Reliance on Section 54.2 To Deem Share Gain To Be Capital

Section 54.2 states that where a person disposes of all or substantially all (ASA) of the assets used in an active business carried on by that person to a corporation for consideration that includes shares, those shares are deemed to be capital property. However, as Atlantic Packaging (2020 FCA 75; aff'g 2018 TCC 183; leave sought to appeal to the SCC) shows, it can be hazardous to rely solely on this section to produce income treatment on a sale of shares. Also, the TCC decision may shed light on the interpretation of ASA tests elsewhere in the Act.

In 2009, Atlantic agreed to sell part of its business ("the tissue division") to Cascades Canada. As part of the pre-closing steps, Atlantic transferred certain tissue division assets to a new corporation ("722") on a tax-deferred basis under section 85 and received common shares of 722 as consideration. Atlantic sold these shares of 722 to Cascades and reported a capital gain. The CRA assessed the sale to be an income amount. Atlantic appealed, and at issue before the TCC was whether section 54.2 applied to the shares of 722.

The TCC contrasted the ASA test in section 54.2 with the ASA test contained in the "small business corporation" definition in subsection 248(1). While the latter ASA test is specifically based on the FMV of assets, the ASA test in section 54.2 is not. The TCC found that this distinction did not preclude it from considering FMV.

Since only 68 percent of the FMV of the assets of the tissue division were transferred to 722, even if the tissue division were a separate business (which the TCC did not rule on), the TCC could not consider Atlantic to have transferred all or substantially all of its assets used in an active business to 722. Atlantic tried to argue that the ASA test could be met using a number of measures other than FMV, such as accounting net book value, floor space, and number of employees. The TCC did not find these to be more reliable measures than FMV in applying the ASA test. Hence, the requirements of section 54.2 were not met, and the appeal was dismissed by the TCC.

At the FCA, the taxpayer attempted to raise a new argument that the shares of 722 were capital property under general principles notwithstanding the non-application of section 54.2. The FCA found this to be a new issue (and not a new argument), which required that the taxpayer show a new development in the law related to the determination of whether a particular property is capital property. Finding that the taxpayer failed to demonstrate this, the FCA rejected the appeal. The FCA also commented that the TCC did not err on the substantive legal issue.

What are some takeaways from the TCC and FCA decisions in Atlantic Packaging?

  • ASA asset tests should almost always start with FMV, even if this is not specified (see, for example, section 22).
  • The TCC acknowledged that "all or substantially all" does not mean 90 percent and may vary depending on context, but it cannot be "something just over two-thirds."
  • The TCC made an obiter comment that it would "struggle" to find the tissue division to be a separate business since Atlantic treated the tissue division and other divisions as a single business for CCA purposes. (Regulation 1101 requires separate businesses to be in separate UCC classes.)

Atlantic likely would have had a better outcome if it had included, from the start, the general-principle argument that the original capital nature of the business assets should be preserved despite the pre-closing packaging transaction. The CRA has frequently stated that prepackaging does not change the nature of the underlying property (see, for example, Information Bulletin IT-291R3, and CRA document nos. 2003-0026225 [January 16, 2004] and 2008-0285151C6 [October 10, 2008]).

Kenneth Keung
Moodys Tax Law LLP, Calgary
[email protected]

Balaji Katlai
Zeifmans LLP, Toronto
[email protected]


Canadian Tax Focus
Volume 10, Number 3, August 2020
©2020, Canadian Tax Foundation