Gain On Sale Of Shares May Be On Account Of Income

• Published date: 27 May 2020
• Author: Tera Li Parizeau
• Subject Matter: Wealth Management, Tax, Wealth & Asset Management, Income Tax, Capital Gains Tax, Tax Authorities
• Law Firm: Cassels

On a sale of shares to a third party, a vendor generally expects that any gain on such sale to be on account of capital which could mean that only one-half of the gain would be taxable to the vendor.

However, in Atlantic Packaging Products Ltd. v. Canada¹, the Tax Court of Canada (TCC) held that the gain on the sale of shares to a third-party purchaser to be on account of income because it did not meet the test in s. 54.2 of the Income Tax Act (Canada) (ITA). This has been recently confirmed by the Federal Court of Appeal (FCA).

Background

Atlantic Packaging Products Ltd. (Atlantic) is a paper products manufacturer with five divisions. As part of a sale agreement between Atlantic and Cascades Canada Inc. (Cascades), Atlantic agreed to sell the tissue division to Cascades. However, prior to the sale, certain assets (Transferred Assets) from the tissue division were transferred by Atlantic to a newly incorporated company (Newco) on a s. 85 rollover basis for consideration that included shares of Newco. Subsequently, the shares of Newco were then sold by Atlantic to Cascades. Atlantic relied on s. 54.2 when it reported the gain from the sale of the shares of Newco to Cascades as a capital gain.

Decision

The main issue to be decided by the TCC was whether the Transferred Assets represented all or substantially all of the assets used in the tissue division. Under s. 54.2, if a person has disposed of property that consisted of all or substantially all of the assets used in an active business carried on by that person to a corporation for consideration that included shares of the corporation, the shares are deemed to be capital property of that person. The Canada Revenue Agency (CRA) has generally interpreted "all or substantially all" as being at least 90 per cent of the value of the assets.

The TCC found that the Transferred Assets transferred to Newco did not represent all or substantially all of the assets used by Atlantic in the tissue division. Based on the evidence before the Court, the Transferred Assets made up only 68% of the total assets of the tissue division. While the Court acknowledged that all or substantially all does not mean 90% and that the specific percentage for the test may depend on the circumstance, the Court did not accept that 68% would meet the test. This calculation was based on the fair market value approach.

As a result, TCC held that the test for s. 54.2 had not been met, and therefore the shares of Newco were not deemed to be...