Holdco received $500,000 in dividends on its common shares of Opco (generating s. 112(1) deductions and then some years later, transferred those shares on a s. 85(1) rollover basis to Opco for 100 new common shares of Opco at an agreed amount corresponding to the transferred shares’ cost, paid-up capital and fair market value. No dividends were received on the new shares, and subsequently realized a business investment loss under s. 50(1)(b)(iii). Would the s. 112(3) stop-loss rule apply?
After noting that there in fact may have been no disposition of the old shares as the attributes of the new shares might have been identical, CRA stated:
Given that section 85 is not referred to in subsection 112(7), a share (a "new share") that is acquired in exchange for another share (an "old share") in a transaction to which section 85 applied would not be deemed, on its disposition, to be the same share as the old share for the purposes of any of subsections 112(3) to (3.2). Thus, an unrealized loss on the new share that would have been generated after the rollover transaction by virtue of section 85 and that would be sustained or realized by a corporation upon the disposition of such new share would not technically be reduced by virtue of subsection 112(3) by the amount of dividends received on the old share.
However, a rollover of shares under subsection 85(1) effected to circumvent section 112(7) could constitute an avoidance transaction, which would lead the CRA to consider the potential application of the general anti-avoidance rule.