Rollovers Under Section 85 Chapter 16 Rollovers Under Section 85

A Transfer At Tax Values Rollovers Defined A Transfer At Tax Values © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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) © 2010, Clarence Byrd Inc.

General Rules Transferor and Transferee Who Can Make The Transfer ITA 85(1) Taxpayer Individual Trust Corporation ITA 85(2) Partnership © 2010, Clarence Byrd Inc.

General Rules Transferor and Transferee Type Of Corporation Canadian (Resident) Subject To Tax Does Not Have To Be A New Corporation © 2010, Clarence Byrd Inc.

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) © 2010, Clarence Byrd Inc.

General Rules Consideration to the Transferor Shares Must Be Included (At Least One) Common Shares (Growth) And Preferred Shares (Non-Growth) © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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) © 2010, Clarence Byrd Inc.

Establishing the Transfer Price General Rules Upper Limit [ITA 85(1)(c)] = Fair Market Value © 2010, Clarence Byrd Inc.

Establishing the Transfer Price General Rules Lower Limit = Greater Of: Boot [ITA 85(1)(b)] Lesser Or Least Of See Next Slides © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

Detailed Transfer Price Rules Inventories and Non-Depreciable Property – ITA 85(1)(c.1) Ceiling = FMV Floor = greater of: Boot Lesser of FMV ACB © 2010, Clarence Byrd Inc.

Detailed Transfer Price Rules Land with ACB of $10,000 FMV of $15,000 Boot = $12,000 Ceiling = $15,000 Floor = $12,000 © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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) © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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. © 2010, Clarence Byrd Inc.

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 Goodwill © 2010, Clarence Byrd Inc.

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. © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

Allocation of Elected Value Position Of Shareholder Allocation Of Consideration Elected Value XXX Non-Share Consideration [ITA 85(1)(f)] ( XXX) ACB All Shares XXX* ACB Preferred Shares [ITA 85(1)(g)] ( XXX) ACB Common Shares [ITA 85(1)(h)] XX* *Usually Nil © 2010, Clarence Byrd Inc.

Allocation of Elected Value Position Of Corporation Non-Depreciable Capital Assets Elected Value = New ACB Usually Equal To Old ACB © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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 $45,000 Elected Value $70,000 Less: Capital Cost ( 45,000) Bump Up $25,000 Inclusion Rate ½ 12,500 Deemed Capital Cost (CCA Only) $57,500 © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

Section 85 Example ACB of Consideration Total elected value $614,000 Less Boot ($250,000 + $75,000) 325,000 Subtotal $289,000 Less Preferred Stock (FMV) 225,000 Common Stock (Residual $ 64,000 © 2010, Clarence Byrd Inc.

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) © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

ITA 85(2.1) PUC Reduction Where, A = Increase in legal stated capital of all shares B = Elected amount, less boot C = FMV of particular class of shares © 2010, Clarence Byrd Inc.

PUC Reduction Example LSC $489,000 Elected Amount $614,000 Boot ( 325,000) ( 289,000) PUC Reduction $200,000 P/S = $225,000 - [(225/489)($200,000)] $132,975 C/S = $264,000 – [(264/489)($200,000)] 156,025 Total PUC $289,000 © 2010, Clarence Byrd Inc.

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. © 2010, Clarence Byrd Inc.

Sale Of Shares Proceeds Of Disposition $489,000 Adjusted Cost Base ($225,000 + $64,000) ( 289,000) Capital Gain $200,000 © 2010, Clarence Byrd Inc.

Redemption At FMV Preferred Common POD $225,000 $264,000 PUC ( 132,975) ( 156,025) ITA 84(3) Deemed Dividend $ 92,025 $107,975 Proceeds Received $225,000 $264,000 ITA 84(3) Deemed Dividend ( 92,025) ( 107,975) Adjusted POD $132,975 $156,025 ACB ( 225,000) ( 64,000) Capital Gain (Loss) ($ 92,025) $ 92,025 © 2010, Clarence Byrd Inc.

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). © 2010, Clarence Byrd Inc.

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. © 2010, Clarence Byrd Inc.

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. © 2010, Clarence Byrd Inc.

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. Fat Cat © 2010, Clarence Byrd Inc.

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) $280,000 FMV Of Assets Transferred ( 200,000) ITA 15(1) Benefit $ 80,000 Increase In Legal Stated Capital $30,000 Excess of elected value over non-share consideration ($100,000 - $250,000) Nil PUC Reduction $30,000 As the reduced PUC is nil, there is no ITA 84(1) dividend. © 2010, Clarence Byrd Inc.

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 © 2010, Clarence Byrd Inc.

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. Example © 2010, Clarence Byrd Inc.

3. Tax Free Dividends To Pay Loan Mr. Jones 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 Limited (JL) Jones Holding (JHL) 3. Tax Free Dividends To Pay Loan Example 1. JHL Borrows $400,000 © 2010, Clarence Byrd Inc.

Results Without ITA 84.1 Example TCG = ($500,000 - $50,000)(1/2) = $225,000 Use ITA 110.6 And Receive Tax Free Example © 2010, Clarence Byrd Inc.

Results With ITA 84.1 Example 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 Example © 2010, Clarence Byrd Inc.

Results With ITA 84.1 Example ITA 84.1(1)(b) Deemed Dividend Increase In Legal Capital $100,000 Boot 400,000 $500,000 Greater of PUC or ACB $ 50,000 PUC Reduction 100,000 ( 150,000) ITA 84.1 Deemed Dividend $350,000 $350,000 = $400,000 - $50,000 Example © 2010, Clarence Byrd Inc.

Dividend Strips Example Capital Gain Proceeds ($500,000 - $350,000) $150,000 ACB ( 50,000) Capital Gain $100,000 Example © 2010, Clarence Byrd Inc.

Capital Gains Strips - Conditions Deductible Dividends A Component Of An Arm’s Length Disposition Of Shares Objective To Convert Capital Gain To Dividend © 2010, Clarence Byrd Inc.

Example One Capital Gains Strip Company A Owns 100 Percent Of The Outstanding Shares Of Company B ACB = $100,000 Company B PUC = $100,000 FMV = $500,000 Safe Income = Nil 1. B Borrows $400,000 2. Pays $400,000 Dividend To A 3. Shares Are Sold For $100,000 (FMV) © 2010, Clarence Byrd Inc.

Example One Application Of ITA 55(2) Dividends Received (Tax Free) $400,000 Dividend From Safe Income Nil Deemed POD [ITA 55(2)] $400,000 Actual POD 100,000 Total POD $500,000 ACB ( 100,000) Capital Gain $400,000 Example 1 © 2010, Clarence Byrd Inc.

Example Two Company A Owns 100 Percent Of The Outstanding Shares Of Company B ACB = $100,000 Company B PUC = $100,000 FMV = $500,000 RDTOH = Nil $500,000 Redeemable P/S PUC = ACB = $100,000 ITA 85 - B Company Shares At $100,000 Purchaser Corporation © 2010, Clarence Byrd Inc.

Example Two Application Of ITA 55(2) Redemption Price $500,000 PUC ( 100,000) ITA 84(3) Dividend $400,000 Deemed Not To Be A Dividend ( 400,000) Remaining ITA 84(3) Dividend Nil Actual POD $500,000 ITA 84(3) Dividend Nil Adjusted POD $500,000 ACB ( 100,000) Capital Gain $400,000 Example 2 © 2010, Clarence Byrd Inc.

End Of Chapter © 2010, Clarence Byrd Inc.