Principal Issues: Whether we could rule that subsection 245(2) would not apply to a proposed series of transactions similar to file No. 2005-0134731R3.
Position: We would recommend to the GAAR Committee to confirm the application of subsection 245(2) to a series of transactions similar to file No. 2005-0134731R3.
Reasons: The Tax Court of Canada held in Descarries v. The Queen, that such a series of transactions involves avoidance transactions which constitutes an abuse of subsection 84.1(1) as it allows the use of V-day value (and/or the capital gains exemption) to avoid the tax on the capital gain.
9 OCTOBER 2015 FEDERAL TAX ROUNDTABLE
2015 APFF CONFERENCE
Question 14
Descarries Judgment and Indirect Monetization of Capital Gains Deduction
In the advance ruling 2005-0134731R3 F dated October 26, 2006, the sole shareholder ("Shareholder") of a corporation ("Corporation") wished to withdraw and transfer all of his shares in the capital stock of the Corporation to his two children, who were actively involved in the corporation's business.
In the course of the proposed series of transactions, Shareholder had, inter alia, disposed of the common shares he held in the capital stock of the Corporation to each of his two children. As a result of this transfer, Shareholder realized a capital gain in respect of which no capital gains deduction under subsection 110.6(2.1) (the "CGD") was claimed.
Corporation concurrently redeemed the preferred shares in its capital stock held by the Shareholder. These shares had nominal paid-up capital ("PUC”) and a high adjusted cost base ("ACB") resulting from the previous crystallization of the CGD by Shareholder. On the redemption of such shares, the Corporation was deemed to have paid and the shareholder was deemed to have received a dividend under subsection 84(3).
In addition, as a result of this share redemption, Shareholder incurred a capital loss. Subsection 40(3.6) did not apply because Shareholder and Corporation were not affiliated immediately after the disposition by Shareholder of the preferred shares in the capital stock of the Corporation. This capital loss was used by the Shareholder to offset the capital gain realized on the share disposition described above.
The CRA issued favorable rulings respecting this series of proposed transactions. More specifically, the CRA inter alia confirmed that the provisions of subsection 245(2) would not apply, notwithstanding the fact that it could be argued that this series of transactions allowed a Shareholder to indirectly monetize the CGD.
Question to CRA
Following the decision in Descarries v. The Queen (Footnote 1), will the CRA agree to issue favourable advance rulings to the effect that the provisions of subsection 245(2) will not apply in respect of proposed transactions similar to those described in the document 2005-0134731R3 F?
CRA Response
In the Descaries decision, the Tax Court of Canada determined that transactions similar to those proposed in document number 2005-0134731R3 F constituted an abuse of section 84.1 and that they were consequently subject to subsection 245(2).
In that case, the particular shareholders of the corporation l’Immobilière d’Oka Inc. (“Oka”) took part in a series of transactions in the course of which inter alia they exchanged their shares of Oka in consideration for shares in the capital of another corporation, with the shares of a particular class (the “1971 FMV Shares”) having a low PUC and an ACB equal to their FMV. Note that the FMV of the shares of Oka on V-Day (December 22, 1971) was isolated in the ACB of the 1971 FMV Shares of the other corporation.
The 1971 FMV Shares were redeemed and the capital loss sustained was applied against a capital gain previously realized in the course of the series of transactions.
The Tax Court of Canada made the following comments respecting these transactions:
In this light, the analysis shown above allows me to find that the additional value accumulated before 1971 was used to avoid the tax payable on the capital gain. Since the capital gain was created to allow the appellants to receive the Class A shares with a maximum adjusted cost base and paid-up capital, I find that the transactions at issue allowed the appellants to use the value accumulated before 1971 to indirectly distribute part of Oka's surpluses tax‑free.
(…)
…The result of all three transactions described above is that the tax-free zone 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. For these reasons, I find that this provision was applied in an abusive fashion. (footnote 2)
Taking the above into account, the CRA recommended to the Committee on the General Anti-Avoidance Rule that it confirm that the provisions of subsection 245(2) apply respecting a series of transactions similar to those proposed in the advance ruling carrying the number 2005-0134731R3 F.
Such transactions effectively accomplish a distribution of surplus of a corporation in the form of a capital gain even while such capital gain is reduced by a capital loss sustained from the disposition of shares whose ACB arose from the CGD, or from the FMV of such shares on V-Day.
Jean Lafrenière
(613) 670-9013
October 9, 2015
2015-059563
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 2014 TCC 75 (hereinafter "Descarries").
2 Idem, paragraphs 57 and 59.