An actual receipt

Tax on mooncake

• In the midst of last year’s economic downturn, Chinese authorities upped their tax-collection efforts (which are usually notoriously lax) in a bid to top up the state’s coffers. One of their main targets was the mooncake — a pastry stuffed with lotus seed paste and egg yolks, or “whatever the baker feels like chucking in,” that is a ubiquitous delicacy especially popular in the fall.

• Mooncakes were traditionally given out during the Mid-Autumn Festival (historically a time of moon worship) to friends and family to cement relationships. But now, many businesses also offer mooncakes to employees or provide coupon vouchers redeemable at local groceries for the treat. Additionally, the cakes are given as a sort of soft bribe to employers, party officials. Where bakers saw a mooncake explosion, government officials saw yuan signs — and launched an inspection of more than 3,100 companies last year, slapping 30 billion yuan (CAD 4.76 billion) worth of back taxes on gifted mooncakes and coupons. In modern China, apparently, you can have your cake and tax it too.

Chapter 16 - Rollovers

Today

• Understand the tax consequences of a property transfer from a shareholder to a corporation

• Understand the options available• The means of payment• Know the potential traps and pitfalls and how

to avoid them

Transfer of property to a corporation by a shareholder

• Ssec 85(1) permits a taxpayer to elect to defer all or part of the income which would otherwise arise on the transfer of certain types of property to a taxable Canadian corporation

• Ssec 85(2) permits all members of a partnership to do the same thing

overview

• General rule is that there is an immediate recognition of a capital gain or loss on disposal of capital property

• Sometimes there is no real change in the economic interest

• Rollovers provide a deferral• Transferor should receive a package of

consideration where FMV = FMV of property transferred

Basic concepts

• On the transfer of assets to a corporation, there is a deemed disposition at FMV. 85(1) provides for an election for the transferor to choose the PoD in order to defer all or some of the gain.

• 85(1) permits a tax-free rollover, or transfer, of property to a corporation, but only if the transferor accepts shares as part of the consideration.

• The idea is that the transferor will be in the same economic position after the transfer as before. The ACB of the shares should exactly equal ACB of the transferred asset.

Basic concepts

• Additional variables– Permitted to trigger income inclusions:

• Capital gains, recapture of CCA etc

– Consideration can include debt and cash in addition to common or pref shares

Three simple situations

• 1 – necessity to make a downward adjustment to PUC to equal tax value of transferred assets

• 2 – transfer price other than tax value in order to trigger income inclusions

• 3 – acceptance of non-share consideration

Elected amount

• Concept of elected amount– Transfer assets and elect the PoD– Cannot create a loss– Elect between tax value and FMV

1 – downward adjustment

• In order to defer a gain, assets must be transferred choosing an elected amount equal to tax value (ie ACB or UCC)

1 – how does it work

Facts• Ms Ava wishes to transfer

land.• ACB = 10,000 • FMV = 50,000• No tax consequences

desired

Results• Proceeds should be

10,000 so no gain triggered

• Consideration could be 1 share with a FMV of 50,000

• Gain will be realized when share is sold

• PUC = tax value

2 – TP other than tax value

• Proceeds can be chosen at any elected amount between TV and FMV. The range will permit taxpayer to trigger an appropriate amount of TCG or other income to offset LCF and ACL. Consideration will also be shares.

2 – how does it work

Facts• Ms Elizabeth wants to

transfer land and building• Land

– ACB = 10,000– FMV = 50,000

• Building– Cost – 95,000– UCC = 75,000– FMV = 110,000

• NCLCF = 10,000

Results• Land s/b 30,000 in order to

utilize NCLCF• Building @ TV and corp will

assume the recapture and CG

• Shares s/b 160,000 as this equals FMV, but due to election, PUC is reduced to 105,000 (75,000 + 30,000)

