ACCO 655/2194

SECTION CC

TAXATION AND DECISION-MAKING

COURSE NOTES

WEEK 10

 ROLLOVERS UNDER SECTION 85

 OTHER ROLLOVERS

John Molson School of Business

Graduate Diploma in Chartered Professional Accountancy Program
Concordia University
Larry Jacobson, MBA, CPA, CA
February, 2020

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 Copyrighted Materials

All book excerpts included in these notes come from the required text for this course:
Byrd & Chens Canadian Tax Principles, 2019-2020 Edition. We gratefully
acknowledge permission from the publisher to use these excerpts.

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 ROLLOVERS UNDER SECTION 85

Byrd & Chen: Chapter 16

What to study regarding Section 85 rollovers?

If tax is NOT your elective role:

You are only required to understand pages 13 and 16-18.

If tax is your elective role:

You need to be able to explain the basic tax considerations of reorganizations, as

well as the basic application of the rules. Therefore you should concentrate
on pages 4-18, 31, and 36-41.

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 What is a Rollover?

It is a transfer of an asset at ACB/UCC.

When is a Section 85 rollover used?

It is normally used when there is a transfer of assets to a corporation, where the

assets have accrued gains.

Examples:

1. Incorporation of a business

2. Estate freeze

3. Corporate reorganizations

4. Transferring profitable assets to a loss corporation in order to use up

available loss carryovers.

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How does a section 85 rollover work?
 Assume a sole proprietor has business assets, including land and buildings,
where the current FMV is in excess of the ACB and UCC. If the proprietor
decides to incorporate a company and transfers these assets to the new
incorporation, there is a possibility for significant capital gains and
recapture.

 Section 85 permits the vendor to elect (choose) the sales price on the
transfer of most assets to a corporation to be anywhere between FMV and
ACB/UCC

 Example: An individual has land and wants to transfer it to a corporation.

FMV $30,000
ACB $10,000

The individual can elect to transfer the land for proceeds

between $10,000 and $30,000

If the individual elects $10,000, we will have:

POD $10,000
ACB 10,000
CG NIL

GENERAL RULES

 Who can make the election?

o ITA 85(1):
- Individual
- Trust
- Corporation

o ITA 85(2):
- Partnership

 Terms? Refer to the following page.

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6
Property Eligible to be Transferred - s. 85(1.1)

Only eligible property can be transferred. The list includes:

 Accounts receivable (unless a s. 22 election made)

 Depreciable and non-depreciable capital property (e.g., land, buildings,

machinery, intangible property)

 Canadian and foreign resource properties

 Inventory (other than real property, such as land or building inventories)

Property that cannot be transferred under s. 85:

 Inventories of real property (land and buildings)

 Real estate owned by non-residents

 Cash

 Prepaids and reserves

 Liabilities (but liabilities can be part of the consideration)

 Depreciable capital properties transferred to an affiliate corporation,

where the FMV of the property is less than the UCC. This will create a
terminal loss, which will be denied (covered later).

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Property for which s. 85 is of no advantage

 Accounts receivable. Usually better to use a s. 22 election.

 Any eligible asset where FMV ≤ tax cost. In these situations section 85
makes the ETP to equal the FMV of the asset, such that s. 85 is not
needed (you can simply sell the asset to the corporation for FMV).
Losses on transfer are deductible for tax purposes, unless the transfer was
to an affiliated corporation.

Consideration

Consideration is the proceeds received by the transferor (i.e., vendor) in return for
the eligible properties transferred to the corporation.

Consideration includes:

1. Shares of the transferee (purchaser) corporation

 Must receive at least one share for each asset transferred

 The shares can be common and/or preferred

2. Non-share consideration (Boot)

 Cash, new debt or the assumption of old debt of the corporation

 Boot is optional

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Making the Election

 Both transferor and transferee must file a joint election, either form T2057
(for an individual/corporation) or T2058 (partnership).

 Time limit to file: Earliest date for filing tax returns by the purchaser and
vendor.

 Late filing election allowed within 3 years of the due date, but with a
penalty.

 The CRA can accept a new or amended election after the 3 year deadline if
it would be “just an equitable.”

 Penalty: Lesser of:

 ¼ of 1% of the deferred gain, or
 $100/month that the election is late

 The maximum penalty is $8,000

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Establishing the Elected Transfer Price (ETP)

The ETP takes on 3 values:

1) The transferor’s proceeds of disposition

2) The transferor’s cost of the consideration received

3) The transferee’s cost of the properties purchased

Example:

Land transferred to a corporation:

 FMV $30,000
 ACB $10,000

 Consideration: Common shares

with a LSC of $30,000

 ETP $10,000

Result:

 POD $10,000

 ACB of shares received from the corporation $10,000

 ACB of land for the corporation $10,000

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Range for the ETP:

 Refer to the handout

 Examples:

ETP: $12,000 $10,000 $17,000

 Takeaway:

1. Example two: There is no advantage to using s. 85 when there is no

accrued gain on an asset.

2. Example three: Don’t take boot in excess of the ACB of the

transferred property. If you do, you must declare a gain on the
transfer.

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12
Sale of Corporate Assets – Accounts Receivable:

Example:

 Face value $100,000

 FMV $ 80,000

If elect under section 85(1):

ETP $ 80,000
Cost 100,000
Capital loss $(20,000)

 ½ is deductible against any TCG

 The loss could be denied (covered later)

If elect under section 22:

 The $20,000 loss above is a business loss and is fully deductible.

 The purchaser of the receivables will

1. Record the receivables at $100,000
2. Include a $20,000 reserve in income
3. Can claim future reserves and bad debts as an expense (vs
capital loss if no election is made).

 Conclusion: Usually best to elect under section 22

Note: For a disposition of accounts receivables to qualify for a section 22

election, the purchaser must acquire “all or substantially all” of the business
assets and to continue “carrying on the business.” These tests would be met
on the incorporation of a proprietorship. Section 22 cannot be used when the
receivables are sold to a factoring company since the disposition does not
meet the “all or substantially all” and “carrying on the business” tests.

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 Sale of Depreciable Assets

 No AccII (the extra 50% depreciation in the year of acquisition) and

no 1/2 year rule (certain class 12 assets) if the asset is transferred from
a related person who previously used the asset for business or property
purposes.

 If elected value is less than capital cost (most situations)

o Usually no CG or recapture
o New UCC = ETP

Example – Machine:
o Cost = $350,000
o UCC = $275,000
o Elected Value = $275,000

Result – Cost to Purchaser:

o UCC = $275,000
o Capital Cost = $350,000 (ITA 85(5))
o $75,000 difference is deemed to be CCA previously claimed

 If elected value greater than capital cost (mostly for buildings)

o Capital gain and recapture will be triggered
o New CC = elected value,
o New UCC = Old capital cost + ½ (elected value – capital cost)

Example - Building:
o Cost $500,000
o FMV $600,000
o UCC $300,000

o ETP $600,000

Result:
o Capital gain: $100,000
o Recapture: $200,000

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 o Cost per ITA 13(7)(e):

New Capital Cost $600,000

New UCC
= Old Cost $500,000
Elected Value $600,000
Less: Capital Cost (500,000)
Bump Up $100,000
Inclusion Rate x½ 50,000
New UCC $550,000

Allocation of Elected Value

 ETP = ACB of consideration received

 ACB allocated in the following order:

1. Boot
2. Preferred shares
3. Common shares

 Example:

Land transferred to a corporation:

