chapter 16 & 17 problems

269

CHAPTER 16

Income Deferral: Rollover on Transfers to

a Corporation and Pitfalls

Solution 1 (Basic)

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

—NOTES TO SOLUTION

(1) (a) Minimum elected amount: Greater 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 .......................................................................................................................... $ 60,000 Cost................................................................................................................................. (60,000) Capital gain/loss .............................................................................................................. Nil


(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................................................................................................................................. 55,000 Gain ................................................................................................................................ $ 5,000 Taxable capital gain ......................................................................................................... $ 2,500

(3) (a) Minimum elected amount:

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

Terminal loss/Recapture: UCC ........................................................................................................................ $ 70,000 Less: lesser of:

(i) Capital cost ......................................................................... $ 85,000 70,000 (ii) Proceeds ............................................................................. $ 70,000

Nil

Introduction to Federal Income Taxation in Canada 270



(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 .................................................................................................................. $ 50,000

Cost ......................................................................................................................... (65,000) Nil

Recapture: UCC ........................................................................................................................ $ 40,000 Less: lesser of:


Recapture ................................................................................................................. $ 5,000


(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 .................................................................................................................. $ 7,000 Cost ......................................................................................................................... (15,000) Gain/Loss................................................................................................................. Nil

Recapture/Terminal loss: UCC ........................................................................................................................ $ 7,000 Less: lesser of:


Recapture Nil



(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 .................................................................................................... 60,000

Nil

Solutions to Chapter 16 Assignment Problems 271

Solution 2 (Basic)

Section 85 rollover

Elijah has only two assets eligible for a subsection 85(1) rollover: the office equipment and the goodwill. To ensure that no income arises on transferring these assets to the corporation, the total elected amount to be agreed

on between him and the corporation should not exceed $10,001. The maximum non-share consideration that Elijah can receive while deferring the maximum amount of gain is $10,001.

Asset Tax Value FMV

Elected

Amount

Assumed

Debt

New

Debt Shares

Office equip. $10,000 $12,000 $10,000 $9,000 $1,000 $ 2,000

Goodwill Nil 20,000 1 - 1 19,999

$10,000 $32,000 $10,001 $9,000 $1,001 $21,999

Other transferred property (non-section 85)

Asset FMV Transfer Consideration received Cash $ 5,000 $ 5,000 note payable to Elijah Accounts receivable** $15,000 $15,000 note payable to Elijah $20,000 $20,000

** An election should be filed under section 22 with regard to the transfer of the receivables. Failure to file the election will

result in any bad debts realized by the company being considered capital losses rather than losses on income account.

Elijah’s income arising on the transfer

The only income realized by Elijah is the $1 from the disposition of the goodwill. The taxable portion of the disposition of that, through the CEC account, is $0.50.

Tax Values of Assets Owned by the Corporation

Assets Cash $ 5,000.00 Accounts receivable 15,000.00 Office equipment 10,000.00

Goodwill (¾ × $1.00) 0.75

$30,000.75

Note that transfer of the bank loan to the corporation requires the approval of the bank. If the bank did not

approve, a note payable to Elijah can be substituted in the rollover.


Solution 3 (Basic)

The following assets cannot or should not be transferred using section 85:

Tax value FMV Transfer

price Debt Income Effect

Cash (not eligible) ........................................... $ 22,000 $ 22,000 $ 22,000 $ 22,000 Nil Inventory(1) ...................................................... 44,000 39,500 39,500 39,500 $ (4,500) $ 66,000 $ 61,500 $ 61,500 $ 61,500 $ (4,500)

The following assets should be transferred using section 85:

Tax value FMV

Minimum transfer

price

Consideration Income Effect Debt Shares

Furniture & fixtures ..................... $ 6,000 $ 8,000 $ 6,000 $ 6,000 $ 2,000 Nil Building ...................................... 45,000 55,000 45,000 45,000 10,000 Nil Land ............................................ 8,000 30,000 8,000 8,000 22,000 Nil Total ........................................... $ 59,000 $ 93,000 $ 59,000 $ 59,000 $ 34,000

There should be no adverse tax consequences on this transfer, since the FMV of the consideration received (i.e., debt and shares) was exactly equal to the FMVs of the transferred assets. In addition, the non-share

consideration did not exceed the tax values of the transferred assets.

Cost of shares received as consideration: Elected transfer price .............................................................................................................. $ 59,000 Deduct: non-share consideration.............................................................................................. 59,000 Adjusted cost base of shares .................................................................................................... Nil

Legal stated capital before reduction.............................................................................................. $ 34,000

Subsection 85(2.1) reduction in PUC: (a) increase in LSC ........................................................................................... $ 34,000 (A) (b) elected amount ........................................................................ $ 59,000

less: boot ................................................................................ 59,000 excess, if any .............................................................................................. Nil (B)

PUC reduction (A – B)................................................................................................................... 34,000 Tax PUC after reduction ................................................................................................................ Nil

The tax PUC after reduction reflects the fact that the tax-paid cost of the assets transferred has been recovered through the debt assumed. The tax basis of all assets was $59,000, which was also the amount Pete

elected for the transfer price and was the amount of non-share consideration Pete wished to assume. This non-share consideration reduces the tax PUC of the common shares to nil, which is a logical result, as all the tax-paid

value of the assets is now in the form of the debt which Pete can withdraw tax-free as he wishes and as funds become available.

—NOTE TO SOLUTION

(1) Since there is no possible income to defer on a transfer to the corporation, section 85 does not have to be

used. The transfer could be made through a direct sale, taking back debt consideration equal to the fair market value, i.e., $39,500.


Solution 4 (Advanced)

Note: Ms. Hart must transfer the business assets to Hart Ltd. at FMV in order to avoid the application of

section 69. If the property is transferred at less than FMV, paragraph 69(1)(b) will still deem Ms. Hart’s proceeds to be FMV.

(A) Income for tax purposes if section 85 not used: Shares in public companies

[$6,000 – $ 11,000 = $5,000 capital loss denied [par. 40(2)(g)], because it is a superficial

loss [sec. 54]; added to the adjusted cost base of the property owned by the corporation [par. 53(1)(f)] .............................................................................................................................. Nil

Accounts receivable (capital property) Include last year’s reserve .................................................................................................... $ 1,000

[$10,000 – $14,000 = $4,000 capital loss denied because it is a superficial loss, as above] Nil

Inventory Business income .......................................................................................................... 1,000 Land (inventory)

Business income ($220,000 – $100,000) ............................................................................... 120,000 Prepaid insurance

Business income (loss) ($600 – $600) .................................................................................. Nil Building

Terminal loss denied [ssec. 13(21.2)] ................................................................................... Nil Land (capital property)

Taxable capital gain [1/2 ($160,000 – $140,000)]................................................................ 10,000 Goodwill

Business income [2/3 3/4 ($80,000 – 0)] ........................................................................... 40,000 Total income ............................................................................................................................... $ 172,000

(B) Items not transferred under section 85:

FMV Shares ................................................................. — (do not transfer—see below) Accounts receivable ............................................ $ 10,000 (use section 22 for full business loss of $4,000) Land (inventory) ................................................. — (do not transfer—see below) Prepaid insurance ................................................ 600 (not capital property) Building .............................................................. 50,000 (unrealized terminal loss, no income to defer) Total transfer price .............................................. $ 60,600 (take back debt consideration)

Items that should not be transferred to corporation:

Shares

If Ms. Hart intends to sell the shares, it might be more advantageous to keep them out of the company and

realize the loss personally rather than in the corporation. It is unlikely that she would need the shares to carry on the business.

The shares would not be earning Canadian active business income. It may therefore make sense to keep the

shares out of the corporation to ensure that Hart Ltd. qualifies as a small business corporation [ssec. 248(1)] and

a qualified small business corporation [sec. 110.6]. Since Mr. Hart is a shareholder of Hart Ltd., section 74.4 may apply if Hart Ltd. is not a small business corporation.

(If the shares are to be transferred, section 85 is not necessary because there is no gain. The shares should be

sold for $6,000 of debt consideration.)

Land inventory

Not eligible for section 85 since not a capital property

Do not transfer in since not needed for the business—better to postpone the realization of the $120,000 business income

(If the land inventory is to be transferred, the consideration should be debt of $120,000.)

