Week 7 - Chapter 17 - watkin & Associates

Report
1
Chapter 16 problems
2
Problem 6
• What is transferred and what is not?
3
Problem 6 part 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.
4
Problem 6 part B – not transferred
Consideration
Asset
Cash
A/R
Tax value
$20,000
FMV
$20,000
Transfer
price
$20,000
96,000
85,000
85,000
Assumed
debt
$20,000
85,000
Income
effect
Comment
Nil not eligible
$(5,000) net of reserve
(1)
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)
5
Problem 6 part C
Consideration
Asset
Land: Parcel I
Tax value
FMV
$200,000 $339,000
Elected
amount
$200,000
Assumed
liabilities New debt
$ 46,000 $154,000
Cl. A
shares
$139,000
Cl. B
shares
—
Income effect
Nil
(3)
Building
Auto
Goodwill
15,000
11,000
Nil
75,000
12,000
60,000
15,000
11,000
1
$226,000
$486,000
$226,001
—
—
—
$46,000
15,000
11,000
—
60,000
1,000
—
—
—
60,000
$180,000
$200,000
$60,000
Nil
Nil
.50
6
Problem 6 part D
Elected amount
Allocation of non-share consideration
— assumed debt
$226,001
$46,000
— new debt
180,000
Cost of share consideration
PUC of share consideration taken:
226,000
$
1
Subsection 85(2.1) reduction in PUC:
Increase in LSC of all shares ($200,000 + $50,000)
Less: Elected amount
Less: Boot
$260,000(A)
$226,001
(226,000)
Excess, if any
1(B)
Total reduction (A – B)
$259,999
Redeemable
preferred
Increase in LSC for each class
Reduction in each class [(A – B)  C/A]
Redeemable pref. shares,
Retractable pref. shares,
Tax PUC after reduction for each class
$200,000(C)
$259,999 
$200,000
$260,000
$259,999 
$60,000
$260,000
Retractable preferred
$60,000(C)
(199,999)
$
1
(60,000)
Nil
7
Chapter 17 Income Deferral –
other rollovers and use of
rollovers in estate planning
8
Today
•
•
•
•
Corporate capital reorganizations
Amalgamations
Winding-up of subsidiary
Basic estate freezes
9
Tax Act sections
• 85 – transfer of property from shareholder
to corporation
• 85.1 – share for share exchange
• 86 – exchange of shares in corporate
reorganization
10
Corporations and shareholders
•
•
•
•
Share for share exchange
Reorganization of capital
Statutory amalgamations
Windup of a subsidiary
11
Share for share exchange
• Tax-free rollover for exchange of shares in
one corporation for shares in another
• Cost of shares is lesser of FMV and PUC
– Exchange shares of A Ltd for B Ltd
– Capital gain is deferred on transfer
– ACB of B is equal to ACB of A
12
Conditions
•
•
•
•
•
The transferred shares must be capital property
Purchaser must be Canadian corporation
Must be previously unissued class (ie new shares)
Must be arms length prior to exchange
The vendor/taxpayer after transfer:
– Must not control purchaser (reverse takeover)
– Own more than 50% of FMV of OS shares
• No election on original transfer
• Vendor cannot have recognized any portion of
capital gain or loss through any other provision
13
Conditions
• If met, then vendor is deemed to dispose
at ACB
• PUC of the exchanged shares is reduced
through a grind
14
Other issues
• If any condition not met:
– No benefit of deferral of capital gain
– If PUC is less than cost, then consider sec 85
transfer to avoid deemed cost restriction
15
Illustration
• Nat owns common shares in Nat’s Trading
Corporation Limited as follows:
– FMV = $950,000
– ACB = $100,000
– PUC = $10,000
• Elaine’s Pubco Ltd, a Canadian public
company, has acquired all of the common
shares and issued its own common shares
for total FMV of $950,000, representing 10%
of the FMV of all shares issued
• What are the tax consequences of a share for
share exchange?
16
Solution
• As long as Nat does
not include in income
any portion of the gain,
all of the conditions will
apply. Tax
consequences are
listed.
