The six taxpayers, who were siblings (or a step-daughter of their deceased father), held all the shares, having an aggregate fair market value (FMV), adjusted cost base (ACB) and paid-up capital (PUC) of $617,466, $361,658 and $25,100 respectively, of a Canadian real estate company (Oka). They sought through the transactions described below to reduce the deemed dividend of $592,362, that otherwise would have arisen on the redemption of their shares, to approximately $265,505 (see 4 and 7 below [minor discrepancy in figures]). CRA assessed on the basis that a deemed dividend of the larger amount had been realized, as there had been an indirect distribution from Oka described in s. 84(2).
- Oka lent $544,354 to a newly-incorporated company (9149) in December 2004.
- In March 2005, the taxpayers exchanged their shares of Oka under s. 85(1) for Class B and C preferred shares of Oka, so that they realized a capital gain of $361,658 (which was offset by the current year's capital loss realized in 4 below and a carryback of the capital loss in 7 below) and with the Class B and C preferred shares having ACBs of $269,618 and $347,848 and low PUC.
- They exchanged their shares of Oka for Class A common shares of 9149 having an ACB and PUC of $347,848 (with such PUC "step-up" complying with s. 84.1) and Class B preferred shares of 9149 having an ACB and PUC of $269,618 and nil.
- Also in March 2005, 9149 redeemed the Class A common shares for their PUC and ACB of $347,848 (so that no deemed divided or capital gain resulted) and redeemed approximately ¾ of the Class B preferred shares, giving rise to a deemed dividend and capital loss of $196,506 to the taxpayers.
- Oka sold its real estate in December 2005, but with title issues not resolved until December 2006.
- Oka was wound-up into 9149 in December 2006, with the loan in 1 being extinguished.
- At the end of 2008, 9149 redeemed the (¼) balance of the Class B preferred shares for $69,000, giving rise to a deemed dividend and capital loss to the taxpayers of $69,000 and $73,112.
In finding that the transactions abused the object of s. 84.1, Hogan J stated (at paras. 56, 59):
The tax specialist was aware of the fact that section 84.1 of the Act would cause the Class B shares issued by 9149 [step 3] to have an adjusted cost base that is higher than their paid-up capital, which would prevent the additional value accumulated before 1971 from being used to strip Oka of its surpluses. However, applying this rule ensures that the redemption of these shares will generate a capital loss that is sufficient to erase the capital gain realized in the preceding step, namely, the internal rollover of Oka's common shares [step 2].
...
The result of all three transactions ... is that the tax-exempt margin made it possible for part of Oka's surplus to be distributed to the appellants tax-free in a manner contrary to the object, spirit or purpose of section 84.1 of the Act.
Having regard to $66,940 of capital gain having been realized on the death of the taxpayers' father, the Minister was directed to assess on the basis that the taxpayers received a deemed dividend of $525,422.