FMV $30,000
ACB $10,000

ETP $10,000

Allocation
Consideration FMV of ACB

Debt $6,000 $6,000

Preferred shares (FMV) 10,000 4,000
Common shares 14,000 Nil
$30,000 $10,000

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DISPOSITIONS TO AFFILIATED PERSONS (STOP LOSS PROVISIONS)

o When capital property is sold (or transferred under s. 85) to an affiliated

person at a loss, the loss will be denied.

o Losses on income account (business losses) are not denied.

o Affiliated person (ITA 251.1):

 An individual and the person’s spouse
 A corporation is affiliated with a person or an affiliated group that
controls the corporation, or the spouse of the person that controls a
corporation

o A person’s child, sibling, parent or corporations controlled by them are not

affiliated with the person, so losses on sales to these persons are not denied.

o The loss denial rules apply whether or not s. 85 is used.

o The rules for loss denial depends on the type of vendor. We will examine:

o Capital losses:
 Corporate vendor
 Individual vendor

o Terminal losses
 Corporate and individual vendor

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Capital Losses

The denied loss treatment depends on whether the vendor is a corporation or an

individual.

o Corporation: If a corporation transfers property to an affiliated person the

denied loss stays in the hands of the transferor (vendor) and can only be used
when the property is no longer owned by the affiliated person (i.e., the
purchaser subsequently sells the property to a third party, the purchaser is
wound-up, or there is an acquisition of control of the purchaser).

Example - Land:
FMV $10,000
ACB $30,000
ETP $10,000

Vendor corporation: The capital loss of $20,000 is

denied. Loss can be used when
affiliated purchaser disposes of the
land to a non-affiliated person,
wind-up, or acquisition of control.

Purchaser corporation: ACB land = $10,000

o Individual: If transferor (vendor) is an individual then capital loss is denied

to transferor and treated as a superficial loss which is added to the ACB of
property to transferee (purchaser).

Example - Land:
FMV $10,000
ACB $30,000
ETP $10,000

Individual vendor: The capital loss of $20,000 is denied

Purchaser: ACB land: $10,000 + $20,000 (denied loss)

= $30,000

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Terminal Losses (depreciable property)

o Corporations and Individuals: 13(21.2) denies terminal losses on transfers

by corporations and individuals to an affiliated person. The loss remains in
the hands of transferor in a separate CCA class and can be amortized based
on its original CCA rate. A terminal loss can be claimed when the affiliated
person either sells the property, there is a change in control, or a winding up
of the purchasing corporation.

o Example - Machine, CCA rate 30%:

Cost $200,000
FMV $70,000
UCC $150,000

Result:
 The rules of section 85 do not apply
 Purchaser has UCC: $70,000; CC: $200,000; CCA deemed to have
been previously claimed $130,000
 Terminal loss for vendor, $80,000, is denied
 The denied loss goes to a separate class and is deemed to be a
depreciable property of the vendor, subject to CCA at 30% (i.e., the
same CCA rate as for the disposed asset)

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PUC OF SHARES ISSUED – ITA 85(2.1):

 When shares are issued under a s. 85 rollover, the LSC of the newly
issued shares is almost always reduced either by 85(2.1) or 84.1 (covered
later).

 When 85(2.1) applies, the PUC for tax purposes

will equal: ETP – Boot

 Example: Land transferred to a corporation

FMV $30,000
ACB $10,000

ETP $10,000

Consideration:
LSC $24,000
Debt $ 6,000

Required: Determine the PUC.

LSC $24,000

Less PUC Reduction:1

Increase in LSC $24,000
Less:
Elected amount $10,000
Less Boot 6,000 4,000 20,000

PUC of newly issued shares $4,000

1 Note: If more than one class of shares are issued, the PUC reduction is prorated
on the basis of the fair market value of the shares.

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GIFT TO RELATED PERSON – ITA 85(1)(e.2)

 Indirect benefit conferred to a family member on a 85(1) rollover.

 If FMV of transferred properties on an 85(1) exceeds the greater of:

1) FMV of consideration received (Boot + FMV of shares)

2) ETP

AND it is reasonable to regard the excess as a gift to a related shareholder,

then the excess is added to the ETP for purposes of:

1. POD, and

2. Cost of property received by the corporation

Note: It is NOT added to the cost of consideration received

 Example: Land transferred to a corporation of which the common shares

are owned 100% by the transferor’s children

FMV of land $60,000

ACB $10,000

ETP $10,000

Consideration:
Preferred shares with a LSC $10,000

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Required: Determine the tax implications.

Benefit:
FMV of land $60,000
Less greater of:
 FMV of consideration $10,000
 ETP $10,000 10,000
Excess (Gift) $50,000

POD:
ETP $10,000
+ Gift 50,000
Deemed ETP (POD) $60,000
Less: ACB of land 10,000
Capital gain $50,000

ACB of land for the purchaser corporation:

ETP $10,000
+ Gift 50,000
Deemed ETP (ACB land) $60,000

Cost of consideration (the shares) received by vendor:

ETP (the gift amount was not added) $10,000

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 PUC of shares received:

LSC $10,000

Less PUC Reduction:

Increase in LSC $10,000
Less:
Deemed ETP $60,000
Less Boot 0 (60,000) 0

PUC of newly issued shares $10,000

Takeaway: When transferring assets to a corporation whose shareholders include

the spouse, children, or other related person of the vendor, ensure that the FMV of
the consideration received is not less than the FMV of the asset transferred to the
corporation.

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EXCESS CONSIDERATION RECEIVED

 In the previous example, the shareholder took less out of the company than
he transferred in (gift situation).

 What would happen if he took out more from the company than he put in?

 There would be a s. 15(1) shareholder benefit

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Takeaway: When transferring assets to a corporation ensure that the FMV of the
consideration received is not in excess of the FMV of the asset transferred to the
corporation.

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SALE OF SHARES TO A RELATED CORP.- CG CRYSTALLIZATION

Capital gain crystallization

 Individuals who own Qualified Small Business Corporation (QSBC) shares

with accrued gains, might wish to crystallize their gain and claim the CGD.

 This can be achieved by selling the QSBC shares to another corporation

owned by the individual or related parties.

 This can also result in a PUC reduction in the shares received as

consideration

Example:

 An individual owns Opco shares:

FMV $950,000
ACB $100,000
PUC $100,000

 The individual believes the ITA might be amended in the near future to
eliminate the CGD. The individual previously used $266,912 of the CGD,
and now wishes to crystallize the remaining $600,000.

 The individual creates a new corporation (Holdco)

 The individual transfers his shares of Opco to Holdco under s. 85

ETP: $700,000

 Consideration received - Shares of Holdco:

FMV: $950,000
LSC: $950,000

Question: Determine the tax implications.

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(CG Crystallization – continued)

Capital gain:

POD (ETP) $700,000

ACB 100,000
CG $600,000
Less: CGD 600,000
Amount subject to tax NIL

ACB of Holdco shares:

ACB = ETP = $700,000

PUC of Holdco shares – ITA 84.1(1)(a):

Increase in the LSC of purchaser corporation (Holdco) $950,000

Less:
Greater of:
o PUC of shares transferred: $100,000
o ACB of shares transferred: $100,000 $100,000

Less: FMV of boot received NIL 100,000

84.1(1)(a) PUC reduction $850,000

LSC $950,000
Less PUC reduction, per above 850,000
PUC of Holdco’s shares for tax purposes $100,000

Takeaway: An individual can crystallize the CGD by selling shares to a related

company, and as long as boot received is not in excess of the greater of the PUC or
ACB of the shares sold, there will be no deemed dividend.