• 55,000 deferral to disposition of shares

3 – Non share consideration

• Introduction of “boot” – non cash consideration that includes:– Cash– Debt

• Consideration is a mix of shares and boot• Shares must be included in order for 85(1)

election to be valid

3 – how does it work

Facts• Mr Benjamin wants to

transfer land– ACB = 10,000– FMV = 50,000– Mortgage = 4,000

• Will take back– Promissory note for 14,000– Assumption of mortgage– Balance in class B shares

• NCLCF = 6,000 from 1999

Results• Need to trigger capital

gain• Elect at 18,000 in order to

use NCLCF ( 6,000 x ½ / ¾)

• Boot does not exceed elected amount

• Boot = 14,000• Mortgage = 4,000• ACB of shares = NIL

3 – lets look at it this way

Stated capital (FMV of land is 50,000 less boot of 18,000

32,000

Minus elected amount 18,000

Less boot 18,000 NIL

PUC reduction 32,000

PUC = FMV – PUC reduction

(32,000 – 32,000) NIL

What if boot > elected amount?

• Assume promissory note of 18,000 because he forgot that the mortgage was being assumed by the corp

• Elected amount bumped by 4,000 to get new elected amount of 22,000 (18,000 + 4,000)

• CG of 6,000 offset by only 4,000• ACB is still NIL• PUC is still NIL

Basic rules

• Eligible property– Capital property– Eligible capital property– Resource property or inventory

• Four conditions to be met– Corp must be defined taxable CDN corp– Consideration must include a minimum of one

share (literal interpretation calls for two shares)– Must be eligible property– Must jointly elect to have rollover provisions apply

Elected transfer price

• Proceeds of disposition to the transferor• Cost of the property to the corporation• Cost of the package of consideration taken

by the transferor from the corporation• Part of the calculation of PUC for tax

purposes of the share consideration received

Restrictions on share priceInventory or capital property other than depreciable property

Depreciable capital property

Eligible capital property

UPPER LIMIT par 85(1)(c)

FMV of property transferred

FMV of property transferred

FMV of property transferred

LOWER LIMITpar 85(1)(e.3)

Greater of Greater of Greater of

Par 85(1)(b) FMV of non-share consideration received

FMV of non-share consideration received

FMV of non-share consideration received

and and and

Lesser ofpar 85(1)(c.1)

Least ofpar 85(1)(e)

Least ofpar 85(1)(d)

1) FMV of property 1) FMV of property 1) FMV of property

2) ACB if capital property or tax value if inventory

2) UCC of class of property

2) 4/3 of the ECC balance

3) Cost of property to transferor

3) Full or actual cost of property to the transferor

Non share consideration

• Not necessary to take boot, but is usually beneficial

• Common error is to forget to include the debts of the transferor

• Debt can be redeemed for cash with no tax consequences

Range of Elected Amounts

Range

1 2 3

100 FMV FMV TV

75 TV BOOT FMV

60 BOOT TV BOOT

Summary• 1 – boot < TV therefore

no impact on lower limit• 2 – LL is boot because

S/H has extracted an extra $15 therefore elected amount is automatically bumped

• 3 –Can’t receive more than FMV without tax consequences

Application

Consideration A B C

Cash etc 0 1,000 1,300

Preferred shares (FMV and legal stated capital)

1,000 300 180

Common shares (FMV and legal stated capital)

500 200 20

TOTAL 1,500 1,500 1,500

Election range

High 1,500 1,500 1,500

Low 1,000 1,000 1,300

Election price (assume lowest) 1,000 1,000 1,300

ACB 1,000 1,000 1,000

Capital gain 0 0 300

Taxable capital gain 0 0 150

Transfer of property with ACB of $1,000 and FMV of $1,500

YOUR TURN

Tax value FMV

Short term investments 15,000 18,000

Inventory 45,000 46,000

Machinery (cost 54,375) 26,250 38,500

Goodwill 0 30,000

86,250 132,500

Liabilities 10,000 10,000

76,250 122,500

Mr Sole wants the following consideration: $70,000 in debt, $35,000 in preferred shares and the balance in common shares to total FMV of assets. Corporation will assume the existing debt

