Chapter 16 Rollovers Under Section 85 © 2010, Clarence Byrd Inc. 2 Rollovers Defined.

Chapter 16Chapter 16

Rollovers Under Section 85Rollovers Under Section 85

© 2010, Clarence Byrd Inc.© 2010, Clarence Byrd Inc. 22

Rollovers DefinedRollovers Defined


Important ExamplesImportant Examples

Transfers Of Property At Tax ValuesTransfers Of Property At Tax Values

• ITA 73: Inter Vivos To A SpouseITA 73: Inter Vivos To A Spouse

• ITA 70: To A Spouse At DeathITA 70: To A Spouse At Death

• ITA 85: To A Corporation At Elected ITA 85: To A Corporation At Elected ValuesValues


The StandardThe StandardSection 85 ScenarioSection 85 Scenario

Example: An unincorporated business has assets Example: An unincorporated business has assets with tax values of $800,000 and liabilities of with tax values of $800,000 and liabilities of $200,000 (net tax value of $600,000). The $200,000 (net tax value of $600,000). The assets have a net fair market value of assets have a net fair market value of $2,000,000 (potential gain of $1,400,000).$2,000,000 (potential gain of $1,400,000).

• Elect $800,000 for assets, corporation Elect $800,000 for assets, corporation assumes liabilitiesassumes liabilities

• $800,000 = POD = ACB$800,000 = POD = ACB• Boot (Non-share consideration) = $800,000 Boot (Non-share consideration) = $800,000

(including the $200,000 in old liabilities)(including the $200,000 in old liabilities)


General RulesGeneral RulesTransferor and TransfereeTransferor and Transferee

Who Can Make The TransferWho Can Make The Transfer• ITA 85(1) TaxpayerITA 85(1) Taxpayer

IndividualIndividual TrustTrust CorporationCorporation

• ITA 85(2) PartnershipITA 85(2) Partnership


General RulesGeneral RulesTransferor and TransfereeTransferor and Transferee

Type Of CorporationType Of Corporation• Canadian (Resident)Canadian (Resident)• Subject To TaxSubject To Tax• Does Not Have To Be A Does Not Have To Be A

New CorporationNew Corporation


General RulesGeneral RulesEligible PropertyEligible Property

Type Of Property - ITA 85(5.1)Type Of Property - ITA 85(5.1)

• Inclusions:Inclusions: Capital PropertyCapital Property Canadian And Foreign Resource PropertiesCanadian And Foreign Resource Properties Eligible Capital PropertyEligible Capital Property InventoriesInventories Real Estate Owned By Non-Resident And Used In A Real Estate Owned By Non-Resident And Used In A

Canadian BusinessCanadian Business

• Exclusions:Exclusions: Inventories Of Real PropertyInventories Of Real Property Real Estate Owned By Non-Residents (Unless used in Real Estate Owned By Non-Residents (Unless used in

a Canadian Business)a Canadian Business)


General RulesGeneral RulesConsideration to the TransferorConsideration to the Transferor

SharesShares• Must Be Included Must Be Included

(At Least One)(At Least One)• Common Shares Common Shares

(Growth) And (Growth) And Preferred Shares Preferred Shares (Non-Growth)(Non-Growth)


General RulesGeneral RulesConsideration to the TransferorConsideration to the Transferor

Non-Share Non-Share Consideration (Boot)Consideration (Boot)• Cash, Other Assets, Cash, Other Assets,

New Debt Or The New Debt Or The Assumption Of Old Assumption Of Old DebtDebt

• Important because it Important because it can be a Tax Free can be a Tax Free DistributionDistribution


General RulesGeneral RulesMaking the ElectionMaking the Election

Form T2057 (taxpayer) or T2058 Form T2057 (taxpayer) or T2058 (partnership)(partnership)

If an asset is not listed, it is deemed If an asset is not listed, it is deemed transferred at FMV (can be a significant transferred at FMV (can be a significant problem)problem)

Late or amended (1/4 percent per month Late or amended (1/4 percent per month on any deferred gain: minimum $100 per on any deferred gain: minimum $100 per month - maximum total $8,000)month - maximum total $8,000)


Establishing the Transfer PriceEstablishing the Transfer PriceGeneral RulesGeneral Rules

Upper Limit [ITA 85(1)(c)] Upper Limit [ITA 85(1)(c)] = Fair Market Value= Fair Market Value


Establishing the Transfer PriceEstablishing the Transfer PriceGeneral RulesGeneral Rules

