A Canadian corporation (ACo) realized a suspended loss when it contributed its shares (i.e., in a drop-down to which s. 85.1(3) did not apply) of a controlled foreign affiliate (CCo) to another CFA (BCo), and then CCo was then liquidated under s. 95(2)(e) into BCo. In 2017-0735771I7, Headquarters considered that such loss was suspended on the basis that, for purposes of s. 40(3.5)(c)(i), Bco was a corporation “formed” on the “merger” of CCo with BCo – with the result that BCo was deemed to continue to own the shares of CCo with which it was affiliated, notwithstanding that CCo had, in fact, ceased to exist.
Headquarters was subsequently asked in 2019-0793481I7 to consider the consequences of ACo dropping its shares of Bco under s. 85.1(3) into another ACo CFA (DCo) followed by a sale by BCo of its subsidiary (Fco - whose decline in value had caused the decline in value of its own shares) to an arm’s length purchaser, and then by the wind-up of BCo into DCo and into another CFA (ECo) through which DCo had held part of its intrest in BCo. Headquarters concluded that this resulted in the loss being de-suspended, stating that “[u]pon the completion of the liquidation of BCo, it would no longer be affiliated with ACo,” so that the suspended loss was deemed to be a capital loss of ACo immediately after the completion of the liquidation of BCo.
Headquarters has now realized that such winding-up of BCo could be a “designated liquidation and dissolution” described in s. 95(2)(e) (perhaps depending on the size of the direct interest of DCo in BCo)– in which event, s. 95(2)(e)(v)(A)(III) would deem DCo to be a continuation of BCo for s. 40(3.5)(c) purposes respecting shares that were deemed under that paragraph to be owned by BCo before the DLAD (i.e., respecting its deemed continued ownership of the CCo shares) – so that the suspended loss was deemed to be a capital loss of ACo immediately after the completion of the liquidation of BCo.
In now modifying this latter view, Headquarters stated:
[T[he conclusion noted in 2019-0793481I7 would only be applicable to the extent that subparagraph 95(2)(e)(v) of the Act does not otherwise apply to a liquidation of BCo. … [U]nder [s. 95(2)(e)(v)(A)(III)] DCo will be deemed to be the same corporation as, and a continuation of, BCo for the purposes of applying paragraph 40(3.5)(c) in respect of any share that was deemed under that paragraph to be owned, at any time before the liquidation and dissolution, by BCo. Accordingly, DCo would take the place of BCo and would be deemed to own the shares of CCo as long as DCo is affiliated with ACo.