Solution – determine elected amounts

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000

Invent. 45,000 46,000

Machine 26,250 38,500

Goodwill NIL 30,000

TOTAL 86,250 132,500

Solution – determine elected amounts

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000

Invent. 45,000 46,000 45,000

Machine 26,250 38,500 26,250

Goodwill NIL 30,000 1

TOTAL 86,250 132,500 86,251

Solution – allocate boot

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000 10,000 5,000

Invent. 45,000 46,000 45,000

Machine 26,250 38,500 26,250

Goodwill NIL 30,000 1

TOTAL 86,250 132,500 86,251 10,000 5,000

Solution – allocate boot

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000 10,000 5,000

Invent. 45,000 46,000 45,000 45,000

Machine 26,250 38,500 26,250

Goodwill NIL 30,000 1

TOTAL 86,250 132,500 86,251 10,000 50,000

Solution – allocate boot

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000 10,000 5,000

Invent. 45,000 46,000 45,000 45,000

Machine 26,250 38,500 26,250 20,000

Goodwill NIL 30,000 1

TOTAL 86,250 132,500 86,251 10,000 70,000

Solution – allocate preferred shares

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000 10,000 5,000 3,000

Invent. 45,000 46,000 45,000 45,000

Machine 26,250 38,500 26,250 20,000

Goodwill NIL 30,000 1

TOTAL 86,250 132,500 86,251 10,000 70,000 3,000

Solution – allocate preferred shares

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000 10,000 5,000 3,000

Invent. 45,000 46,000 45,000 45,000 1,000

Machine 26,250 38,500 26,250 20,000

Goodwill NIL 30,000 1

TOTAL 86,250 132,500 86,251 10,000 70,000 4,000

Solution – allocate preferred shares

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000 10,000 5,000 3,000

Invent. 45,000 46,000 45,000 45,000 1,000

Machine 26,250 38,500 26,250 20,000 18,500

Goodwill NIL 30,000 1

TOTAL 86,250 132,500 86,251 10,000 70,000 22,500

Solution – allocate preferred shares

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000 10,000 5,000 3,000

Invent. 45,000 46,000 45,000 45,000 1,000

Machine 26,250 38,500 26,250 20,000 18,500

Goodwill NIL 30,000 1 12,500

TOTAL 86,250 132,500 86,251 10,000 70,000 35,000

Solution – allocate common shares

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000 10,000 5,000 3,000

Invent. 45,000 46,000 45,000 45,000 1,000

Machine 26,250 38,500 26,250 20,000 18,500

Goodwill NIL 30,000 1 12,500 17,500

TOTAL 86,250 132,500 86,251 10,000 70,000 35,000 17,500

Solution – income inclusion

FMV of consideration

Tax value FMV Elected Assumed debt

New debt Preferred shares

Common shares

Income

Short term invest.

15,000 18,000 15,000 10,000 5,000 3,000 0

Invent. 45,000 46,000 45,000 45,000 1,000 0

Machine 26,250 38,500 26,250 20,000 18,500 0

Goodwill NIL 30,000 1 12,500 17,500 $0.50

TOTAL 86,250 132,500 86,251 10,000 70,000 35,000 17,500 0.50

The corporations position

• Elected transfer price is corporation’s cost• The corporation steps into the transferors

tax position• Half year rule for CCA does not apply if

– Transferor was not dealing at arms’ length– Property owned continuously for at least 365

days from end of tax year to date of election

The shareholders position

• Elected transfer price is basically allocated to become cost of property received– Property other than shares up to FMV of that

property as long as not exceeding FMV of transferred property

– Pref shares up to FMV of those shares as long as FMV does not exceed PofD

– Common shares that PofD exceeds sum of FMV of boot and pref shares

PUC reduction

• Where shares have no par value or stated value, PUC = FMV (normally)

