Principal Issues: (1) Whether the GAAR would apply to a series of transactions (“Series”) pursuant to which an individual (“Brother”) would transfer his shares in a Canadian-controlled private corporation (“Opco”) to a newly incorporated corporation (“Brother Holdco”) on rollover basis prior to Brother Holdco’s disposition of the Opco shares at their FMV (“Sale”) to a corporation newly incorporated by his sister (“Sister Holdco”) for a cash consideration of $200,000 and the balance of the sale price payable within a period of four years after the date of the Sale? (2) Whether a provision can be claimed by Brother Holdco under subparagraph 40(1)(a)(iii) (“Provision”) as a result of the terms of the Sale?
Position: (1) Unlikely; (2) Unable to answer.
Reasons: (1) See below (2) See below.
FEDERAL TAX ROUNDTABLE, OCTOBER 7, 2022
APFF CONFERENCE 2022
8. Using a holding company to effect the sale of shares
Mr. A ("Brother") and Ms. B ("Sister") are 60 and 45 years old respectively.
Brother and Sister each directly hold 50 common shares of the capital stock of an operating company ("Opco") with a paid-up capital of $50, an ACB of $50 and an FMV of $1 million. These shares essentially constitute the "retirement fund" for Brother.
In anticipation of his retirement, Brother wishes to sell all of the shares he holds in the capital stock of Opco to Sister in order to receive the cash he will gradually require in the future for personal use (the "Transfer").
Brother would be subject to section 84.1 if he transferred the shares he holds in the capital stock of Opco to a corporation owned by Sister.
In order to reduce the tax consequences resulting from the Transfer, Brother and Sister propose to implement the following series of transactions (the "Proposed Transaction Series"):
(a) Brother forms a new corporation of which he is the sole shareholder ("Brother-Portfolioco");
(b) Brother transfers all of the 50 common shares he holds in the capital stock of Opco (the "Transferred Shares") to Brother-Portfolioco pursuant to the rules in subsection 85(1). In this regard, the agreed amount between Brother and Brother-Portfolioco is equal to the ACB to Brother of the Transferred Shares.
(c) Sister also forms a new corporation of which she is the sole shareholder ("Sister-Holdco");
(d) Brother-Portfolioco sells the 50 common shares it holds in the capital stock of Opco to Sister-Holdco (the "Sale") for $1 million (the "Sale Price");
e) Brother-Portfolioco realizes a capital gain as a result of the Sale (the "Capital Gain");
(f) The non-taxable portion of the capital gain resulting from the Sale is added to the capital dividend account ("CDA") of Brother-Portfolioco;
(g) Upon completion of the Sale, Sister-Holdco immediately pays Brother-Portfolioco the sum of $200,000 previously lent to Sister;
(h) Sister-Holdco pays the balance of the Sale Price of $800,000, bearing interest at the rate of 5%, payable annually, to Brother-Portfolioco over the next four years at a rate of $200,000 per year;
(i) Sister-Holdco pledges to Brother-Portfolioco the shares of the capital stock of Opco that it acquired as security in the event of default in payment of the balance of the Sale Price;
(j) A capital gains reserve (the "Reserve") could be claimed by Brother-Portfolioco to the extent that Sister-Holdco is not controlled, directly or indirectly in any manner whatever, by Brother-Portfolioco. This appears to be the case unless the CRA alleges "de facto" control by Brother-Portfolioco;
(k) In the taxable years following the Sale, Brother-Portfolioco pays to Brother capital dividends from its CDA as well as taxable dividends.
Questions to the CRA
(a) Can the CRA confirm that in the context of a bona fide business transaction between siblings as described in the Proposed Transaction Series, it would not apply the General Anti-Avoidance Rule (“GAAR”) provided under subsection 245(2) by reason of the specific creation of Brother-Portfolioco in order to minimize the tax consequences of the Sale? It should be noted that if Brother already held the shares of the capital stock of Opco through a holding company or a family trust providing for a corporate beneficiary created or to be created, the appropriate corporate structure to implement the series of transactions would have already been in place for a number of years.
(b) Would the CRA's response to Question 8(a) be the same if Brother-Portfolioco were instead to sell 20% of the common shares of the capital stock of Opco per year for the next five years at their applicable FMV on each of those dates rather than immediately selling the 50 shares with a balance of sale price owing?
(c) Can the CRA confirm that Brother-Portfolioco could claim the Reserve to reduce the amount of the capital gain on the Sale?
CRA Response to Question 8(a)
The potential application of the GAAR pursuant to subsection 245(2) requires an analysis of all the facts and circumstances relating to a particular situation. Consequently, only a detailed analysis of all the facts would allow us to make a definitive decision as to the application of the GAAR to a particular situation. That said, we can make the following general comments.
The CRA remains concerned about any form of corporate surplus stripping arrangement and tax planning that is contrary to the integration principle. Consequently, where the principles established by the jurisprudence can be applied in a file, the CRA continues to invoke the GAAR to counter such plans.
However, in a situation such as the one described, the CRA would not rely on the application of the GAAR solely because of the specific formation of Brother-Portfolioco to proceed with the Sale.
CRA Response to Question 8(b)
The CRA's conclusion would be the same even if Brother-Portfolioco instead sold 20% of the common shares in the capital stock of Opco per year for the next five years at their FMV at the time of sale.
CRA Response to Question 8(c)
Pursuant to subparagraph 40(1)(a)(iii), Brother-Portfolioco may claim a reasonable allowance if it can demonstrate that the conditions set out in that subparagraph are satisfied and that the restriction set out in paragraph 40(2)(a) do not apply, in particular, because immediately after the Sale:
- Sister-Holdco was not controlled, directly or indirectly, in any manner whatever, by Brother-Portfolioco or by a person or group of persons who controlled, directly or indirectly, in any manner whatever, Brother-Portfolioco, or
- Sister-Holdco did not control, directly or indirectly, in any way whatever, Brother-Portfolioco.
With respect to the Proposed Series of Transactions, such a determination is based on the ability to establish that immediately following the Sale:
- Brother-Portfolioco or Brother did not have de facto control of Sister-Holdco; and
- Sister-Holdco did not have de facto control of Brother-Portfolioco.
As provided for in subsection 256(5.11) and the applicable jurisprudence, any factor, whether contractual, commercial, economic, moral or familial, may be taken into consideration in order to determine whether a person or group of persons has influence, direct or indirect, the exercise of which would result in de facto control of a corporation ("Influence"). In this regard, only a complete review of all relevant facts, actions, circumstances and documents surrounding a particular situation can enable us to determine whether a person has Influence over a Corporation.
In view of the limited facts that have been provided, we cannot give a final opinion on this matter without first considering all the facts relating to the Proposed Series of Transactions.
François Mathieu
October 7, 2022
2022-094215