D'Arcy – Tax Court of Canada finds that a use of PUC-averaging to increase the PUC of individuals’ shares with a stepped-up ACB was abusive

The taxpayers (a couple) transferred their shares of Opco to a new holding company in consideration for preferred shares of Holdco at s. 85(1) agreed amounts that used up lifetime capital gains exemption balances. Stopping there, s. 84.1 would have limited the PUC of the preferred shares to the nominal PUC of the transferred shares. However, they also caused Opco to transfer significant assets to Holdco on an s. 85(1) basis in consideration for Holdco preferred shares of the same class, so that with PUC-averaging, the PUC of the taxpayers’ shares increased. Several years later, they used their PUC balance to eliminate shareholder loan advances that otherwise would have been included in their income under s. 15(2).

Russell J concluded that these transactions “inflated” the PUC of their shares to amounts that did not reflect any capital investment made by them, so that the extraction of such PUC constituted abusive surplus-stripping (in particular, abuses of s. 84.1 and the PUC-averaging rules). He rejected a submission that the overarching purpose of the series of transactions was creditor-proofing, noting inter alia that the this objective could have been accomplished without Holdco issuing shares of the same class to both Opco and the taxpayers.

Accordingly, he confirmed the GAAR assessments to generate deemed dividends that arose once the PUC-averaging was ignored.

Neal Armstrong. Summary of D'Arcy v. The King, 2025 TCC 128 under s. 245(4).