Transcript B&L Chapter 16 - Pearson Education Canada

Chapter 16
Rollovers Under Section 85
Rollovers Defined
© 2010, Clarence Byrd Inc.
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Important Examples

Transfers Of Property At Tax
Values
• ITA 73: Inter Vivos To A Spouse
• ITA 70: To A Spouse At Death
• ITA 85: To A Corporation At Elected
Values
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The Standard
Section 85 Scenario

Example: An unincorporated business has
assets with tax values of $800,000 and liabilities
of $200,000 (net tax value of $600,000). The
assets have a net fair market value of
$2,000,000 (potential gain of $1,400,000).
• Elect $800,000 for assets, corporation
assumes liabilities
• $800,000 = POD = ACB
• Boot (Non-share consideration) = $800,000
(including the $200,000 in old liabilities)
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General Rules
Transferor and Transferee

Who Can Make The Transfer
• ITA 85(1) Taxpayer
Individual
 Trust
 Corporation

• ITA 85(2) Partnership
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General Rules
Transferor and Transferee

Type Of Corporation
• Canadian (Resident)
• Subject To Tax
• Does Not Have To Be A
New Corporation
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General Rules
Eligible Property

Type Of Property - ITA 85(5.1)
• Inclusions:





Capital Property
Canadian And Foreign Resource Properties
Eligible Capital Property
Inventories
Real Estate Owned By Non-Resident And Used In
A Canadian Business
• Exclusions:


Inventories Of Real Property
Real Estate Owned By Non-Residents (Unless used
in a Canadian Business)
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General Rules
Consideration to the Transferor

Shares
• Must Be Included
(At Least One)
• Common Shares
(Growth) And
Preferred Shares
(Non-Growth)
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General Rules
Consideration to the Transferor

Non-Share
Consideration (Boot)
• Cash, Other Assets,
New Debt Or The
Assumption Of Old
Debt
• Important because it
can be a Tax Free
Distribution
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General Rules
Making the Election



Form T2057 (taxpayer) or T2058
(partnership)
If an asset is not listed, it is deemed
transferred at FMV (can be a significant
problem)
Late or amended (1/4 percent per month
on any deferred gain: minimum $100 per
month - maximum total $8,000)
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Establishing the Transfer Price
General Rules

Upper Limit [ITA 85(1)(c)]
= Fair Market Value
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Establishing the Transfer Price
General Rules

Lower Limit = Greater Of:
• Boot [ITA 85(1)(b)]
• Lesser Or Least Of

See Next Slides
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Detailed Transfer Price Rules

Accounts Receivable
• Should not be transferred under ITA 85
• Should use ITA 22 election
• See Chapter 6 for discussion of this
election
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Detailed Transfer Price Rules

Inventories and
Non-Depreciable Property
– ITA 85(1)(c.1)
• Ceiling = FMV
• Floor = greater of:

Boot

Lesser of
• FMV
• ACB
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Detailed Transfer Price Rules

Land with
• ACB of $10,000
• FMV of $15,000
• Boot = $12,000

Ceiling = $15,000

Floor = $12,000
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Losses On Transfer Of
Non-Depreciable Property To Affiliated Persons

Affiliated Persons
(ITA 251.1)
• Individuals: Spouses Only
• Corporation Is Affiliated
With:



A Person By Whom It Is
Controlled
Each Member Of An Affiliated
Group That Controls
Spouse Of Any Of The Above
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Losses On Transfer Of
Non-Depreciable Property To Affiliated Persons

Stop Loss Provision
• ITA 40(2)(g) Deems Certain Losses To
Be Nil (Including Superficial Losses)
• Superficial Losses Include Transfers To
A Corporation By An Affiliated Person
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Losses On Transfer Of
Non-Depreciable Property To Affiliated Persons

Treatment Of Loss
• Individuals: Add To ACB Of Property On
Books Of Transferee
• Corporations, Trusts, And Partnerships:
Retained On The Books Of The Transferor
 Loss Deferred Until