• ACB of shares acquired
are $100,000 and the
gain is deferred until
Elaine shares are
disposed
Proceeds
ACB of Nat
Capital gain
100,000
(100,000)
NIL
17
Other notes to solution
• Nat may not receive boot. 85(1) election
can be made in place of 85.1 is this is a
concern
• Joint election can receive boot up to
$100,000
• Sec 85 not feasible if many shareholders
• 85.1 is an automatic blanket provision
18
Reorganization of Capital
• When reorganizing the capital of a
corporation, a class of shares can be
converted into another class.
• Done through amendment
• Rollover provides for deferral of accrued
gains
• PUC of new shares will normally be equal
to PUC of old shares less boot
19
Three conditions
• The shares are capital property to the
shareholder
• All of the shares of a particular class
owned by the shareholder are exchanged
• Property receivable by the shareholder on
the exchange includes other shares
• Sec 86 will not apply if Sec 85 has been
used
20
Conceptual view
• There are two transactions involved
– Issuance of new shares
• Calculate PUC and ACB of new shares
– Redemption of old shares
• Calculate deemed dividend on redemption of old
shares and capital gain or loss on disposition
• To fully defer the unrealized gain on the old
shares, ie for a full rollover, boot exchanged
should not exceed PUC
• To avoid the benefit rule, balance the FMV of
the old shares with the total FMV of the
package of consideration received.
21
Issuance of new shares
• On the issuance there is an initial grind to
the PUC to avoid triggering a deemed
dividend
• PUC of new will equal PUC of old
• Cost calculated by first allocating ACB of
existing shares to boot up to FMV and
allocate remainder to new shares.
– If more than one class of shares, allocate
proportionately
22
Redemption of old shares
• Calculate deemed dividend and capital gain
• Previous rollover involved cash and boot.
Inclusion of shares adds complexity
• PoD = boot + PUC of new shares
• PoD for CG = FMV of boot + cost of new
shares
• Capital losses are denied if realized – added
to cost base of new shares
• Indirect benefit to related person
23
How it works
FACTS
Old shares given up
Consideration received
FMV
150 Boot - FMV
100
ACB
100 New shares –
FMV
50
PUC
100 - LSC
50
24
Calculation
Procedure
ISSUANCE OF SHARES
Reduced PUC
LSC increase
50
Less PUC of old shares
100
Less boot
100
NIL
PUC reduction
50
Reduced PUC
NIL
ACB of old shares
100
Less FMV of boot
100
Cost of new shares
NIL
Cost of boot received
100
25
Calculation
Procedure
REDEMPTION OF SHARES
1
Proceeds on redemption
Reduced PUC of new shares
NIL
FMV of boot
100
Proceeds
100
Deemed dividend on
redemption
Redemption proceeds
PUC of old shares
Deemed dividend
100
(100)
NIL
26
Calculation
Procedure
2
Capital gain
Cost of new shares
NIL
FMV of boot
100
100
Less deemed dividend
NIL
PoD on old shares
100
CG(CL) on old shares
PoD
100
ACB
(100)
CG/L
NIL
27
Calculation
Procedure
NET EFFECT
Deemed dividend
NIL
CG/L
NIL
Accrued CG
FMV
50
ACB
NIL
Net effect (equal to accrued
gain on old shares)
50
50
PUC of new shares will be NIL since all of the original PUC of $100 has
been recovered through the boot of $100
28
Example
• Trebor Maeb owns a
controlling interest in Six
Sixty-One Ltd and
therefore is not at arms’
length with the
corporation. His present
common shares have
PUC and ACB of $2500
and FMV of $3700.
Corporation is
reorganizing its capital
structure and will
exchange shares as
listed. What are the tax
consequences of the
reorganization?
