In December 2005, the appellant (“Québecor”) held 54.72% of the shares of another holding company (“Québecor Media”) which, in turn, held all the common shares of a third holding company (“366”) directly and preferred shares of 366 through a fourth holding company (“9101”). The common shares of 366 had an adjusted cost base (“ACB”) of $400 million and a nil fair market value (“FMV”) and the preferred shares of 366 had an FMV, ACB and paid-up capital (“PUC”) of $195.6 million, $166.5 million and $166.5 million, respectively. 366 held shares of an operating subsidiary with a net accrued capital loss of approximately $200 million.
In December 2005:
- The PUC of the preferred shares held by 9101 in 366 was reduced to a nominal amount.
- Québecor transferred its common shares of Abitibi Consolidated Inc. (“Abitibi”), having an FMV of $191.8 million and a nominal ACB, to 366 on a s. 85(1) rollover basis in exchange for preferred shares of 366.
- 366 then redeemed such preferred shares in consideration for issuing a note to Québecor, and repaid the note by transferring the Abitibi shares back to Québecor.
- On a winding-up of 366, all its assets were transferred to 9101. Given that s. 69(5) applied to this winding up, it thereby realized a capital loss on its shares of its subsidiary, which more than offset the capital gain realized by it on its transfer of Abitibi shares in 2 above, and was deemed by s. 84(2) to pay a dividend to 9101. Furthermore, Québecor Media thereby realized the accrued capital loss on its common shares of 366. S. 112(3) did not apply to deny this capital loss given that only 9101, not Québecor Media, received a deemed dividend on the winding-up.
In finding that the transfer of the Abitibi shares on a rollover basis to 366 did not constitute an abuse of the object and spirit of s. 85(1), Ouimet J stated (at para. 280, TaxInterpretations translation) that “this provision allows two related corporations ... to transfer a capital gain to be realized on a property from one corporation that does not have a capital loss to another that does have a capital loss, so that the latter can deduct it from the capital gain to be realized on the transferred property.” Although he accepted (e.g., at para. 281) that the object of s. 85(1) was to provide for the deferral rather than the elimination of tax, here the step-up of the ACB of the Abitibi shares in the hands of Québecor entailed the receipt by it of a deemed dividend that was included in its income (albeit, eligible for the s. 112(1) deduction), and the capital gain realized by 366 on disposing of the Abitibi shares was included in computing its income (para. 293).
In finding that it was not an abuse of ss. 88 and 69(5) for 366 to have been wound-up on a non-rollover basis so as to realize a capital loss, Ouimet J noted (at para. 274) that the scheme of s. 88 was to provide for both wind-ups on a rollover basis under s. 88(1) and for wind-ups on a taxable basis under ss. 88(2) and 69(5) and stated (at para. 273) that the specific exclusions of stop loss rules and other anti-avoidance rules in ss. 69(5)(c) and (d) “indicates the intention to allow, in the wound-up company's final year, the recognition of losses that would otherwise not have been realized under the specific anti-avoidance rules.”
Regarding the realization of capital losses at two levels (by 366 and by Québecor Media), Ouimet J stated (at para. 242) that “there is no provision that prevents a capital loss at two levels to the extent that the ACB of the shares exceeds the proceeds of disposition of the shares at both levels.”
The appeal was allowed.