2015-0610711C6 2015 CTF Q.11, Impact of the Descarries decision

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether the Income Tax Rulings Directorate (“ITRD”) can rule that subsection 245(2) does not apply to a proposed series of transactions similar to those in F 2005-0134731R3.

Position: The ITRD would now recommend to the GAAR Committee that subsection 245(2) be applied to a series of transactions similar to those described in 2005-0134731R3.

Reasons: In Descarries et al. v. The Queen, the Tax Court of Canada held that a series of transactions involving avoidance transactions may constitute an abuse of subsection 84.1(1) if it allows the use of V-day value (and/or the capital gains deduction) to extract corporate surplus tax-free.

Author: Lafrenière, Jean

Section: 84.1, 245(2)

2015 Canadian Tax Foundation Conference
CRA Roundtable

Question 11: Impact of the Descarries Decision on Intergenerational Family Business Transfer Tax Planning

In the advance income tax ruling F 2005-0134731R3 (October 26, 2006), an individual (“Mr. X”) owned all of the issued and outstanding shares of a holding corporation (“HOLDCO”).  In turn, HOLDCO owned all of the issued and outstanding shares of an operating corporation (“OPCO”).  Mr. X wanted to retire and transfer his HOLDCO shares to his 2 children who were actively involved in the OPCO business. 

Under the proposed transactions, Mr. X sold all of his HOLDCO common shares to his children in consideration for promissory notes.  Mr. X realized a capital gain in respect of the sale but did not claim the capital gains deduction (“CGD”) under subsection 110.6(2.1) (footnote 1) . 

HOLDCO then repurchased all of the HOLDCO preferred shares owned by Mr. X.  The preferred shares had nominal paid-up capital (“PUC”) and a high adjusted cost base (“ACB”) as a result of a previous crystallisation of the CGD.  The share repurchase gave rise to a deemed dividend to Mr. X as well as a capital loss. A portion of the capital loss was applied to offset the capital gain that arose on the earlier sale of the HOLDCO common shares to the children.  The loss denial rules in subsection 40(3.6) did not apply as Mr. X and HOLDCO were not affiliated immediately after the share repurchase. 

The CRA issued favourable rulings with respect to this series of transactions.  Among others, the CRA confirmed that subsection 245(2) would not apply, notwithstanding the fact that it could be argued that this series of transactions allowed Mr. X to indirectly monetize his CGD. 


Following the Descarries v. The Queen (footnote 2)  decision, would the CRA agree to issue a favourable ruling to the effect that subsection 245(2) would not apply to a series of transactions similar to the ones described in F 2005-0134731R3?

CRA Response

In Descarries, the Tax Court of Canada held that transactions similar to the proposed series of transactions described in F 2005-0134731R3 resulted in an abuse of section 84.1. 

In the Descarries case, the individual shareholders of L’immobilière d’Oka Inc. (“OKA”) were involved in a series of transactions in which, among others, they exchanged their OKA shares for shares of another corporation (“NEWCO”), some of which (the “NEWCO V-day Shares”) had low PUC and a high ACB equal to the FMV of the OKA shares on V-Day (December 22, 1971). As a result, the V-Day value of the OKA shares became isolated/crystallized in the ACB of the NEWCO V-day Shares. 

The NEWCO V-day Shares were repurchased, giving rise to a deemed dividend to the individual shareholders as well as a capital loss that was applied to offset a capital gain realized earlier in the same series of transactions. 

The Tax Court of Canada made the following comments in Descarries: 

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-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. For these reasons, I find that this provision was applied in an abusive fashion (footnote 3) . 

Based on the reasoning in this decision, the CRA would now recommend to the GAAR Committee that subsection 245(2) be applied to a series of transactions similar to the proposed transactions described in F 2005-0134731R3.  The proposed transactions result in the extraction of corporate surplus as capital gains.  Furthermore, such capital gains are offset or reduced by capital losses realized on a disposition of shares whose ACB was increased by the CGD or V-day value. 

In these circumstances and based on the Descarries decision, the CGD or the V-day value has been used to enable corporate surplus to be distributed to the shareholders tax-free, in a manner contrary to the object, spirit and purposes of section 84.1. 

Jean Lafrenière
November 24, 2015


Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  Unless otherwise stated, all statutory references herein are to the Income Tax Act. 
2  2014 TCC 75 (“Descarries”). 
3  Idem, at paragraphs 57 and 59. 

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