Items transferred under section 85:

Consideration

Tax value FMV Elected Amount

Assumed Debt

New Debt Shares Income

Inventory ......................... $ 8,000 $ 9,000 $ 8,000 $ 8,000 Nil $ 1,000 Nil Land (capital property) ..... 140,000 160,000 140,000 52,000 88,000 20,000 Nil

Goodwill .......................... Nil 80,000 1 Nil Nil 80,000 $ 0.50 $ 148,000 $ 249,000 $ 148,001 $ 60,000 $ 88,000 $ 101,000 $ 0.50


ACB of shares received: Elected transfer price ......................................................................... $ 148,001 Allocated to debt consideration

Debt assumed ....................................................... $ 60,000 New debt issued ................................................... 88,000 148,000

ACB of shares ................................................................................... $ 1 PUC of shares received: LSC before reduction ......................................................................................................................... $ 101,000 Subsection 85(2.1) reduction in PUC

(A) Increase in LSC of all shares ...................................................................... $ 101,000(A) (B) Elected amount ................................................................... $ 148,001

Less: boot ........................................................................... 148,000 Excess, if any .................................................................................................... 1 (B)

Total PUC reduction (A) – (B) ..................................................................................................... $ 100,999 Tax PUC after reduction ..................................................................................................................... $ 1

Tax cost to corporation of assets transferred:

Tax cost Reason Shares* ...................................................... $ 11,000 $6,000 FMV transfer price plus $5,000 superficial loss

[par. 53(1)(f)] Accounts receivable ................................... 14,000 Actual cost $14,000, before any reserve claimed by

purchaser corporation at its year end [sec. 22] Inventory ................................................... 8,000 Elected amount [par. 85(1)(a)]

Land inventory* ......................................... 220,000 FMV transfer price Prepaid ...................................................... 600 FMV transfer price Building ..................................................... 50,000 UCC is deemed to be $50,000 [par. 85(5)(b)]; Capital

cost is deemed to be $90,000 [par. 85(5)(a)] Land .......................................................... 140,000 elected amount [par. 85(1)(a)] Goodwill .................................................... .50 CEC = 3/4 $1 elected amount – 1/2 $0.50

[par. 85(1)(a), ssec.14(5)] * if these properties are transferred to the corporation

(C) Proceeds of disposition ............................................................ $ 101,000

Less: Adjusted cost base .......................................................... 1 Capital gain............................................................................. $ 100,999

Taxable capital gain (1/2 $100,999) ....................................... $ 50,500

(D) Proceeds of redemption ........................................................... $ 101,000

Less: PUC ............................................................................... 1 Deemed dividend [ssec. 84(3)]................................................. $ 100,999 Proceeds of disposition ............................................................ $ 101,000 Less Deemed dividend [ssec. 84(3)] ......................................... 100,999 Adjusted proceeds of disposition [spar. 54(h)(x)] ..................... $ 1 Adjusted cost base ................................................................... 1

Capital gain (loss) ................................................................... $ Nil



(A) Shares of Supplyco Ltd. should not be transferred to the corporation, if they would jeopardize the

qualification of the shares of the new corporation as QSBCS. At this time, the FMV of the Supplyco Ltd. shares is less than 10% of the FMV of all of the assets of the new corporation, but this could change in the future. There

is no advantage to having the corporation owning these shares.

Shares of Clientco Ltd. should not be transferred to the corporation. The accrued loss of $900 would be denied as a superficial loss [par. 40(2)(g)] and added to the adjusted cost base of the Clientco Ltd. shares held by

the new corporation. There is also no advantage to having the corporation own these shares.

(B) Items not transferred under section 85:

Cash (not capital property [ssec. 85(1.1)]) ..................................................... $ 12,000 Accounts receivable ...................................................................................... 102,000(1) Equipment (no income to defer; simpler not to use ssec. 85(1)) ...................... 40,000(2) Total debt consideration to be taken .............................................................. $ 154,000

(C) Items transferred under section 85:

Tax value FMV

Minimum transfer

price

Consideration

Effect on income

Assumed liabilities Notes Prefs.

Inventories .............. $ 90,000 $ 100,000 $ 90,000 $ 90,000 Nil $ 10,000 Nil Land ....................... 96,000 103,000 102,000 61,000 41,000 1,000 $3,000 TCG(3) Buildings ................ 42,000 144,000 42,000 Nil 42,000 102,000 Nil 1990 Acura ............. 1,000 5,000 1,000 Nil 1,000 4,000 Nil Goodwill ................. Nil 90,000 1(4) Nil Nil 90,000 0.50

Total ................ $ 229,000 $ 442,000 $ 235,001 $ 151,000(5) $ 84,000(5) $ 207,000

(D) Cost of consideration received:

Elected transfer price (excluding benefit) ........................................... $ 235,001 less: debt assumed ............................................ $ 151,000

debt issued ................................................ 84,000 235,000 ACB of preferred shares .................................................................... $ 1 Tax PUC of shares received: LSC before reduction...................................................................................................................... $ 207,000 Subsection 85(2.1) reduction:

(i) Increase in LSC of all shares ...................................................................... $ 207,000 (A) (ii) Elected amount .................................................................. $ 235,001

Less: boot ........................................................................... 235,000

Excess, if any............................................................................................. 1 (B) Total PUC reduction (A – B) .................................................................................... (206,999)

Tax PUC after reduction ................................................................................................................. $ 1

(E) The FMV of the assets transferred to the corporation would be greater than the consideration received and since his three children will own the common shares there is a problem with “gifting” [par. 85(1)(e.2]. Note

that the fair market value of assets transferred ($442,000) under section 85 is greater than the total fair market value of consideration ($385,000) received by the transferor. Since the transferor’s children will own common

shares in the corporation, the excess of $57,000 can be considered a benefit. Thus, the elected amount must be increased by the $57,000 to $292,001 for the purpose of determining the proceeds of disposition to the transferor

and cost to the corporation, but not the adjusted cost base of the consideration received. The $57,000 will have to be added to the elected amount of various assets transferred under section 85. Thus, the elected amount of such

assets as the land and goodwill should be increased because only a portion of the increase will be subjected to

tax. If the increase had been made to the inventories or the building, the full increase would be taxed.

Minimum transfer price ..................................................................... $ 235,001 Increase due to benefit ....................................................................... 57,000 Elected transfer price after benefit ...................................................... $ 292,001

Cost of share consideration received: Elected transfer price (excluding benefit) $235,001 Less: debt assumed $151,000 debt issued 84,000 235,000 ACB of preferred shares $ 1


Tax PUC of shares received: LSC before reduction $150,000 Subsection 85(2.1) reduction: (i) increase in LSC of all shares $150,000 (A) (ii) elected amount (including benefit) $292,001 less boot 235,000 excess, if any 57,000 (B) Total PUC reduction (92,999) Tax PUC after reduction $ 57,001

The increase in the elected amount as a result of the paragraph 85(1)(e.2) benefit of $57,000 is reflected in the

PUC after reduction because subsection 85(2.1) uses the increased elected amount in item B. Since income is created

for the transferor by the $57,000 benefit, the $57,000 can be considered to be a tax-paid cost that was not recovered through boot received, along with the $1 of tax-paid cost created by electing to transfer the goodwill at $1.

(F) The newly determined fair market value of the goodwill ($120,000) transferred to the corporation would

be greater than the total debt and share consideration ($90,000) received on the transfer. In order to ensure that the subsequent valuation does not result in the benefit [par. 85(1)(e.2)] problem, discussed in (E) above, a price

adjustment clause should be added to the documentation of the transaction. The effect is to adjust the value of the share consideration to $120,000, so that the total consideration reflects the newly determined value of the

goodwill. As suggested in the text, case law indicates that a price adjustment clause will only be recognized if the parties have reasonably, and in good faith, attempted to determine values that equal fair market values.


(1) Section 22 election is recommended on transfer of accounts receivable so that the purchaser is eligible for a reserve for bad debts and a bad debt write-off of these accounts and the vendor incurs a business loss of

$18,000 rather than an allowable capital loss of $9,000. In order to qualify for this election, the vendor’s loss must be taken into the purchaser’s income. If section 22 is not elected, then the loss will be a capital loss which is

denied as a superficial loss [sec. 54] by paragraph 40(2)(g) with an increase in the cost base of the receivables owned by the corporation after the transfer [par. 53(1)(f)], whether or not section 85 is used for the transfer of the

receivables. The 2010 reserve of $10,000 must be included in 2011 income in either case.

(2) The accrued terminal loss is denied [ssec. 13(21.2)]. The UCC of the equipment in the corporation will be $40,000. Joe will retain a UCC of $17,000 to be depreciated until SEL sells the amounts to an arm’s length

party.

(3) In order to use the net capital loss of $4,500, an elected transfer price of $102,000 should be chosen. This amount will trigger a capital gain of $6,000 (a taxable capital gain of $3,000). The net capital loss of $4,500

realized in 1999 will be adjusted to $3,000 (i.e., $4,500 1/2 3/4).

(4) Goodwill must be transferred at a nominal amount of $1.00.

(5) New debt issued by corporation ($84,000) plus actual debts assumed ($151,000) total $1 less than the

maximum debt of $235,001, equal to the elected amount.


Solution 6 (Advanced) (A) The shares in Public Co. should not be transferred to the corporation since the capital loss would be denied under paragraph 40(2)(g) and the section 54 definition of “superficial loss” whether or not section 85 is

used on the transfer. These shares should be held personally so that capital loss can be realized on their disposition to a third party.

Similarly, the land (Parcel II) should not be transferred to the corporation. Since this land would be land inventory, it cannot be transferred on a tax-free basis on section 85 [ssec. 85(1.1)]. Any other form of transfer

must be at fair market value since Mr. Schminkie and the corporation do not deal at arm’s length, and will result in triggering an income inclusion. Recommend that this parcel of land be held personally.

