Parentco holds shares of a wholly-owned subsidiary (Subco1) with a fair market value (“FMV”) and adjusted cost base (“ACB”) of $200,000 and $2,000, respectively. Subco1 held a subsidiary (Subco1) whose shares had an FMV and ACB of $20,000 and $2,000, respectively. Subco2 is spun-off to a newly-incorporated subsidiary of Parentco (i.e., Parentco transfers 10% of its shares of Subco1on an s. 85 rollover basis to Newco for Newco shares, Subco1 transfers its Subco2 shares on an s. 85 rollover basis to Newco for Newco shares, and the cross-shareholdings are cross-redeemed) as a result of which Parentco’s shareholding in Newco now had an FMV and ACB of $20,000 and $200, respectively. On an s. 88(1) winding-up of Newco, Parentco acquired the shares of Subco2 at a cost (under s. 88(1)(c)) of $2,000 (i.e., an $1,800 increase over the $200 ACB that it had for its shares of Newco).
Is CRA concerned by this $1,800 increase in the ACB of the assets of Parentco?
CRA indicated that the transfer of the Subco1 shares by Parentco causes a misalignment between outside and inside basis, so that the reorganization, followed by the winding up of Newco, results in what CRA considers as an inappropriate tax benefit.
In situations like the one described, CRA would not rule favourably and would consider applying the GAAR, because there is an undue increase in the hands of Parentco that is contrary to the scheme of the Act, and, more specifically, of s. 55(2).
CRA then referred to an alternative reorganization where, there was an arrangement of the transactions such that, upon the winding-up of Newco into Parentco under s. 88(1), the outside basis in Newco ($2,000) matches the inside basis (a $2,000 ACB of the shares of Subco2 to Newco). In that situation, there could be a favourable ruling because Parentco thus had transferred enough ACB in the shares of Subco 1 to Newco to cover the ACB of the assets that were then transferred by Subco 2 to Newco. This would result in an alignment of the outside and inside basis.