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Chapter 16

Chapter 16. Rollovers Under Section 85. Rollovers Defined. A Transfer At Tax Values. 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. The Standard Section 85 Scenario.

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Chapter 16

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  1. Chapter 16 Rollovers Under Section 85

  2. 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 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 $1,400,000). • 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 RulesTransferor and Transferee • Who Can Make The Transfer • ITA 85(1) Taxpayer • Individual • Trust • Corporation • ITA 85(2) Partnership © 2010, Clarence Byrd Inc.

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

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

  9. General RulesConsideration 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 RulesMaking 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 PriceGeneral Rules • Upper Limit [ITA 85(1)(c)] = Fair Market Value © 2010, Clarence Byrd Inc.

  12. Establishing the Transfer PriceGeneral 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 ValuePosition Of Corporation • Non-Depreciable Capital Assets • Elected Value = New ACB • Usually Equal To Old ACB © 2010, Clarence Byrd Inc.

  29. Allocation of Elected ValuePosition 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 ValuePosition 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 © 2010, Clarence Byrd Inc.

  34. Section 85 ExamplePUC 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)] 156,025 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 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.

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

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

  50. 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 Example © 2010, Clarence Byrd Inc.

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