Other Rollovers Flashcards
Section 84.1 Tax trap
Section 84.1 prevents the tax-free removal of corporate surplus on a non-arm’s length transfer of shares. The two consequences are:
- A reduction in PUC to the extend that the transaction resulted in an increase and
- A deemed dividend to the extent of any NSC received that is greater than PUC or modified ACB.
If the elected amount on Section 85 is greater than the greater of ACB or PUC of shares then section 84.1 will trigger a deemed dividend.
If the elected amount on Section 86 is greater than the ACB of shares then section 84.1 will trigger a deemed dividend.
Section 85 - Estate freeze steps (External Freeze)
- Form a holding company and have family members subscribe for common shares at a nominal amount.
- Transfer shares of the operating company to the holding company under the provisions of Section 85 in exchange for non-share consideration and Holdco preferred shares. Ensure non-share consideration is not in excess of the greater of the modified ACB and the PUC of the operating company shares to avoid a Section 84.1 deemed dividend.
- If the taxpayer wishes to crystallize a capital gain, elect a transfer price equal to the ACB of the operating company shares plus the taxpayer’s remaining CGE available.
- Determine whether the preferred shares should be voting or non-voting.
Section 85 — internal freeze option
Section 85 - freeze without establishing a holding company. Conditions to be met:
- Shares must transfer to a CAN corp
- Consideration received must include shares of the transferee corp
- Property transferred must be eligible property
- A joint election must be made
Transfer common shares back to the operating company under section 85 in exchange for NSC and preferred shares.
NSC is not in excess of > of ACB and PUC to avoid deemed dividend.
Family will subscribe for common shares at nominal amount.
Section 86 - Exchange of shares in a reorganization - Estate freeze (Internal Freeze) - Conditions
Required conditions:
(i) The original owner’s shares must be capital property to that shareholder.
(ii) The original owner of the shares must exchange all shares owned of a particular class for shares of the same corporation. This condition does not require all shareholders owning shares of a particular class to exchange their shares.
(iii) The share exchange must be as a consequence of the reorganization of the capital of the corporation. The CRA has accepted that a reorganization of capital has occurred if the articles of incorporation are amended.
Non-share consideration may be received as part of the transfer. To ensure there are no tax consequences, the amount of non-share consideration should be no greater than the PUC of the shares exchanged.
Section 86 estate freeze steps
- The existing shareholders exchange their common shares for preferred shares with a fixed redemption value equal to the fair value of the common shares exchanged. The preferred shares may be voting or non-voting depending on the taxpayer’s preference for managing the future direction of the corporation.
- The related parties subscribe for newly issued common shares at a nominal value. The common shares have a nominal value because the full value of the corporation is in the preferred shares; the preferred shares have the characteristics of a liability because they are redeemable or retractable for a fixed value at the option of the holder.
No election is required but revision of articles of incorporation is required
Section 51 Rollovers
Under Section 51, a taxpayer may exchange existing shares of a corporation for convertible securities of the same corporation without triggering a capital gain. The ACB of the convertible securities will be the same as the ACB of the shares which were converted.
The shareholder is not required to exchange all of the shares of a particular class.
No non-share consideration is given as part of the exchange
Section 85.1 — share-for-share exchange
A shareholder can exchange shares of one corporation for shares of another corporation without paying tax.
This provision is commonly used in a situation where a public company (purchaser) wishes to acquire the share of another company (target) but does not wish to pay cash to directly purchase the shares.
It only applies to a share-for-share exchange with parties that are dealing at arm’s length.
No election is required, provisions automatically apply
Section 85.1 — share-for-share exchange
Requirements
Provisions of Section 85.1 automatically apply when the following conditions are met:
(i) The parties to the transaction must be dealing with each other at arm’s length. As a result of this requirement, Section 85.1 cannot be used in an estate freeze.
(ii) The target must be a Canadian corporation, and purchaser must be a taxable Canadian corporation.
(iii) The target must not own 50% or more of the fair value of all outstanding shares of the purchaser.
(iv) No NSC on a tax-deferred basis.
(v) The target must not have recognized any part of a capital gain or loss on the shares exchanged under any other provision of the ITA
Section 85.1 — share-for-share exchange
Consequences
Consequences of the share exchange are as follows:
- The target’s shares are deemed sold for proceeds equal to the ACB of the shares exchanged.
- The cost of the new shares to the target is equal to the ACB of the shares exchanged.
- The PUC of the target’s shares is added to the PUC of the issued and outstanding shares of the purchaser corporation.
- The purchaser will have an ACB for the acquired shares of the lesser of:
- Fair Value of the target’s shares.
- PUC of the target’s shares.
The target may not elect an amount greater than the ACB of shares given up to trigger a capital gain and crystalize a CGE.
Purpose of an estate freeze
The most common objective of an estate freeze is to freeze the value of assets owned by a wealthy taxpayer (often shares of an operating company) at their current fair value and pass future increases in value of the assets on to younger family members.
An estate freeze may be accomplished through a Section 85 rollover (holdco freeze) or using the provisions of Section 86 (internal freeze)
Section 85 vs Section 86 for estate freeze
Section 85
• Income splitting flexibility
• Potential creditor protection
• Can avoid transferring items expected to generate a capital loss if want to keep the loss in the business to use.
• Can transfer assets other than shares
• Can elect an amount other than cost to trigger capital gains and use LCGE
• Joint election is required
• Partial exchange of shares allowed
• pass future growth to family members on a tax deferral basis
Section 86
• Can only transfer shares (share for share transfer)
• Must transfer all of owned shares in a share class
• Family members are active in the business and want to pass future growth to them on a tax deferral basis
• Less costly since do not have to set up a new corporation
• No election required, amendment to articles of incorporation required
• Limited NSC can be received
• Old and new shares does not have to be held by a taxable CDN corp
Section 85 other uses than estate freeze
- Individuals who want to incorporate their sole proprietorship and contribute their business assets to the new corporation
- Parent companies that want to transfer assets to a new Canadian subsidiary
