable to the common shares) and X’s child and 3rd-Party Holdco subscribed $60 and $40 for Class A common shares (so that X’s child acquired de jure control).
Would s. 55(2) apply if proportional portions of the Class B preferred shares were redeemed simultaneously (or, alternatively, sequentially on the same day – Holdco’s shares being redeemed first)?
CRA first noted that there would be no significant increase in 3rd-Party Holdco's interest in Opco on the common share subscription (being an increase of $40 out of $5,000,100 in absolute dollar terms, and with no change in the 40% percentage interest) and the simultaneous preferred share redemption also would not result in any increase in the direct interest of 3rd-Party Holdco in Opco.
However, there would be “a significant increase in the direct interest of X's child in Opco for purposes of subparagraphs 55(3)(a)(ii) and (v)” since (per the Summary) that child “acquires 60% of the future value of Opco.” Furthermore, the s. 86(1) share exchange would result in a disposition of the Class A shares to Opco (unrelated to 3rd-Party Holdco), so as to come within subparagraphs 55(3)(a)(i) and (iii). Thus, s. 55(2) would apply in the simultaneous redemption scenario.
The sequential redemption scenario required a determination as to whether the percentage of the value of the Opco shares held by 3rd-Party Holdco would have a significant increase immediately after the redemption. If so “the deemed dividend paid pursuant to subsection 84(3) on the redemption of the Class B preferred shares held by Holdco … would technically be subject to subsection 55(2).”