The taxpayer was a paper products manufacturer. One of its five divisions was its Tissue Division which focused on the manufacturing and sale of toilet paper and paper towels. In 2009, the taxpayer entered into a number of transactions designed to effect the transfer of the Tissue Division to a competitor named Cascades Canada Inc. A rollover of certain assets of the Tissue Division was made to a newly formed corporation named 7228392 Canada Inc. (“722”) pursuant to s. 85(1) in exchange for common shares of 722, which were ultimately sold to Cascades. The Tissue Division operated from three different locations, two of which, (the “Progress Property” and the “Whitby Property” where large tissue rolls were produced from recycled paper), were owned by the taxpayer and the third location, (the “Converting Property” where those rolls were converted into rolls of toilet paper and paper towels), was leased from an affiliated party. The only assets that were transferred to 722 were the Converting Mill and the remaining converting assets. All of the other assets of the Tissue Division were either sold directly to Cascades, leased to Cascades or retained by the taxpayer. The taxpayer’s leasehold interest in the Converting Property was subleased to Cascades for $1 per year.
The taxpayer reported its $29.2 million gain on the sale of the shares of 722 as a capital gain in reliance on s. 54.2. The Minister reassessed the taxpayer on the basis that the gain should have been reported on income account as the Tissue Division was not a business in itself but rather was a part of the Appellant’s overall paper products business, and in any case the taxpayer did not transfer all or substantially all of the assets used in the Tissue Division to 722. The only issue before Graham J was the applicability of s. 54.2.
Before going on to find that s. 54.2 did not apply, Graham J first noted that it was unnecessary, given his findings below, for him to address whether the Tissue Division was a separate business, and then stated (at paras 25, 27 and 28):
It is unclear on the face of section 54.2 how I am to determine whether the assets … transferred to 722 represent all or substantially all of the assets of the Tissue Division. …The test in section 54.2 can be contrasted to the definition of “small business corporation” found in subsection 248(1). That definition requires an examination of whether “all or substantially all of the fair market value of the assets” of the corporation meets certain tests. …[W]hen Parliament wants to require the use of fair market value in an “all or substantially all” test, it does so explicitly. However, …[i]t simply indicates that I am not limited to considering value.
While there does not appear to be a requirement that the recipient of the assets be able to carry on the business, the inverse is not necessarily true. It is arguable that the test in section 54.2 could be satisfied so long as the recipient had received all of the key assets of the business, regardless of their value. …
…I find that the test in section 54.2 is intended to be a somewhat flexible test but that there is no reason not to consider the fair market value of the assets when applying the test. …
Graham J found, to the extent that the test in s. 54.2 considers fair market value, the taxpayer had not met the test, stating (at paras 32, 33):
… [T]he assets transferred to 722 would make up only 68% of the total assets of the Tissue Division. While I acknowledge that all or substantially all does not mean 90% and that the specific percentage that meets the test in any given context may vary, I cannot accept that it means something just over two-thirds. …
There was no evidence as to the fair market value of the portion of the Progress Property [or] … the Whitby Property used by the Tissue Division. … Had these assets been included in the … calculation, the percentage of fair market value transferred to 722 would have been even lower.
He also rejected (at paras. 38 et seq.) on the evidence that the dropped-down assets represented “the heart of the business of the Tissue Division.”