Background. All of the shares of Mr. A in A Co (which carried on a "business activity" of trading a portfolio) at the time of his death were deemed under ss. 70(5)(a) and (b) to be disposed of and reacquired at fair market value (“FMV”) and were bequeathed along with the residue equally to his four children (Child 1, 2, 3 and 4). They also were the executors of the resident Estate, and were resident in Canada, except for Child 2, who was resident in the U.S. The shares had no V-day value basis and no deduction had been or could be claimed under s. 110.6.
Completed transactions. After two preliminary s. 86 reorganizations, including an exchange by the Estate of shares of three classes (which had been created on the first s. 86 reorganization) for shares of a further new Class (Class B shares), and following the subscription by the Estate for shares of a new class (Class C), A Co repurchased Class B shares (the “Purchased Shares”), being XX% of all outstanding shares, for their FMV, thereby resulting in the receipt by the Estate of a deemed dividend. Such redemption proceeds will be allocated and paid (less withholding tax) by the Estate to Child 2 through its issuance of a non-interest bearing demand promissory note. The Estate will claim a capital loss from the share repurchase based on its proceeds of disposition being reduced under para. (j) of the definition thereof. By virtue of an election under s. 164(6), that loss will be deemed to be a terminal year loss.
Proposed transactions. A conventional pipeline transaction will be implemented respecting the the remaining Class B shares, as well as the Class C shares, of A Co now held by the Estate:
- The Estate will transfer the shares to its newly-incorporated subsidiary ("Newco") in consideration for a note equal to the ACB of the transferred shares minus $X, and for additional Class A shares, electing under s. 85(1).
- After at least one year (during which A Co will continue to carry on its portfolio business activity), A Co will be amalgamated with Newco to form Amalco.
- Thereafter, Newco may gradually repay (out of proceeds of marketable securities) the note payable to the Estate over a period of at least one year (and without discontinuing its portfolio-trading business activity), but with any quarter's payments not exceeding XX% of the note's original principal.
- After full repayment of the note, Amalco will distribute its assets (net of discharged obligations) to the Estate pursuant to winding-up proceedings.
- Within a reasonable time following the receipt of any dividend refund, Amalco will be dissolved. By virtue of written agreement of the four legatees/trustees, no portion of the amount received by the Estate under Amalco's winding-up will be allocated to Child 2, so that any capital dividend account will only be distributed to Canadian resident legatees.
U.S. tax considerations. A Co is a PFIC. The manner of Child 2's removal as an A Co shareholder ensures that he can receive the distribution from A Co "as a capital gain" for Code purposes and avoid the complications of being a PFIC shareholder. Unless Amalco is dissolved within a reasonable time following the purchase of the Purchased Shares by Newco [sic, A Co], Child 2 will suffer adverse U.S. tax consequences with respect to the dividend received by him. The transactions are being undertaken as a “Plan of Liquidation” of A Co, which encompasses all of the completed and proposed transactions. As long as all distributions directly or indirectly from A Co are made pursuant to such Plan of Liquidation, they will be received by Child 2 as "capital gains...rather than as dividends" for Code purposes. [TaxInterpretations comment: the quoted references to capital gains treatment are potentially confusing. The estate would have acquired its A Co shares with a stepped up basis, so that they could then be disposed of with no gain being recognized, provided that dividend treatment was avoided through receiving Code s. 331 liquidation treatment.]
Rulings. For ss. 84.1, 84(2) and 245(2).