The traditional dynamic for business sale negotiations often involves a seller wanting to sell shares of the corporation that operates the business and a buyer wanting to acquire assets. Hybrid business sale structures developed to allow for a business sale to be structured as a "hybrid" asset sale and a share sale, often to allow a seller to make use of their lifetime capital gains exemption.
Historically the Canada Revenue Agency ("CRA") looked to apply Income Tax Act ss. 84(2) to recharacterize share sale proceeds in hybrid sales transactions as dividends. After the Tax Court of Canada ("TCC") decision in Geransky, the CRA generally respected hybrid business sale transactions. However, recent cases may have reignited CRA reviews of these transactions.
Generally ss. 84(2) applies where funds or property of a corporation resident in Canada have been distributed or otherwise appropriated, in any manner whatever, for the benefit of shareholders of any class of shares in its capital stock, on a winding up, discontinuance or reorganization of its business. In Geransky, the buyer wanted to acquire a cement plant and related assets of an operating company ("Opco"), the shares of which were owned by a holding company ("Holdco"). Holdco incorporated a new company ("Newco"). The target assets were then transferred to Holdco via a dividend in kind payment and then moved to Newco on the redemption of Holdco's shares in Newco.
The shares of Newco were then acquired by the Buyer. The CRA reassessed to recharacterize the proceeds of the sale of Newco's shares as dividends, pursuant to ss. 84(2). The TCC held, among other things, that it did not see where any funds or property of the Opco ended up in the hands of Mr. Geransky, the appellant, who sold his shares of Newco.
In the course of its reasons, the TCC reviewed a number of surplus stripping cases (notably RMM Enterprises and McNichol). Both cases involved identifiable corporate surplus that was transferred to the shareholders of a corporation.
Recent decision – MacDonald
Subsequently, in the MacDonald decision, the Federal Court of Appeal ("FCA") upheld the application of ss. 84(2) to proceeds from the sales of shares of a medical professional corporation ("PC"). The assets of PC were first liquidated and sold by the shareholder of PC to his brother-in-law ("JS") for a promissory note. JS then transferred the shares to his newly incorporated company, again in consideration for a promissory note payable by the new company. Dividends were then declared and endorsed over to JS and then over to the shareholder of PC. The FCA focussed on the wording in ss. 84(2) respecting funds or property of a corporation being distributed or otherwise appropriated, in any manner whatever, for the benefit of the PC's shareholder and held that the reorganization involved a circuitous means of transferring corporate property to the PC shareholder.
The recent TCC decision in Foix upheld the application of ss. 84(2) in relation to a hybrid business sale transaction. In this case, the transaction was originally proposed as an asset sale, but the parties converted it to a hybrid sale of assets and shares. There was an ongoing agreement that the excess cash of the corporation could be distributed to shareholders prior to closing. The TCC held that the purchasers were the instruments and intermediaries through which the distribution of the target corporation's funds or assets for the benefit of its shareholders took place, following a prior reorganization that brought about the hybrid sale.
Some recent CRA reviews suggest that the CRA may take the position that the Foix decision has called into question all hybrid business sale transactions.
However, as in Geranksy, the law remains that some funds or property of the corporation in issue must be distributed or appropriated. In an ongoing audit or tax dispute, look to ensure there were identifiable corporate funds or corporate surplus that was distributed. The value of corporate shares will always be tied to the value of the underlying assets, even as concerns shares sold in the context of a hybrid business sale and obviously does not, in and of itself, support the application of ss. 84(2).
Moreover, as in McNichol, even where identifiable corporate funds or surplus are distributed, the TCC may nevertheless overturn a ss. 84(2) reassessment where the vendor is truly arm's length and cannot be said to have participated in the transaction to accommodate the seller's desire to extract corporate surplus on a tax free basis.
Should you have any specific questions about this article or would like to discuss it further, you can contact the author or a member of our Tax Dispute Resolution Group.
 All statutory references are to the Income Tax Act.
 (2001) D.T.C. 243 (TCC).
 RMM Canadian Enterprises Inc. v. R.,  T.C.J. No. 302 (TCC).
 McNichol v. Canada  T.C.J. 302 (TCC).
 Foix c. La Reine, 2021 TCC 52; under appeal.