13 January 2016 External T.I. 2015-0604521E5 - ACB increase in paragraph 55(3)(a) reorganization -- summary under Paragraph 55(3)(a)

Parentco owns 100% of Holdco which owns 100% of Opco. There are two alternatives for spinning-off one of Opco’s existing business lines to Newco, a new subsidiary of Holdco:

Alternative 1:

1. Holdco transfers shares of Opco (with a value equaling the Opco assets transferred in step 2) to Newco for Newco shares, electing under s. 85(1).
2. Opco transfers the relevant assets to Newco for Newco preferred shares, electing under s. 85(1).
3. Newco redeems its preferred shares in consideration for the “Newco note”.
4. Opco redeems the shares that Newco received in step 2 in consideration for the issuance to Newco of the “Opco note”.
5. The two notes are set off.

Alternative 2:

1. Opco transfers the relevant assets to Newco for Newco preferred shares, electing under s. 85(1).
2. Newco redeems the shares that it issued to Opco in step 1 in consideration for the “Newco note”.
3. Opco transfers the Newco note to Holdco in redeeming a portion of its shares (with a value equal to the value of the Opco assets transferred in step 1).
4. Holdco transfers the Newco note to Newco as a capital contribution or share subscription.

In either case, the series of transactions does not include a triggering event involving an unrelated person described in s. 55(3)(a). Would either alternative engage s. 55(2) or 245(2)?

Before concluding that GAAR or s. 55(2) would not apply to the first alternative, CRA noted that although the receipt of the Opco or Newco Notes may result in an increase in the ACB of property held by Newco or Opco “both notes are offset and cancelled, eliminating therefore any increase in ACB of property held by either Newco or Opco.”

Respecting the second alternative, CRA noted that as a result of the transactions “the aggregate ACB in all the shares held by Holdco in Opco and Newco…is significantly greater than the ACB of the shares of Opco that were held by Holdco at the beginning of the series,” and that the scheme of s. 55(2) in its proposed form “is to prevent…the creation or multiplication of ACB with the use of tax-free inter-corporate dividends, and concluded that it “would consider the application of GAAR to Alternative 2,” and also would consider arguing that any ultimate disposition of Newco shares to an unrelated person was part of the series.