2021-0912101C6 86.1 exchange of shares

Principal Issues: Will 86.1 apply to an exchange of share transaction?

Position: No.

Author: Argento, Angelina
Section: 86.1

2021 CTF Annual Tax Conference
CRA Roundtable

Question 3 – Share Exchanges and section 86.1

Consider the following situation:

US Pubco is a corporation incorporated under the laws of the United States (U.S.) and its common shares are listed and traded on a U.S. Stock Exchange. A Canadian resident individual (the “Taxpayer”) owns common shares of US Pubco. Under a Canadian butterfly transaction, US Pubco wants to package one of its businesses into a new corporation incorporated under the laws of the U.S. (“US Pubco Spinco”).

US Pubco owns all of the issued and common shares of US Pubco Spinco and intends to spin out all of its common shares of US Pubco Spinco to its common shareholders pursuant to an exchange offer (the “Exchange Transaction”). Under the terms of the Exchange Transaction, US Pubco will offer its common shareholders the option to exchange their US Pubco common shares for its US Pubco Spinco common shares on a pro rata basis.

The Exchange Transaction does not contemplate a distribution by US Pubco of its US Pubco Spinco common shares to its shareholders as a dividend in kind.   The disposition by the Taxpayer of the common shares of US Pubco is an essential condition for the receipt of the shares of US Pubco Spinco, such that the Taxpayer cannot simultaneously own both common shares of US Pubco and common shares of US Pubco Spinco.

Question

Will the Taxpayer who exercises the Exchange Transaction benefit from the provisions of section 86.1?

CRA Response

Paragraph 86.1(1)(a) applies in respect of a distribution by a corporation that qualifies as an “eligible distribution” under subsection 86.1(2). Where applicable, that paragraph provides that “the amount of an eligible distribution received by a taxpayer shall not be included in computing the income of the taxpayer”. Where property is received by a shareholder in consideration for the disposition of a share of the corporation, section 86.1 does not adjust the income inclusion or the deduction of the loss resulting from the disposition of the share. On that basis, paragraph 86.1(1)(a) is not applicable to the Taxpayer in respect of the Exchange Transaction.

Accordingly, the surrender by the Taxpayer of their common shares of US Pubco as consideration for the receipt of common shares of US Pubco Spinco does not constitute an “eligible distribution” contemplated by section 86.1.

Angelina Argento
2021-091210
November 25, 2021

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