Chapter 16 - Rollovers

Report
An actual receipt
Tax on mooncake
•
•
In the midst of last year’s economic downturn, Chinese authorities upped
their tax-collection efforts (which are usually notoriously lax) in a bid to top up
the state’s coffers. One of their main targets was the mooncake — a pastry
stuffed with lotus seed paste and egg yolks, or “whatever the baker feels like
chucking in,” that is a ubiquitous delicacy especially popular in the fall.
Mooncakes were traditionally given out during the Mid-Autumn Festival
(historically a time of moon worship) to friends and family to cement
relationships. But now, many businesses also offer mooncakes to employees
or provide coupon vouchers redeemable at local groceries for the treat.
Additionally, the cakes are given as a sort of soft bribe to employers, party
officials. Where bakers saw a mooncake explosion, government officials saw
yuan signs — and launched an inspection of more than 3,100 companies last
year, slapping 30 billion yuan (CAD 4.76 billion) worth of back taxes on gifted
mooncakes and coupons. In modern China, apparently, you can have your
cake and tax it too.
Chapter 16 - Rollovers
Today
• Understand the tax consequences of a
property transfer from a shareholder to a
corporation
• Understand the options available
• The means of payment
• Know the potential traps and pitfalls and
how to avoid them
Transfer of property to a
corporation by a shareholder
• Ssec 85(1) permits a taxpayer to elect to
defer all or part of the income which would
otherwise arise on the transfer of certain
types of property to a taxable Canadian
corporation
• Ssec 85(2) permits all members of a
partnership to do the same thing
overview
• General rule is that there is an immediate
recognition of a capital gain or loss on
disposal of capital property
• Sometimes there is no real change in the
economic interest
• Rollovers provide a deferral
• Transferor should receive a package of
consideration where FMV = FMV of
property transferred
Basic concepts
• On the transfer of assets to a corporation, there is
a deemed disposition at FMV. 85(1) provides for
an election for the transferor to choose the PoD in
order to defer all or some of the gain.
• 85(1) permits a tax-free rollover, or transfer, of
property to a corporation, but only if the transferor
accepts shares as part of the consideration.
• The idea is that the transferor will be in the same
economic position after the transfer as before. The
ACB of the shares should exactly equal ACB of
the transferred asset.
Basic concepts
• Additional variables
– Permitted to trigger income inclusions:
• Capital gains, recapture of CCA etc
– Consideration can include debt and cash in
addition to common or pref shares
Three simple situations
• 1 – necessity to make a downward
adjustment to PUC to equal tax value of
transferred assets
• 2 – transfer price other than tax value in
order to trigger income inclusions
• 3 – acceptance of non-share consideration
Elected amount
• Concept of elected amount
– Transfer assets and elect the PoD
– Cannot create a loss
– Elect between tax value and FMV
1 – downward adjustment
• In order to defer a gain, assets must be
transferred choosing an elected amount
equal to tax value (ie ACB or UCC)
1 – how does it work
Facts
• Ms Ava wishes to transfer
land.
• ACB = 10,000
• FMV = 50,000
• No tax consequences
desired
Results
• Proceeds should be
10,000 so no gain
triggered
• Consideration could be 1
share with a FMV of
50,000
• Gain will be realized
when share is sold
• PUC = tax value
2 – TP other than tax value
• Proceeds can be chosen at any elected
amount between TV and FMV. The range
will permit taxpayer to trigger an
appropriate amount of TCG or other
income to offset LCF and ACL.
Consideration will also be shares.
