Post Mortem Pipeline Potentially Upset by FCA
In Canada v. MacDonald (2013 FCA 110, rev'g. 2012 TCC 123),
the FCA ruled against a surplus-stripping transaction that was very
similar to a typical post-mortem pipeline strategy used in estate
planning. Given the uncertainty created by the decision, tax
practitioners may want to consider obtaining a ruling from the CRA
before they implement pipeline strategies for their clients.
In MacDonald, a heart surgeon who was moving to the United
States was able to alter his interest in his Canadian professional
corporation from that of a shareholder to that of a creditor by selling
his shares of the corporation to a non-arm's-length party in exchange
for a promissory note. By doing this, he essentially avoided the
potential double tax problem in the United States that would have
resulted from his inability to step up the basis of his shares of the
The key issue was whether the extraction of the funds triggered a
deemed dividend under subsection 84(2). The FCA stated that the language
"in any manner whatever" in subsection 84(2) was intended to encompass
various ways in which the funds of a corporation could come into the
shareholder's hands. Applying a textual, contextual, and purposive
analysis of the provision, the court considered (1) who initiated the
winding up, discontinuance, or reorganization of the business; (2) who
received the funds of the business as a result of the transactions; and
(3) the circumstances in which the distributions took place.
The FCA concluded that the person receiving the funds must be a
shareholder at the time when the planning takes place--not at the time
when the funds are ultimately received. This finding is contrary to the
reasoning of the TCC. It did not matter that the taxpayer was a
creditor, rather than a shareholder, of the company when he received the
funds. Because the taxpayer had initiated the winding up of his
business while he was still a shareholder, and had set various
transactions in motion so that he could extract funds from the business
tax-free, the FCA concluded that subsection 84(2) applied.
When implementing a post mortem pipeline strategy, practitioners should ask the following questions:
Is a Canadian-resident corporation involved?
Is the corporation winding up, discontinuing, or reorganizing?
Is there a distribution or appropriation of the corporation's funds or property in any manner whatever?
Is the distribution or appropriation to or for the benefit of the shareholders?
If the answer to all of these questions is yes, then subsection 84(2)
may apply to deem the shareholder to have received a dividend.
In the past, favourable rulings have been granted for pipeline
strategies where the following conditions are met (CRA document no.
the transaction does not involve a cash corporation;
the business is continued for at least one year following the implementation of the pipeline structure; and
the one-year period is followed by a gradual distribution of the corporation's assets over an additional period.
It remains to be seen whether the CRA will continue to issue rulings
in such situations, given that the legal basis may have been undercut by
the FCA'S decision in MacDonald.
For more details on MacDonald, see Ian Pryor, "FCA To Rule on Post Mortem Pipeline Planning," Canadian Tax Focus, August 2012, and Nick Moraitis and Manu Kakkar, "Stopping the Pipeline--In Any Manner Whatever," Tax for the Owner-Manager, July 2013.
Grant Thornton LLP, Vancouver