• Property Is Disposed Of
• There Is An ITA 88(2) Winding Up
• There Is An Acquisition Of Control Of The
Transferor Corporation
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Detailed Transfer Price Rules

Depreciable capital property
– ITA 85(1)(e)
• Ceiling = FMV
• Floor = Greater of:
Boot
 Least Of:

• FMV of the individual asset
• Cost of the individual asset
• UCC of the class
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Detailed Transfer Price Rules

Building with
• UCC of $6,000
• ACB of $10,000
• FMV of $15,000
• Boot = $6,000

Ceiling = $15,000

Floor = $6,000
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Detailed Transfer Price Rules
Example: A class with a balance of
$28,000 has two assets, one with a cost of
$15,000 and a FMV of $20,000, the other
with a cost of $30,000 and a FMV of $25,000
Analysis: The assets have to be transferred
individually in order to avoid recapture – ITA
85(1)(e.1)
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Terminal Losses
Example: Asset with a cost of
$200,000 and a FMV of $75,000.
balance in UCC = $150,000.
■Terminal loss of $75,000
■Disallowed on transfer to
affiliated person
■No reason to use ITA 85
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Terminal Losses
Disposition:
Loss goes to a separate class and
is deemed to be a depreciable
property, subject to CCA.
Remains there until it is sold,
there is a change in control, or
the corporation is wound up.
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Detailed Transfer Price Rules
Eligible Capital Property
– ITA 85(1)(d)
 Least Of

• FMV = $1,500
• ACB = 4/3 CEC = 4/3($750) = $1,000
• Cost = $1,200
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Detailed Transfer Price Rules

If the taxpayer ceases to carry on
business, ¾ of disposition proceeds will be
subtracted from CEC
• Negative balance: Will be taken into income
like recapture
• Positive balance – Like a terminal loss
• Will be disallowed if transfer is to an affiliated
person.
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Allocation of Elected Value

Importance
• ITA 85(1)(a)





POD To Transferor
ACB To Transferee
Minimum Election Equals
Maximum Deferral
Generally Boot = Elected Value
Generally Avoid Losses
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Allocation of Elected Value
Position Of Shareholder
•Allocation Of Consideration
Elected Value
Non-Share Consideration [ITA 85(1)(f)]
ACB All Shares
ACB Preferred Shares [ITA 85(1)(g)]
ACB Common Shares [ITA 85(1)(h)]
XXX
( XXX)
XXX*
( XXX)
XX*
*Usually Nil
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Allocation of Elected Value
Position Of Corporation

Non-Depreciable Capital Assets
• Elected Value = New ACB
• Usually Equal To Old ACB
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Allocation of Elected Value
Position Of Corporation

Depreciable Assets
• 1. No 1st Year Rules

If Previously Used In Business
• 2. Capital Cost = Elected Value (Unusual)

Elected Value = Cost = UCC
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Allocation of Elected Value
Position Of Corporation

Depreciable Assets
• Elected Value < Cost (Normal)




Cost = $350,000;
UCC = Elected Value = $275,000
New UCC = $275,000
New Capital Cost = $350,000 – ITA 85(5)
$75,000 Difference Is Deemed CCA
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Capital Gains Triggers
Example: Asset with cost of $45,000 and FMV of $70,000. UCC
for class = $40,000. Elect $70,000: Gives capital gain of
$25,000, recapture of $5,000.
ITA 13(7)(e)
Cost
Elected Value
Less: Capital Cost
Bump Up
Inclusion Rate
Deemed Capital Cost (CCA Only)
$70,000
( 45,000)
$25,000
½
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$45,000
12,500
$57,500
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Section 85 Example
Example Assets with a book value of $620,000 and FMV
of $814,000 are transferred to a new corporation under the
provisions of ITA 85.
The transferor receives $250,000 in new debt, $225,000 in
preferred shares (FMV) and $264,000 in common shares
(FMV). In addition, the corporation assumes of the
$75,000 of old debt that was owed by the business.
The transfer is made at an elected value of $614,000
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Section 85 Example

