2017-0693411C6 2017 STEP – Q6 - GAAR on share redemption-55(3)(a)

Principal Issues: Whether cost amount needs to be "used" to trigger the application of GAAR.

Position: If there is a purpose to significantly increase cost amount, the CRA would seek to apply GAAR and the use is irrelevant.

Reasons: The scheme of new 55(2) is to address increase in cost amount that was not subject to tax, whether or not that cost amount has been used in the series.

Author: Ton-That, Marc
Section: 55(2), 55(3)(a)

STEP CRA Roundtable – June 13, 2017

QUESTION 6.  Application of GAAR to Share Redemption Transactions Relying on Paragraph 55(3)(a)

In CRA document #2015-0610681C6, the CRA indicated that it would seek to apply GAAR to a transaction that relies on paragraph 55(3)(a) to artificially create or unduly preserve ACB. The CRA listed the below as an example of such transaction:

“A note or other property (other than assets owned by the dividend payer at the beginning of the series that includes the redemption) received by a dividend recipient as consideration for a redemption of shares in a reorganization that is exempt under paragraph 55(3)(a) is used by a person to generate ACB that is significantly greater than the ACB of the shares that were redeemed.”

We see the CRA applying this principle in CRA document #2015-0604521E5, which describes a reorganization where a promissory note was issued to Holdco on a share redemption and the promissory note was subsequently transferred to Newco as a capital contribution. The deemed dividend arising on the share redemption would not be subject to subsection 55(2) if paragraph 55(3)(a) applied. Since the amount of the promissory note was higher than the ACB of the redeemed shares and the amount of the promissory note increased Holdco’s ACB of the shares of Newco, the CRA viewed these transactions to have artificially increased the ACB in the hands of Holdco and indicated that it would seek to apply the GAAR for Holdco’s reliance on paragraph 55(3)(a).

Can the CRA confirm that a subsequent transaction to ‘use’ the note or other property (including cash) received as consideration for a share redemption, such as the transfer of the note to Newco in #2015-0604521E5, is a necessary trigger for a GAAR determination with respect to paragraph 55(3)(a)? In other words, could the receipt of a note or other property with ACB higher than the ACB of the redeemed shares in itself cause the GAAR to apply?

CRA Response

As illustrated in the CRA Round Table Question #8 of the 2016 CTF Annual Conference, the role of subsection 55(2) is to question whether one of the purposes of the payment or receipt of a dividend that is not derived from income that has been subject to tax is, amongst other objectives, to significantly increase the cost amount of property of the dividend recipient.  If so, such dividend should not be tax-free.  Where a purpose to increase the cost amount of property of the dividend recipient exists, subsection 245(2) would be triggered and it is irrelevant whether such cost amount has been used in the series of transactions that includes the dividend.

Marc Ton-That
2017-069341

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