2014-0547401C6 Q.4 212.1 and the GAAR

Principal Issues: Whether GAAR applies to pre-acquisition PUC planning.

Position: GAAR applies.

Reasons: As discussed in response below.

Author: Laurikainen, Olli
Section: 212.1, 245

2014 CTF Conference – CRA Roundtable
Q.4 – 212.1 and the GAAR

At the International Fiscal Association (IFA) Conference in May 2013, the CRA made comments regarding the potential application of the GAAR to cross-border paid-up capital (PUC) planning.  The comments were provided in the context of three scenarios referred to as, pre-acquisition, post-acquisition and non-acquisition, PUC planning.  In its response the CRA indicated that the GAAR Committee had determined that GAAR applies to cases involving post-acquisition and non-acquisition planning but that the Committee had not recently addressed pre-acquisition PUC planning.   Has the GAAR Committee had the opportunity to consider pre-acquisition PUC planning since the time of those earlier comments?

For the purpose of this question consider the following hypothetical fact pattern.

1)    A non-resident corporation (Foreign Parent) makes a capital contribution to its wholly-owned Canadian resident acquisition company (CanAc).  The PUC of the shares of CanAc are increased by the amount of the capital contribution.

2)    CanAc acquires from an arm’s length vendor the shares of a non-resident corporation (NR Target).  NR Target owns high value, low PUC shares of a Canadian operating corporation (CanOpco).

3)    NR Target then sells the shares of CanOpco to CanAc in consideration for a Note Receivable in an amount equal to the fair market value of the shares of CanOpco.  The capital gain realized by NR Target is not taxable in Canada as the shares of CanOpco are not taxable Canadian property.  Section 212.1 does not apply because of the exception thereto in subsection 212.1(4).

4)    CanAc distributes the shares of NR Target to Foreign Parent on a reduction of PUC.

5)    After the completion of the above transactions the surplus of CanOpco is distributed to CanAc via dividend that is deductible to CanAc under subsection 112(1).  CanAc then distributes the same amount outside Canada as a principal repayment on the Note Receivable.

Given the infusion of new capital by Foreign Parent into CanAc followed by an arm’s length acquisition of NR Target, would the CRA consider the above outcome offensive having regard to section 212.1?

It is noteworthy that in light of the PUC reinstatement rule in subsection 212.3(9), the above transactions would not appear to be impeded by section 212.3 even if carried out after March 28, 2012.

CRA Response

The GAAR Committee has addressed a pre-acquisition PUC planning scenario and concluded that the GAAR would apply.  On the basis of that GAAR decision, we feel that in the hypothetical scenario described above the GAAR indeed applies.  The infusion of capital by Foreign Parent into CanAc and the arm’s length acquisition of the shares of NR Target by CanAc do not mitigate the potential for the future payment of Part XIII tax by NR Target on the distribution of CanOpco surplus.  The PUC of the shares of CanOpco held by NR Target remains low such that NR Target’s access to CanOpco’s surplus is reliant on CanOpco making dividend distributions to NR Target.  

Subsection 212.1(1) is an anti-surplus stripping rule designed to prevent a non-resident corporation from avoiding Part XIII tax when extracting the corporate surplus of a corporation resident in Canada by way of a disposition of the shares of that corporation to a non-arm’s length corporation resident in Canada.  Subsection 212.1(1) does not apply, however, if the conditions in subsection 212.1(4) are satisfied. 

Subsection 212.1(4) is intended to provide relief if there has been no corporate surplus stripped out of Canada and no increase in the ability to strip surplus tax-free out of Canada.  For example, this would be the case where the ultimate parent company in the group is a corporation resident in Canada.  The sale of CanOpco shares to CanAc together with the subsequent transfer by CanAc of NR Target to Foreign Parent sidestep the provisions of subsection 212.1(1) resulting in the surplus of CanOpco being transferred offshore without payment of Part XIII tax by NR Target.  It would be inappropriate for subsection 212.1(4) to operate to prevent a deemed dividend arising under paragraph 212.1(1)(a) and/or a reduction of PUC under paragraph 212.1(1)(b) in respect of a sale of shares that results in or enables the tax-free distribution of the corporate surplus of CanOpco.  Therefore, the CRA is of the view that the application of subsection 212.1(4) in this case would defeat the objective of section 212.1 and we would seek to apply the GAAR.

We observe that other transactions could be carried out by the corporate group after the capitalization of CanAc by Foreign Parent and the acquisition by CanAc of the shares of NR Target as described in facts 1 and 2 above, to achieve the tax-free distribution of the surplus of CanOpco out of Canada.  From a policy perspective, the CRA considers that the result of these transactions is similar to that of the post-acquisition and non-acquisition PUC planning arrangements that were discussed at the 2013 IFA Conference where a series of transactions enables a non-resident taxpayer to create cross-border PUC which can later be used to extract the corporate surplus of a Canadian resident corporation without attracting Part XIII tax in a manner that is contrary to the object and spirit of section 212.1.  While any such series would have to be analysed based on its own facts, the series would be viewed by the CRA as abusive and it would seek to apply the GAAR.

Olli Laurikainen
2014-054740

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