Chapter 18 Rollovers Under Section 85

© 2007, Clarence Byrd Inc.2 Rollovers Defined

© 2007, Clarence Byrd Inc.3 Important Examples Transfers Of Property At Tax Values ITA 73: Inter Vivos To A Spouse ITA 70: To Spouse At Death ITA 85: To Corporation At Elected Values

© 2007, Clarence Byrd Inc.4 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)

© 2007, Clarence Byrd Inc.5 Section 85 Basic Rules Who Can Make The Transfer ITA 85(1) Taxpayer Individual Trust Corporation ITA 85(2) Partnership

© 2007, Clarence Byrd Inc.6 Conditions For Transfer Type Of Corporation Canadian (Resident) Subject To Tax Does Not Have To Be A New Corporation

© 2007, Clarence Byrd Inc.7 Conditions For Transfer Type Of Property - ITA 85(5.1) Inclusions: Capital Property Canadian And Foreign Resource Properties Eligible Capital Property Inventories Exclusions: Inventories Of Real Property Real Estate Owned By Non-Residents

© 2007, Clarence Byrd Inc.8 Conditions For Transfer Consideration To Transferor Shares Must Be Included (At Least One) C/S (Growth) And P/S (Non-Growth)

© 2007, Clarence Byrd Inc.9 Conditions For Transfer Consideration To 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

© 2007, Clarence Byrd Inc.10 Conditions For Transfer Election Form 2057 (Taxpayer) Or 2058 (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)

© 2007, Clarence Byrd Inc.11 Limits On Transfer Price Upper Limit [ITA 85(1)(c)] = Fair Market Value

© 2007, Clarence Byrd Inc.12 Limits On Transfer Price Lower Limit = Greater Of Boot [ITA 85(1)(b)] Lesser Or Least Of See Next Slides

© 2007, Clarence Byrd Inc.13 Limits On Transfer Price Non-Depreciable Property – ITA 85(1)(c.1) Lesser Of FMV = $1,000 ACB = $500

© 2007, Clarence Byrd Inc.14 Limits On Transfer Price Depreciable Capital Property – ITA 85(1)(e) Least Of FMV = $1,500 Cost = $1,000 UCC = $800

© 2007, Clarence Byrd Inc.15 Limits On Transfer Price Eligible Capital Property – ITA 85(1)(d) Least Of FMV = $1,500 ACB = 4/3 CEC = 4/3($750) = $1,000 Cost $1,200

© 2007, Clarence Byrd Inc.16 Selection Of Transfer Price Importance ITA 85(1)(a) POD To Transferor ACB To Transferee Minimum Election Equals Maximum Deferral Generally Boot = Elected Value Generally Avoid Losses

© 2007, Clarence Byrd Inc.17 Position Of Corporation Non-Depreciable Capital Assets Elected Value = New ACB Usually Equal To Old ACB

© 2007, Clarence Byrd Inc.18 Position Of Corporation Depreciable Assets 1. No 1st Year Rules If Previously Used In Business 2. Capital Cost Equal To Elected Value (Unusual) Elected Value = Cost = UCC

© 2007, Clarence Byrd Inc.19 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

© 2007, Clarence Byrd Inc.20 Position Of Shareholder Allocation Of Consideration Elected ValueXXX Non-Share Consideration [85(1)(f)]( XXX) ACB All SharesXXX* ACB Preferred Shares [85(1)(g)]( XXX) ACB Common Shares [85(1)(h)]XX* *Usually Nil

© 2007, Clarence Byrd Inc.21 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

© 2007, Clarence Byrd Inc.22 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

© 2007, Clarence Byrd Inc.23 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 As A Separate CCA Class By Transferor Loss Deferred Until  Property Is Sold  There Is An ITA 88(2) Winding Up  There Is An Acquisition Of Control Of The Corporation

© 2007, Clarence Byrd Inc.24 Establishing PUC - Example General Rules PUC = Legal Stated Capital = FMV Of Consideration Given For Shares PUC (Before Reduction) In Following Example = $489,000 ($225,000 + $264,000) ACB = $289,001 ($225,000 + $64,001)

© 2007, Clarence Byrd Inc.25 Establishing PUC – The Problem The Problem Sale Of Shares Would Result In Capital Gain Of $199,999 (Use Of ITA 110.6) Redemption Would Result In No ITA 84(3) Dividend And A Capital Gain Of $199,999 (Use Of ITA 110.6) However, PUC Of $489,000 Could Be Removed Tax Free