2 – how does it work
Facts
• Ms Elizabeth wants to
transfer land and building
• Land
– ACB = 10,000
– FMV = 50,000
• Building
– Cost – 95,000
– UCC = 75,000
– FMV = 110,000
• NCLCF = 10,000
Results
• Land s/b 30,000 in order to
utilize NCLCF
• Building @ TV and corp will
assume the recapture and
CG
• Shares s/b 160,000 as this
equals FMV, but due to
election, PUC is reduced to
105,000 (75,000 + 30,000)
• 55,000 deferral to
disposition of shares
3 – Non share consideration
• Introduction of “boot” – non cash
consideration that includes:
– Cash
– Debt
• Consideration is a mix of shares and boot
• Shares must be included in order for 85(1)
election to be valid
3 – how does it work
Facts
• Mr Benjamin wants to
transfer land
– ACB = 10,000
– FMV = 50,000
– Mortgage = 4,000
• Will take back
– Promissory note for 14,000
– Assumption of mortgage
– Balance in class B shares
• NCLCF = 6,000 from
1999
Results
• Need to trigger capital
gain
• Elect at 18,000 in order to
use NCLCF
( 6,000 x
½ / ¾)
• Boot does not exceed
elected amount
• Boot = 14,000
• Mortgage = 4,000
• ACB of shares = NIL
3 – lets look at it this way
Stated capital (FMV of
land is 50,000 less boot
of 18,000
32,000
Minus elected amount
18,000
Less boot
18,000
PUC reduction
PUC = FMV – PUC
reduction
NIL
32,000
(32,000 – 32,000)
NIL
What if boot > elected
amount?
• Assume promissory note of 18,000
because he forgot that the mortgage was
being assumed by the corp
• Elected amount bumped by 4,000 to get
new elected amount of 22,000 (18,000 +
4,000)
• CG of 6,000 offset by only 4,000
• ACB is still NIL
• PUC is still NIL
Basic rules
• Eligible property
– Capital property
– Eligible capital property
– Resource property or inventory
• Four conditions to be met
– Corp must be defined taxable CDN corp
– Consideration must include a minimum of one
share (literal interpretation calls for two shares)
– Must be eligible property
– Must jointly elect to have rollover provisions apply
Elected transfer price
• Proceeds of disposition to the transferor
• Cost of the property to the corporation
• Cost of the package of consideration taken
by the transferor from the corporation
• Part of the calculation of PUC for tax
purposes of the share consideration
received
Restrictions on share price
Inventory or capital
property other than
depreciable property
Depreciable capital
property
Eligible capital
property
UPPER LIMIT
par 85(1)(c)
FMV of property
transferred
FMV of property
transferred
FMV of property
transferred
LOWER LIMIT
par 85(1)(e.3)
Greater of
Greater of
Greater of
Par 85(1)(b)
FMV of non-share
consideration received
FMV of non-share
consideration received
FMV of non-share
consideration received
and
and
and
Lesser of
par 85(1)(c.1)
Least of
par 85(1)(e)
Least of
par 85(1)(d)
1) FMV of property
1) FMV of property
1) FMV of property
2) ACB if capital
property or tax value if
inventory
2) UCC of class of
property
2) 4/3 of the ECC
balance
3) Cost of property to
transferor
3) Full or actual cost of
property to the
transferor
Non share consideration
• Not necessary to take boot, but is usually
beneficial
• Common error is to forget to include the
debts of the transferor
• Debt can be redeemed for cash with no
tax consequences
Range of Elected Amounts
Range
1
2
3
100
FMV
FMV
TV
75
TV
BOOT
FMV
60
BOOT
TV
BOOT
Summary
• 1 – boot < TV therefore
no impact on lower limit
• 2 – LL is boot because
S/H has extracted an
extra $15 therefore
elected amount is
automatically bumped
• 3 –Can’t receive more
than FMV without tax
consequences
Consideration
A
Cash etc
B
C
0
1,000
1,300
Preferred shares (FMV and
legal stated capital)
1,000
300
180
Common shares (FMV and
legal stated capital)
500
200
20
1,500
1,500
1,500
High
1,500
1,500
1,500
Low
1,000
1,000
1,300
Election price (assume lowest)
1,000
1,000
1,300
ACB
1,000
1,000
1,000
Capital gain
0
0
300
Taxable capital gain
0
0
150
TOTAL
Election range
Transfer of property with ACB of $1,000 and
FMV of $1,500
Application
Tax value
FMV
Short term investments
15,000
18,000
Inventory
45,000
46,000
Machinery (cost 54,375)
26,250
38,500
0
30,000
86,250
132,500
10,000
10,000
76,250
122,500
Goodwill
Liabilities
Mr Sole wants the following consideration: $70,000 in
debt, $35,000 in preferred shares and the balance in
common shares to total FMV of assets. Corporation will
assume the existing debt
YOUR TURN
Solution – determine elected
amounts
FMV of consideration
Tax value
FMV
Short term
invest.