(B) Items which cannot or should not be transferred under section 85:

Asset Tax value FMV Transfer

price

Consideration

Comment Assumed

debt Income effect

Cash............................... $ 20,000 $ 20,000 $ 20,000 $ 20,000 Nil not eligible A/R ................................ 96,000 85,000 85,000 85,000 $ (5,000)(1) net of reserve Inventory ....................... 86,000 86,000 86,000 86,000 Nil no inc. to defer Equipment...................... 35,000 5,000 5,000 5,000 Nil(2) no inc. to defer

$ 237,000 $ 196,000 $ 196,000 $ 196,000 $ (5,000)

(C) Items transferred under section 85:

Asset Tax value FMV

Consideration

New debt

Cl. A

shares

Cl. B

shares Income effect

Elected

amount

Assumed

liabilities

Land: Parcel I.. $ 200,000 $ 339,000 $ 200,000 $ 46,000 $ 154,000(3)

$ 139,000 — Nil

Building .......... 15,000 75,000 15,000 — 15,000 60,000 — Nil

Auto ................ 11,000 12,000 11,000 — 11,000 1,000 — Nil

Goodwill ......... Nil 60,000 1 — — — 60,000 .50

$ 226,000 $ 486,000 $ 226,001 $ 46,000 $180,000 $ 200,000 $ 60,000

(D) Cost of consideration taken on section 85 transfer: Elected amount ................................................................................................................................. $ 226,001 Allocation of non-share consideration

— assumed debt ........................................................................................ $ 46,000 — new debt ............................................................................................... 180,000 226,000

Cost of share consideration ......................................................................................................... $ 1 PUC of share consideration taken:

Subsection 85(2.1) reduction in PUC: Increase in LSC of all shares ($200,000 + $50,000)............................. $ 260,000(A)

Less: Elected amount ........................................................... $226,001 Less: Boot ................................................................... (226,000) Excess, if any ............................................................................. 1 (B) Total reduction (A – B)............................................................... $ 259,999

Redeemable preferred Retractable preferred

Increase in LSC for each class........................................................................... $ 200,000 (C) $ 60,000 (C)

Reduction in each class [(A – B) C/A]

Redeemable pref. shares, 000,260$

000,200$999,259$ ....................................... (199,999)

Retractable pref. shares, 000,260$

000,60$999,259$ ......................................... (60,000)

Tax PUC after reduction for each class .............................................................. $ 1 Nil

The $1 total PUC after the reduction reflects the fact that all of the tax-paid cost in the assets transferred (i.e., $226,000) has been recovered through assumed liabilities and new debt received.

(E) Proceeds of redemption ...................................................... $ 260,000 Less: PUC (total) ................................................................ 1 Deemed dividend [ssec. 84(3)] ............................................ $ 259,999 Proceeds of disposition ....................................................... $ 260,000

Less: deemed dividend [ssec. 84(3)] .................................... 259,999 Adjusted proceeds of disposition ......................................... $ 1 Adjusted cost base (total) .................................................... 1 Capital gain (loss)(3) ............................................................ Nil


(F) An additional $10,000 of new debt should be taken to balance the FMV of assets transferred with total FMV of consideration, to avoid a benefit under paragraph 85(1)(e.2) because of the wife’s shares. The result is an increase in the elected amount. The gain should be triggered on capital property or eligible capital property

which would result in an amount that is only taxable at ½. Note, also, that $196,000 of the $242,000 in proprietorship liabilities were assumed as consideration for assets not transferred under section 85. This leaves

$46,000 (i.e., $242,000 – $196,000) to be assumed as consideration for the land.


(1) Section 22 election:

Proprietorship Corporation

Reserve................................... $ 6,000 Accounts receivable ................ $ 96,000 Income ............................ $ 6,000 Consideration .................... $ 85,000

Consideration .......................... 85,000 Income .............................. 11,000 Business loss on transfer 11,000 — can take a reserve.

Accounts receivable ......... 96,000 — can write off bad debts.

(2) A terminal loss of $30,000 is not allowed to Mr. Schminkie by virtue of subsection 13(21.2). The corporation will have a UCC of $5,000, and Mr. Schminkie will retain a UCC in that class of $30,000.

(3) Since Mr. Schminkie and his wife are affiliated with the corporation, had there been a capital loss, the

capital loss would have been denied and added to the cost base of the common shares held by Mr. Schminkie by

virtue of subsection 40(3.6).


Solution 7 (Basic)

This transaction will be subject to the provisions in section 84.1. In order for this section to apply, a number

of conditions must be met. An individual, resident in Canada (i.e., Mrs. Andrews), must dispose of shares of a corporation resident in Canada (i.e., Plummer) to another corporation (VHL) with which the individual (i.e.,

Mrs. Andrews) does not deal at arm’s length. As Mrs. Andrews owns 100% of the shares of VHL, Mrs. Andrews and VHL do not deal at arm’s length, since they are related [spar. 251(2)(a)(i)]. After the transaction Plummer

and VHL must be connected, within the meaning assigned by subsection 186(4). Plummer and VHL are connected as VHL controls Plummer. Therefore, all the conditions for section 84.1 to apply are met.

Paragraph 84.1(1)(a) will apply to reduce the tax PUC of the shares Mrs. Andrews takes back from VHL.

This reduction is calculated as follows:

Increase in LSC of VHL shares ................................................................................................ $ 800,000 (A) Less: greater of:

PUC of Plummer shares ....................................................... $ 1,000 Modified ACB of Plummer .................................................. $ 200,000 $ 200,000 Less: FMV of boot .................................................................................... 200,000

Excess, if any .......................................................................................................................... Nil (B)

PUC reduction (A – B) ............................................................................................................ $ 800,000 PUC after reduction ($800,000 – $800,000) .............................................................................. Nil

The nil PUC after reduction reflects the fact that all of the “hard cost” of the Plummer shares has been recovered by the $200,000 note taken back as consideration on the transfer.

No deemed dividend will arise [par. 84.1(1)(b)], since the non-share consideration did not exceed the greater of the PUC ($1,000) or modified ACB ($200,000) as shown below.

Deemed dividend equals: Sum of:

(1) Increase in LSC of VHL shares ............................................................................. $ 800,000 (2) FMV of boot ........................................................................................................ 200,000

$ 1,000,000 Less: the sum of:

(3) Greater of: (a) PUC of Plummer .............................................. $ 1,000 (b) Modified ACB of Plummer .............................. $ 200,000 $ 200,000

(4) PUC reduction [par. 84.1(1)(a)] ...................................................... 800,000 1,000,000 Deemed dividend ................................................................................................................. Nil

Mrs. Andrews should elect to transfer the Plummer shares to VHL for $600,000. This represents the $200,000 cost base plus the $400,000 inherent capital gain that she wishes to crystallize to utilize her capital

gains deduction for qualified small business corporation shares.

Elected amount (deemed proceeds of disposition) .......................................................................... $ 600,000 Less: deemed dividend [par. 84.1(1)(b)] ........................................................................................ Nil Adjusted proceeds of disposition [sec. 54] ..................................................................................... $ 600,000 Adjusted cost base ........................................................................................................................ 200,000 Capital gain equal to capital gains exemption ................................................................................ $ 400,000 Mrs. Andrews has an adjusted cost base for the VHL shares of $400,000. Elected amount ............................................................................................................................. $ 600,000

Less: boot or non-share consideration ............................................................................................ 200,000 Adjusted cost base of VHL shares ................................................................................................. $ 400,000

If an arm’s length purchaser can be found, Mrs. Andrews will be able to reduce the potential capital gain on such a sale by $400,000, with the adjusted cost base as determined above.



(A) PUC reduction [par. 84.1(1)(a)]:

1. increase in LSC of Sam Pickings shares......................................................................... $ 1,250,000 (A) Less: 2. greater of:

(a) PUC of Low-Cal shares ........................................... $ 250,000 $ 250,000 (b) modified ACB of Low-Cal shares ............................ $ 250,000 Less: FMV of boot ................................................................................. 750,000 Excess, if any ............................................................................................................... Nil (B)

PUC reduction (A – B) ......................................................................................................... $ 1,250,000 PUC after reduction ($1,250,000 – $1,250,000) .................................................................... $ Nil

The nil PUC after reduction reflects the fact that all of the hard cost of the shares of Low-Cal Limited has

been recovered through boot received from Sam Pickings Limited.

Deemed dividend [par. 84.1(1)(b)]: Sum of:

1. increase in LSC of Sam Pickings ........................................................................... $ 1,250,000 (A) 2. FMV of boot ......................................................................................................... 750,000 (D)

(A + D) $ 2,000,000 Less sum of: 3. greater of:

(a) PUC of Low-Cal shares ................................ $ 250,000 $ 250,000 (E) (b) modified ACB of Low-Cal shares.................. $ 250,000

4. PUC reduction under par. 84.1(1)(a) ............................................... 1,250,000 (F) (E + F) 1,500,000 Deemed dividend ...................................................................................... (A + D) – (E + F) $ 500,000

The deemed dividend is effectively equal to the $750,000 of boot received in excess of the $250,000 of hard cost of the Low-Cal shares transferred.

Capital gain on Low-Cal shares:

Elected under section 85 for Low-Cal shares (proceeds of disposition) .................................. $ 750,000 Less: sec. 54 exclusion for par. 84.1(1)(b) deemed dividend .................................................. 500,000 Adjusted proceeds of disposition for Low-Cal shares ............................................................ $ 250,000 Less: ACB of Low-Cal shares .............................................................................................. 250,000 Capital gain (loss) ................................................................................................................ Nil Taxable income of Mrs. Domm from capital gain: Cost of Sam Pickings shares after allocation to “boot” [par. 85(1)(g)] (elected amount

$750,000 minus boot $750,000) .................................................................................... Nil

Note how there is no capital gain eligible to offset the QSBC share capital gains deduction as a result of section 84.1.

(B) Transfer the shares of Low-Cal Limited to Sam Pickings Limited and elect an amount of $750,000 under

section 85. Take back $250,000 in cash and $1,750,000 in preferred shares of Sam Pickings Limited.

The following will result:

PUC reduction [par. 84.1(1)(a)]: (a) Increase in LSC of Sam Pickings shares ............................................................... $ 1,750,000 (A) Less: (b) Greater of:

(i) PUC of Low-Cal shares ............................ $ 250,000 $ 250,000 (ii) Modified ACB of Low-Cal shares ............. $ 250,000

less: FMV of boot............................................................... 250,000 Excess, if any ............................................................................................ Nil (B)

PUC reduction (A – B) ............................................................................................ $ 1,750,000 PUC after reduction ($1,750,000 – $1,750,000) ........................................................ Nil

The nil PUC reflects the fact that all $250,000 of hard cost in the Low-Cal shares has been recovered by

cash from Sam Pickings.