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 SALE OF SHARES TO A RELATED CORPATION

DIVIDEND STRIPPING - ITA 84.1(1)(b)

Purpose of ITA 84.1(1)(b): Prevent dividend Strips

Dividend stripping: Where an individual removes assets from a corporation on a

tax free basis.

How do you dividend strip?

 One method would be to convert a dividend payment to an individual

shareholder into a capital gain which qualifies for the $866,912 CGD

How does ITA 84.1(1)(b) prevent dividend strips?

 Converts capital gains into taxable dividends

Example: Shares sold to a related corp. and boot received by the shareholder.

 An individual owns Opco shares:

FMV $950,000
ACB $100,000
PUC $100,000

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  The individual believes the ITA might be amended in the near future to
eliminate the CGD. The individual previously used $266,912 of the CGD,
and now wishes to crystallize the remaining $600,000.

 The individual would like to take out $500,000 cash from his company, not
as a taxable dividend but rather as a capital gain.

 The individual creates a new corporation (Holdco)

 The individual transfers his shares of Opco to Holdco under s. 85

ETP: $700,000

 Consideration received -
Shares of Holdco:
FMV and LSC: $450,000
Cash: $500,000

Required: Determine the tax implications.

Note: Whenever boot is received when shares are sold to a related corporation that
are connected, you must check for an 84.1(1)(b) deemed dividend.

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PUC of Holdco shares:

PUC Reduction ITA 84.1(1)(a):

Increase in the LSC of purchaser corporation (Holdco) $450,000

Less:
Greater of:
o PUC of shares transferred: $100,000
o ACB of shares transferred: $100,000 $100,000
Less: FMV of boot received (500,000) NIL

84.1(1)(a) PUC reduction $450,000

LSC of Holdco $450,000

Less PUC reduction, per above 450,000
PUC of Holdco’s shares for tax purposes NIL

Deemed Taxable Dividend – ITA 84.1(1)(b):

Increase in LSC of purchaser corporation $450,000

Plus: FMV of boot 500,000
$950,000
Less:
Greater of:
1) PUC of shares transferred $100,000
2) ACB of shares transferred $100,000 $100,000

Plus:
PUC reduction under 84.1(1)(a)
(see below) 450,000 550,000

84.1(1)(b) Deemed taxable dividend $400,000

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Capital Gain or Capital Loss on disposal of Opco shares:

ETP $700,000
Less: 84.1(1)(b) Deemed dividend 400,000
Deemed POD $300,000

Less: ACB of Opco shares 100,000

Capital gain $200,000

Less: CGD 200,000
Amount subject to tax NIL

ACB of Holdco shares:

ETP $700,000
Less: Amount allocated to boot 500,000
ACB of Holdco shares received $200,000

Takeaway:

If an individual sells shares of a closely held company to a related company, you

can crystallize your CGD, but there will be a deemed dividend (and not a CG) if:

Boot received is > (PUC or ACB of the shares sold) = Deemed dividend

When does ITA 84.1 apply? (All 4 conditions must be met)

1. There is a disposition by an individual to a corporation,

2. Only applies to the transfer of shares,

3. The individual and the purchaser corporation are not at arm’s length,
and
4. The subject corporation (the shares of the corporation whose shares are sold)
must be connected (i.e., > 10% ownership or control) to the purchaser
corporation after the transfer.

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 Section 85 rollover

Examiner’s comments taken from a previous UFE:

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 CFE Question concerning s. 85(1) Rollover

Sale of assets (including shares) to a taxable Canadian corporation using s 85:

Issues:

Candidate should give basic details of the s. 85(1) rollover, such as:

1. ETP can be chosen anywhere between FMV and cost.

2. Form T2057 must be filed and agreed to by both the purchaser and vendor.

3. Late election can be filed, with penalty (Maximum $8,000).

4. ETP usually at cost, to avoid any immediate tax implications.

5. The election is useful for eligible assets with accrued gains.

6. Consideration taken back must include at least one share.

7. The ACB of the consideration received will equal the ETP.

8. Always check to see if the sale of shares is made by an individual to a related

corporation and boot is received (whether or not section 85 is used). S. 84.1
could convert the boot from a capital gain into a deemed dividend.

Planning:
1. Consider using an ETP higher than cost in cases where you can use the
CGD, or have unutilized losses.

2. When selling business assets to a corporation, always be sure to rollover

intangibles (e.g., Class 14.1 goodwill), even if it had no cost and is not on the
balance sheet of the vendor. If it has no cost, the ETP would be $1.

3. Consider including a price adjustment clause in the sales agreement if

uncertain about the FMV of the assets sold (to avoid s. 85(1)(e.2) gift or s.
15(1) shareholder benefit implications).

4. Use of s 85(1) to crystallize CGD.

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CAPITAL GAINS STRIPPING ITA 55(2)

This is an anti-avoidance provision designed to prevent corporations from

converting capital gains to dividends on the disposition of share investments to an
arm’s length party.

Criteria for application of 55(2):

1. A corporation received a dividend, deductible under s. 112, as part of a

transaction involving the disposition of shares,

2. The dividend significantly reduced the capital gain on the disposition of the
shares,

and

3. The sale of the shares by the corporation was to an arm’s length party.

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EXAMPLE:

Lor Inc. currently owns Lee Ltd. An arm’s length purchaser has made an offer for
$800,000 to buy the shares of Lee Ltd. In order to reduce the amount of the CG,
the following plan was carried out.

Step 1: Lee Ltd borrows $600,000 from a bank.

Step 2: Lee Ltd pays a $600,000 dividend to Lor Inc.

Step 3: Lor Inc. sells the shares of Lee Ltd to the purchaser for $200,000

Result before s. 55(2) for Lor Inc: POD $200,000

ACB (200,000)
CG NIL

s. 55(2) will add the dividend received of $600,000 to the POD.

POD $200,000
Add dividend received 600,000
Revised POD $800,000
ACB (200,000)
Revised CG $600,000

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Tax Planning:

Under ITA 55(5)(f) the corporation receiving the dividend (Lor Inc. in our case)
can designate the dividend received to be more than just one dividend.

In our example, Lor Inc. would designate that it received two separate dividends, as
follows:
 Dividend of $250,000 (equal to save income)
 Dividend of $350,000 (to be added to POD)

Note that the “safe income” amount (Retained Earnings after 1971 computed on a
tax basis) will remain as a dividend.

By designating that 2 dividends were received, the CG realized by Lor Inc. was
reduced from $600,000 to $350,000.

Takeaway: The CG on the sale of shares by a corporation can be reduced to the

extent that a dividend is paid out prior to the sale equal to the safe income. If the
dividend is in excess of the safe income, then a designation can be made to
consider the dividend to be two or more dividends, one of which should equal the
safe income.

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 SECTION 85 PROBLEM

Mr. Rollover, a client, indicates that he wishes to incorporate early in 2019 his sole
proprietorship which he carried on as an active business in Ontario.