Lower Limit = Greater Of:Lower Limit = Greater Of:• Boot [ITA 85(1)(b)]Boot [ITA 85(1)(b)]• Lesser Or Least OfLesser Or Least Of

See Next SlidesSee Next Slides


Detailed Transfer Price RulesDetailed Transfer Price Rules

Accounts ReceivableAccounts Receivable• Should not be transferred under ITA 85Should not be transferred under ITA 85• Should use ITA 22 electionShould use ITA 22 election• See Chapter 6 for discussion of this See Chapter 6 for discussion of this

election election



Inventories and Inventories and Non-Depreciable Property – Non-Depreciable Property – ITA 85(1)(c.1)ITA 85(1)(c.1)• Ceiling = FMVCeiling = FMV

• Floor = greater of:Floor = greater of: BootBoot Lesser ofLesser of

• FMVFMV• ACBACB



Land withLand with• ACB of $10,000ACB of $10,000• FMV of $15,000FMV of $15,000• Boot = $12,000Boot = $12,000

Ceiling = $15,000Ceiling = $15,000

Floor = $12,000Floor = $12,000


Losses On Transfer Of Losses On Transfer Of Non-Depreciable Property To Affiliated PersonsNon-Depreciable Property To Affiliated Persons

Affiliated Persons Affiliated Persons (ITA 251.1)(ITA 251.1)• Individuals: Spouses OnlyIndividuals: Spouses Only• Corporation Is Affiliated Corporation Is Affiliated

With:With: A Person By Whom It Is A Person By Whom It Is

ControlledControlled Each Member Of An Affiliated Each Member Of An Affiliated

Group That ControlsGroup That Controls Spouse Of Any Of The AboveSpouse Of Any Of The Above



Stop Loss ProvisionStop Loss Provision• ITA 40(2)(g) Deems Certain Losses To ITA 40(2)(g) Deems Certain Losses To

Be Nil (Including Superficial Losses)Be Nil (Including Superficial Losses)• Superficial Losses Include Transfers To A Superficial Losses Include Transfers To A

Corporation By An Affiliated PersonCorporation By An Affiliated Person



Treatment Of LossTreatment Of Loss• Individuals: Add To ACB Of Property On Individuals: Add To ACB Of Property On

Books Of TransfereeBooks Of Transferee• Corporations, Trusts, And Partnerships:Corporations, Trusts, And Partnerships:

Retained On The Books Of The TransferorRetained On The Books Of The Transferor Loss Deferred UntilLoss Deferred Until

• Property Is Disposed OfProperty Is Disposed Of• There Is An ITA 88(2) Winding UpThere Is An ITA 88(2) Winding Up• There Is An Acquisition Of Control Of The There Is An Acquisition Of Control Of The

Transferor CorporationTransferor Corporation



Depreciable capital property Depreciable capital property – ITA 85(1)(e)– ITA 85(1)(e)• Ceiling = FMVCeiling = FMV• Floor = Greater of:Floor = Greater of:

BootBoot Least Of:Least Of:

• FMV of the individual assetFMV of the individual asset• Cost of the individual assetCost of the individual asset• UCC of the classUCC of the class



Building withBuilding with• UCC of $6,000UCC of $6,000• ACB of $10,000ACB of $10,000• FMV of $15,000FMV of $15,000• Boot = $6,000Boot = $6,000

Ceiling = $15,000Ceiling = $15,000

Floor = $6,000Floor = $6,000



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)


Terminal LossesTerminal 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


Terminal LossesTerminal 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.



Eligible Capital Property Eligible Capital Property – ITA 85(1)(d)– ITA 85(1)(d)

Least OfLeast Of• FMV = $1,500FMV = $1,500• ACB = 4/3 CEC = 4/3($750) = $1,000ACB = 4/3 CEC = 4/3($750) = $1,000• Cost = $1,200Cost = $1,200



If the taxpayer ceases to carry on If the taxpayer ceases to carry on business, ¾ of disposition proceeds will be business, ¾ of disposition proceeds will be subtracted from CECsubtracted from CEC

• Negative balance: Will be taken into income Negative balance: Will be taken into income like recapturelike recapture

• Positive balance – Like a terminal lossPositive balance – Like a terminal loss

• Will be disallowed if transfer is to an affiliated Will be disallowed if transfer is to an affiliated person.person.