Deemed dividend [par. 84.1(1)(b)]:

Sum of: (a) Increase in LSC of Sam Pickings shares ................................................................. $ 1,750,000 (A) (b) FMV of boot .......................................................................................................... 250,000 (D) (A + D).................................................................................................................. $ 2,000,000

Less sum of: (c) Greater of:

(i) PUC of Low-Cal shares ............................. $ 250,000 $ 250,000 (E) (ii) Modified ACB of Low-Cal shares ............. $ 250,000

(d) PUC reduction [par. 84.1(1)(a)] .................................................. 1,750,000 (F) (E + F) ................................................................................................................... 2,000,000

Deemed dividend (A + D) – (E + F) ................................................................................ Nil

There is no deemed dividend because the boot received from Sam Pickings does not exceed the hard cost of

the Low-Cal shares.

Taxable income of Mrs. Domm from capital gain:

Elected amount [sec. 85] for Low-Cal shares .................................................................... $ 750,000 Less: Sec. 54 exclusion for par. 84.1(1)(b) deemed dividend ............................................. Nil Adjusted proceeds of disposition for Low-Cal shares ........................................................ $ 750,000 Less: ACB of Low-Cal shares .......................................................................................... 250,000

Capital gain ..................................................................................................................... $ 500,000

Taxable capital gain (1/2 $500,000) ................................................................................ $ 250,000

Less: capital gains deduction ............................................................................................ 250,000 Effect on taxable income of Mrs. Domm .......................................................................... Nil ACB of Sam Pickings shares: Cost of Sam Pickings shares after par. 85(1)(g) allocation to boot (elected amount of

$750,000 – boot of $250,000) ................................................................................... $ 500,000

Note what has occurred in this situation. Mrs. Domm has given up shares in Low-Cal Limited with a cost

base of $250,000 and a fair market value of $2,000,000. She has acquired cash of $250,000 and shares with a cost base of $500,000 and a fair market value of $1,750,000. She has done so without immediate tax

consequences. Of the accrued gain of $1,750,000 on the shares of Low-Cal Limited, she has protected $500,000 from future taxation as a capital gain when the shares of Sam Pickings Limited are sold and deferred the other

$1,250,000 in the fair market value of the Sam Pickings shares in excess of their cost. The $500,000 cost base of the shares of Sam Pickings Limited represents the $500,000 crystallization of the capital gains exemption.

(C) Mrs. Domm would have to sell 29 shares to realize a capital gain which would utilize all of the remaining

$500,000 QSBC share exemption:

($2,000,000 – $250,000) 100 shares = $17,500

$500,000 $17,500 = 29 shares (rounded)

The conditions of section 84.1 would still be met by this outright sale to the non-arm’s length corporation, Sam Pickings Limited. Since the holding corporation is paying only cash for the shares of Low-

Cal Limited, no shares of Sam Pickings Limited are issued and, hence, no PUC reduction will occur. However, there will be an immediate deemed dividend computed as follows:

Sum of: (a) Increase in LSC of Sam Pickings shares ................................................................... Nil (A)

(b) FMV of boot (29 shares @ $20,000 per share) ......................................................... $ 580,000 (D) (A + D) .................................................................................................................. $ 580,000

Less sum of: (c) Greater of:

(i) PUC of Low-Cal shares (29 shares @ $2,500) $ 72,500 $ 72,500 (E) (ii) Modified ACB of Low-Cal shares (29 shares) $ 72,500

(d) PUC reduction [par. 84.1(1)(a)] ........................................................ Nil (F)

(E + F) ..................................................................................................................... $ 72,500 Deemed dividend (A + D) – (E + F) ................................................................................. $ 507,500

Again, the $507,500 of deemed dividend reflects the $580,000 of boot received in excess of the hard cost of $72,500 in the Low-Cal shares.


Proceeds of disposition for the Low-Cal Limited shares will be reduced under section 54 so that there

will be no capital gains against which to offset the capital gains deduction, as follows:

Consideration in cash received on sale — Proceeds of disposition ................................. $ 580,000 Less: sec. 54 exclusion from proceeds for sec. 84.1 deemed dividend ............................ 507,500 Adjusted proceeds of disposition .................................................................................. $ 72,500 ACB of Low-Cal shares ............................................................................................... (72,500) Capital gain ................................................................................................................. Nil

Note how $500,000 of the gain on the shares, which should have been protected by the capital gains

exemption, is taxed as a deemed dividend on the sale of the shares for cash.

(D) (i) Ultimate redemption of shares of Sam Pickings: Part A Part B

Proceeds on redemption ............................................................................ $ 1,250,000 $ 1,750,000

Less: PUC ................................................................................................ Nil Nil Deemed dividend [ssec. 84(3)] .................................................................. $ 1,250,000 $ 1,750,000 Proceeds of disposition ............................................................................. $ 1,250,000 $ 1,750,000 Less: deemed dividend ............................................................................. 1,250,000 1,750,000 Adjusted proceeds of disposition [sec. 54] ................................................. Nil Nil Less: adjusted cost base ............................................................................ Nil $ 500,000 Capital loss .............................................................................................. Nil $ (500,000) Summary of income effects:

sec. 84.1 deemed dividend ................................................................ $ 500,000 Nil

ssec. 84(3) deemed dividend ............................................................. 1,250,000 1,750,000 capital gain (loss) on sec. 85 transfer — Low-Cal .............................. Nil 500,000 capital gain (loss) on redemption — Sam Pickings ............................. Nil (500,000) net economic effect ........................................................................... $ 1,750,000 $ 1,750,000

Note how the full accrued capital gain on the Low-Cal Limited shares is subject to tax as a deemed dividend, which would have resulted from a direct redemption of the Low-Cal shares by Low-Cal Limited

itself.

Part A Part B

(ii) Ultimate sale of shares of Sam Pickings: .................................................. Proceeds of disposition ............................................................................ $ 1,250,000 $ 1,750,000 Less: adjusted cost base ........................................................................... Nil 500,000 Capital gain............................................................................................. $ 1,250,000 $ 1,250,000 Summary of income effects: ....................................................................

sec. 84.1 deemed dividend ............................................................... $ 500,000 Nil

capital gain — Low-Cal ................................................................... Nil $ 500,000 capital gain — Sam Pickings ............................................................ 1,250,000 1,250,000 net economic effect .......................................................................... $ 1,750,000 $ 1,750,000

Note that the $1,750,000 represents the accrued capital gain on the Low-Cal shares.



Both Plan A and Plan B would result in an application of subsection 55(2) by the CRA, converting what

would have been a tax-free intercorporate dividend or a deemed dividend into proceeds of disposition for capital gains purposes. Under Plan B, only part of the dividend would be a deemed dividend under subsection 84(3) on

the redemption of the Corporate Raider Inc. shares.

Subsection 55(2) applies in both of these scenarios because:

(a) Holden Limited and Corporate Raider Inc. are not related;

(b) Holden Limited received a dividend that was deductible under section 112; and

(c) one of the purposes of the dividend in Plan A and one of the results of the dividend in Plan B was to effect a significant reduction in the capital gain on the ultimate sale of the shares of Profits Galore Inc.

The results of these two proposed transactions would be:

Plan A

Of the $1,900,000 dividend received by Holden Limited from Profits Galore Inc., $900,000 can be attributed

to post-1971 earnings; therefore, these $900,000 of dividends are excluded from the calculation of the deemed proceeds of disposition of the Profits Galore Inc. shares for purpose of subsection 55(2). Since Profits Galore Inc.

has only active business income, there is no income subject to Part IV tax which would further shelter the dividend paid to Holden Limited from the effects of subsection 55(2). The balance of the dividend (i.e.,

$1,000,000) will be deemed part of the proceeds of disposition and added to the actual proceeds of $500,000. As a result, the following capital gain on the disposition of the Profit Galore shares would be computed:

Actual proceeds of disposition ................................................................................................ $ 500,000 Add: Deemed proceeds of disposition:

Dividend received ................................................................................ $ 1,900,000 Less: post-1971 earnings ...................................................................... 900,000 1,000,000

Total proceeds of disposition .................................................................................................. $ 1,500,000 Less: Adjusted cost base ...................................................................................................... 500,000 Capital gain ........................................................................................................................... $ 1,000,000

These results are equivalent to Holden Limited receiving a dividend from Profits Galore of $900,000 (equal to the sheltered post-1971 earnings) and then selling the shares to Corporate Raider Inc. for their then fair market

value of $1,500,000, giving rise to a capital gain of $1,000,000 (i.e., $1,500,000 – $500,000).

Plan B

Under this alternative, the Profits Galore shares are to be transferred to Corporate Raider using section 85 and electing a transfer price of $500,000 equal to the adjusted cost base of the transferred shares. Therefore, the

adjusted cost base of the shares accepted as consideration (i.e., the special shares of Corporate Raider) will also be $500,000.

When Corporate Raider Inc. redeems these shares from Holden Limited there will be a deemed dividend

[ssec. 84(3)] calculated as:

Redemption/retraction price ............................................................................................... $ 2,400,000 Less: Paid-up capital ........................................................................................................ 500,000 Deemed dividend [ssec. 84(3)] ........................................................................................... $ 1,900,000 Less: Amount deemed not to be a dividend but proceeds of disposition .......... $1,900,000

Less: post-1971 earnings(1) ................................................................... 900,000 1,000,000 Remaining deemed dividend under ssec. 84(3).................................................................... $ 900,000 Capital gain on the disposition of the shares: Proceeds of disposition (redemption price) ......................................................................... $ 2,400,000 Less: Remaining ssec. 84(3) deemed dividend as determined above(2) ............................... 900,000 Deemed proceeds of disposition ......................................................................................... $ 1,500,000 Less: Adjusted cost base .................................................................................................. 500,000 Capital gain ....................................................................................................................... $ 1,000,000


(1) Holden Limited would have to designate a separate dividend of $900,000 [par. 55(5)(f)]. Subsection 55(2) would deem the other $1,000,000 to be proceeds of disposition. The $900,000 dividend would not be

deemed to be proceeds of disposition since subsection 55(2) excludes post-1971 earnings.