The assets and liabilities of the sole proprietorship, as at December 31, 2019, are listed below:

Book Fair Market

Assets value value
Inventories ................................................................. $10,000 $ 10,000
Prepaid rent…………………………………………. 2,000 2,000
Accounts receivable………………………………… 6,000 4,000
Land (investment)………………………………..…. 1,000 10,000
Investment in long term bonds……………………... 40,000 50,000
Land………………………………………………… 5,000 75,000
Building…………………………………………….. 20,000 120,000
Equipment…………………………………………... 10,000 40,000
Goodwill……………………………………………. Nil 80,000
$94,000 $391,000
Liabilities
Bank loan…………………………………………… $15,000 $ 15,000
Accrued liabilities…………………………………... 5,000 5,000
Mortgage on building……………………………….. 10,000 10,000
$30,000 $ 30,000

Additional Information:

(1) The prepaids have not been written off for tax purposes.

(2) The raw land has no structure on it and is a speculative investment.

(3) The following information relates to the fixed assets as at January 1, 2019:

Undepreciated Capital
capital cost cost
Land ................................................................. — $ 25,000
Building……………………………………… $100,000 110,000
Equipment…………………………………… 60,000 100,000

(4) Mr. Rollover has $22,500 of net capital losses which arose in 1997 and which he would
like to use.

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Required:
(A) Concerning Mr. Rollover’s transfer of assets to his new corporation, explain:
(i) Which assets which should not be transferred to the corporation, and
(ii) Which assets should be transferred to the corporation, but cannot are should not be
transferred under subsection 85(1), .and provide the amount and type of
consideration that should be received for each asset.

(B) For assets which should be transferred to the corporation using s. 85(1), take back the
maximum debt for each asset (to the nearest $100) without causing an increase in his
taxable income. Also, Mr. Rollover wants the new corporation to assume the liabilities
of the sole proprietorship.

(C) (i) Determine the cost of the consideration received from the corporation.

(ii) What would be the tax consequences if the shares of the newly created corporation
are sold to an arm’s length party for their fair market value shortly after the subsection
85(1) rollover?

(D) (i) Determine the paid-up capital for tax purposes of the shares received from the
corporation.

(ii) What would be the tax consequences if the shares are redeemed by the corporation for
their fair market value shortly after the subsection 85(1) rollover?

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 SECTION 85 SOLUTION

(A) Assets which should not be

transferred:
Bond investments Do not transfer to corporation. If transferred, corporation
will not be a QSBC, so not eligible for the CGD. Also, no
tax advantages for a corporation to earn interest income.

Land investment No advantages to transfer to the corporation, and is not an

active asset for QSBC purposes.

Assets not eligible:

Prepaid rent Not capital property. Transfer at $2,000 for debt
consideration. No tax implications.

Land investment Land is inventory and not capital property; ineligible.

Do not transfer to the corporation; no advantage.

Assets where rules don’t apply:

Equipment Cannot use section 85. Transfer at $40,000 for debt
consideration. $20,000 terminal loss will be denied.
Mr. Rollover can claim CCA on this loss every year.

Assets not recommended to use ssec. 85(1):

Inventory No advantage in using section 85; there is no gain to defer.
Transfer at $10,000 for debt consideration.

Accounts receivable If use section 85, will have a $2,000 capital loss which will
be denied. If s. 22 is used, the $2,000 is deductible as a
business loss and is not denied. Transfer for $4,000 debt
consideration.

(B) Items transferred under ssec. 85(1)

Tax Elected Consideration Effect on

value F.M.V. amount Debt Shares taxble income

Land ................................................. 25,000 75,000 55,000 55,000 $ 20,000 Nil3

Building ........................................... 100,000 120,000 100,000 100,000 20,000 Nil
Goodwill .......................................... Nil 80,000 1 Nil 80,000 $0.50
$125,000 $275,000 $155,001 $155,000 $120,000
Liabilities
assumed
............................................................................................................... 30,000
New debt
issued
............................................................................................................... $125,000

38
(C) (i) Elected transfer
price
.............................................................................................................................................. $ 155,001
Allocation of A.C.B. to debt consideration:
Debt assumed $ 30,000
New debt issued 125,000 (155,000)
A.C.B. of shares $ 1

(ii) Proceeds of disposition (FMV) $ 120,000

A.C.B. (1)
Capital gain $ 119,999

D) (i) Legal stated capital (L.S.C.) of shares $ 120,000

Less: ssec. 85(2.1) reduction in P.U.C.
(1) increase in L.S.C. of all shares on transfer $120,000 (A)
(2) corporation’s cost of property under ssec. 85(1)
(i.e., elected amount) $155,001
F.M.V. of non-share consideration 155,000
excess, if any 1 (B)
(A−B) $119,999
P.U.C. reduction for one class of shares ........................................................................... 119,999
P.U.C. for tax purposes ..................................................................................................... $ 1

Deemed dividend and capital gains computation:

(ii) Redemption amount $ 120,000

P.U.C. for tax purposes (1)
Deemed dividend [ssec. 84(3)] $ 119,999
Proceeds of disposition $ 120,000
Deemed dividend [ssec. 84(3)] (119,999)
Adjusted proceeds of disposition [par. (j) of def. ‘‘proceeds of disposition’’ in sec. 54] $ 1
A.C.B. [after ssec. 85(1)] (1)
Capital gain (loss) Nil

― NOTES TO SOLUTION

(1) The capital cost of the building to the corporation will be the original capital cost of
$110,000.

(2) Subsection 13(21.2) applies to deny the unrealized terminal loss where the transferor is
an individual and the asset is transferred to an affiliated person. The capital cost addition
to U.C.C. to the corporation will be $40,000. Mr. Rollover will have a notional asset of
$20,000, equal to the amount of the terminal loss. CCA can be claimed on the $20,000 at
the same rate as the equipment class.

(3) The elected amount of the land was increased by $30,000, so that net capital losses of
$15,000 could be fully utilized ($22,500 x 4/3 = $30,000 x ½ = $15,000).

39
 CFE CASE

Section 85(1) Rollover

Sept 2017 CFE

(For Tax Elected Role Candidates)

The following is the suggested answer to a question which required the use of s. 85(1).
This question was asked when the Tax Elective Role required a “B” level. As it is now
a “C” level, Elective Role candidates need only understand the discussion below, in
particular the highlighted areas.

Suggested Solution:

40
Section 85(1) Solution - continued

41
 OTHER ROLLOVERS
Byrd & Chen: Chapter 17

OTHER ROLLOVERS AND USE OF ROLLOVERS IN ESTATE

PLANNING

ITA 85.1: Share for share exchanges

ITA 86: Reorganization of share capital

ITA 87: Amalgamations

ITA 88(1): Wind-up of a subsidiary into its parent corporation

ITA 88(2): Wind-up (dissolution) of a corporation

ITA 55(1): Convertible properties

42
85.1 SHARE FOR SHARE EXCHANGES

Note: As there is nothing in the 2019 CPA Competency Map which refers to
Section 85.1, it should not be tested on the CFE, and you can ignore pages
46-48 of these notes.

Use of Section 85.1

 Used when one corporation takes over another

 Instead of paying cash for the acquisition, newly issued shares of the
purchaser are used

 ITA 85.1 makes it easier to have a takeover offer accepted, as there is no

capital gain for the vendor on the sale of the shares. ITA 85.1 provides for
an automatic rollover at ACB for the vendor. No election forms are
required.