• Bumps and grinds• Bump – a bump in FMV from transfer• Grind – a reduction in PUC after

disposition of property

The Grind

• (A-B) x C/A• Where

– A = the increase in LSC of all shares after disposition under section 85

– B = the excess (boot)– C = the increase in LSC of a particular class

on transfer

Illustration

Facts• Tax value = 10,000• FMV = 15,000

– Elected amount = 10,000– FMV of boot = 10,000– FMV of share consideration

= 5,000– ACB = NIL

Effect

LSC pre reduction

5,000

Increase in LSC on transfer

5,000 A

Elected amt 10,000

Less boot 10,000

Excess NIL B

Grind (A-B) 5,000

Tax PUC NIL

The effect

With reduction No reduction

Proceeds 5,000 5,000

Less PUC NIL 5,000

Deemed dividend 5,000 NIL

Proceeds 5,000 5,000

Deemed dividend 5,000 NIL

Proceeds NIL 5,000

ACB NIL NIL

Capital gain NIL 5,000

The PUC reduction converts the capital gain into a deemed dividend

Other rules

• Depreciable capital property– Need to designate the order

of dispositions within particular classes

– Stop loss rules on terminal losses

– Can only transfer amounts that have been paid, not accrued (ie capital gains accruals)

– Same applies for CECA– Cannot transfer at zero,

need nominal amount of $1 (goodwill)

• Non depreciable property with unrealized capital losses to affiliated persons– Affiliated persons are

affiliated with each member of a group and control the corporation

– Stop loss rules deny losses in all situations where transferee and transferor are affiliated

Summary of stop loss rulesTransferer is a corporation, trust or partnership

Transferor is an individual

Capital loss on transfer:

* To an affiliated purchaser (251.1) * To an affiliated purchaser

* Capital loss is denied (40(3.4)) *Capital loss is denied as a superficial loss (Sec 54 Par 40(2)(g)

* Capital loss is kept with the transferor until the transferee sells the asset to a non-affiliated person

* Denied loss is added to the cost of the asset to the transferee

Terminal loss

* On transfer to an affiliated purchaser * Same as for corporations, trusts or partnerships

* Terminal loss is denied

* Terminal loss is kept with transferor until the transferee sells the asset to an non-affiliated person

* Transferee records the asset with a cost equal to the cost to the transferor and an addition to UCC equal to FMV

Capital loss on redemption

* Affiliated immediately after the redemption * Same as for corporations, trusts or partnerships

Summary of Rules

Property transferred FMV of non share consideration

FMV of total consideration

>FMV Elected amount = FMV of property transferred. Ssec 15(1) will apply on income received as well as accrued income realized

Even if the increase in LSC of shares was greater than increase in net assets, there will be no deemed dividend since the tax PUC of shares will be reduced to NIL resulting in deemed dividend on disposition

FMV Optimal FMV of total consideration

Tax value Minimum elected amount = FMV of boot; realization of all or some accrued income will result

Optimal FMV of share consideration

Minimum elected amount = tax value of property transferred therefore no realization of income

Optimal FMV of boot

0

Filing requirements

• T2057 applies to elections made under 85(1). This form must be filed separately

• Deadline is the earliest date on which any of the parties to the election has to file an income tax return for the taxation year in which the transfer occurred.

• 150(1) requires an individual to file for the calendar year. 25(1) 99(2) extends the fiscal period of a proprietor who disposed of a business

Late and amended elections

• 85(7) will allow you to file an election up to three years after the filing deadline

• Generally allowed if the amendment is to revise an agreed amount where there would be unintended tax consequences if not amended

• If late, must pay penalty of ¼% of excess property FMV AND

• 100 per month up to 8,000

Example

Worksheet setup

Min. elected amount Income Max. boot

Land(1)

Marketable securities(2)

Building(3)

Equipment(4)

Furniture and fixtures(5)

Licence(6)

Worksheet setup

Min. elected amount Income Max. boot

Land(1) $60,000 Nil $60,000

Marketable securities(2) 60,000 $2,500 55,000

Building(3) 70,000 Nil 70,000

Equipment(4) 45,000 5,000 40,000

Furniture and fixtures(5) 7,000 Nil 7,000

Licence(6) 80,000 Nil 80,000

(1) (a) Minimum elected amount on landGreater of:

(i) FMV of boot $50,000(ii) Lesser of:

(A) FMV of property $75,000$60,000

(B) ACB $60,000(b) Income:

Proceeds $60,000Cost (60,000)Capital gain/loss Nil

Worksheet setup

Min. elected amount Income Max. boot

Land(1) $60,000 Nil $60,000

Marketable securities(2) 60,000 $2,500 55,000

Building(3) 70,000 Nil 70,000

Equipment(4) 45,000 5,000 40,000

Furniture and fixtures(5) 7,000 Nil 7,000

Licence(6) 80,000 Nil 80,000

(2) (a) Minimum elected amount: marketable securities

Greater of:(i) FMV of boot $ 60,000(ii) Lesser of:

(A) FMV of property $65,000$ 55,000

(B) ACB $55,000(b) Proceeds $ 60,000

Cost 55,000Gain $ 5,000Taxable capital gain $ 2,500

Worksheet setup

Min. elected amount Income Max. boot

Land(1) $60,000 Nil $60,000

Marketable securities(2) 60,000 $2,500 55,000

Building(3) 70,000 Nil 70,000

Equipment(4) 45,000 5,000 40,000

Furniture and fixtures(5) 7,000 Nil 7,000

Licence(6) 80,000 Nil 80,000

(3) (a) Minimum elected amount building

Greater of:(i) FMV of boot $ 55,000(ii) Least of:

(A) FMV of property $95,000

(B) UCC of class $70,000 $ 70,000

(C) Cost of property $85,000(b) Taxable capital gain:

Proceeds $ 70,000Cost (85,000)Gain/Loss Nil

Worksheet setup

Min. elected amount Income Max. boot

Land(1) $60,000 Nil $60,000

Marketable securities(2) 60,000 $2,500 55,000

Building(3) 70,000 Nil 70,000

Equipment(4) 45,000 5,000 40,000

Furniture and fixtures(5) 7,000 Nil 7,000

Licence(6) 80,000 Nil 80,000

(4) (a) Minimum elected amount equipment

Greater of:(i) FMV of boot $ 45,000(ii) Least of:

(A) FMV of property $50,000

(B) UCC of property $40,000 $ 40,000(C) Cost of property $65,000

(b) Taxable capital gain:Proceeds $ 50,000Cost (65,000)

Nil

Worksheet setup

Min. elected amount Income Max. boot

Land(1) $60,000 Nil $60,000

Marketable securities(2) 60,000 $2,500 55,000

Building(3) 70,000 Nil 70,000

Equipment(4) 45,000 5,000 40,000

Furniture and fixtures(5) 7,000 Nil 7,000

Licence(6) 80,000 Nil 80,000

(5) (a) Minimum elected amount furniture and fixtures

Greater of:(i) FMV of boot $ 5,000(ii) Least of:

(A) FMV of property $10,000

(B) UCC of class $ 7,000 $ 7,000(C) Cost of property $15,000

(b) Taxable capital gain:Proceeds $ 7,000Cost (15,000)Gain/Loss Nil

Worksheet setup

Min. elected amount Income Max. boot

Land(1) $60,000 Nil $60,000

Marketable securities(2) 60,000 $2,500 55,000

Building(3) 70,000 Nil 70,000

Equipment(4) 45,000 5,000 40,000

Furniture and fixtures(5) 7,000 Nil 7,000

Licence(6) 80,000 Nil 80,000

(6) (a) Minimum elected amount licence

Greater of:(i) FMV of boot $ 15,000(ii) Least of:

(A) FMV of property $100,000

(B) 4/3 of CEC $80,000 $ 80,000

(C) Cost of property $82,500(b) CEC $ 60,000

Proceeds: 3/4 $80,000 60,000Nil

Examples

• Problem 3• Problem 5

Next week

• Read Chapter 17• Do the following from chapter 16:

– Problem 6• Assignment #2: problem 8