2017-0693421C6 2017 STEP – Q7 - 55(2) and pipeline planning

Principal Issues: 1. Does 55(2) apply to redemption of shares obtained from deceased with full ACB? 2. Does GAAR apply? 3. Is there safe income?

Position: 1. No, 2. No, 3. No.

Reasons: 1. Result and purpose tests not met. 2. There is no purpose of increasing cost or reducing FMV. 3. Shares have no accrued gain.

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

STEP CRA Roundtable – June 13, 2017

QUESTION 7. Subsection 55(2) and pipeline planning

An individual dies and leaves in his or her estate a holding company (H1) with an investment portfolio. A capital gain is recognized by the deceased. The estate then structures a pipeline type transaction where the shares of H1 are transferred to H2 and the estate receives a note. Later, the shares of H1 held by H2 are redeemed or purchased for cancellation.  Now that subsection 55(2) applies when there is a purpose of reducing fair market value or increasing cost amount, does this mean that the provisions could apply to deem a capital gain to result?   Would the estate have a carryover of the safe income of the deceased or would the starting safe income to the estate be nil?

CRA Response

In this situation, we assume that the ACB of the shares of H1 to the estate is equal to their FMV at the time of the transfer of those shares to H2 and at the time of their redemption or purchase for cancellation.  Since there would be no capital gain had those shares been disposed of at FMV immediately before their redemption, the redemption of the shares of H1 would not result in any reduction of such gain.  Furthermore, the purpose test in subparagraph 55(2.1)(b)(ii) does not apply to a dividend that is deemed to be received under subsection 84(3).

In this situation, the dividend deemed to be received on the redemption or purchase for cancellation would not be subject to subsection 55(2).  This is different from situations where we considered that there was an attempt to artificially create or unduly preserve ACB in a reorganization that would be exempt under either paragraph 55(3)(a) or 55(3)(b) and that would frustrate the object, spirit and purpose of subsection 55(2).  In this situation, the cost amount of property of H2 is the same before and after the redemption or purchase for cancellation of the shares of H1 and the reduction of FMV of the shares being redeemed or purchased for cancellation does not result in any deductible loss to H2.  Consequently, the CRA would not seek to apply GAAR to this situation.

There is no carry-over of the “income earned or realized” (the “safe income”) that contributed to the gain on the H1 shares since there was no gain on such shares.

Marc Ton-That
2017-069342

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