ACB of Consideration
Total elected value
Less Boot ($250,000 + $75,000)
Subtotal
$614,000
325,000
$289,000
Less Preferred Stock (FMV)
Common Stock (Residual
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225,000
$ 64,000
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Section 85 Example
PUC Reduction

General rules
• PUC = legal stated capital = FMV of
consideration given for shares
• PUC (before reduction) $489,000
($225,000 + $264,000)
• ACB = $289,000 ($225,000 + $64,000)
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Section 85 Example

The Problem
• Sale Of Shares Would Result
In Capital Gain Of $200,000
(Use Of ITA 110.6)
• Redemption Would Result In
No ITA 84(3) Dividend And A
Capital Gain Of $200,000
(Use Of ITA 110.6)
• However, PUC Of $489,000
Could Be Removed Tax Free
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ITA 85(2.1)
PUC Reduction
A - BC A 
Where,
A = Increase in legal stated capital of all shares
B = Elected amount, less boot
C = FMV of particular class of shares
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PUC Reduction Example
LSC
Elected Amount
Boot
PUC Reduction
$489,000
$614,000
( 325,000) ( 289,000)
$200,000
P/S = $225,000 - [(225/489)($200,000)]
C/S = $264,000 – [(264/489)($200,000)]
Total PUC
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$132,975
156,025
$289,000
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PUC Reduction Example
Note The allocation of the PUC reduction is pro
rata on the basis of fair market value of the two
classes of shares. ACB is allocated sequentially,
starting with Boot, followed by preferred shares,
and ending with common stock as a residual.
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Sale Of Shares
Proceeds Of Disposition
Adjusted Cost Base ($225,000 + $64,000)
Capital Gain
$489,000
( 289,000)
$200,000
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Redemption At FMV
POD
PUC
ITA 84(3) Deemed Dividend
Preferred
Common
$225,000 $264,000
( 132,975) ( 156,025)
$ 92,025 $107,975
Proceeds Received
ITA 84(3) Deemed Dividend
Adjusted POD
ACB
Capital Gain (Loss)
$225,000 $264,000
( 92,025) ( 107,975)
$132,975 $156,025
( 225,000) ( 64,000)
($ 92,025) $ 92,025
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Benefit To Related Person
- ITA 85(1)(e.2) – Example

Property with an ACB of
$100,000 and a FMV of
$250,000, is transferred to a
corporation. The transferor
elects a value of $100,000 for
the property. The transferor
takes back a $100,000 Note
and Preferred Stock that is
redeemable at $80,000 (FMV).
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Benefit To Related Person
- ITA 85(1)(e.2) – Example

If related party holds
Common Stock of
corporation, than there is
a gift of $70,000
($250,000 - $180,000).
Daughter buys common
shares for $1,000.
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Benefit To Related Person
- ITA 85(1)(e.2) – Example




Election price = amount elected, plus gift
ACB: preferred shares = nil
ACB: common shares = unchanged
Income
• At transfer
$ 70,000
• Sale of P/S
80,000
• Sale of C/S
69,000
• Total
$219,000
• This is more than the $150,000 that would result
from the sale of the property.
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Benefit To Transferor Shareholder
- ITA 15(1) - Example
Property with an ACB of $100,000 and a fair market value of
$200,000, is transferred to a corporation at an elected value of
$100,000. The transferor takes back cash of $250,000 and shares with
a FMV and PUC of $30,000.
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Benefit To Transferor
Shareholder - ITA 15(1)
 If FMV Consideration > FMV Of Assets Transferred: A
Benefit Under ITA 15(1)
FMV Of Consideration ($250,000 + $30,000)
FMV Of Assets Transferred
ITA 15(1) Benefit
Increase In Legal Stated Capital
Excess of elected value over non-share
consideration ($100,000 - $250,000)
PUC Reduction
$280,000
( 200,000)
$ 80,000
$30,000
Nil
$30,000
As the reduced PUC is nil, there is no ITA 84(1) dividend.
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Dividend Strips - Conditions
• Sale Of Shares Of A Subject Corporation By
A Canadian Taxpayer Other Than A
Corporation
• Corporation Shares Must Be Capital
Property
• Corporation Must Be Resident In Canada
• Purchaser Must Be A Corporation With
Which The Taxpayer Is Not Dealing At Arm’s
Length
• Subject And Purchaser Corporations Must
Be Connected
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Basic Data