(2) The definition of proceeds of disposition in section 54 would exclude the subsection 84(3) deemed dividend on the redemption of shares.


CHAPTER 17

Income Deferral: Other Rollovers and Use of

Rollovers in Estate Planning


Part (A)

If Jason accepts the first alternative, section 85.1 will not apply, since one of the conditions (see (c), below) of this provision has not been met:

(a) the vendor’s shares (Jason’s shares of Quality Appliances) must be capital property to him (consistent

with the facts in this case);

(b) these shares must be shares of a Canadian corporation (i.e., Quality Appliances, which fits the definition);

(c) the consideration for this exchange must be only issued shares of the purchaser (i.e., Big Distributors

Ltd.);

(d) there can be no capital gain on this exchange;

(e) the vendor (Jason) and the purchaser (Big Distributors Ltd.) must be at arm’s length before the share exchange (given);

(f) after the share exchange the vendor may not control (de jure) the purchaser or may not own more than

50% of the FMV of the shares (given).

For section 85.1 to be operative, only share consideration can be received [par. 85.1(2)(d)]. Since cash is received under this alternative, Jason will realize a capital gain of $75,000 ($125,000 – $50,000). One half of this

gain, $37,500, will be a taxable capital gain. This gain may be eligible for the capital gains deduction if the

shares are qualified small business corporation shares. If Jason does not have his capital gains deduction available, he will be required to pay tax on this capital gain, even though he has received cash of only $25,000 on

this disposition. Note that Jason is not eligible for a capital gains reserve, since he has received FMV consideration in total [par. 40(1)(a)].

Jason may be able to minimize his tax cost under the first option if he could negotiate the restructuring of

the transaction as two separate dispositions. The first disposition would be a cash sale of shares for $25,000. A proportionate amount of the ACB would be allocated to these shares. In this way, any tax on the capital gain

would not exceed the cash realized. The remaining shares, exchanged for shares of Big Distributors Ltd., would qualify for the rollover under section 85.1.

Under the second alternative, section 85.1 will apply to the share exchange offered. Jason’s proceeds of

disposition for the Quality Appliances shares, and the ACB of the Big Distributors shares received will be $50,000. Therefore, no capital gain or loss to Jason arises.

Big Distributors’ addition to paid-up capital for the shares issued to Jason will be limited to the PUC of the

Quality Appliances shares ($25,000), through the PUC reduction mechanism [ssec. 85.1(2.1)]. The ACB to Big Distributors Ltd. of the Quality Appliances shares acquired will be equal to the lesser of their fair market value

on the exchange ($125,000) and their PUC ($25,000). Therefore, the ACB will be $25,000.

Part (B)

Under the first alternative, a subsection 85(1) election would be advisable if Jason wishes to defer the capital gain. As Jason is the only vendor, it is relatively easy to comply with the administrative requirement of filing the

joint election form. The elected amount could be set at $50,000 to fully defer the capital gain. The ACB to Jason of the new shares in Big Distributors Ltd. would be set at $25,000 (i.e., elected amount of $50,000 – boot of

$25,000), while their FMV would be $100,000. Big Distributors’ PUC of the shares issued to Jason would be $25,000 [ssec. 85(2.1)]. This amount is calculated as:


LSC before reduction ........................................................................................................... $ 100,000 Less: Increase in PUC of all shares................................................................ $ 100,000 Elected amount ............................................................ $ 50,000 Less: Boot ................................................................... 25,000 (25,000) (75,000)

PUC after reduction ............................................................................................................. $ 25,000

If a subsection 85(1) election is made for the second alternative, the accrued capital gain on the Quality Appliances shares transferred would be fully deferred. The ACB to Jason of Big Distributors’ shares, issued to

Jason, would be equal to the elected amount of $50,000. The PUC of Big Distributors’ shares would be $50,000 after the reduction, reflecting the amount of the cost (i.e., $50,000) of the Quality Appliances Ltd. shares not

recovered by boot from Big Distributors Ltd.



(a) There is no deemed dividend [ssec. 84(1)] because of the PUC reduction [par. 86(2.1)(a)] to give a total

reduced PUC of $210,000 which is less than the PUC of the old shares of $300,000. There is also no deemed dividend [ssec. 84(3)] because the redemption amount paid, consisting of boot of $90,000 and total reduced PUC

of shares issued, $210,000, does not exceed the PUC of the old shares of $300,000.

Issuance of New Shares (1) PUC of new shares:

LSC increase for all new shares .............................................................................. $ 810,000 Less: PUC of old shares ................................................................. $ 300,000 Less: boot ($10K + $80K) ..................................................... 90,000 210,000 PUC reduction........................................................................................................ $ 600,000 Reduced PUC of all shares ($810K – $600K) .......................................................... $ 210,000

Allocation of reduced PUC: Preferred

shares Common shares

LSC increase by share class .............................................................. $ 600,000 $ 210,000 PUC reduction:

Class A preferred shares: 000,810$

000,600$000,600$ 444,444

Class B preferred shares: 000,810$

000,210$000,600$

155,556

Reduced PUC by class .............................................................. $ 155,556 $ 54,444

(2) Cost of all new shares: ACB of old shares ............................................................................ $ 300,000 Less: Cost of boot............................................................................. 90,000 $ 210,000

Allocation of cost of new shares:

Class A preferreds: $600,000/$810,000 $210,000 ................................................. $ 155,556

Class B preferreds: $210,000/$810,000 $210,000 ................................................. $ 54,444

Cost of non-share consideration (=FMV) ...................................................................... $ 90,000

Redemption of Old Shares (1) Proceeds of redemption of old shares:

Reduced PUC of new shares ................................................................................... $ 210,000

FMV of non-share consideration (boot) ................................................................... 90,000 Redemption proceeds ............................................................................................. $ 300,000

Deemed dividend [ssec. 84(3)]: Redemption proceeds ............................................................................................. $ 300,000 PUC of old shares................................................................................................... (300,000) Deemed dividend [ssec. 84(3)] ................................................................................ Nil

(2) Proceeds of disposition of old shares: Cost of all new shares ............................................................................................. $ 210,000 Boot ....................................................................................................................... 90,000 Total ...................................................................................................................... $ 300,000 Less: ssec. 84(3) deemed dividend .......................................................................... Nil Proceeds of disposition of old shares ....................................................................... $ 300,000

CG or CL on disposition of old shares: Proceeds ................................................................................................................ $ 300,000 ACB ...................................................................................................................... 300,000 CG/CL ................................................................................................................... Nil

Net economic effects: Deemed dividend on reorganization ........................................................................ Nil CG (CL) on disposition of old shares ...................................................................... Nil Accrued CG on new shares:

FMV ........................................................................................ $ 810,000 ACB ......................................................................................... (210,000) $ 600,000

The accrued gain on the new shares reflects the same accrued gain on the old shares before the reorganization.


The PUC of the new preferred shares and common shares will be equal to the reduced PUC calculated

above. These PUC values reflect the remaining tax-paid cost which has not been returned to the shareholder in the form of non-share consideration (i.e., cash of $10,000 and a bond of $80,000).

(b) In this case, there will be no deemed dividend [ssec. 84(1)]. The PUC of the corporation has not

increased. Prior to the reorganization, the PUC of the corporation was $300,000 and after the reorganization PUC is nil. A deemed dividend does arise, however, under subsection 84(3). This is because the redemption amount

paid, consisting of boot of $500,000 and total reduced PUC of shares issued of nil, exceeds the PUC of the old shares of $300,000.

Issuance of New Shares (1) Reduced PUC:

LSC increase for all shares...................................................................................... $ 400,000 Less: PUC of old shares ................................................................. $ 300,000

Less: boot ............................................................................. 500,000 Nil PUC reduction........................................................................................................ $ 400,000 Total reduced PUC ($400K – $400K) ..................................................................... Nil

(2) Cost of new shares received: ACB of old shares .................................................................................................. $ 300,000 Less: Boot .............................................................................................................. 500,000 Cost of new shares.................................................................................................. Nil

Cost of boot (= FMV) .................................................................................................. $ 500,000

Redemption of Old Shares (1) Redemption proceeds of old shares:

Reduced PUC of new shares ................................................................................... Nil Boot ....................................................................................................................... $ 500,000 Redemption proceeds ............................................................................................. $ 500,000

Deemed dividend [ssec. 84(3)]: Redemption proceeds ............................................................................................. $ 500,000 Less: PUC of old shares .......................................................................................... 300,000

Deemed dividend [ssec. 84(3)] ................................................................................ $ 200,000 (2) Proceeds of disposition of old shares:

Boot ....................................................................................................................... $ 500,000 Cost of new shares.................................................................................................. Nil Total ...................................................................................................................... $ 500,000 Less: Ssec. 84(3) deemed dividend [par. (j) of def. “proceeds of disposition”

in sec. 54] ........................................................................................................... (200,000)

Proceeds of disposition of old shares ....................................................................... $ 300,000

Capital gain (loss) on disposition of old shares: Adjusted proceeds of disposition ............................................................................. $ 300,000 ACB of old shares .................................................................................................. (300,000)

Capital gain (loss) ........................................................................................................ Nil

The PUC will be nil [ssec. 86(2.1)], since all of the PUC of the old shares of $300,000 has been recovered through the cash consideration of $500,000.

