Reorganization Strategies for Proposed Paragraph 55(3)(a)

The 2015 budget proposals affecting section 55 have forced advisers and taxpayers to rethink many standard corporate distributions and reorganizations. The proposals are effective as of budget day (April 21, 2015). Although draft legislation has been released, many details are still under discussion between the government and tax practitioners. For non-pressing matters, the prudent strategy may be to defer action. However, because waiting may not be an option for some, this article discusses alternative means by which assets may be moved within a related corporate group on a tax-deferred basis.

Consider a corporate group comprising Parentco, Parentco’s subsidiary Holdco, and Holdco’s subsidiary Opco. The group intends to transfer one of Opco’s existing business lines to Newco, a new subsidiary of Holdco, in a way that results in a clean structure (such that Holdco is the only owner of shares or debt of Newco). The key goal of the structuring is to ensure that all dividends arise under subsection 84(3), so that proposed paragraph 55(3)(a) applies to exclude the transactions from the uncertainty associated with the application of proposed subsection 55(2). Thus, the series of transactions that includes one of the alternatives below must not include a triggering event involving a person unrelated to the dividend recipient.

The transfer can be accomplished using the following steps:

Alternative 1
  1. Holdco forms Newco.

  2. Opco transfers the relevant assets to Newco on a tax-deferred basis pursuant to subsection 85(1) in exchange for shares of Newco. (Preferred shares rather than common shares are typically used, largely to avoid valuation issues.)

  3. Newco redeems the shares transferred to Opco in step 2 in exchange for a note.

  4. Opco redeems a portion of its shares (with a value equal to the value of the Opco assets transferred to Newco in step 2) and transfers the Newco note to Holdco as an in-kind redemption payment.

  5. Holdco transfers the Newco note to Newco in exchange for shares or as a capital contribution (thereby cancelling the note).

Before the budget, step 4 may have consisted of Opco declaring a dividend in kind of the Newco note to preserve Holdco’s ACB of the Opco shares. This is no longer an effective strategy, however, because dividends in kind do not fall under the protective cover of proposed paragraph 55(3)(a).

If the redemption of the Opco shares will result in a capital gain (that is, if the ACB is less than the PUC), Opco may want to take the steps necessary to reduce the PUC in respect of those shares so that the ACB is greater than or equal to the PUC. Before doing so, Opco may want to exchange the shares that it will redeem for shares of a different class (for example, exchanging common shares for preferred shares pursuant to section 51, 85, or 86).

Some practitioners might consider another way of implementing the transfer, which differs in steps 3 through 6:

Alternative 2
  1. Holdco forms Newco.

  2. Opco transfers the relevant assets to Newco on a tax-deferred basis pursuant to subsection 85(1) in exchange for shares of Newco. (Preferred shares rather than common shares are typically used, largely to avoid valuation issues.)

  3. Holdco transfers shares of Opco (with a value equal to the value of the Opco assets transferred to Newco in step 2) to Newco in exchange for shares of Newco on a tax-deferred basis.

  4. Newco redeems the shares that it issued to Opco in step 2 and issues a note to Opco as an in-kind redemption payment for the redeemed shares.

  5. Opco redeems the shares that Newco received in step 3, and issues a note to Newco as an in-kind redemption payment for the redeemed shares.

  6. The notes issued in steps 3 and 4 are offset and cancelled.

The two alternatives differ in their final outcomes with respect to Holdco’s ACB of the Newco shares:
  • In alternative 1, the ACB is the FMV of the Newco note (plus the nominal incorporating amount).

  • In alternative 2, the ACB is Holdco’s ACB of the Opco shares that Holdco transferred to Newco in step 3 (plus the nominal incorporating amount).

The two ACB amounts could be the same, but in most circumstances the first amount will be greater. Accordingly, it is likely that alternative 1 will be the preferred approach.

Carla Hanneman
KPMG Law LLP, Toronto
carlahanneman@kpmglaw.ca

Canadian Tax Focus
Volume 5, Number 3, August 2015
©2015, Canadian Tax Foundation