15,000
18,000
Invent.
45,000
46,000
Machine
26,250
38,500
Goodwill
NIL
30,000
86,250
132,500
TOTAL
Elected
Assumed
debt
New debt
Preferred
shares
Common
shares
Income
Solution – determine elected
amounts
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
45,000
Machine
26,250
38,500
26,250
Goodwill
NIL
30,000
1
86,250
132,500
86,251
TOTAL
New debt
Preferred
shares
Common
shares
Income
Solution – allocate boot
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
45,000
Machine
26,250
38,500
26,250
Goodwill
NIL
30,000
1
86,250
132,500
86,251
TOTAL
New debt
10,000
5,000
10,000
5,000
Preferred
shares
Common
shares
Income
Solution – allocate boot
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
45,000
Machine
26,250
38,500
26,250
Goodwill
NIL
30,000
1
86,250
132,500
86,251
TOTAL
10,000
New debt
5,000
45,000
10,000
50,000
Preferred
shares
Common
shares
Income
Solution – allocate boot
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
45,000
45,000
Machine
26,250
38,500
26,250
20,000
Goodwill
NIL
30,000
1
86,250
132,500
86,251
TOTAL
10,000
New debt
10,000
5,000
70,000
Preferred
shares
Common
shares
Income
Solution – allocate preferred
shares
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
45,000
45,000
Machine
26,250
38,500
26,250
20,000
Goodwill
NIL
30,000
1
86,250
132,500
86,251
TOTAL
10,000
New debt
10,000
5,000
70,000
Preferred
shares
3,000
3,000
Common
shares
Income
Solution – allocate preferred
shares
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
Machine
26,250
Goodwill
TOTAL
10,000
New debt
Preferred
shares
5,000
3,000
45,000
45,000
1,000
38,500
26,250
20,000
NIL
30,000
1
86,250
132,500
86,251
10,000
70,000
4,000
Common
shares
Income
Solution – allocate preferred
shares
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
Machine
26,250
Goodwill
TOTAL
10,000
New debt
Preferred
shares
5,000
3,000
45,000
45,000
1,000
38,500
26,250
20,000
18,500
NIL
30,000
1
86,250
132,500
86,251
70,000
22,500
10,000
Common
shares
Income
Solution – allocate preferred
shares
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
Machine
26,250
Goodwill
TOTAL
10,000
New debt
Preferred
shares
5,000
3,000
45,000
45,000
1,000
38,500
26,250
20,000
18,500
NIL
30,000
1
86,250
132,500
86,251
12,500
10,000
70,000
35,000
Common
shares
Income
Solution – allocate common
shares
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
Machine
26,250
Goodwill
TOTAL
10,000
New debt
Preferred
shares
5,000
3,000
45,000
45,000
1,000
38,500
26,250
20,000
18,500
NIL
30,000
1
86,250
132,500
86,251
10,000
70,000
Common
shares
12,500
17,500
35,000
17,500
Income
Solution – income inclusion
FMV of consideration
Tax value
FMV
Elected
Assumed
debt
Short term
invest.
15,000
18,000
15,000
Invent.