Notes at FMV
1,000
New pref (LSC = FMV)
2,700
Total
3,700
29
Solution
• First calculate the issuance of new shares
and then the cost of the preferred shares
30
Issuance of new shares
1
Reduced PUC
LSC increase for new preferred shares
2,700
Less PUC of old common shares
2,500
Less boot
1,000
1,500
PUC reduction
1,200
Reduced PUC (2,700 – 1,200)
1,500
The primary objective of this calculation is to show that the PUC reduction will
avoid the triggering of a deemed dividend
31
Issuance of shares
2
Cost of shares received
ACB of old shares
2,500
Less FMV of boot
1,000
Cost of preferred shares
1,500
Cost of notes received (FMV)
1,000
32
Redemption of shares
1
Proceeds on redemption of old shares
FMV of boot
1,000
Reduced PUC – new preferred shares
1,500
Redemption proceeds
2,500
Proceeds on redemption (above)
2,500
PUC old common shares
2,500
Deemed dividend on redemption
NIL
33
Redemption of shares
2
Proceeds of disposition of old shares
for capital gain purposes
Cost of all new shares
1,500
Plus cost of boot
1,000
Proceeds of disposition of old shares
2,500
Less deemed dividend
NIL
Proceeds
2,500
ACB of old shares
2,500
Capital gain/loss
NIL
34
Net economic effect
Deemed dividend on redemption
NIL
Capital gain / loss on old shares
NIL
Accrued capital gain
FMV
2,700
ACB of new shares
1,500
Net economic effect
1,200
1,200
NEF is equal to the accrued gain on the old shares
35
Statutory amalgamations
• Applies at both corporate and shareholder
levels
• Distinct from business combination
accounting
• Combination = separate entities
• Amalgamation = new entity
36
Conditions
• Must be taxable Canadian corporations
• All of the property and liabilities of
predecessor except interco must belong to
the new company by virtue of
amalgamation
• All shareholders must receive shares of
the new corporation
• Transfer of property cannot occur as the
result of a normal purchase of such
property
37
Problem 1
38
Problem 1 – sec 85.1
• 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).
39
• 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)].
40
• 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.
41
• 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.
42
Under sec 85
• 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)].
LSC before reduction
Less:
$
100,000
Increase in PUC of all shares
$
100,000
Elected amount
$50,000
Less: Boot
25,000
PUC after reduction
(25,000) (75,000)
$25,000
43
Two levels
• The rollover deals with
– Transfer of capital property to permit deferral
of capital gains
– Exchange of shares to permit deferral of
capital gain
44
Income tax consequences
• Treated as continuation of predecessor
corporation
• Like putting two balance sheets together
and adding them up
• Tax treatment
– Deemed year end – short year provisions
– Prorated SBD
– Loss of one year for LCF
45
Picture it
12/31/2008
12/31/2005
12/31/2006
12/31/2007
12/31/2008(1)
12/31/2008
12/31/2009
12/31/2010
6/30/2005
6/30/2006
6/30/2007
6/30/2008
9/30/2008(2)
46
What happens?
Paragraph
Item
Effect
87(2)(b)
Inventory
At cost
87(2)(d)
Depreciable cp
At UCC
87(2)(e)
Nondep cp
At ACB
87(2)(f)
ECP
At 4/3 of CEC balance
87(2)(g)
Reserves
Flowed through
87(2.1)
NonCL
Flowed through
87(2.1)
NCL
Flowed through
87(2.1)
Restricted farm losses
Flowed through
87(2.1)
Farm losses
Flowed through
87(2)(z.1)
CDA
Flowed through
87(2)(aa)
RDTOH
Flowed through
47
Planning opportunities
• Utilization of prior year losses or current
year losses against income of predecessor
corporation
• Amalgamation of a parent company and
sub can utilize subs losses against parent
income
• Can facilitate a change in year end
48
Effects on shareholder
• Deemed disposition of shares at PoD =
ACB and acquired new shares at ACB =
PoD
– No consideration for shares other than shares
including boot
– Original shares are capital property to
shareholder
– No deemed gift to person related to
shareholder
49
Windup of subsidiary
• Rules apply where CDN co owns at least
90% of shares of another CDN co
– Resource property disposed at NIL
– Other property at original cost
• No deemed year end
– Sub ceases to exist as there are no assets
and no shares
50
Rollovers and estate freezes
• Objective is to freeze all or part of the
value of a growing asset at current FMV
so that future growth accrues to next
generation
51
Secondary objectives
• Don’t want immediate tax cost
• Want to maintain control over assets value
and perhaps retain a source of income
• May coincide with planning to split income
but need to avoid attribution rules and
kiddie tax
• Utilize capital gains deduction on QSBCS
• Allows next generation to accrue capital
gains to utilize their own deductions
52
Holdco freeze
• Uses section 85 as primary device
• Take debt and pref shares as
consideration (new class of shares)
• Future growth is reflected in value of
common shares
53
Before and after
PARENT
PARENT
Debt and
pref shares
HOLDCO
growing
assets
Growing
assets
Section 85
CHILDREN
Common
shares
54
Internal freeze
• Capital reorganization
– Don’t need to incorporate new company
– Rollover provision is automatic
55
Before and after
PARENT
PARENT
Debt and
pref shares
Common
shares
OPCO
Section 86
CHILDREN
Common
shares
OPCO
56
Problem 3
ACB
PUC
FMV
Current Position:
Mr. Fresser
80% $
50,000
Daughter
20%
12,500
$
62,500
$
90,000
$
50,000
$
12,500
$
62,500
500,000
125,000
$
625,000
Proposed Consideration:
Cash
Pref shares
300,000
$
390,000
57
Problem 3 Part 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.
