Canco realized a suspended loss when it contributed its shares of a controlled foreign affiliate (CCo) to another CFA (BCo), and then took the position that such loss was de-suspended when CCo was then liquidated into BCo. This position turned on the proposition that s. 40(3.5)(c)(i) did not apply because such liquidation did not satisfy two requirements in order for s. 40(3.5)(c)(i) to apply: the liquidation (a.k.a., winding-up) was not a "merger" of the loss corporation (CCo) with another corporation (BCo); and such "merger" resulting in the formation of a corporation (BCo).
CRA inferred from the somewhat loose meaning of the term “merger” and the fact that various provisions (but not s. 40(3.5)(c)(i)) exclude a winding-up from a merger, that the liquidation of CCo into BCo was a merger of the two corporations, and then took the further position that it could be inferred from the fact that s. 40(3.5)(c)(i) is stated not to apply to mergers referred to in s. 40(3.5)(b) - which refers to rollover transactions, some of which do not result in a new legal entity being formed - that BCo (which, was already in existence) nonetheless was to be regarded as having been formed on the liquidation.
In commenting in this regard on s. 40(3.5)(b), the Directorate stated:
Generally speaking, paragraph 40(3.5)(b) provides that a share of the capital stock of a corporation that is acquired (i.e., new share) in exchange for another share (i.e., old share) in a transaction is deemed to be a property that is identical to the other share (i.e., old share) if section 51, 86, 87 or 85.1 applies to the transaction. Accordingly, in addition to a winding-up, transactions that fall within sections 51, 86, 87 or 85.1 may also fall within the ambit of a “merger” for purposes of subparagraph 40(3.5)(c)(i). …
Above, it was noted that transactions that fall within sections 51, 86, 87 or 85.1 are carved out of a “merger” in subparagraph 40(3.5)(c)(i). Accordingly, the term “merger” as used therein is broad enough to capture a subsection 86(1) reorganization of capital, as one example. The rollover provisions of subsection 86(1) apply where all of the shares of the capital stock of a particular class are exchanged for new shares in the course of a reorganization of the corporation’s capital. In such a transaction there is no corporation “formed” in the traditional sense. The same can be said for transactions that fall within sections 51 and 85.1. Consequently, the use of the word “formed” in subparagraph 40(3.5)(c)(i) does not, in our view, preclude a merger from including a winding-up.