45,000
46,000
Machine
26,250
Goodwill
TOTAL
10,000
New debt
Preferred
shares
Common
shares
Income
5,000
3,000
0
45,000
45,000
1,000
0
38,500
26,250
20,000
18,500
0
NIL
30,000
1
86,250
132,500
86,251
10,000
70,000
12,500
17,500
$0.50
35,000
17,500
0.50
The corporations position
• Elected transfer price is corporation’s cost
• The corporation steps into the transferors
tax position
• Half year rule for CCA does not apply if
– Transferor was not dealing at arms’ length
– Property owned continuously for at least 365
days from end of tax year to date of election
The shareholders position
• Elected transfer price is basically allocated
to become cost of property received
– Property other than shares up to FMV of that
property as long as not exceeding FMV of
transferred property
– Pref shares up to FMV of those shares as
long as FMV does not exceed PofD
– Common shares that PofD exceeds sum of
FMV of boot and pref shares
PUC reduction
• Where shares have no par value or stated
value, PUC = FMV (normally)
• Bumps and grinds
• Bump – a bump in FMV from transfer
• Grind – a reduction in PUC after
disposition of property
The Grind
• (A-B) x C/A
• Where
– A = the increase in LSC of all shares after
disposition under section 85
– B = the excess (boot)
– C = the increase in LSC of a particular class
on transfer
Illustration
Facts
• Tax value = 10,000
• FMV = 15,000
– Elected amount = 10,000
– FMV of boot = 10,000
– FMV of share consideration
= 5,000
– ACB = NIL
Effect
LSC pre
reduction
5,000
Increase in
LSC on
transfer
Elected amt
10,000
Less boot
10,000
Excess
Grind
Tax PUC
(A-B)
5,000
A
NIL
B
5,000
NIL
The effect
The PUC reduction converts the
capital gain into a deemed dividend
With reduction
No reduction
Proceeds
5,000
5,000
Less PUC
NIL
5,000
Deemed dividend
5,000
NIL
Proceeds
5,000
5,000
Deemed dividend
5,000
NIL
Proceeds
NIL
5,000
ACB
NIL
NIL
Capital gain
NIL
5,000
Other rules
• Depreciable capital
property
– Need to designate the
order of dispositions
within particular classes
– Stop loss rules on
terminal losses
– Can only transfer
amounts that have been
paid, not accrued (ie
capital gains accruals)
– Same applies for CECA
– Cannot transfer at zero,
need nominal amount of
$1 (goodwill)
• Non depreciable
property with unrealized
capital losses to
affiliated persons
– Affiliated persons are
affiliated with each
member of a group and
control the corporation
– Stop loss rules deny
losses in all situations
where transferee and
transferor are affiliated
Summary of stop loss rules
Transferer is a corporation, trust or
partnership
Transferor is an individual
Capital loss on transfer:
* To an affiliated purchaser (251.1)
* To an affiliated purchaser
* Capital loss is denied (40(3.4))
*Capital loss is denied as a superficial loss (Sec
54 Par 40(2)(g)
* Capital loss is kept with the transferor until the
transferee sells the asset to a non-affiliated
person
* Denied loss is added to the cost of the asset to
the transferee
Terminal loss
* On transfer to an affiliated purchaser
* Same as for corporations, trusts or partnerships
* Terminal loss is denied
* Terminal loss is kept with transferor until the
transferee sells the asset to an non-affiliated
person
* Transferee records the asset with a cost equal
to the cost to the transferor and an addition to
UCC equal to FMV
Capital loss on redemption
* Affiliated immediately after the redemption
* Same as for corporations, trusts or partnerships
Summary of Rules
Property transferred
FMV of non share
consideration
FMV of total consideration
>FMV
Elected amount = FMV of
property transferred. Ssec 15(1)
will apply on income received as
well as accrued income realized
Even if the increase in LSC of
shares was greater than
increase in net assets, there will
be no deemed dividend since
the tax PUC of shares will be
reduced to NIL resulting in
deemed dividend on disposition
FMV
Tax value
0
Optimal FMV of total
consideration
Minimum elected amount = FMV
of boot; realization of all or
some accrued income will result
Optimal FMV of share
consideration
Minimum elected amount = tax
value of property transferred
therefore no realization of
income
Optimal FMV of boot
Filing requirements
• T2057 applies to elections made under
85(1). This form must be filed separately
• Deadline is the earliest date on which any
of the parties to the election has to file an
income tax return for the taxation year in
which the transfer occurred.
