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
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]).
Moodys Tax Law LLP, Calgary
Zeifmans LLP, Toronto