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The traditional dynamics of business sale negotiations often involve a seller wanting to sell shares of the company that operates the business and a buyer wanting to acquire assets. Hybrid business sale structures developed to allow a business sale to be structured as a “hybrid” asset sale and stock sale, often to allow a seller to use their lifetime exemption from capital gains.
Historically, the Canada Revenue Agency (“BOW“) sought to apply income tax law1 by. 84(2) to recharacterize proceeds from the sale of shares in hybrid dividend sale transactions. After the Tax Court of Canada (“CCT“) decision in
Geransky2, the CRA has generally respected hybrid business sale transactions. However, recent cases may have revived CRA reviews of these transactions.
As a general rule, arts. 84(2) applies where the funds or property of a corporation resident in Canada have been distributed or otherwise appropriated in any way for the benefit of the shareholders of any class of shares of its capital stock, during a liquidation, termination or reorganization of its business. In
Geransky, the buyer wanted to acquire a cement factory and the ancillary assets of an operating company (“opco“), whose shares were held by a holding company (“holdco“). Holdco incorporated a new company (“newcoThe target assets were then transferred to Holdco via an in-kind dividend payment and then transferred to Newco upon the repurchase of Holdco’s shares in Newco.
The shares of Newco were then acquired by the Purchaser. The CRA reassessed to reclassify the proceeds from the sale of Newco shares as dividends pursuant to ss. 84(2). The TCC found, among other things, that it could not see where any Opco funds or assets ended up in the hands of Mr. Geransky, the appellant, who sold his Newco shares.
As part of its reasons, the TCC considered a number of surplus stripping cases (including RMM companies3and McNichol4). Both involved identifiable corporate surpluses that had been transferred to corporate shareholders.
Recent decision – McDonald’s
Subsequently, in the McDonald’s5decision, the Federal Court of Appeal (“CIF“) upheld the application of s. 84(2) to proceeds from the sale of shares of a professional medical corporation (“pc“). PC’s assets were first liquidated and sold by PC’s shareholder to his brother-in-law (“JS“) against a promissory note. JS then transferred the shares to his newly incorporated company, again in return for a promissory note payable by the new company. The dividends were then declared and endorsed in favor of JS, then the PC shareholder.The FCA focused on the wording of subsection 84(2) regarding distributed or otherwise appropriated funds or property of a corporation, in any wayfor the benefit of the PC shareholder and concluded that the reorganization involved a devious means of transferring corporate assets to the PC shareholder.
The recent ICC decision in Faith6 confirmed the application of art. 84(2) in relation to a sale of hybrid business transaction. In this case, the transaction was originally offered as an asset sale, but the parties converted it to a hybrid asset and equity sale. There was an ongoing agreement that the company’s excess cash could be distributed to shareholders before closing. The ICC held that the acquirers were the instruments and intermediaries through which the distribution of funds or assets of the target company took place for the benefit of its shareholders, following a prior reorganization that led to the hybrid sale.
Some recent CRA reviews suggest that the CRA may be taking the position that the Faith decision called into question all hybrid business disposal operations.
However, as in geranksy, the law remains that certain funds or property of the company in question must be distributed or appropriated. As part of an ongoing tax audit or dispute, ensure that identifiable corporate funds or corporate surplus have been distributed. The value of a company’s shares will always be linked to the value of the underlying assets, even with regard to shares sold in a hybrid business sale and obviously does not, in itself, justify the application of art. 84(2).
Moreover, as in McNichol, even where identifiable company funds or surplus are distributed, the TCC may nevertheless set aside a s. 84(2) where the vendor is truly arm’s length and cannot be said to have entered into the transaction to satisfy the vendor’s desire to extract corporate surplus tax-free.
1 All statutory references refer to the income tax law.
2 (2001) DTC 243 (TCC).
3 RMM Canadian Enterprises Inc. v. R., TCJ No. 302 (TCC).
4 McNichol v. Canada  TCJ 302 (TCC).
5 2013 CIF 110.
6 Faith c. The Queen, 2021 CCI 52; on appeal.
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