• 150(1) requires an individual to file for the
calendar year. 25(1) 99(2) extends the
fiscal period of a proprietor who disposed
of a business
Late and amended elections
• 85(7) will allow you to file an election up to
three years after the filing deadline
• Generally allowed if the amendment is to
revise an agreed amount where there
would be unintended tax consequences if
not amended
• If late, must pay penalty of ¼% of excess
property FMV AND
• 100 per month up to 8,000
Example
Worksheet setup
Min. elected
amount
Land(1)
Marketable securities(2)
Building(3)
Equipment(4)
Furniture and fixtures(5)
Licence(6)
Income
Max. boot
Worksheet setup
Land(1)
Min. elected
amount
$60,000
Income
Nil
Max. boot
$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
7,000
Nil
7,000
80,000
Nil
80,000
Furniture and fixtures(5)
Licence(6)
(1) (a)
Minimum elected amount on land
Greater of:
(i) FMV of boot
(ii) Lesser of:
(A) FMV of property
$50,000
$75,000
$60,000
(B) ACB
(b) Income:
Proceeds
Cost
Capital gain/loss
$60,000
$60,000
(60,000)
Nil
Worksheet setup
Min. elected
amount
$60,000
Land(1)
Income
Nil
Max. boot
$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
7,000
Nil
7,000
80,000
Nil
80,000
Furniture and fixtures(5)
Licence(6)
(2) (a)
Minimum elected amount: marketable securities
Greater of:
(i) FMV of boot
(ii) Lesser of:
(A) FMV of property
$ 60,000
$65,000
$ 55,000
(B) ACB
(b) Proceeds
Cost
Gain
Taxable capital gain
$55,000
$ 60,000
55,000
$ 5,000
$ 2,500
Worksheet setup
Min. elected
amount
$60,000
Land(1)
Income
Nil
Max. boot
$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
7,000
Nil
7,000
80,000
Nil
80,000
Furniture and fixtures(5)
Licence(6)
(3) (a)
Minimum elected amount building
Greater of:
(i) FMV of boot
(ii) Least of:
(A) FMV of property
UCC of class
(C) Cost of property
(b) Taxable capital gain:
Proceeds
Cost
Gain/Loss
$ 55,000
$95,000
$70,000
$ 70,000
(B)
$85,000
$ 70,000
(85,000)
Nil
Worksheet setup
Min. elected
amount
$60,000
Land(1)
Income
Nil
Max. boot
$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
7,000
Nil
7,000
80,000
Nil
80,000
Furniture and fixtures(5)
Licence(6)
(4) (a)
Minimum elected amount equipment
Greater of:
(i) FMV of boot
(ii) Least of:
$ 45,000
$50,000
(A)
FMV of property
(B) UCC of property
(C) Cost of property
(b) Taxable capital gain:
Proceeds
Cost
$40,000
$65,000
$ 40,000
$ 50,000
(65,000)
Nil
Worksheet setup
Min. elected
amount
$60,000
Land(1)
Income
Nil
Max. boot
$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
7,000
Nil
7,000
80,000
Nil
80,000
Furniture and fixtures(5)
Licence(6)
(5) (a)
Minimum elected amount furniture and fixtures
Greater of:
(i) FMV of boot
(ii) Least of:
$ 5,000
$10,000
(A)
FMV of property
(B) UCC of class
(C) Cost of property
(b) Taxable capital gain:
Proceeds
Cost
Gain/Loss
$ 7,000
$15,000
$ 7,000
$ 7,000
(15,000)
Nil
Worksheet setup
Min. elected
amount
$60,000
Land(1)
Income
Nil
Max. boot
$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
7,000
Nil
7,000
80,000
Nil
80,000
Furniture and fixtures(5)
Licence(6)
(6) (a)
Minimum elected amount licence
Greater of:
(i) FMV of boot
(ii) Least of:
(A) FMV of property
(B)
$ 15,000
$100,000
$80,000
$ 80,000
4/
3 of CEC
(C) Cost of property
(b) CEC
Proceeds: 3/4  $80,000
$82,500
$ 60,000
60,000
Nil
Examples
• Problem 3
• Problem 5
Next week
• Read Chapter 17
• Do the following from chapter 16:
– Problem 6
• Assignment #2: problem 8

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