Net economic effect:

Deemed dividend [ssec. 84(3)] ............................................................................... $ 200,000 Capital gain (loss) on old shares ............................................................................. Nil Accrued capital gain on new shares:

FMV ........................................................................................ $ 400,000

ACB ......................................................................................... Nil 400,000 Net economic effect ............................................................................................... $ 600,000

The net economic effect is equal to the capital gain inherent in the old shares ($900,000 – $300,000).



The following is a summary of the information for Mr. Fresser and his daughter.

ACB PUC FMV

Current Position:

Mr. Fresser 80% 50,000$ 50,000$ 500,000$

Daughter 20% 12,500 12,500 125,000

62,500$ 62,500$ 625,000$

Proposed Consideration:

Cash 90,000$

Pref shares 300,000

390,000$

(A) Subsection 86(2) will apply to this situation because:

(i) the fair market value of the old shares ($500,000 = 80% × $625,000) is greater than the sum of the cost

of the non-share consideration (equal to its fair market value of $90,000) plus the fair market value (i.e.,

the retraction value) of the new shares ($300,000); and (ii) it is reasonable to regard the $110,000 excess as a benefit to a related person, Mr. Fresser’s daughter.

Issuance of New Shares (1) Reduced PUC:

LSC increase in respect of new shares ......................................................................... $ 300,000 Less: PUC of old shares ..................................................................... $ 50,000

Less: boot ................................................................................. 90,000 Nil PUC reduction ........................................................................................................... $ 300,000 Reduced PUC ($300K – $300K) ................................................................................. Nil

(2) Cost of new preferred shares received on reorganization [par. 86(2)(e)]:

Adjusted cost base of old shares.................................................................................. $ 50,000 Less: Cost of non-share consideration ................................................. $ 90,000 Benefit ..................................................................................... 110,000 200,000 Cost of preferred shares (excess, if any) ...................................................................... Nil

Cost of new-share consideration (equal to its FMV) ............................................................ $ 90,000

Redemption of Old Shares

There is a deemed dividend [ssec. 84(3)], as shown by the following calculation: (1) Redemption proceeds:

Cash .................................................................................................... $ 90,000 Reduced PUC of preferred shares received ............................................ Nil $ 90,000

Less: PUC of old shares ..................................................................................................... 50,000 Deemed dividend [ssec. 84(3)] ........................................................................................... $ 40,000 The following results from the application of subsection 86(2):

(2) Deemed proceeds of disposition of old shares [par. 86(2)(c)]: Lesser of:

(1) cost (equal to FMV) of non-share consideration ........................................... $ 90,000 plus: benefit ................................................................................................ 110,000

$ 200,000 (2) fair market value of old shares ..................................................................... $ 500,000

Capital gain on disposition of old shares on reorganization: Deemed proceeds of disposition (lesser of (1) and (2), above) ...................................... $ 200,000

Less: Ssec. 84(3) deemed dividend ............................................................................. 40,000 Adjusted proceeds of disposition ................................................................................ $ 160,000 Adjusted cost base of old shares.................................................................................. (50,000) Capital gain................................................................................................................ $ 110,000

The final PUC after the exchange will be nil [ssec. 86(2.1)], since all of the PUC of the old shares of $50,000 has been recovered through the boot of $90,000 cash.

The following net economic effect can be aggregated from the foregoing:

Deemed dividends [ssec. 84(3)] .................................................................................................. $ 40,000 Capital gain (loss) on disposition of common shares ................................................................. 110,000


Potential accrued capital gain on new preferred shares:

FMV........................................................................................................................................................... $ 300,000 ACB ........................................................................................................................ Nil 300,000

Net economic effect .................................................................................................................. $ 450,000

This net economic effect of $450,000 reflects the accrued gain of $450,000 (i.e., $500,000 – $50,000). Note how Mr. Fresser has lost the ability to recover $60,000 in tax-paid cost, because he was or will be taxed on $450,000 but only received $390,000 in value. In addition, the original tax-paid cost of $50,000 is lost due to the

benefit. Note also that the value of the common shares held by his daughter has increased by $110,000 with no offsetting ACB increase. Therefore, she will realize an added $110,000 in capital gain on her disposition of the

shares. This is another penalty inherent in subsection 86(2).

(B) Redemption of preferred shares Redemption proceeds ................................................................................ $ 300,000 Less PUC .................................................................................................. Nil Deemed dividend [ssec. 84(3)] .................................................................. $ 300,000 Proceeds of disposition ............................................................................. $ 300,000 Less: deemed dividend .............................................................................. 300,000 Adjusted proceeds of disposition ............................................................... Nil Less: adjusted cost base............................................................................. Nil Capital gain .............................................................................................. Nil

Note how the deemed dividend of $300,000 equals the potential accrued gain on the new preferred shares

(i.e., $300,000 – Nil = $300,000). However, he only received on the exchange a total fair market value consideration of $390,000 and the common shares held by the daughter have increased in value by $110,000

(i.e., the amount of the benefit) and there is no offsetting increase in the adjusted cost base of these shares. Therefore, the $110,000 will be taxed as a capital gain, again, on the disposition of the daughter’s shares. The

penalty inherent in subsection 86(2), where the shares acquired in the reorganization are redeemed, is the potential taxation of the same amount of the capital gain twice. This result is, in essence, the same as the result if

the shares acquired on the reorganization are ultimately sold.



Jonsub Ltd. is deemed to have disposed of its assets for proceeds equal to the cost amount of the assets

immediately before the amalgamation or the winding-up and Normpar Ltd. is deemed to have acquired the property at a cost equal to the deemed proceeds of the subsidiary.

Cash ................................................................................................................................ $ 80,000 Marketable securities at cost ............................................................................................ 300,000 Accounts receivable ($800,000 plus $30,000 reserve)....................................................... 830,000 Inventory at lower of cost or market ................................................................................. 920,000 Land at cost ..................................................................................................................... 1,200,000 Building at UCC .............................................................................................................. 300,000 Equipment at UCC........................................................................................................... 200,000

Goodwill (4/3 Nil CEC balance)..................................................................................... Nil

$ 3,830,000

“Bump” in ACB of non-depreciable capital property Normpar Ltd.’s ACB of Jonsub Ltd.’s shares ................................................................... $ 4,000,000 Less cost amount of subsidiary net assets:

Cash ................................................................................................ $ 80,000 Marketable securities at cost ............................................................ 300,000

Accounts receivable ($800,000 plus $30,000 reserve) ...................... 830,000 Inventory at lower of cost or market ................................................. 920,000 Land at cost ..................................................................................... 1,200,000 Building at UCC .............................................................................. 300,000 Equipment at UCC .......................................................................... 200,000

Goodwill (4/3 Nil CEC balance) .................................................... Nil

Reserve ........................................................................................... (30,000) Accounts payable and accrued liabilities .......................................... (709,000) Loans payable.................................................................................. (1,000,000)

$ 2,091,000 Add: dividends paid by Subco to Parentco............................................... 500,000 2,591,000 Maximum bump $ 1,409,000

Limit of bump on non-depreciable capital property: Fair market value of marketable securities at time Normpar Ltd. acquired control ............. $ 800,000 ACB of marketable securities ........................................................................................... 300,000 Limit of bump on marketable securities ............................................................................ $ 500,000 Fair market value of land at time Normpar Ltd. acquired control ...................................... $ 1,900,000 ACB of land .................................................................................................................... 1,200,000 Limit of bump on land ..................................................................................................... $ 700,000

Because the building and the goodwill are not non-depreciable capital properties, the bump cannot be allocated to these two assets.

Allocation of “bump” to securities and land

Since Normpar Ltd. plans to sell Jonsub Ltd.’s marketable securities in the next few years, the $1,409,000 bump should first be allocated to the marketable securities to the $500,000 limit. The remaining

$909,000 bump ($1,409,000 – $500,000) should be allocated to the land to the $700,000 limit. This results in the land and marketable securities having new ACBs as follows:

Land: ACB before bump ................................................................................................................. $ 1,200,000 Bump allocated ......................................................................................................... 700,000

ACB after bump .................................................................................................................... $ 1,900,000 Marketable securities:

ACB before bump .................................................................................................................. $ 300,000 Bump allocated ......................................................................................................... 500,000 ACB after bump .................................................................................................................... $ 800,000

Whether the two companies are amalgamated or Jonsub Ltd. is wound up into Normpar Ltd., the results should be the same, since the “bump” is also available on vertical amalgamations.


Deemed disposition of shares by Normpar Ltd. Proceeds equal to greater of: (a) lesser of:

(i) PUC of shares of Jonsub Ltd . $ 1,000 } $ 1,000 } (ii) cost amount of net assets $2,091,000 } } $4,000,000

(b) ACB of shares held by Normpar Ltd. $4,000,000 } ACB (4,000,000) Capital gain (loss) Nil

Note from this formula that a gain will be rare, since PUC of the Jonsub Ltd. Shares would have to be greater than their ACB to Normpar Ltd. A loss is impossible from this formula, because proceeds cannot be less than ACB.



(A) Amalgamation under section 87,

(i) subsection 87(2.1) provides that for the purposes of determining non-capital and net capital losses of

Tetley it shall be deemed to be a continuation of Rose;

(ii) Rose and Tetley are deemed to have a taxation year-end on June 30, 2011,

— this will count as one of the years available for the carryforward of non-capital losses,

— the 2008, 2009, and 2010 non-capital losses will be available to Tetley in its 2012 (i.e., the first taxation year of the amalgamated company) and subsequent taxation years until expiry

under the 20-year limitation,

— all of the net capital losses will also be deductible.

