1. Rollovers Under Section 85
Chapter 16
Rollovers Under Section 85

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

3. 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.

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)
© 2010, Clarence Byrd Inc.

5. 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.

6. 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.

7. 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.

8. 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.

9. 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.

10. 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.

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

12. 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.

13. 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.

14. 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.

15. 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.

16. 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.

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

22. 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.

23. 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.

24. 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.

25. 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.

26. 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.

27. 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.

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

29. 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.

30. 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.

31. 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.

32. 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.

33. 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.

34. 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.

35. 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.

36. 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.

37. 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)] ,025
Total PUC $289,000
© 2010, Clarence Byrd Inc.

38. 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.

39. 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.

40. 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.

41. 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.

42. 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.

43. 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 ,000
Total $219,000
This is more than the $150,000 that would result from the sale of the property.
© 2010, Clarence Byrd Inc.

44. 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.

45. 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.

46. 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.

47. 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.

48. 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.

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

50. 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.

51. 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.

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

53. 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.

54. 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.

55. 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.

56. 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.

57. 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.

58. End Of Chapter
© 2010, Clarence Byrd Inc.