Chapter 18

Rollovers Under Section 85

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Rollovers Defined

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Important Examples

Transfers Of Property At Tax Values

ITA 73: Inter Vivos To ASpouse

ITA 70: To Spouse At Death

ITA 85: To Corporation At Elected Values

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The StandardSection 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 $1,200,000).

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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Section 85 Basic Rules

Who Can Make The Transfer ITA 85(1) Taxpayer

Individual Trust Corporation

ITA 85(2) Partnership

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Conditions For Transfer

Type Of Corporation Canadian (Resident) Subject To Tax Does Not Have To Be A New

Corporation

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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

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Conditions For Transfer

Consideration To Transferor Shares

Must Be Included (At Least One)

C/S (Growth) And P/S (Non-Growth)

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Conditions For Transfer

Consideration To Transferor Non-Share Consideration

(Boot) Cash, Other Assets, New

Debt Or The Assumption Of Old Debt

Important Because It Is A Tax Free Distribution

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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)

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Limits On Transfer Price

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

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Limits On Transfer Price

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

See Next Slides

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Limits On Transfer Price

Non-Depreciable Property – ITA 85(1)(c.1)

Lesser Of FMV = $1,000 ACB = $500

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Limits On Transfer Price

Depreciable Capital Property – ITA 85(1)(e) Least Of

FMV = $1,500 Cost = $1,000 UCC = $800

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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

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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

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Position Of Corporation

Non-Depreciable Capital Assets Elected Value = New ACB Usually Equal To Old ACB

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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

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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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Position Of Shareholder

•Allocation Of Consideration

Elected ValueXXXXX

Non-Share Consideration [85(1)(f)]( XXXX)

ACB All SharesXXXX*

ACB Preferred Shares [85(1)(g)]( XXX)

ACB Common Shares [85(1)(h)]XX*

*Usually Nil

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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 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

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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)

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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

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ITA 85(2.1)PUC Reduction

A-B CA

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

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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)] $132,976C/S = $264,000 - ](264/489)($199,999)] 156,025Total PUC $289,001

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Sale Of Shares

Proceeds Of Disposition $489,000

Adjusted Cost Base ($225,000 + $64,001) ( 289,001)

Capital Gain $199,999

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Redemption At FMV

Preferred CommonPOD $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

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Depreciable PropertyOrdering Under ITA 85(e.1)

Property A Property BCapital Cost $100,000 $200,000FMV $125,000 $180,000Possible Elections $100,000 $180,000UCC 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

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

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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).

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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 70,000• Total $220,000

• More Than The $150,000 that would result from sale of 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. 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)

Cash $250,000 FMV Of Assets Transferred ( 200,000)ITA 15(1) Benefit $ 50,000

PUC Of Shares $30,000 Increase In Net Assets Nil ITA 84(1) Deemed Dividend $30,000

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Price Adjustment Clauses

The Problem FMVs Are Uncertain Adverse Effects If Wrong (e.g.,

ITA 69) IT-169 Provides For Price

Adjustment Clause IC89-3 Provides Guidance

On Business Valuation IT-405 Provides Remedies

Where Errors Are Accidental

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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

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)

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Results Without ITA 84.1

TCG = ($500,000 - $50,000)(1/2) = $22,000

Use ITA 110.6 And Receive Tax Free

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Results With ITA 84.1

ITA 84.1(1)(a) PUC ReductionIncrease In LSC $100,000PUC Or ACB $ 50,000 Boot ( 400,000) NilPUC Reduction $100,000

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

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Results With ITA 84.1

ITA 84.1(1)(b) Deemed DividendIncrease In Legal Capital $100,000 Boot 400,000

500,000 Greater PUC or ACB $50,000 PUC Reduction 100,000 ( 150,000)ITA 84.1 Deemed Dividend $350,000

$350,000 = $400,000 - $50,000

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Dividend Strips

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

ACB = $100,000

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

RDTOH = Nil

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 OneApplication Of 55(2)

Dividend $400,000 Post-1971 Earnings Nil Deemed POD [ITA 55(2)] $400,000 Actual POD 100,000 Total POD $500,000 ACB ( 100,000)Capital Gain $400,000

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Example 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

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Example TwoApplication 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) Dividend Nil

Actual POD $500,000 ITA 84(3) Dividend Nil Adjusted POD $500,000 ACB ( 100,000)Capital Gain $400,000

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