On August 9, 2022, the Department of Finance released draft legislation, along with explanatory notes, regarding technical amendments to the Income Tax Act and Income Tax Regulations. This article will address the proposed amendments to subsection 88(3.3) (the FA suppression election) and to regulation 5907(2.01), which concerns FA asset-packaging transactions.
Subsection 88(3.3), commonly referred to as the suppression election, allows a taxpayer to reduce the capital gain that would otherwise be realized on the disposition of a share of a liquidating affiliate, upon a qualifying liquidation and dissolution, by electing a lower amount of proceeds of disposition (and, in consequence, a lower cost base going forward) on a particular distributed capital property of the liquidating affiliate.
Proposed subsection 88(3.3) reads as follows:
For the purposes of paragraph (3)(a), if the liquidation and dissolution is a qualifying liquidation and dissolution of the disposing affiliate and the taxpayer would, in the absence of this subsection and, for greater certainty, after taking into account any election under subsection 93(1), realize a capital gain (the amount of which is referred to in subsection (3.4) as the “capital gain amount”) from the disposition of a disposed share, the taxpayer may elect, in accordance with prescribed rules, that distributed property that was, immediately before the disposition, capital property (that is a share of the capital stock of another foreign affiliate of the taxpayer) of the disposing affiliate be deemed to have been disposed of by the disposing affiliate to the taxpayer for proceeds of disposition equal to the amount claimed (referred to in subsection (3.4) as the “claimed amount”) by the taxpayer in the election. [Emphasis added.]
Under the proposed amendment, the distributed capital property for which the suppression election can be used is limited solely to shares of another FA of the taxpayer. This amendment is expected to substantially reduce the effectiveness of the suppression election.
In the explanatory notes to the August 9 proposals, Finance indicated that the proposed amendment was drafted because of Finance’s concern that the current rules allow the accrued gain from the acquisition of shares or debt of a Canadian-resident corporation to be (1) deferred indefinitely while still allowing a Canadian-resident corporation to have use of the underlying property, or (2) eliminated altogether through a reorganization of the Canadian-resident corporation following the dissolution. Arguably, an alternative response to Finance’s concern could have been a requirement that the capital property be foreign capital property. In its current form, the proposed amendment to subsection 88(3.3) seems to cover more dispositions than was intended.
The amendment to subsection 88(3.3) applies in respect of dispositions that occur on or after August 9, 2022.
Finance proposed two amendments to regulation 5907(2.01)(a).
Regulation 5907(2.01) overrides the non-recognition rules in regulations 5907(5.1) and 5907(2)(f) and (j). When an FA’s assets are packaged for sale and the conditions set out in regulation 5907(2.01)(a) are met (including the disposition to an arm’s-length person, within 90 days, of the shares of another FA received as consideration for the packaged assets), the non-recognition rules should not apply to the transfer, and surplus recognition on any unrealized value on the packaged assets should be allowed.
The first amendment to regulation 5907(2.01)(a) adds a requirement that the shares received by the disposing affiliate as consideration for the packaged assets be shares of the receiving affiliate. Proposed regulation 5907(2.01)(a)(i) states that “the only consideration in respect of the particular disposition is one or any combination of (i) shares of the capital stock of the other affiliate, and. . . .”
The second amendment relaxes the requirements for the “consideration received” in regulation 5907(2.01)(a); this is, we believe, a response to an issue raised in a 2014 CRA income tax ruling. In CRA document no. 2014-0550451E5 (April 22, 2015), the CRA confirmed that “consideration received” by the disposing affiliate for the purposes of regulation 5907(2.01) included the assumption of the disposing FA’s debt by the receiving FA. Because regulation 5907(2.01)(a) previously required that the only “consideration received” be the shares of another FA, the transfer would not meet the requirements of regulation 5907(2.01)(a), and, therefore, the non-recognition rules could apply.
Proposed regulation 5907(2.01)(a) allows the consideration received to include “the assumption by the other affiliate of a debt or other obligation owing by the particular affiliate that arose in the ordinary course of the business of the particular affiliate to which the affiliate property relates.”
The extension of the “consideration received” rule to debt arising in the ordinary course of the disposing affiliate’s business is a welcome expansion of the rules.
In sum, these amendments, which apply in respect of dispositions that occur on or after August 9, 2022, support taxpayers in the packaging of FA assets, but they limit their unpacking.
EY Law LLP, Montreal