Tax Court Finds Abusive Indirect Strip of V-Day Value

In Lucie Descarries v. The Queen, 2014 TCC 75, the Tax Court of Canada (TCC) held that one result of the taxpayer’s share transactions was to indirectly extract from her company, on a tax-free basis, value that had accumulated before 1971 (V-Day Value) (see paragraphs 56 and 57).  This result defeated the underlying rationale of s. 84.1, and could therefore be set aside as abusive tax planning under the general anti-avoidance rule in s. 245(1).  Although the amounts in the judgment are difficult to follow, it appears the abusive result was achieved as follows:

1. creating a capital gain in respect of post-V-Day Value, and generating stepped-up tax cost (including hard ACB), on an internal share-for-share exchange with the existing operating company (Opco) under s. 85(1);
2. transferring the new Opco shares to a new holding company (Holdco) in exchange for Holdco Shares, allowing for the operation of s. 84.1 to eliminate any V-Day Value from the PUC of the Holdco Shares – but preserving all the ACB and the PUC created in respect of the hard ACB;
3. redeeming the Holdco shares, resulting in a deemed dividend and a capital loss in respect of V-Day Value; and
4. using the capital loss in respect of V-Day Value in 3 above to offset the capital gain in respect of post-V-Day Value in 1 above.

Also of interest is the Court’s decision that s. 84(2) could not apply on the redemption of the Holdco shares because: (A) none of Opco’s assets were actually distributed at the time the Holdco shares were redeemed (paragraph 27), (B) the redemption of Holdco shares did not coincide with a winding-up, discontinuance or reorganization of Opco’s business (paragraphs 29 and 34), and (C) s. 84(2) and s. 84(3) cannot be applied at the same time to the same distributions (paragraph 37).