© 2007, Clarence Byrd Inc.26 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

© 2007, Clarence Byrd Inc.27 PUC Reduction Example LSC$489,000 Elected Amount$614,001 Boot( 325,000)( 289,001) PUC Reduction$199,999 P/S = $225,000 - [(225/489)($199,999)]$132,976 C/S = $264,000 - ](264/489)($199,999)] 156,025 Total PUC$289,001

© 2007, Clarence Byrd Inc.28 Sale Of Shares Proceeds Of Disposition$489,000 Adjusted Cost Base ($225,000 + $64,001)( 289,001) Capital Gain$199,999

© 2007, Clarence Byrd Inc.29 Redemption At FMV PreferredCommon POD$225,000 $264,000 PUC( 132,976)( 156,025) ITA 84(3) Deemed Dividend$ 92,024 $107,975 Proceeds Received$225,000 $264,000 ITA 84(3) Deemed Dividend( 92,024)( 107,975) Adjusted POD$132,976 $156,025 ACB( 225,000)( 64,001) Capital Gain (Loss)($ 92,024)92,024

© 2007, Clarence Byrd Inc.30 Depreciable Property Ordering Under ITA 85(e.1) Property AProperty B Capital Cost$100,000$200,000 FMV$125,000$180,000 Possible Elections$100,000$180,000 UCC Of Class = $210,000 Least Of: $210,000 (The Class) $280,000 (Cost Of A + FMV Of B) Can Avoid Recapture By Electing One At A Time

© 2007, Clarence Byrd Inc.31 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

© 2007, Clarence Byrd Inc.32 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 ½12,500 Deemed Capital Cost (CCA Only)$57,500

© 2007, Clarence Byrd Inc.33 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).

© 2007, Clarence Byrd Inc.34 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).

© 2007, Clarence Byrd Inc.35 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/S80,000 Sale Of C/S 70,000 Total$220,000 More Than The $150,000 that would result from sale of property.

© 2007, Clarence Byrd Inc.36 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.

© 2007, Clarence Byrd Inc.37 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 84(1) dividend.

© 2007, Clarence Byrd Inc.38 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

© 2007, Clarence Byrd Inc.39 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.

© 2007, Clarence Byrd Inc.40 Mr. Jones Jones Holding (JHL) 3. Tax Free Dividends To Pay Loan 2. JL Shares To JHL Under ITA 85(1). Elect $500,000. Receives $400,000, Plus Shares With PUC And ACB Of $100, JHL Borrows $400,000 Jones Limited (JL)

© 2007, Clarence Byrd Inc.41 Results Without ITA 84.1 TCG = ($500,000 - $50,000)(1/2) = $225,000 Use ITA And Receive Tax Free

© 2007, Clarence Byrd Inc.42 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

© 2007, Clarence Byrd Inc.43 Results With ITA 84.1 ITA 84.1(1)(b) Deemed Dividend Increase In Legal Capital$100,000 Boot400, ,000 Greater PUC or ACB$50,000 PUC Reduction100,000 ( 150,000) ITA 84.1 Deemed Dividend$350,000 $350,000 = $400,000 - $50,000

© 2007, Clarence Byrd Inc.44 Dividend Strips Capital Gain Proceeds ($500,000 - $350,000)$150,000 ACB( 50,000) Capital Gain$100,000

© 2007, Clarence Byrd Inc.45 Capital Gains Strips - Conditions Deductible Dividends A Component Of An Arm’s Length Disposition Of Shares Objective To Convert Capital Gain To Dividend

© 2007, Clarence Byrd Inc.46 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, Pays $400,000 Dividend To A 3. Shares Are Sold For $100,000 (FMV)

© 2007, Clarence Byrd Inc.47 Example One Application Of ITA 55(2) Dividends Received (Tax Free)$400,000 Dividend From Safe IncomeNil Deemed POD [ITA 55(2)]$400,000 Actual POD100,000 Total POD$500,000 ACB( 100,000) Capital Gain$400,000

© 2007, Clarence Byrd Inc.48 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 Purchaser Corporation ITA 85 - B Company Shares At $100,000 $500,000 Redeemable P/S PUC = ACB = $100,000

© 2007, Clarence Byrd Inc.49 Example Two Application Of 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) DividendNil Actual POD$500,000 ITA 84(3) DividendNil Adjusted POD$500,000 ACB( 100,000) Capital Gain$400,000

© 2007, Clarence Byrd Inc.50