 Example:

Results:

1. No gain or loss on sale by Ms. Cowper

2. ACB and PUC of shares sold roll over to new shares received

43
Summary of Results

1. No gain or loss on sale

2. ACB and PUC of shares sold roll over to new shares received

3. ACB of shares acquired by the purchaser = lesser of:

 FMV of acquired shares

 PUC of acquired shares

44
Conditions for 85.1 to Apply:

1) Cannot have made a 85(1) rollover for the same transaction

2) Shares being transferred are capital property

3) Transferor and transferee are arm’s length

4) Transferee (purchaser) is a Canadian corporation

5) Transferor (vendor) cannot control Transferee Corporation after 85.1

6) Transferee (purchaser) must issue only one class of shares to transferor

(vendor)

85.1 is an automatic rollover

 No election is required

 If the vendor does not want to take advantage of the rollover, they need
only declare the gain or loss on the sale, or file a section 85(1) rollover

Tax Planning:

 The vendor may choose not to take advantage of the rollover by including
the gain or loss resulting from the disposition in his/her tax return for the
year of the exchange (to take advantage of the CGD, or unused losses).

45
SEC 86 REORGANIZATION OF SHARE CAPITAL

If tax is NOT your elective role:

You are not required to know pages 46-52.

If tax is your elective role:

You need to be able to explain the basic tax considerations of a section 86

reorganization, as well as the basic application of the rules. Therefore you
should cover pages 49-55.

Section 86, what is it?

 The reorganization of the capital (i.e., share) structure of a single

corporation

 If the rules are followed, it is done on a tax free basis

When is it used?

 To put into effect an estate freeze (Week 11)

 To sell the company to a key employee

How is it accomplished?
 It involves the exchange of all the shares of a particular class owned by a
taxpayer for another class of newly issued shares, and sometimes boot is
included
 Typical example is the exchange all of a person’s common shares for
preferred shares.

46
ITA 86(1) Procedures

 When the shares are exchanged by the corporation, it involves:

1. Both a redemption and disposition of the old shares and

2. An acquisition of new shares by the shareholder

ITA 86(1) Rules

1) Cost of Boot = FMV of the Boot

2) Cost of new shares = Cost of old shares - Boot

3) PUC of new shares = PUC of old shares – Boot (can never be

negative)

4) Proceeds of redemption of old shares = PUC of new shares + Boot

5) Proceeds of disposition of old shares = Cost of new shares + Boot

Note:

 Will have an 84(3) deemed dividend if boot is > PUC of old shares

 Could also have a capital gain or a capital loss on the disposition of the old
shares

 Capital loss will be denied if the shareholder is affiliated with the

corporation after the reorganization (i.e., the shareholder or spouse controls).
The loss would be added to the ACB of the new shares received [ITA
40(3.6)].

47
Example: Estate Freeze, No Gift

48
Takeaway for CFE: Reorganization of Capital

1. If no boot is received in the reorganization:

 The ACB and PUC of the old shares transfers to the new shares.
 No gains or deemed dividends would result from the reorganization
 The purchaser of the new common shares directly from the company will
now own the growth shares

2. If boot is received in the reorganization:

 The ACB and PUC of the new shares is reduced by the boot,
 There could be a deemed dividend and capital gain if the boot received
exceeds the old PUC and ACB (as per the example starting on the
previous page).

49
PLANNING: KEY EMPLOYEE SUCCESSIONS

 Assume that an owner/manager wishes to sell the company to a key

employee

 Key employee might not have sufficient funds for the purchase

 The above freeze transaction can be carried out, with the key employee
acquiring the new common shares and the owner/manager exchanging their
old common shares for new preferred shares

 The key employee could then either:

1. Redeem the preferred shares over a number of years, as the employee

earns income from the business, or

2. The company could redeem the shares over a number of years.

50
ITA 86(2) Benefit Rule (Review only if tax is your elective role)

 Exists to prevent a taxpayer from using the s. 86 reorganization provisions

to confer a benefit (gift) on a related person

 Gift = FMV of old shares - (FMV of new shares + Boot)

 Tax consequences:

i. Proceeds of disposition:
Lesser of:
o FMV of Boot + Gift amount
o FMV of old shares

ii. Cost of new shares = Cost of old shares - boot - gift

iii. Capital loss: If one occurs it is deemed to be nil – ITA 86(2)(d)

51
Example: Estate Freeze, With Gift

52
AMALGAMATIONS – ITA 87

There is no reference in the 2019 CPA Competency Map for Section 87

Amalgamations. Therefore you don’t need to know pages 56-59.

The very basics:

1. An amalgamation occurs when two or more corporations are combined to

form a new corporation.

2. Shareholders of the previous corporation receive shares of the new

corporations on a rollover basis.

3. All assets, liabilities, and tax accounts including any loss carryovers are
transferred on a rollover basis to the new corporation.

4. Main purpose for amalgamating: To use losses of an unprofitable corporation

against the profits of the new amalgamated corporation.

5. Amalgamations are sometimes used after an acquisition of control.

53
Detailed explanation:

 An amalgamation occurs when two or more corporations are merged into

one single corporation

 The shareholders of the predecessor corporations receive shares (no boot

allowed) of the new merged corporation

 The basic rules:

1. Predecessor corporations: Deemed POD of all assets at ACB

2. Amalgamated corporation: Deemed acquisition of assets at ACB.
3. Shareholders: ACB and PUC of old shares transfers to new shares.

We will now examine the above three items in more detail.

1. Tax implications for the predecessor corporations

 The assets of the predecessor corporations are transferred to the new

corporation on a tax free basis

 The predecessor corporations are deemed to have a year end the day before
the amalgamation.

 This may give rise to a short year, meaning certain items have to be
prorated, such as CCA and the SBD. It also counts as a year for purposes
of the loss carry forwards.

54
 Tax implications for the new amalgamated corporation

 Asset values, losses, and the tax accounts of the predecessor corporations
flow through to the new corporation, as follows:

 The tax year begins the day of the amalgamation, and the new corporation
can choose its year end.

3. Tax implications for the shareholders

 Deemed disposition of predecessor shares at ACB

 Deemed acquisition of the new shares at the same ACB

 PUC rolls over

55
Vertical Amalgamations

 An amalgamation can be horizontal or vertical

 For a vertical amalgamation, where a subsidiary is amalgamated with its

parent, there can be a loss of basis to the parent.

 Example: Parentco buys all the shares of Subco for $1,000,000.

Several years later the two companies are amalgamated. The
ACB of the assets of the subsidiary are $650,000. On amalgamation
the ACB of the assets ($650,000) flow through to Parentco, while
the investment in Subco is deemed to be disposed of for $1,000,000.
Parentco has lost $350,000 of basis.

In cases where the parent company owns 100% of the subsidiary, certain
assets of the subsidiary can be bumped by a total of $350,000.

The bump will be reviewed when we examine s. 88(1) wind-ups.

Tax Planning: Why Amalgamate?

1) Transfer of losses from an unprofitable corporation to a profitable

corporation. Note: The acquisition of control rules can apply to
amalgamations.

2) Possible to claim more CCA than could otherwise be claimed by an

unprofitable company.

3) To meet  90% FMV of asset rule for QSBC share rules.

4) To simplify a corporate structure (cost savings).

56
WINDING UP OF A CANADIAN CORPORATION – ITA 88

 A corporation is considered to have been "wound up" where it has followed

the legal procedures for winding-up and dissolution under the federal or
provincial statutes.

 Winding up is tax concept. Dissolution is a legal concept which requires

shareholder’s approval.

 After winding up, a corporation ceases to exist as a separate legal entity and
obtains a certificate of dissolution from the government (i.e. it surrenders its
charter).

