The Canada Revenue Agency (CRA) recently ruled on a post-mortem “pipeline” transaction involving a private corporation whereby the children of the last-to-die parent (B) received shares of a private corporation where the deceased had reported a deemed disposition gain on their final income tax return.
A pipeline transaction is a form of transaction whereby the assets of a corporation are distributed to shareholders utilizing the high adjusted cost base resulting from the capital gains realized on death, rather than as a distribution in the form of a dividend. In this sense, the use of a pipeline is often justified as avoiding “double-tax” in the sense that there has been tax imposed as a capital gain on the death of the shareholder followed by further tax in the form of a dividend realized when the assets are distributed. Both of these taxes would be shareholder-level taxes on ultimately the same assets (additional corporate-level tax may apply if the assets of the corporation have accrued but unrealized capital gains).
The steps in the proposed plan see the children incorporate a new corporation, Newco. Next the children will transfer the shares in the corporation received on B’s death to Newco in exchange for a promissory note having a principal amount equal to such child’s adjusted cost base of such shares (being the fair market value of the shares at B’s death) and shares of Newco. Following a period of at least one year, Newco and the corporation will amalgamate and the promissory notes will be repaid.
In implementing a pipeline, the general concern is that the repayment of the promissory note is considered a dividend equal to the amount or value of the funds or property distributed, minus (b) the reduction in the paid-up capital in respect of the shares of that class. As a result of this concern, it is commonplace for a pipeline ruling to provide the one-year “cooling off” period prior to a distribution of the corporation’s assets.
The CRA has issued favourable rulings where there is a one-year cooling off period that starts with repayment of the promissory note(s) – good things do come to those who wait.