Allocation of Elected ValueAllocation of Elected Value

ImportanceImportance• ITA 85(1)(a)ITA 85(1)(a)

POD To TransferorPOD To Transferor ACB To TransfereeACB To Transferee

Minimum Election Equals Minimum Election Equals Maximum DeferralMaximum Deferral

Generally Boot = Elected ValueGenerally Boot = Elected Value Generally Avoid LossesGenerally Avoid Losses


Allocation of Elected ValueAllocation of Elected Value Position Of Shareholder 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


Allocation of Elected ValueAllocation of Elected ValuePosition Of CorporationPosition Of Corporation

Non-Depreciable Capital AssetsNon-Depreciable Capital Assets• Elected Value = New ACBElected Value = New ACB• Usually Equal To Old ACBUsually Equal To Old ACB



Depreciable AssetsDepreciable Assets• 1. No 1st Year Rules1. No 1st Year Rules

If Previously Used In BusinessIf Previously Used In Business

• 2. Capital Cost = Elected Value (Unusual)2. Capital Cost = Elected Value (Unusual) Elected Value = Cost = UCCElected Value = Cost = UCC



Depreciable AssetsDepreciable Assets

• Elected Value < Cost (Normal)Elected Value < Cost (Normal) Cost = $350,000; Cost = $350,000;

UCC = Elected Value = $275,000UCC = Elected Value = $275,000 New UCC = $275,000New UCC = $275,000 New Capital Cost = $350,000 – ITA 85(5)New Capital Cost = $350,000 – ITA 85(5) $75,000 Difference Is Deemed CCA$75,000 Difference Is Deemed CCA


Capital Gains TriggersCapital 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 $45,000Elected Value $70,000 Less: Capital Cost ( 45,000)Bump Up $25,000Inclusion Rate ½12,500Deemed Capital Cost (CCA Only) $57,500

Section 85 ExampleSection 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


ACB of ConsiderationACB 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


Section 85 ExampleSection 85 ExamplePUC ReductionPUC Reduction

General rulesGeneral rules

• PUC = legal stated capital = FMV of PUC = legal stated capital = FMV of consideration given for sharesconsideration given for shares

• PUC (before reduction) $489,000 PUC (before reduction) $489,000 ($225,000 + $264,000)($225,000 + $264,000)

• ACB = $289,000 ($225,000 + $64,000)ACB = $289,000 ($225,000 + $64,000)



The ProblemThe Problem • Sale Of Shares Would Result Sale Of Shares Would Result

In Capital Gain Of $200,000 In Capital Gain Of $200,000 (Use Of ITA 110.6)(Use Of ITA 110.6)

• Redemption Would Result In Redemption Would Result In No ITA 84(3) Dividend And A No ITA 84(3) Dividend And A Capital Gain Of $200,000 Capital Gain Of $200,000 (Use Of ITA 110.6)(Use Of ITA 110.6)

• However, PUC Of $489,000 However, PUC Of $489,000 Could Be Removed Tax FreeCould Be Removed Tax Free


ITA 85(2.1)ITA 85(2.1)PUC ReductionPUC Reduction

ACB-A

Where,A = Increase in legal stated capital of all sharesB = Elected amount, less bootC = FMV of particular class of shares


PUC Reduction ExamplePUC 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)] $132,975C/S = $264,000 – [(264/489)($200,000)] 156,025Total PUC $289,000


PUC Reduction ExamplePUC 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.


Sale Of SharesSale Of Shares

Proceeds Of Disposition $489,000

Adjusted Cost Base ($225,000 + $64,000) ( 289,000)

Capital Gain $200,000


Redemption At FMVRedemption At FMV

Preferred CommonPOD $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


Benefit To Related PersonBenefit To Related Person - ITA 85(1)(e.2) – Example - ITA 85(1)(e.2) – Example

Property with an ACB of Property with an ACB of $100,000 and a FMV of $100,000 and a FMV of $250,000, is transferred to a $250,000, is transferred to a corporation. The transferor corporation. The transferor elects a value of $100,000 for elects a value of $100,000 for the property. The transferor the property. The transferor takes back a $100,000 Note takes back a $100,000 Note and Preferred Stock that is and Preferred Stock that is redeemable at $80,000 (FMV).redeemable at $80,000 (FMV).



If related party holds If related party holds Common Stock of Common Stock of corporation, than there is corporation, than there is a gift of $70,000 a gift of $70,000 ($250,000 - $180,000). ($250,000 - $180,000). Daughter buys common Daughter buys common shares for $1,000.shares for $1,000.



