Amalgamations: Avoiding PUC Shifts

Subsection 87(3) provides computation rules for PUC in respect of a class of shares of a corporation that is formed on an amalgamation. This provision can create a shift of PUC relative to the PUC of the shares of the predecessor corporation, but this can often be avoided by using the subsection 87(3.1) election. This results from the interplay between the Act and the relevant corporate law.

Suppose Mr. A owns all of the issued and outstanding shares of ACo, which have an FMV of $1,000 and PUC of $100. Mr. B is in a similar position with respect to BCo, except that his PUC is $10. The two corporations are amalgamated and continued as ABCo under the CBCA, and Mr. A and Mr. B are issued class A and B common shares of ABCo ("the substituted classes") in exchange for their shares of ACo and BCo ("the exchanged classes"), respectively. Pursuant to subsection 87(3), the PUC of each substituted class is $55 ($1,000 − [$2,000 − $110] * [$1,000 / $2,000]).

This may be problematic if the two parties want their PUC amounts to continue at the pre-amalgamation level. Thus, the goal would be to create two distinct classes of shares in ABCo: Mr. A wants to receive class A shares with PUC of $100, and Mr. B wants to receive class B shares with PUC of $10.

One way to do this would be to take advantage of the subsection 87(3.1) election. This election requires, among other things, that the PUC of each substituted class be identical to the PUC of the corresponding exchanged class. Both of these amounts are to be determined without reference to the provisions of the Act—which, in this example, means using the stated capital amounts for the two classes of shares as determined under the CBCA. Thus, for ABCo, class A shares need to have a stated capital of $100, and class B shares need to have a stated capital of $10.

Although the CBCA does not specifically define "stated capital," one can infer from section 26(3) of the CBCA that it is essentially the amount of capital contributions made directly to the corporation by its shareholders; therefore, for corporate-law purposes, stated capital is the equivalent of PUC since it generally serves the same function (that is, to track share capital contributions). Normally, a corporation is required to add to its appropriate stated capital account the FMV of the share capital contributions. However, CBCA section 26(3)(b), together with CBCA section 26(4), permits an amalgamated corporation to designate the stated capital account of any class of its shares as an amount between nil and the FMV of the contributions made. This permits ABCo to designate the stated capital account for classes A and B as the desired amounts of $100 and $10, respectively, and hence the subsection 87(3.1) election achieves the two parties' goal.

This example illustrates the legal principle that the Canadian income tax system is an accessory system: the legal substance of a given transaction or event has to be determined first by applicable common or statutory law, and then the tax consequences can be determined pursuant to tax law based on that legal substance. This concept was first articulated in The Queen v Lagueux & Frères Inc. (74 DTC 6569 (FCTD)) and has been discussed in the CTF 2006 annual tax conference report paper, "The Tax Treatment of Transformation Transactions."

Yahui Zhu
Ernst & Young LLP, Vancouver
[email protected]

Canadian Tax Focus
Volume 9, Number 1, February 2019
©2019, Canadian Tax Foundation