 Generally, before the government issues a certificate of dissolution

the corporation must show:

- All debts, payables, including income taxes, have been paid (or
creditors have given consent to dissolution if corporation did not
have sufficient funds)

- All remaining property after paying off the above is distributed to the
shareholders.

- There are no pending lawsuits against the corporation.

57
There are two types of wind-ups

ITA 88(1): Wind-up of a ≥ 90% owned subsidiary into its parent. 88(1) is a
rollover provision.

ITA 88(2): Wind-up of all other corporations (e.g.: Corporations owned <
90% by parent, or corporations owned by individuals). 88(2) is
not a rollover provision.

ITA 88(1) Wind-Ups into its Parent

There is no reference in the 2019 CPA Competency Map for Section 88(1) Wind-
Ups. Therefore you don’t need to know pages 61-66.

The very basics:

1. All assets, liabilities, and tax accounts, including any loss carryovers, are
transferred on a rollover basis to the parent corporation.

2. Main purpose for winding-up into a parent corporation: To use losses of an

unprofitable subsidiary against the profits of the parent corporation.

3. Wind-ups are sometimes used after an acquisition of control.

58
Detailed rules:

 Usually undertaken in order to:

o Utilize losses
o Simplify an organization structure (cost savings)

 There are four components to an 88(1) wind-up:

1. Subsidiary: Disposition of assets at ACB

2. Parent: Acquisition of assets at ACB

3. Parent: Disposition of subsidiary’s shares (normally no gain

or loss on disposal)

4. Parent: Asset Bump-Up

We will now examine each item in more detail.

1. DISPOSITION OF ASSETS BY SUBSIDIARY

 Subsidiary deemed to have disposed of its assets and tax accounts as

follows:

Inventory ----------------------------------->
Tax Value
Non-Depreciable Capital Property-------> ACB
Depreciable Capital Property ------------>UCC
Debts ---------------------------------------->
Amount of Debts
Reserve ------------------------------------->
Amount of reserve
GRIP of CCPC ---------------------------->Flows thru to CCPC
parent
LRIP of non-CCPC -----------------------> Flows thru to non-CCPC
parent

 Therefore, there are no capital gains, capital losses or recapture recognized

by the subsidiary on wind-up.

59
2. ACQUISITION OF ASSETS BY PARENT

 The parent is deemed to have acquired the subsidiary's property at a cost =

deemed proceeds of disposition of the subsidiary. Therefore, the tax values
roll over.

 These asset values can be bumped. Covered later.

3. DEEMED DISPOSITION OF SUBSIDIARY SHARES

 Parent is deemed to have disposed of its shares in the subsidiary for the
following proceeds:

Greater of:

i. Lesser of:

a) PUC of shares of subsidiary

b) Net tax cost of subsidiary’s assets

ii. ACB of shares of subsidiary

 Because of this formula, a loss is not possible

60
4. ASSET BUMP-UP

 Certain assets acquired by the parent can be bumped (increased).

 Example

 If the above amounts were reversed; with the potential bump being
$1,000,000 while the excess of the FMV over the cost of the assets was
$650,000, the unused bump of $350,000 would be lost.

 Only non-depreciable capital property can be bumped (such as land,

investments, etc.)

 You cannot bump depreciable property nor goodwill or other intangibles.

61
YEAR-END

 Subsidiary: No deemed year-end when assets are transferred to the parent.

Final year-end when the charter is surrendered

 Parent: No deemed year-end.

TRANSFER OF SUBSIDIARY'S LOSS CARRY FORWARDS

 All losses are transferred to the parent and can be utilized starting in the
first taxation year of the parent after the wind-up

 For carry forward purposes, if a subsidiary had a different year end than
the parent, the subsidiary’s losses are deemed to have occurred in the
parent's year that includes the subsidiary’s year end

 Example
If a parent’s fiscal year begins on February 1 and the winding-up
commences on February 15, 2019, the losses of the subsidiary will not be
available to the parent until its fiscal year beginning February 1, 2020.

CONDITIONS FOR 88(1) TO APPLY:

1) A taxable Canadian corporation must be wound up into another taxable

Canadian corporation, and

2) The parent must own at least 90% of each class of shares of the subsidiary
before the wind-up.

62
COMPARISON – AMALGAMATION VS 88(1) WIND-UP

63
ITA 88(2) WINDING-UP OF A CANADIAN CORPORATION

The very basics:

 After a corporation has sold all of its assets, and the corporation’s
remaining funds are distributed to the shareholder(s), the rules of ITA
88(2) are used. Commonly, this occurs when the shareholder/owner
decides to retire.

 ITA 88(2) is not a rollover provision.

THERE ARE FIVE COMPONENTS TO AN 88(2) WIND-UP

1. Corporation to be wound up either transfers assets to the shareholder(s) or

sells them at FMV

2. The corporation computes taxes on the recapture, capital gains, etc. as a

result of the wind-up

3. The corporation pays all taxes and liabilities

64
4. The cash available after the liquidation of all assets, less the liabilities and
taxes, is used to redeem its shares. Example:

Redemption proceeds $100

Less PUC (30)

84(2) Deemed Dividend $70

Less CDA (30)

Taxable dividend $40

Note: The taxable dividend will trigger a dividend refund if the

corporation has RDTOH. The refund is added to the cash available
above.

5. The capital gain or loss on the wind-up is computed as follows:

Redemption proceeds $100

Less deemed dividend (70)

POD $30

Less ACB (20)

Capital gain $10

Note:

 The CG will not be eligible for the CGD as the corporation will not
qualify as a QSBC at the time of wind-up

 If there is a capital loss it will not be denied.

65
Example taken from “Introduction to Federal Income Taxation in Canada” (Beam,
Laiken, et al)

66
 Solution

Assess the Situation

1. Draw a diagram identifying all stakeholders and their relationships, e.g., corporate org charts

Mr. Prasad Cdn resident

Top tax rate

related 100% ACB/PUC 18K Purchaser

affiliated unrelated

J. Tilkenhurst Ltd CCPC

2. Identify the relationships among the stakeholders, e.g., related, affiliated, associated, connected
 Mr. Prasad owns 100% of the company so they are related and affiliated
 Planning to sell the assets of JTL in January 2020 and wind up the company
 He is in the top tax bracket in 2019 and 2020
 In 2021 and later years he expects his income to be approximately $100,000
3. Identify the profile of each stakeholder, e.g., tax features, risk profile

67
  Mr. Prasad
 An individual resident in Canada (since JTL is a CCPC)

 J. Tilkenhurst Ltd.
 CCPC (given)
 Purchaser
 A corporation
4. Understand the decision maker and their objectives
 Mr. Prasad wants to retire
 He wants the company to sell its assets and wind up JTL
 Wants to determine how much capital he has to invest if he winds up JTL
 He wants to know whether he should wind up JTL or keep it
5. Identify the relevant past transaction/events or planned future transactions/events and create a timeline
 Mr. Prasad purchased the shares 10 years ago
 He wants the company to sell its assets and wind up in January 2020
 Planning transaction

Identify the Issues

1. Identify all of the major tax issues and any non-tax issues
 Tax treatment of an asset sale
a. Quantitative: After-tax cash in JTL after selling the assets?
 Tax treatment of a wind up of JTL
a. Quantitative: After-tax cash with Mr. Prasad on winding up the company?
 Pro and cons of retaining the corporation
a. Should he wind up JTL or keep it?
2. Identify missing information or assumptions made
 Assume that JTL and the purchaser are neither related not affiliated

