Ch. 30 & 29 Incorporation of a Proprietorship - 85, 86rollover

Question 1

What are the advantages of incpororation?

Answer 1

limited liability for shareholders
tax deferral on earnings - as RE and dividend payments
potential tax reduction on earnings - SBD
Potential for income splitting between family members
Flexibility for owner-manager compensation
Flexibility regarding fiscal year selection
access to lifetime capital gains exemption on future disposition of shares that qualify for SBD shares

Question 2

What are the disadvantages of incorporation

Answer 2

initial incorporation and ongoing compliance rules - FS, corp returns, annual filings
can’t claim corporate losses against personal income

Question 3

What is the secion 85 rollover

Answer 3

This is used when transferring assets from a proprietorship to a corporation or transferring shares to a new holding company.

Note: Difference between 85(1) and 85(2) is person transfer to corp vs partnership to corp (partnership is not a person)

Requirements:
- Transferred to a taxable canadian corporation
- must be eligible assets
- must take back a share of the corporation as consideration
may also take back non-share consideration
- consideration must equal the FMV of property and can include both share and NSC
joint election

Question 4

What are the types of eligible assets allowable under 85(1)

Answer 4

inventories, non-depreciable capital property and depreciable capital property

Question 5

What amounts do you need to elect?

Answer 5

Proceeds of dispositions - determiens tax consequences of transfer
Consideration received - can be shares or NSC
Cost of property to the corporation

Question 6

What are the limits to the election?

Answer 6

The ceiling - FMV of asset
Minimum - Greater of:
1) FMV of any NSC (boot)
2)Lesser of: FMV of asset or ACB of asset (tax cost)

or
For depreciable proeprty
2) LEsser of: FMV of Asset or UCC of Class or Capital Cost

Generally you want to maximize boot, because it is a tax-free withdrawal from the company. NSC should be the tax basis

You can also transfer more than the tax value of assets to make use of any capital losses - however this is preferred on assets w/o depreciation as this would cause recapture once it is later sold

The floor is to prevent losses from being created

Question 7

Sale ofsharesvs Redemptions

Answer 7

Redemptions - when a company gets shareholders to sell a portion of their shares back to the comapny.

Redemptions = deemed dividiend (FMV - PUC), but this is not desirable as this is taxed at a higher rate than capital gains (sale of shares)

Sale of shares - sold at FMV

Question 8

Section 85 - terminal losses

Answer 8

Accrued losses are also denied to prevent a market for losses. There is a deemed disposition on accrued losses when there is a disposition event

unrealized terminal losses are not allowed to be transferred using 85. The loss will be denied, but the transferor can hold the terminal loss and continue to claim CCA in a separate pool

Question 9

Section 22 - Accounts receivable

Answer 9

AR is considered capital property in the absence of 22. However, this results in an issue becuase most times you will be selling AR at a loss - resulting in a capital loss (not allowed under 85)

losses then become business losses and are fully deductible and fully taxable.

more often than not, 22 election will always be made

Question 10

Goodwill

Answer 10

Good will does not have a tax cost - however, you should always assign a small value to it to prevent issues with the CRA

Question 11

Methods to freeze estates using 85

Answer 11

Holding company - incorporate a holding co and issue 100% common shares to children at nominal value, transfer sahres to holding co using 85 in exchange for PS and NSC (PS can be voting or non-voting for the level of control he wants), elect a transfer price equal to ACB of shares and CGE (if any)

Internal Freeze - Transfer your shares of your company to the corporation, you will get PS isntead with a fixed redemption value. Transferor and corporation will need to elect section 85. The children can then subscribe for common shares for a nominal amount.

Question 12

What is section 86’s method of freezing assets?

Answer 12

Shares are exchanged for another type of shares of the same corporation

Conditions:
I) shars must be capital property
ii) original owner of shares must exchange all shares of a particular class for share sof the same corporation - does not require all shareholders of the share class
iii) must be a consequence of reorganization of capital and required articles of incorporation to be amended.

Question 13

Holdco Freeze

Answer 13

• Form holding company
• transfer shares of operating comp to holdingco under 85 for NCS and PS (make sure NCS is not greater than PUC and ACB) to avoid 84.1 deemed dividend
• determine whether the PS should be voting or non-voting
  have family buy shares of holdco at nominal amount

Question 14

Internal Freeze

Answer 14

• Transfer CS of operating companies under 85 for NSC and PS of the same operating companies.
• Ensure NCS is not greater than ACB and PUC to avoid 84.1
• requires joint election
• have family members subscribe for common shares at a nominal amount

Question 15

86

Answer 15

• Existing shareholder have shares that are capital property
• all shares of a class are exchanged for new shares of the same corporation - CS to PS
• Exchange id one in the course of reorganization - requires amending articles of incorporation
• Automatically applies
• NCS can be taken up to PUC on the shares exchanged
• PUC and ACB of new shares are equal to those of old minus NSC
• No capital gain on disposition of old shares

Question 16

51

Answer 16

VEry similar to 86 except youd o not need to exchange all of the old for new shares without triggering capital gain.

share-for-share exchange may be preferred when shareholders wish to create two or more classes of convertible shares to declare dividends on each (different)

51 only applies to transactions when 85 and 86 do not apply

Question 17

85.1

Answer 17

Similar but this is made for the purchase of another company w/o cash

Rules:
- parties must be dealing at arm’s length (cannot be used as a estate freeze)
- corporation whose shares are acquired must be a Canadian corp, acquiring corporation must also be a taxable Canadian corporation
- vendor must not control purchaser after the purchase
- no cash or non-share consideration may be received - only shares may be exchanged
- vendor most not recognize any capital gain or loss on the shares exchanged

Why we do it:
- vendor shares are deemed sold for proceeds equal to aCB of shares exchanged
- cost of the new sahres is equal to the ACB of shares
- PUC of vendor shares are added to the PUC Of the issued and o/s of the purchaser corporation
- purchase will have an ACB for the acquired shares given up to trigger a capital gain and cryalize CGE

Reason: if share are widely held, it is difficult to use section 85 rollover, as it would requrie each shareholder to file the exchange. This is the advantage over 85.

Question 18

Which sections can transfer assets other than shares?

Answer 18

85 only

Question 19

Which sections require an election?

Answer 19

85 only

Question 20

Which sectino allows you to elect an amount other than cost?

Answer 20

85 only

Question 21

What section required you to be dealing at non-arms length

Answer 21

85.1 only

Question 22

which section allows NSC to be received

Answer 22

85 and 86

Question 23

What requried reorganizatino of capital

Answer 23

86 only

Question 24

What must require new shares from a taxable canadian corporation to be traded?

Answer 24

85 and 85.1

Question 25

what required old shares to be taxable canadian corporations

Answer 25

85.1 only

Question 26

What allows a prrtial exchange of share classes?

Answer 26

85 and 85.1 only