An individual ("A") wholly-owning Holdco, held Holdco common shares with a nominal FMV, ACB and PUC, and Holdco preferred shares having an FMV of $1M and an ACB of $0.5 million (as a result of a previous capital gains crystallization transaction) and a nominal PUC. Holdco, which wholly-owned Opco, held Opco common shares having a nominal FMV, ACB and PUC, and Opco preferred shares having an FMV and ACB of $1M, and nominal PUC.
A first exchanged all his Holdco preferred shares for new preferred shares having a redemption value of $0.5M and (pursuant to s. 86(1)(g)) a deemed cost of $0.5M and for common shares having an FMV of $0.5M, and cost (pursuant to s. 85(1)(h)) of nil and a nominal PUC. After acquiring A’s Holdco common shares for FMV consideration ($0.5M in notes issued by them to A), A’s children then sold those shares to a Newco formed by them in exchange for a Newco promissory note for $0.5M. Holdco then redeemed its preferred shares held by A for $0.5M (paid with a $0.5M note of Holdco), so that Holdco received a deemed dividend of $0.5M and sustained a capital loss of $0.5M. Opco then redeemed its preferred shares held by Holdco for $0.5M, thereby enabling the repayment of the $0.5M note owing by Holdco to A. Holdco paid dividends to Newco, thereby permitting Newco to repay the notes issued to the children.
CRA indicated that on the disposition by the children to Newco for $0.5M of their common shares of Holdco acquired for $0.5M, the aggregate ACB to them of such shares would not have been reduced pursuant to s. 84.1(2)(a.1)(ii) (before any GAAR application), stating:
[N]o part of the aggregate ACB to the children of the common shares of the capital stock of Holdco would be attributable to the capital gains deduction claimed by A … on the crystallization transactions … [given] that, by the application of paragraph 85(1)(g), the entire amount of the capital gain realized by A and in respect of which he would have claimed a capital gains deduction pursuant to section 110.6 would have been attributed to the preferred shares of the capital stock of Holdco.
CRA went on to indicate that there would have been such a reduction in the aggregate ACB had the preliminary transaction to exchange the Holdco common shares for new preferred shares and commons shares not been implemented, and the shares sold to the children included some of the old preferred shares.