68
Analyze the Issues

1. Identify and perform the qualitative analysis of the transactions and plans including an analysis of the
applicable provisions of the Act
Tax treatment of asset sale
 The sale of assets will result in:
o Dispositions of the properties sold for tax purposes.
o Taxable income in JTL
o Possible additions to the CDA and non-eligible RDTOH
o Liabilities, including income tax, paid
o After-tax cash in the corporation available for distribution to Mr. Prasad
 Tax treatment of a wind up of JTL
 If JTL is to be “wound up” so s. 84(2) applies
o While s. 88(2) does apply, the assets have already been sold so there are no assets remaining to be
deemed to be disposed of; the only asset is cash. 88(2) applies to a Canadian corporation where all
or substantially of the property owned is distributed to the shareholders on wind up.
o Consequences of wind up – The shares will disappear along with the company. As a result the
wind up is treated like a redemption since the funds are coming from the company to Mr. Prasad.
Therefore, calculate
 Deemed dividend [84(2)]
 Capital gain or loss [84(9)]
 Pros and cons of retaining JTL
 If JTL is NOT to be wound up
o The PUC and CDA can still be paid out tax free
o The dividend refund is not received but future dividends can be paid to generate a dividend refund.
Dividends can be paid out over time at lower tax rates.
o Investment income earned in a corporation is taxed at the highest tax rate and there is a tax cost to
earning investment income in a corporation.
o Avoids immediate tax on the deemed dividend on wind up under 84(2)
o More difficult to access funds held in a corporation.
 If JTL is wound up
o Mr Prasad no longer has ongoing filing and administrative costs associated with having a
corporation.
o Funds from the corporation can be invested personally and taxed at lower marginal tax rates or
could be invested in an RRSP or TFSA where investment income is not taxed.
o Significant deemed dividend on wind up will be taxed at highest marginal tax rate of 42.5%.

69
2. Identify and complete the supporting quantitative analysis of the transactions and plans using an appropriate
analysis format

Sale of Assets
Calculate the tax cost of selling all the assets of the company and the after-tax corporate cash available for distribution
if the JTL is wound up.

Proceeds ABI AII CDA RDTOH

Opening balance 12,000 6,000
Cash 15,000
Accounts receivable 52,000 5,000 (4,000) (4,000) 1
Inventory 127,000 17,000 2
Land 150,000 32,500 32,500 3
Building 97,000 43,000 15,500 15,500 4
Equipment 6,000 (4,000) 5
Marketable securities 26,000 - 6
Class 14.1 Assets 130,000 11,239 43,774 43,774 7
Liabilities (45,000) 72,239 87,774
13% 50.67% 8
Income taxes (53,863) 9,391 44,472
504,137
RDTOH 32,917 26,917 9
537,054 99,774 32,917
/ 38.33%
85,871

70
Wind up the Company

Calculate the components of the distribution

Deemed Dividend
Funds available for distribution 537,054
Less: paid-up capital (18,000)
Deemed dividend on winding up 519,054
Less: capital dividend elected (99,774)
Deemed taxable dividend (sufficient to clear RDTOH) 419,280
Taxable capital gain to shareholder:
Proceeds on winding-up 537,054
Less: Deemed dividend (519,054)
Proceeds of disposition 18,000
Cost (18,000)
Capital gain -
Taxable capital gain -
Calculate the tax cost and after-tax cash to Mr. Prasad personally
Cash distribution 537,054
Tax on non-eligible dividend 419,280 42.5% (178,194)
After-tax cash 358,860
* (1 + .15) x 50% - .15 = 42.5%

Compare the after-tax cash available to invest if JTL is wound up (Option A) to the after-tax cash available if the
company is retained (Options B & C). If the company is retained the PUC and CDA can be distributed tax free to
provide some personal funds for Mr. Prasad to invest (Option B). If the company is retained, it would also be possible
to pay a non-eligible dividend of $85,871 to receive a refund of the company’s non-eligible RDTOH balance of
$32,917 at a low tax cost of $3,578.

71
 Option A Option B Option C
Asset Sale Asset Sale Asset Sale
Wind Up No Wind Up No Wind Up

Corporation JTL JTL JTL

After- tax Cash 504,137 504,137
PUC Distribution (18,000) (18,000)
Capital Dividend (99,774) (99,774)
Taxable Dividend Paid - (85,871)
Dividend Refund - 32,917
Available to Invest - 386,363 333,409

Individual Mr P Mr P Mr P
Cash Received on Wind up 537,054
PUC Distribution Rec'd 18,000 18,000
Capital Dividend Rec'd 99,774 99,774
Taxable Dividend Rec'd - 85,871
Tax on Dividend (178,194) (36,495)
Available to Invest 358,860 117,774 167,150

Total Available to Invest 358,860 504,137 500,559

3. Identify any risks including missing information, assumptions and uncertain research positions
 None identified
4. Reach a conclusion on each issue
a. If Mr. Prasad sells the assets for the amounts specified and subsequently winds up the company he will have
personal after-tax cash of $358,860 to invest personally.
b. If he does not wind up the company, JTL will have $504,137 (before the dividend refund) available to invest.
c. If he does not wind up the company
 He will be able to withdraw the PUC ($18,000) and CDA ($99,774) tax free.
 Between the corporation and Mr. Prasad they will have a total of $504,137 available to invest.
 He will also be able to access the $32,917 of non-eligible RDTOH on the payment of a dividend of
$85,871. Since his personal tax rate on this non eligible dividend of 42.5% is greater than the dividend
refund rate of 38 ⅓% he should wait until he is in a lower personal tax bracket before paying this
dividend
 He will be able to defer the personal tax of $178,194 on the winding-up dividend.
5. Evaluate the strengths/weaknesses/risks of your conclusions
 No weaknesses identified

72
Advise/Recommend
Advise the decision maker, integrating your conclusions on each of the issues with their objectives, giving priority to
the most important issues
 Do not wind up
 Pay out the PUC and CDA and invest in a TFSA or RRSP
 Pay a dividend to generate the dividend refund when he is in a lower tax bracket

—NOTES TO SOLUTION
(1) Accounts receivable:
Inclusion of last year’s reserve (active business income) ............................................................ $ 5,000
Proceeds of disposition* ............................................................................................................. 52,000
Cost ............................................................................................................................................. (60,000)
Capital loss .................................................................................................................................. (8,000)
Allowable capital loss ( /2  $8,000) ...........................................................................................
1 (4,000)
Capital dividend account ( /2  $8,000) ......................................................................................
1 $ (4,000)

* The disposition does not qualify for the section 22 election, since the accounts receivable were sold to a factoring
company and, hence, the disposition does not meet the “all or substantially all” and “carrying on the business” tests.
(2) Inventory:
Proceeds ...................................................................................................................................... $ 127,000
Cost ............................................................................................................................................. (110,000)
$ 17,000
(3) Land:
Proceeds of disposition ............................................................................................................... $ 150,000
Cost ............................................................................................................................................. (85,000)
Capital gain ................................................................................................................................. $ 65,000
Taxable capital gain .................................................................................................................... $ 32,500
Capital dividend account (1/2  $65,000) .................................................................................... $ 32,500

(4) Building:
UCC ............................................................................................................................................ $ 23,000
LOCP .......................................................................................................................................... (66,000)
Recapture .................................................................................................................................... $ 43,000

Proceeds of disposition ....................................................................................................................... $ 97,000

