Ch. 30 & 29 Incorporation of a Proprietorship - 85, 86rollover Flashcards
What are the advantages of incpororation?
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
What are the disadvantages of incorporation
initial incorporation and ongoing compliance rules - FS, corp returns, annual filings
can’t claim corporate losses against personal income
What is the secion 85 rollover
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
What are the types of eligible assets allowable under 85(1)
inventories, non-depreciable capital property and depreciable capital property
What amounts do you need to elect?
Proceeds of dispositions - determiens tax consequences of transfer
Consideration received - can be shares or NSC
Cost of property to the corporation
What are the limits to the election?
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
Sale ofsharesvs Redemptions
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
Section 85 - terminal losses
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
Section 22 - Accounts receivable
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
Goodwill
Good will does not have a tax cost - however, you should always assign a small value to it to prevent issues with the CRA
Methods to freeze estates using 85
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.
What is section 86’s method of freezing assets?
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.
Holdco Freeze
- 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
Internal Freeze
- 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
86
- 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
51
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
85.1
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.
Which sections can transfer assets other than shares?
85 only
Which sections require an election?
85 only
Which sectino allows you to elect an amount other than cost?
85 only
What section required you to be dealing at non-arms length
85.1 only
which section allows NSC to be received
85 and 86
What requried reorganizatino of capital
86 only
What must require new shares from a taxable canadian corporation to be traded?
85 and 85.1
