Holdco, whose common shares of Opco have a nominal adjusted cost base ("ACB") and paid-up capital ("PUC"), a fair market value ("FMV") of $2 million and safe income on hand ("SIOH") attributable to those shares of $900,000, increases the PUC of those shares by $1 million, and transfers those common shares (or to be more precise, new common shares issued in replacement therefor on the PUC increase) to Opco for cancellation in consideration for the issuance by Opco of (i) preference shares of Opco having an FMV, PUC and ACB (determined under s. 85(1)(g)) of $1 million; and (ii) common shares having a FMV of $1 million and nominal PUC and ACB.
If s. 55(2) did not apply to the s. 84(1) dividend, then the ACB of the common shares of Opco held by Holdco following that PUC increase would be determined under s. 53(1)(b) as the excess of the s. 84(1) deemed dividend of $1 million minus $100,000, being the portion of that dividend that did not come out of SIOH - i.e., $900,000.
On the other hand, if s. 55(2) applied to the s. 84(1) dividend, the ACB of those common shares would be the excess of the s. 84(1) deemed dividend received by Holdco (which, by virtue of s. 55(2) would be limited to the SIOH of $900,000) over the nil portion of that deemed dividend that did not come out of SIOH hand - i.e., also $900,000.
Accordingly, in both scenarios, Holdco would realize a $100,000 capital gain on the "dirty s. 85" transfer of the common shares, i.e., the excess of the agreed amount of $1 million over the ACB of $900,000. No amount would be added to the proceeds of disposition of the common shares because of the exclusion under s. 55(2)(b); and CRA would not apply s. 55(2)(c).
Respecting the application of s. (a)(i)(A) of the CDA definition, CRA stated:
As indicated in Technical Interpretation No. 2011-0421141E5, in situations where it is determined that subsection 55(2) would not apply to a transaction or series of transactions or events, according to the proposed changes to the CDA definition, it would be necessary to recalculate the capital gain for the purposes of calculating the CDA as if the decrease in ACB provided for in subparagraph 53(1)(b)(ii) (as proposed) had not been effected. This would have the consequence that for the purpose of calculating the CDA, the capital gain added under clause 89(1)(a)(i)(A) of the CDA definition would be less than the capital gain calculated for the purposes of section 39. Thus, in [the dirty s. 85 exchange in[ Step 14 and in computing the CDA of Holdco, the proceeds of disposition to Holdco of the 2,000,000 common shares held in the capital stock of Opco would be $1,000,000 by virtue of paragraph 85(1)(a), and the ACB of those shares would also be $1,000,000 by reason of clause 89(1)(a)(i)(A) and paragraph 53(1)(b) (without taking into account subparagraph 53(1)(b)(ii)) (as proposed). Accordingly, no capital gain would be realized for the purposes of clause 89(1)(a)(i)(A) in such a context.