Less: capital cost................................................................................................................................. (66,000)
Capital gain......................................................................................................................................... $ 31,000
Taxable capital gain ( /2  $31,000) ............................................................................................
1 $ 15,500
Capital dividend account ( /2  $31,000) ....................................................................................
1 $ 15,500

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 (5) Equipment:
UCC ............................................................................................................................................ $ 10,000
Less: lower of cost or proceeds ................................................................................................... 6,000
Terminal loss ............................................................................................................................... $ (4,000)

(6) Marketable securities:

Proceeds ...................................................................................................................................... $ 26,000
Adjusted cost base....................................................................................................................... (26,000)
Increase in value.......................................................................................................................... Nil
Taxable capital gain .................................................................................................................... Nil
Capital dividend account ............................................................................................................. Nil

(7) Sale of intangibles

Proceeds $130,000
Cost 42,453
Capital gain $87,547
Taxable capital gain $43,774
Capital dividend account $43,774

UCC opening balance $20,600

Lower of cost and proceeds (42,453)
Negative balance (21,853)
Adjustment: 25% x LOCP for customer list purchased before January 1, 2017 10,613
Recapture $11,240

(8) Tax @ 13% on active business income (13% of $72,239) .......................................................... $ 9,391
2 2
Tax @ 50 /3% on investment income (50 /3% of $87,774) ......................................................... 44,472
Total tax ...................................................................................................................................... $ 53,863
(9) Refundable Part I Tax(302/3% of $87,774).................................................................................. $ 26,917

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CONVERTIBLE PROPERTIES – ITA 51

If tax is NOT your elective role:

You are not required to know this topic:

If tax is your elective role:

You need to be able to explain the basic tax considerations of a section 51

convertible property, as well as the basic application of the rules. Therefore
you should know this topic.

The Basics:

 This is an automatic rollover. No election form is required.

 Permits a holder of convertible shares or debt of a corporation to

exchange those securities for shares of that corporation on a tax free
basis.

 Rules:

 The exchange is not deemed to be a disposition

 ACB of new shares = ACB of old shares or debt

 PUC of new shares = PUC of old shares or debt value

 No boot allowed

 End result: No immediate tax consequences

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SALE OF INCORPORATED BUSINESS

 In selling an incorporated business we have the following alternatives:

1. Sell the assets

2. Sell the shares

 Regardless which alternative is chosen, they often involve “Restrictive

Covenants”

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RESTRICTIVE COVENANTS – ITA 56.4(2) and (3)

 a.k.a. non-competition agreements

 This is an agreement where an individual agrees not to compete with the

business being sold (either the shares or assets).

 The agreement often refers to a geographical area and has a duration

 Tax treatment: The general rule is that the amount received for agreeing
to a restrictive covenant is 100% included in “other” income (ITA
56.4(2)).

 Exceptions to the 100% income inclusion in other income:

o Employment income: If the restricted covenant amount relates to past

employment, the amount can be included in employment income.
Advantage: Amount does not have to be included in recipient’s
income until it is received, while employer can deduct when accrued
(as long as it is paid within 180 days of the year-end).

o Sale of Assets: When assets are being sold, the restrictive covenant
amount can be treated as an acquisition of a Class 14.1 asset by the
payor, and as Class 14.1 proceeds of disposition by the recipient (the
vendor and purchaser must jointly elect). Advantage: If the vendor
doesn’t have a
Class 14.1 balance, ½ of the proceeds is included in income as a
capital gain.

o Sale of Shares: If shares are sold, the restrictive amount can be added
to the proceeds of disposition of the shares, if the vendor and
purchaser jointly elect. Advantage: Only ½ of the proceeds is
included in income as a capital gain.

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 PURCHASE AND SALE OF ASSETS VS SHARES

SALE OF ASSETS

1. If the assets are sold and the company is liquidated, the tax results are similar
to an 88(2) wind-up (i.e., deemed dividend and capital gain/loss).

2. In order to defer the tax on the dividend and capital gain, the company might
not be liquidated and instead the company:

a. Might use the funds to invest in a new business

b. Might invest in portfolio of securities and run as an investment

company.

3. If the company is to be liquidated it might choose to pay out the assets over
several years to lessen the tax bite of the shareholders.

4. Before a company can be wound up it needs to receive government

certificates ensuring that all creditors and income taxes have been paid.

SALE OF SHARES

1. POD – ACB = CG or CL

2. If QSBC shares, an individual shareholder will be entitled to the $866,912 CGD

(2019).

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 EVALUATION OF ALTERNATIVES
SELL SHARES
 Simple, one transaction
 Capital gain on share sale ½
taxable
 Gain eligible for CGD if QSBC
 If the shares are sold at a loss, it
will be an ABIL (if it is a SBC)
which can be written off against
any source of income
 Unused non-capital losses
(business losses) can be carried
forward, subject to the acquisition
of control rules
 No land transfer taxes
 UCC balances transfer over,
usually at values lower than FMV
 Cannot create goodwill on the
purchase. The purchase price is
allocated to ACB of the shares
 When shares purchased, all assets
are acquired
 When shares are acquired all
liabilities are acquired including
the company’s credit rating
 Purchaser responsible for hidden
tax and other unforeseen liabilities.
Planning: In the sales agreement,
ensure vendor is still responsible
for these liabilities
SELL ASSETS
 Complex: Sell many different
assets, legal costs, winding-up
procedures
 Recapture 100% taxed. CG’s on
sale of assets are AII (no SBD).
Corporate taxes and tax on wind-up
dividend
 No CGD
 If the depreciable assets are sold at
a loss, the corporation will have
terminal losses which are fully
deductible against any source of
income
 Non-capital losses (business losses)
carry overs not available to the
purchaser
 Land transfer taxes possible
 Asset values are usually increased,
equal to the purchase price,
permitting greater write-offs in the
future
 Part of the purchase price can be
allocated to goodwill, permitting
Class 14.1 deductions by the
purchaser
 Don’t have to purchase unwanted
assets
 Possible purchaser could obtain
more favourable financing terms
when acquiring the assets
 Purchaser not responsible for the
corporations liabilities, as the
corporation has not been purchased
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Conclusion re sell assets or sell shares

1. Each case needs to be evaluated based on its own facts.

2. Generally, vendors prefer to sell shares, especially if their CGD is available.

3. Purchasers normally prefer to purchase assets as they obtain a higher cost

base for the assets purchased, meaning more CCA available in the future
(tax shield), and no hidden liabilities are assumed.

4. If the purchaser wishes to obtain the vendor’s non-capital losses, then the
shares must be purchased.

5. Usually more is offered to purchase assets than to purchase shares.

SELLING CONTROL OF A CCPC: SPECIAL CASES

Planning when selling control of a CCPC to a Public Corporation

a) SBD: Small Business Deduction could no longer be claimed.

b) CDA: Tax free dividends could no longer be paid tax free out of the CDA.
Therefore, prior to the sale of the company, capital dividends should be paid
to the shareholders.

c) RDTOH: The refundable taxes will be lost, so taxable dividends equal to the
RDTOH ÷ .3833 should be paid out prior to the sale.

Planning when selling control of a CCPC to a Non-Resident Corporation

a) SBD: Small Business Deduction could no longer be claimed.

b) CDA: The Corporation will maintain the CDA, but dividends paid out to
non-residents will be subject to Canadian withholding tax (25% unless the
rate is reduced by a tax treaty). Therefore, prior to the sale of the company,
capital dividends should be paid to the Canadian shareholders.

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