(B) Winding-up under subsection 88(1),

(i) Rose’s non-capital losses and net capital losses are available to Tetley, but not until the first taxation year of the parent commencing after the wind-up, i.e., the taxation year commencing February 1, 2012

and ending January 31, 2013.

Losses of

Rose for its

fiscal year

ended become

Losses of

Tetley for its

fiscal year

ended1

Available for deduction by parent for fiscal years ended

January 31

’12 ’13 ’14 ’15 … ’28 ’29 ’30 ’31 ’32

Dec. 31, ’10 Jan. 31, ’11 X … expired

Dec. 31, ’09 Jan. 31, ’10 X … expired

Dec. 31, ’08 Jan. 31, ’09 X … expired

losses not available in year of wind-up

(ii) The 2008 and following losses of Rose would have been deductible in the 2012 taxation year which is

the year following the year of the beginning of the winding-up (2011).

(iii) Therefore, on the basis of the deductibility of losses, both provisions allow for the same deductions,

although the amalgamation may allow faster absorption of losses if the new corporation sets an early fiscal year-end for its first year.

(C) Other factors

(i) The ACB “bump” on non-depreciable capital property is available on either an amalgamation or a

winding-up.

(ii) The short taxation years for Rose and Tetley on amalgamation will advance the period for loss carryovers, investment tax credit carryovers, unpaid amounts, capital cost allowance, etc.,

— any provision that depends on a taxation year will be affected in an amalgamation.

(iii) A winding-up under subsection 88(1) is generally more expensive to implement administratively than

an amalgamation under section 87.

1 For non-capital losses incurred in a taxation year that ends after March 22, 2004, the carryforward period is

10 years, and for taxation years that end after 2005, the carryforward period is 20 years.



(A) Transfer of shares under sec. 85

The following represents the normal section 85 chart used to reflect the transfer of assets to a corporation.

FMV TV EA Debt Pref Income

KML common 1,800$ 400$ 800$ 800$ 1,000$ CG $400

ACB of KHL preferred shares

Elected amount equal to: Greater of:

(a) fair market value of boot............................................................................. $ 800,000 (b) lesser of:

(i) fair market value of shares transferred (KML) ............. $ 1,800,000

$ 400,000 (ii) ACB of shares transferred (KML) .............................. $ 400,000

Elected amount ....................................................................................................... $ 800,000 Allocated to debt ..................................................................................................... (800,000) Cost of preferred shares (KHL) ................................................................................ Nil

Paid-up capital of KHL preferred shares PUC reduction [par. 84.1(1)(a)]:

(a) increase in LSC of holding company (KHL) ..................................................... $ 1,000,000 (A) less:

(b) greater of: (i) PUC of KML shares ............................... $ 100,000 $ 400,000 (ii) modified ACB of KML shares ............... $ 400,000 less: FMV of boot ..................................................................... 800,000 excess, if any ............................................................................ Nil (B)

PUC reduction ......................................................................................... (A – B) $ 1,000,000 PUC of KHL shares after reduction .......................................................................... Nil

Deemed dividend [par. 84.1(1)(b)]: Sum of:

(a) increase in LSC of holding company (KHL) .............................................. $ 1,000,000 (A) (b) FMV of boot ............................................................................................ 800,000 (D)

(A + D) $ 1,800,000 less sum of:

(c) greater of: (i) PUC of KML shares ...................... $ 100,000

$ 400,000 (E) (ii) modified ACB of KML shares ....... $ 400,000

(d) PUC reduction [par. 84.1(1)(a)] ......................................... 1,000,000 (F) (E + F) 1,400,000

Deemed dividend (A + D) – (E + F) $ 400,000

This deemed dividend could have been avoided by taking no more than $400,000 in non-share consideration.

Capital gain/loss: Elected amount under ssec. 85(1) for KML shares* ............................................................. $ 800,000 Less: sec. 54 exclusion for par. 84.1(1)(b) deemed dividend ................................................ 400,000 Proceeds of disposition for KML shares .............................................................................. $ 400,000 Less: adjusted cost base ...................................................................................................... 400,000 Capital gain/loss ................................................................................................................. Nil

* Cannot be less than the boot consideration.

(B) (i) If these KHL preferred shares are sold in an arm’s length transaction for their fair market value of

$1,000,000, the following would result: Proceeds of disposition ................................................................................................................. $ 1,000,000 Less: adjusted cost base (see the first calculation under Part (A)) ..................................................... Nil Capital gain.................................................................................................................................. $ 1,000,000

This capital gain may be eligible for the QSBCS capital gains exemption, if Mrs. Knight has not used all of her exemption and the shares meet the tests for qualifying small business corporation shares.


(ii) If, instead, the same shares were redeemed for $1,000,000, the following would result: Redemption proceeds ................................................................................................................... $ 1,000,000 Less: PUC (see par. 84.1(1)(a) calculation above) ........................................................................... Nil Deemed dividend [ssec. 84(3)] ...................................................................................................... $ 1,000,000 Proceeds on redemption ................................................................................................................ $ 1,000,000 Less: deemed dividend [ssec. 84(3)] .............................................................................................. 1,000,000 Adjusted proceeds of disposition [sec. 54] ...................................................................................... Nil Less: adjusted cost base ................................................................................................................ Nil Capital gain/loss ........................................................................................................................... Nil

(C) Insurance of New Shares (1) Reduced PUC [par. 86(2.1)(a)]:

LSC .................................................................................................................................. $ 1,000,000 Less: PUC of old shares .........................................................................................$100,000 Less: boot .............................................................................................................. 800,000 Nil PUC reduction ................................................................................................................... $ 1,000,000 Reduced PUC ($1,000K – $1,000K) .................................................................................... Nil

(2) Cost of new KML preferred shares: Adjusted cost base of old shares .......................................................................................... $ 400,000 Less: FMV of non-share consideration ................................................................................. 800,000

Cost of preferred shares [par. 86(1)(b)] ................................................................................ Nil Cost of non-share consideration (equal to FMV) ................................................................... $ 800,000

Redemption of Old Shares (1) Proceeds of redemption of old common shares:

Reduced PUC of new shares ............................................................................................... Nil FMV of non-share consideration ......................................................................................... $ 800,000 Redemption proceeds ......................................................................................................... $ 800,000 Deemed dividend [ssec. 84(3)]: Proceeds of redemption....................................................................................................... $ 800,000 PUC of old common shares ................................................................................................. 100,000 Deemed dividend ............................................................................................................... $ 700,000

(2) Proceeds of disposition of KML common (old) shares [par. 86(1)(c)]:

Cost of preferred shares [par. 86(1)(b)] ................................................................................ Nil Add: cost of non-share consideration ................................................................................... $ 800,000 Total.................................................................................................................................. $ 800,000 Less: exclusion for ssec. 84(3) deemed dividend in sec. 54 def. of P of D ............................... 700,000 Proceeds of disposition ....................................................................................................... $ 100,000 Capital gain or loss on disposition of KML common (old) shares: Proceeds of disposition ....................................................................................................... $ 100,000 Less: ACB ......................................................................................................................... 400,000

Capital loss of $300,000 denied [ssec. 40(3.6)] ..................................................................... Nil(1) (3) ACB of KML preferred shares (after denied loss):

ACB of preferred shares (above) ......................................................................................... Nil Add: denied capital loss on disposition of old shares [par. 53(1)(f.2)] ..................................... $ 300,000 ACB of preferred shares ..................................................................................................... $ 300,000

The PUC (final) of the new preferred shares will be nil since all the PUC of the old common shares of

$100,000 has been recovered through the debt consideration of $800,000.

(D) (i) If the KML preferred shares are sold in an arm’s length transaction for their fair market value of

$1,000,000, the following would result:

Proceeds of disposition ....................................................................................................... $ 1,000,000 Less: adjusted cost base ...................................................................................................... 300,000 Capital gain........................................................................................................................ $ 700,000 This capital gain may be eligible for the QSBCS capital gains exemption, if Mrs. Knight has not used all of her exemption and the shares meet the tests for qualifying small business corporation shares.


(ii) If, instead, the same shares were redeemed for $1,000,000, the following would result: Proceeds on redemption ...................................................................................................... $ 1,000,000 Less: PUC ......................................................................................................................... Nil Deemed dividend [ssec. 84(3)] ............................................................................................ $ 1,000,000 Proceeds on redemption ...................................................................................................... $ 1,000,000 Less: deemed dividend [ssec. 84(3)] .................................................................................... 1,000,000 Adjusted proceeds of disposition [sec. 54] ............................................................................ Nil Less: adjusted cost base ...................................................................................................... $ 300,000 Capital loss ........................................................................................................................ $ (300,000)

(E) (i) Comparison of alternatives (I) (II) Holdco Freeze Internal Freeze Ultimate arm’s

length sale Ultimate

redemption Ultimate arm’s


redemption Summary of income effects

Par. 84.1(1)(b) deemed dividend ............... $ 400,000 $ 400,000 N/A N/A Ssec. 84(3) deemed dividend on KML old common shares................................... N/A 1,000,000 $ 700,000 $ 700,000

Capital loss on KML common (old) shares ...................................................... N/A N/A Nil Nil Ssec. 84(3) deemed dividend on KML (new) shares ............................................. N/A N/A Nil 1,000,000 Capital gain (loss) on KHL/KML new shares ...................................................... 1,000,000 Nil 700,000 (300,000) Net economic effect ................................. $ 1,400,000 $ 1,400,000 $ 1,400,000 $ 1,400,000

While the nature and the timing of the income differ, the net economic effect is the same and it is

equal to the accrued gain on the original shares.