Mr. Jones owns all of the outstanding shares
of Jones Ltd. These shares have a PUC of
$50,000. This is also the ACB of the shares.
The shares have a current FMV of $500,000.
Mr. Jones wishes to retain control of the
company. Mr. Jones has made no use of his
lifetime capital gains deduction and Jones Ltd.
is a qualified small business corporation.
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Mr. Jones
Jones
Limited
(JL)
2. JL Shares To JHL
Under ITA 85(1).
Elect $500,000.
Receives $400,000,
Plus Shares With
PUC And ACB Of
$100,000
Jones
Holding
(JHL)
3. Tax Free Dividends To
Pay Loan
1. JHL Borrows $400,000
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Results Without ITA 84.1
• TCG = ($500,000 - $50,000)(1/2) =
$225,000
• Use ITA 110.6 And Receive Tax Free
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Results With ITA 84.1

ITA 84.1(1)(a) PUC Reduction
Increase In LSC
$100,000
PUC Or ACB
$ 50,000
Boot
( 400,000)
Nil
PUC Reduction
$100,000
PUC = $100,000 - $100,000 = Nil
© 2010, Clarence Byrd Inc.
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Results With ITA 84.1
ITA 84.1(1)(b)
Deemed Dividend
Increase In Legal Capital
Boot
Greater of PUC or ACB
PUC Reduction
ITA 84.1 Deemed Dividend
$100,000
400,000
$500,000
$ 50,000
100,000
( 150,000)
$350,000
$350,000 = $400,000 - $50,000
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Dividend Strips
Capital
Gain
Proceeds ($500,000 - $350,000)
ACB
Capital Gain
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$150,000
( 50,000)
$100,000
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Capital Gains Strips Conditions


Deductible Dividends
A Component Of An
Arm’s Length
Disposition Of Shares
Objective To Convert
Capital Gain To
Dividend
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Example One
Capital Gains Strip
Company A Owns
100 Percent Of The
Outstanding Shares
Of Company B
Company B
PUC = $100,000
FMV = $500,000
Safe Income = Nil
ACB = $100,000
1. B Borrows $400,000
2. Pays $400,000 Dividend To A
3. Shares Are Sold For $100,000 (FMV)
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Example One
Application Of ITA 55(2)
Dividends Received (Tax Free)
Dividend From Safe Income
Deemed POD [ITA 55(2)]
Actual POD
Total POD
ACB
Capital Gain
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$400,000
Nil
$400,000
100,000
$500,000
( 100,000)
$400,000
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Example Two
Company A Owns 100
Percent Of The
Outstanding Shares Of
Company B
Company B
PUC = $100,000
FMV = $500,000
RDTOH = Nil
ACB = $100,000
$500,000 Redeemable P/S
PUC = ACB = $100,000
ITA 85 - B Company
Shares At $100,000
Purchaser Corporation
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Example Two
Application Of ITA 55(2)
Redemption Price
PUC
ITA 84(3) Dividend
Deemed Not To Be A Dividend
Remaining ITA 84(3) Dividend
$500,000
( 100,000)
$400,000
( 400,000)
Nil
Actual POD
ITA 84(3) Dividend
Adjusted POD
ACB
Capital Gain
$500,000
Nil
$500,000
( 100,000)
$400,000
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© 2010, Clarence Byrd Inc.
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