Election price = amount elected, plus giftElection price = amount elected, plus gift ACB: preferred shares = nilACB: preferred shares = nil ACB: common shares = unchangedACB: common shares = unchanged IncomeIncome

• At transferAt transfer $ 70,000$ 70,000• Sale of P/SSale of P/S 80,00080,000• Sale of C/SSale of C/S 69,000 69,000• TotalTotal $219,000$219,000

• This is more than the $150,000 that would result This is more than the $150,000 that would result from the sale of the property. from the sale of the property.


Benefit To Transferor Shareholder Benefit To Transferor Shareholder - ITA 15(1) - Example- 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.


Benefit To Transferor Benefit To Transferor Shareholder - ITA 15(1)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 $30,000Excess of elected value over non-share consideration ($100,000 - $250,000) NilPUC Reduction $30,000

As the reduced PUC is nil, there is no ITA 84(1) dividend.


Dividend Strips - ConditionsDividend Strips - Conditions

• Sale Of Shares Of A Subject Corporation By Sale Of Shares Of A Subject Corporation By A Canadian Taxpayer Other Than A A Canadian Taxpayer Other Than A CorporationCorporation

• Corporation Shares Must Be Capital PropertyCorporation Shares Must Be Capital Property

• Corporation Must Be Resident In CanadaCorporation Must Be Resident In Canada

• Purchaser Must Be A Corporation With Purchaser Must Be A Corporation With Which The Taxpayer Is Not Dealing At Arm’s Which The Taxpayer Is Not Dealing At Arm’s LengthLength

• Subject And Purchaser Corporations Must Be Subject And Purchaser Corporations Must Be ConnectedConnected


Basic DataBasic Data Mr. Jones owns all of the outstanding shares of Mr. Jones owns all of the outstanding shares of

Jones Ltd. These shares have a PUC of Jones Ltd. These shares have a PUC of $50,000. This is also the ACB of the shares. $50,000. This is also the ACB of the shares. The shares have a current FMV of $500,000. The shares have a current FMV of $500,000. Mr. Jones wishes to retain control of the Mr. Jones wishes to retain control of the company. Mr. Jones has made no use of his company. Mr. Jones has made no use of his lifetime capital gains deduction and Jones Ltd. lifetime capital gains deduction and Jones Ltd. is a qualified small business corporation.is a qualified small business corporation.


Mr. Jones

JonesHolding (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 $100,000

1. JHL Borrows $400,000

JonesLimited

(JL)


Results Without ITA 84.1Results Without ITA 84.1

• TCG = ($500,000 - $50,000)(1/2) = TCG = ($500,000 - $50,000)(1/2) = $225,000$225,000

• Use ITA 110.6 And Receive Tax FreeUse ITA 110.6 And Receive Tax Free


Results With ITA 84.1Results With ITA 84.1 ITA 84.1(1)(a) PUC ReductionITA 84.1(1)(a) PUC Reduction

Increase In LSCIncrease In LSC $100,000$100,000PUC Or ACBPUC Or ACB $ 50,000$ 50,000 BootBoot ( 400,000)( 400,000) NilNilPUC ReductionPUC Reduction $100,000$100,000

PUC = $100,000 - $100,000 = NilPUC = $100,000 - $100,000 = Nil


Results With ITA 84.1Results With ITA 84.1

ITA 84.1(1)(b) Deemed DividendIncrease 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


Dividend StripsDividend Strips

Capital GainProceeds ($500,000 - $350,000) $150,000 ACB ( 50,000)Capital Gain $100,000


Capital Gains Strips - Capital Gains Strips - ConditionsConditions

Deductible Dividends Deductible Dividends A Component Of An A Component Of An Arm’s Length Arm’s Length Disposition Of SharesDisposition Of Shares

Objective To Convert Objective To Convert Capital Gain To Capital Gain To DividendDividend


Example One Example One Capital Gains StripCapital Gains Strip

Company A Owns 100 Percent Of The Outstanding Shares

Of Company B

ACB = $100,000

Company BPUC = $100,000FMV = $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)


Example OneExample OneApplication Of ITA 55(2)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 TwoExample Two

Company A Owns 100 Percent Of The

Outstanding Shares Of Company B

ACB = $100,000

Company BPUC = $100,000FMV = $500,000

RDTOH = Nil

Purchaser CorporationITA 85 - B CompanyShares At $100,000

$500,000 Redeemable P/SPUC = ACB = $100,000


Example TwoExample TwoApplication Of ITA 55(2)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

Chapter 16 Rollovers Under Section 85 © 2010, Clarence Byrd Inc. 2 Rollovers Defined.

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Transcript of Chapter 16 Rollovers Under Section 85 © 2010, Clarence Byrd Inc. 2 Rollovers Defined.