Sarah was a resident of Canada and a widow. She was also the sole shareholder of a private Canadian corporation, CanCo, that produces pet care products at a facility in Ontario. Sarah died suddenly and while she had a will, she had not completed comprehensive estate or succession planning. Her executors, Tim and Julie, began to review Sarah's estate (the “Estate”). They wanted to ensure that the Estate was handled in an efficient manner that would provide the largest benefit to the beneficiaries. After reading Sarah's will, Tim and Julie identified that the beneficiaries of the Estate were Sarah's sister Rachel and Rachel's two children Chris and Alex. Sarah's brother John and his three children Miriam, Jordan, and Kat were also beneficiaries. They also identified that the CanCo shares were the most significant asset in the Estate.

Tim and Julie contacted the beneficiaries and learned that Jordan and Kat were residing in Germany while the rest of the beneficiaries were residents of Canada. As they began to consult professionals and familiarize themselves with their responsibilities as executors, Tim and Julie became concerned about the tax liability relating to Sarah's death and the administration of the Estate. They decided to consult a tax expert about post-mortem planning and retained Yvette to advise them on their goal of minimizing overall taxation.

Tim and Julie had already recognized that Sarah's gain on her shares of CanCo was subject to tax due to the deemed disposition of Sarah's assets on her death. They told Yvette that the gain on the shares was driven by the increase in value of CanCo's assets such as its facility. They also told her that CanCo still held the assets. Yvette recognized that there was a risk of double taxation without further post-mortem planning. The increase in the value of the CanCo shares had been taxed when Sarah's gain was taxed. However, the beneficiaries would be subject to further tax if they sought to receive value from the company because the paid-up capital was not increased when Sarah's gain was recognized.

Post-Mortem Planning Options

Yvette considered several post-mortem planning options. Her initial impression was that a pipeline transaction would be the most advantageous for the Estate. She also knew that section 84.1 of the Income Tax Act (“ITA”), which she would usually consider when planning a pipeline, only applies to Canadian residents. As the Estate was resident in Canada it appeared that section 84.1 would be the operative provision of the ITA. However, Yvette decided to conduct more research see what impact the non-resident beneficiaries might have on the availability of a pipeline before preparing a recommendation for Tim and Julie.

Yvette quickly identified section 212.1 of the ITA. It addressed non-residents and had many similarities to section 84.1. The basic structure of sections 212.1 and 84.1 involves four criteria:

(1) a taxpayer disposes of shares (“subject shares”) of a corporation resident in Canada (“subject corporation”);

(2) the disposition of the subject shares are to another corporation resident in Canada (“purchaser corporation”);

(3) the taxpayer and the purchaser corporation do not deal at arm's-length; and

(4) immediately after the disposition, the subject corporation is connected with the purchaser corporation.

When the criteria are met, there is a deemed dividend or reduction in paid-up capital. Where that applies it means that the pipeline goal of avoiding double taxation will not be met.

While there were many similarities, Yvette also noticed an important difference. Section 212.1 contains deeming rules for trusts that would apply to the Estate. In fact, the non-resident beneficiaries of the Estate would be deemed to have disposed of the their proportionate interest in the shares of CanCo if the Estate disposed of the CanCo shares to a NewCo in accordance with the usual structure of a pipeline. Section 84.1 does not contain this particular deeming rule and Yvette notes that this means that section 212.1 could apply even though the Estate itself is resident in Canada. It also means that the first criteria for the application of section 212.1 would be met.

Yvette also notices that the Tax Policy Branch of the CRA has issued a comfort letter addressing this provision. It indicates that the application of the rule deeming a non-resident beneficiary to have disposed of shares disposed of by the trust to post-mortem pipelines is not consistent with policy and that they will recommend that the Ministry of Finance amend the law. She is hopeful that this will occur. However, the Minister has not announced proposed legislation. Yvette decides to proceed by assuming this provision will stay as it is and considering if the other portions of section 212.1 apply.

Since the standard structure of a pipeline involves a disposition to a new Canadian corporation, Yvette concludes that the second criteria for the application of section 212.1 would also apply.

Yvette then observes that the final criteria would likely apply as well. Sarah owned all of the shares of CanCo and the Estate would typically transfer all of them to NewCo as part of a pipeline. Yvette sees that NewCo would control CanCo after a transfer because it would own more than 50% of the shares of CanCo. She also sees that this means that the two corporations would be connected.

Yvette turns to consider the third criteria; would the two non-resident beneficiaries be arm's length from NewCo? She knows that under a standard pipeline the non-residents would not own shares of NewCo immediately after the disposition, the Estate would. Jordan and Kat are also uninvolved, and Yvette has no reason to think they would have any special factual connections to NewCo. Yvette notes that, like section 84.1, section 212.1 contains deeming rules for non-arm's length relationships involving control by groups of less than six. She concludes that there is a likely interpretation that the deeming rule applies. In that case, the non-resident beneficiaries would be deemed to be non-arm's length with NewCo as the purchaser corporation, and the third criteria would be met.

Having concluded that section 212.1 may apply, Yvette considers the consequences of this. In doing so, she notices another important distinction between sections 212.1 and 84.1. Under paragraphs 84.1(1)(a) and (b) there is a reduction in the paid-up capital of new shares or a deemed dividend respectively, only to the extent that the value of the consideration received in the disposition of the CanCo shares exceeds the greater of (i) the paid-up capital of the CanCo shares and (ii) the “hard ACB” of the CanCo shares. Section 212.1 does not include adjusted cost base in the determination. Subject shares held by an estate, like the shares in CanCo, typically have a high adjusted cost base due to the deemed disposition on death. Accordingly, section 212.1 results in a significant deemed dividend or paid-up capital reduction in situations where section 84.1 would not. This would prevent the goal of a pipeline from being achieved. A deemed dividend would be subject to immediate taxation and a reduction in paid-up capital would further reduce the amount that the beneficiaries could receive from the corporation without additional tax.

If subsection 212.1(1.1) applies, it would trigger a deemed dividend or paid-up capital reduction on the portion of the CanCo shares sold by the Estate allocated to the non-resident beneficiaries under paragraph 212.1(6)(b).


Yvette concludes that under the existing legislation, a pipeline will be only partially effective. It will be effective with respect to the portion of the CanCo shares representing the proportionate interest of the resident beneficiaries of the Estate. It will not be effective with respect to the portion of the CanCo shares representing the proportionate interest of the non-resident beneficiaries in the Estate.

A version of this article originally appeared in Tax Topics published by Wolters Kluwer.

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