28 May 2021 External T.I. 2021-0889611E5 - ACB and Safe income allocation on corporate reorg. -- summary under Paragraph 55(2.1)(c)

Assume that Parentco owns 100% of the shares of Holdco 1 which owns 100% of Holdco 2 which owns 100% of Opco. The group intends to transfer one of Opco’s existing business assets (“Property 1”) to Holdco 1. Holdco 1 and 2 own assets in addition to the above shareholdings.

Tax attributes include:

The correspondent presented two scenarios which CRA appeared to consider to have a similar effect. Under “Alternative B”:

1. Opco transfers Property 1 to Newco (newly formed by Holdco 1) on a s. 85(1) rollover basis in exchange for Newco preferred shares.
2. Holdco 2 exchanges all of its Opco shares under s. 85(1) for Opco preferred shares with a redemption value equaling the fair market value (“FMV”) of Property 1 (and, per s. 85(1)(g), having a cost of $65), and for new common shares.
3. The Newco preferred shares held by Opco, and the Opco preferred shares held by Holdco 2 are redeemed through the issuance by Newco, and the assignment by Opco, of Newco A Promissory Note.
4. Holdco 1 exchanges all of its Holdco 2 shares under s. 85(1) for Holdco 2 preferred shares with a redemption value equaling the FMV of Property 1 (and, per s. 85(1)(g), having a cost of $75), and for new common shares.
5. The Holdco 2 preferred shares held by Holdco 1 are redeemed in consideration for Holdco 2 assigning Newco A Promissory Note.
6. Newco is wound up under s. 88(1) and, by virtue of a s. 80.01(4) election, Newco A Promissory Note (held by Holdco 1) is deemed to have been settled at its cost amount.

The questioner noted that Newco A Promissory Note, whose amount represented a streaming of cost base under s. 85(1)(g) is cancelled, thereby eliminating the cost based that was steamed under s. 85(1)(g) and that, under the transactions, there should be no concern about misalignment of outside and inside basis as described at 2020-0860991C6. In this context, does CRA require representations regarding direct safe income (“DSI”) and indirect safe income (“ISI”) of each corporation, both prior to and following the reorganization, before ruling?

CRA indicated:

• Prior to the reorganization, the $65 cost of the Opco shares to Holdco 2 and Opco’s $170 safe income had contributed to the acquisition of property of Opco with a total cost of $235 ($100 + $135).
• Applying the position in 2020-0861031C6 and 2021-0876441E5, when Opco has transferred Property 1 out on a tax-free basis, its DSI should be reduced and, in particular, Opco is considered to have transferred a portion of its DSI on the tax-free transfer of Property 1to Holdco 2 and, in turn, by Holdco 2 to Holdco 1.
• The DSI and ISI of each corporation and the required ACB transfer to avoid misalignment of outside and inside cost would be calculated as follows:

1. DSI on the shares of Opco after reorg: DSI of Opco prior to reorg ($170 x net cost amount of assets retained by Opco ($135) / total cost amount of assets of Opco prior to reorg ($235) = $98.

2. DSI of Opco considered to be transferred to Holdco 2: $170 - $98= $72.

3. The ACB of shares of Opco held by Holdco 2 that is required to be eliminated on the reorg is $28 (i.e., the fraction represented by the $100 cost amount of the transferred property to the pre-transfer cost amount of all the Opco property of $235 applied to the $65 beginning ACB of the Opco shares, is $28), resulting in a remaining ACB in the shares of Opco held by Holdco 2 after the reorg of (65-28) $37. In the current situation, this ACB of $37, combined with the remaining safe income of Opco of $98 would be the correct amount required to support the cost of the remaining assets of Opco of $135.

4. DSI of Holdco 2 after reorg: (DSI of Holdco 2 prior to reorg ($10) + $72 DSI considered to have been received from Opco per 2 above) x net cost amount of assets considered retained by Holdco 2 ($37 per 3 above, plus the $20 cost of other assets, totaling $57) / (net cost amount of assets of Holdco 2 “prior to” [sic] reorg ($57) + net cost amount of assets considered to have been received from Opco ($100 cost of Property 1)) = 82 x 57/157 = $30.

5. DSI of Holdco 2 considered to be transferred to Holdco 1: $82 – $30 = $52.

6. ISI of Holdco 2 after reorg: equal to DSI of Opco after reorg = $98.

7. The ACB of shares of Holdco 2 held by Holdco 1 that is required to be eliminated on the reorg is $48, resulting in a remaining ACB in the shares of Holdco 2 held by Holdco 1 after the reorg of (75-48) $27. In the current situation, this ACB of $27, combined with the remaining safe income of Holdco 2 of $30 would be the correct amount required to support the cost of the remaining assets of Opco of $57 ($37 in the cost of the shares of Opco and $20 in the cost of other assets).

8. DSI of Holdco 1 after reorg: DSI of Holdco 1 prior to reorg ($1,000) + amount considered to have been received from Holdco 1 ($52) = $1,052. The DSI of Holdco 1 of $1,052, combined with the cost on the shares of Holdco 1 held by Parentco of nil, would be the correct amount required to support the cost of the assets held by Holdco 1 after the reorg of $1,052 (being the aggregate of $100 of cost on Property 1, remaining ACB in the shares of Holdco 2 of $27 and cost of other assets of $925).

9. The ISI of Holdco 1 after reorg would be $98 + $30= $128.

• CRA indicated that, as the safe income at each level below Holdco 1 is reduced, the ACB of the shares held by a direct parent in each corporation does not need to be totally eliminated in order to avoid a misalignment of inside and outside ACB. Conversely, the full elimination of ACB of the shares of a corporation in a reorganization does not necessarily address the issue of misalignment of ACB “especially when the corporations involved have a significant amount of safe income that was not capitalized.’ However, in the above situation, where there was the full elimination of ACB on the shares at each level, there did not seem to be a misalignment of ACB that would be of concern.