3295940 Canada – Federal Court of Appeal finds no abuse in a tax plan producing the same gain as if the ultimate shareholder had directly used its high outside basis for its investment

The taxpayer (3295) was a holding company with a minority shareholding in a target company (Holdings) with a low ACB, whereas 3295’s parent (Micsau) had a high ACB for its 3295 shares. Unfortunately, the majority shareholder of Holdings (RoundTable) negotiated the initial terms of the sale without Micsau’s involvement, which provided for a sale of the shares of Holdings to Novartis by its two shareholders. However, Micsau subsequently contacted Novartis, and negotiated that it could sell its shares of Holdings through a Newco (4244 referred to below).

Under that plan:

1. Micsau created a sister company (4244) to 3295 to which it transferred newly-created preference shares of 3295 having an ACB (of $31.5M) equal to their redemption amount in exchange for full-ACB shares of 4244.
2. 3295 then transferred its Holdings shares to 4244 on a partial s. 85 rollover basis in exchange for Class D and common shares, and realized a capital gain corresponding to the capital gain (of $53M) that it would have realized had it sold its 3295 shares to Novartis; this capital gain was reflected in the full-ACB (of $57M) Class D shares which it received from 4244, whereas its common shares of 4244 had a high FMV (of $31.5M) and nominal ACB.
3. 3295 redeemed the preference shares held by 4244 (see 1 above) for a $31.5M note, and elected for the resulting $31.5M deemed dividend to be a capital dividend paid to 4244.
4. 4244 redeemed $31.5M of the low-ACB common shares that it had issued to 3295 in Step 2 for a $31.5M note, and elected for the resulting $31.5M deemed dividend to be a capital dividend paid to 3295.
5. Then the two notes were set off, Micsau transferred its shares of 4244 to 3295, and 3295 sold the shares of 4244 to Novartis at no further capital gain.

Goyette JA found that in determining “whether transactions forming part of a series are abusive, one must consider the ‘entire series of transactions’ or its ‘overall result’” and that, here, the overall result of the series was the same as if Micsau had sold its 3295 shares to Novartis.

Furthermore, the Tax Court had erred in considering that the cross-redemption capital dividend (Steps 3 and 4) reduced the capital gain that 3295 would have realized from disposing of its commons shares in 4244 immediately before the dividend. Thus, the “series’ overall result [was] consistent with the object, spirit and purpose of the capital gains regime as previously identified by this Court—that is, to tax real economic gains: Triad Gestco … “.

In addition, "courts consider alternative transactions’ tax consequences when determining whether tax avoidance is abusive”. The Tax Court had erred in failing to consider four alternative transactions which would have produced the same tax result (of using the high outside tax basis in 3295 shares) as those implemented, such as a tuck-under transaction, or having RoundTable purchase the 3295 shares, and bump the Holdings’ shares under s. 88(1)(d) on winding-up 3295.

Goyette JA stated that these transactions were relevant because they were: available under the Act; realistic alternatives; commercially similar to the subject transactions and with similar tax results; and reflecting a similar absence of abuse, i.e., they “would have enabled Micsau to realize its high ACB without attracting the application of the GAAR.”

Neal Armstrong. Summary of 3295940 Canada Inc. v. Canada, 2024 FCA 42 under s. 245(4).