(ii) The deemed dividend in alternative (I) [par. 84.1(1)(b)] can be avoided by limiting the non-share consideration to $400,000. Then, preferred shares with a fair market value of $1,400,000 should be

taken as consideration. Their PUC for tax purposes would be reduced to nil [par. 84.1(1)(a)]. However, the elected amount under subsection 85(1) could remain at $800,000 and would thereby trigger a capital

gain of $400,000 since the section 84.1 deemed dividend has been eliminated. The adjusted cost base of the preferred shares would be $400,000 (i.e., $800,000 – $400,000).

The deemed dividends in alternative (II) [ssec. 84(3)] can be avoided by limiting the sum of the

PUC of the preferred shares and the non-share consideration to $100,000. Consideration in the reorganization could consist of $100,000 in non-share consideration and preferred shares with one cent

in PUC and fair market value of $1,700,000. The adjusted cost base of the preferred shares would be $300,000 [ssec. 86(1)]. It is not possible to elect to create a capital gain to use up the capital gains

deduction.

If the above steps are taken the following comparison would result: (I) (II) Holdco Freeze Internal Freeze Ultimate arm’s


redemption Ultimate arm’s


redemption Summary of income effects

Capital gain on initial reorganization......... $ 400,000 $ 400,000 N/A N/A Ssec. 84(3) deemed dividend .................... N/A 1,400,000 N/A $ 1,700,000 Capital gain (loss) .................................... 1,000,000 (400,000) $ 1,400,000 (300,000) Net economic effect ................................. $ 1,400,000 $ 1,400,000 $ 1,400,000 $ 1,400,000

—NOTE TO SOLUTION

(1) This capital loss of $300,000 is denied by subsection 40(3.6), because Ms. Knight controls the

corporation after the reorganization and, hence, the corporation is affiliated with her. However, the denied loss can be added to the adjusted cost base of the preferred shares she receives as consideration in the reorganization

[par. 53(1)(f.2)].


Advisory Cases

Case 1: Georgette & Vitality Plus Canada Ltd.

—ADVISORY CASE DISCUSSION NOTES

Memo to file:

Georgette & Vitality Plus Canada Ltd.

The objective for Georgette is to maximize her after-tax returns from her business and capital gains and

allow the transfer of ownership of her business to her children. Since Georgette is not ready to retire, she will want to retain control of the corporation until her daughter(s) are ready to take over the business.

Issues:

Income splitting — salary to Candice and corporate tax

Estate freeze and transfer of ownership

Accrued capital gains

RRSP

Corporate tax rate/Salary to Candice

Since Vitality Plus Canada Ltd. is a Canadian-controlled private corporation with active business income, the company qualifies for the small business deduction on the first $500,000 of taxable income. The federal tax rate on the first $500,000 of taxable income is 11%. Taxable income in excess of $500,000 is subject to the

general federal tax rate of 18%.

Even at the federal tax rate of 18% on income above $500,000, it may not be tax effective to remove that income by dividends. As Candice is working for a nominal salary, it would be appropriate to increase her salary

to an amount that recognizes her economic contribution to the company. Her personal tax rate on that salary would be less than that on any additional salary to Georgette. Additionally, Candice could then maximize her

RRSP contribution.

Estate freeze and transfer of growth

Georgette is interested in transferring the business to her daughters; yet, she is not ready to retire. There are a few ways that she can complete this task. Georgette should first perform an estate freeze, with the objective of freezing the value of her shares so that further increases in the value of the company accrue to the children.

To conduct the estate freeze, Georgette would incorporate a holding company and transfer her shares of Vitality Plus to the holding company in exchange for non-participating, voting, non-cumulative, retractable preferred/special shares. Her daughters, or a family trust, could then subscribe for common shares of the holding

company at a nominal amount. Any future growth will then accrue to other family members. As Georgette’s shares are voting, she retains control over the company. If the common shares are held by a family trust, she

would also have effective control over those shares by being the trustee.

As her three children are all over the age of 18, the “kiddie tax” would not apply to dividends received by the trust and then paid out by the trust. The use of a trust, rather than having the children hold the shares directly,

may be preferred as there is some uncertainty about the interest of the two younger children in the business. A discretionary trust might be ideal, as it would empower Georgette (the trustee) to eventually distribute the shares

to one or more of the children in any proportion she desired.

A similar result can be achieved with an internal freeze, using a section 86 capital reorganization. This option has the advantage of having only one corporation, Vitality Plus Canada Ltd., to contend with. However, a crystallization (see below) cannot be accomplished using section 86.

Georgette may also want to consider including the public utility shares she owns as part of the estate freeze. In this way, all future growth in those shares will accrue to her daughters. The most effective way to accomplish this is to transfer those shares to the holding company and file a joint section 85 election with the company.

While the dividend income from those shares will be taxed to the company, the tax will be 1/3 under Part IV, and

this is (likely) approximately the same tax Georgette currently pays on those shares. However, the danger in

combining the investment shares with the shares of Vitality Plus Canada Ltd. is that the shares of the holding company may not qualify under the QSBCS tests.

Crystallization

As part of the estate freeze, Georgette should crystallize the capital gains deduction available on the Vitality Plus Canada Ltd shares. By locking in the capital gains deduction, she ensures that the taxes to her estate are

minimized on any deemed disposition of her shares. The estate will not be taxed on up to $750,000 of capital gain.


Retirement

After Georgette retires, she can redeem her preferred/special shares gradually over time. This will provide her with a predictable and certain minimum level of retirement income. For tax purposes, the redemption will result in dividend income, eligible for the dividend tax credit.

At age 71, Georgette must convert her RRSP into either an annuity or a RRIF. The RRIF offers the advantage of capital retention and minimizes income in the early years after conversion. A recommendation as to annuity or RRIF cannot be made at this time, as it would be premature. In the meantime, she might wish to

consider, depending on her wishes, to name her new spouse as the RRSP beneficiary. That way, should Georgette die holding the RRSP, it can be rolled over to him on a tax-deferred basis.

Marriage

Georgette should visit a family law lawyer to settle a marriage contract prior to her marriage. Under family law, Georgette’s husband will have certain entitlements as her spouse. It would be most unfortunate if these took

precedence over her daughters’ entitlements.


Case 2: Orillia Resorts Inc.


The main focus of this case is on an estate freeze that doesn’t work.

1. Valuation

How was the value of the shares arrived at, given that the value of the shares is based on the value of

the underlying real estate? o Compare to the sale of shares versus assets type of problem.

What gives the preference shares their value?

o The fact that they are retractable.

2. Section 84.1

He took too much cash and this will result in a deemed dividend of $749,900.

3. Small business corporation

Do we know that Orillia Resorts Inc. is an SBC?

4. Connected corporations

Will Holdco and Orillia Resorts Inc. be connected to avoid Part IV tax on the dividends? It will

depend on whether the preference shares are voting which is not clear.

5. Associated corporations

Will Holdco and Orillia Resorts Inc. be associated to prevent the personal service business rules from applying? Initially they will be associated regardless of the voting features of the preference shares

since Holdco owns virtually all of the value of Orillia and is therefore deemed to control [par. 256(1.2)(c)].

6. Corporate attribution

If dividends are accumulated in Holdco causing it to cease to qualify as a small business corporation then the corporate attribution rules may apply.


Case 3: Whyte Co. Inc.


This case deals with succession planning for the business owner, which includes both retirement and estate

planning. It also includes non-tax issues. The following are the major topics within succession planning.

1. Retirement income

Relying on the company for retirement income.

Consider a holding company to accumulate dividends away from the risks of the business.

Retiring allowance.

Salary continuation in retirement.

Rent from the real estate.

2. Asset protection

Try to reduce or eliminate personal guarantees.

3. Estate liquidity

Assuming that the cost base of the shares and the real estate is low, there will be a significant tax liability on the second death.

The tax on the Whyte Co. shares alone could be approximately $1,035,000 [($4,500,000 − $100) × 50% × 46%].

o There will not be enough liquid assets in the estate to pay the tax. o As a result, either the real estate used in the business will have to be sold or the company will

have to be sold.

You will need to calculate the potential tax on all accrued gains to determine the extent of tax

liability.

Life insurance could be taken out to cover this tax liability.

Consider an estate freeze to limit the tax liability.

4. Estate equalization

If the shares are divided equally, then Sandra will be out-voted on business decisions by Paul and

Joan who are not active in the business. o This will set up a conflict that will be difficult to avoid.

Without life insurance, there will be little choice but to leave business assets to the two children who are not active in the business, since all the other assets will be used up to pay the tax on death.

If the tax on death can be provided for, then, perhaps, the land and building could be left to Paul and Joan with a long-term lease in place.

Can you equate the value of private company shares with cash, i.e., are shares valued at $4.5 million worth the same as $4.5 million in cash?

5. Tax minimization

The tax that has accrued to this point cannot be avoided except for the tax on the capital gain eligible for the capital gain exemption.

They might consider an estate freeze on Whyte Co. and even the real estate to limit tax to the amount accrued to date.

6. Business survival

An important issue with all family-owned business is, will the business survive when the current

owner(s) die? o Will the departure of Bill and Betty cause the business to decline in value due to a lack of

confidence in the successor by the customers, suppliers, employees and bankers?

7. Opportunities

The opportunity centres around the need for succession planning in all private business in order to address the needs of the owner, the family and the business.

chapter 16 & 17 problems

Documents

price adjustment

net economic

capital gains

sam pickings

federal income

federal tax

capital gains

adjusted cost