58
Reverse or asset freeze
• Removal of some or all of the growth
assets of a corporation and replace with
nongrowth assets
• Attribution rules do not apply because
transferor is not an individual
59
Before and after
PARENT
PARENT
CHILDREN
Common
shares
Debt and pref
shares
Common
shares
OPCO
OPCO
Debt and pref
shares of
NEWCO
NEWCO
Growth assets
60
Just a couple of case studies
APPLICATION
61
Analysis - simplified
• Each reorganization method has the same
objective.
– Define the problem in the existing structure and
the objective to be satisfied by changing that
structure
– Choose and test one of the reorganization
techniques – involves determining immediate and
future tax consequences of the method
– Determine whether the immediate and future tax
implications satisfy all or a portion of the problem.
Anticipate possible future activities
– If all of the problems are not solved and/or if new
difficulties are created, then choose another
method and perform the analysis again
62
Discussion case – Blue Ltd
– Blue Ltd is a CDN corporation and
manufactures mens clothing.
Current year profit is $500,000
and expected to be similar in the
future. Blue has two wholly owned
subs, A Ltd and B Ltd.
– A was acquired 5 years ago and
manufactures winter clothing.
Profit is $50,000 annually
– B was acquired 2 years ago. B
had unused business losses CF of
$200,000. B has incurred
additional losses of $150,000 and
expected to lose $80,000 in the
next 3 years. B operates retail
outlets and owns land and
buildings for 2 stores. Value has
increased.
Family
shareholders
Blue Ltd
(profitable)
A Ltd
(profitable)
B Ltd
(losses)
63
Analysis
– Major problem is that
two companies are
profitable and one is
not
– Combined profit of
$670, but taxed on
$750
– What are the options
and what would you
do?
Blue Ltd
700,000
A Ltd
50,000
B Ltd
(80,000)
670,000
64
Options
– B Ltd sells assets to A Ltd
• 1) sell assets that have appreciated – would use up
losses but leave business operations in B
• 2) sell entire operation – might use up all losses and
losses are used by A – however A profits are less than
B losses
– A Ltd sells assets to B Ltd
• Eliminates taxes on $50,000 profit, but leaves $30,000
in annual losses plus accumulated losses
– Amalgamation of A and B
• Similar to #2 and does not resolve the matter of how to
use the annual future losses and past losses
– Windup of B into Blue
• Assets of B transferred at tax values; losses transferred
to Blue
65
Preferred treatment
– Windup B into Blue
• Utilize losses
– Also accomplished with amalgamation of B
into Blue
66
Another case – The Mavis
Group
• The Mavis Group
• CDN company
• Sells womens shoes
• History of substantial
profits
• $600,000 in 20X7
• Owns three 100%
owned subs
Mavis
Mavis
Corp
Triple A
Ltd
Double
A Ltd
Bean
Ltd
67
The Subs
• Triple A
– Acquired 5 years ago in 20X2
– Manufactures informal summer shoes
– Pretax profit of $100,000
• Double A
– Acquired in 20X3
– Manufactures high fashion shoes
– Profitable for first two years and now has regular losses – current
NCLCF is $400,000 and expects $50,000 loss in each of next
three years
• Bean
– Acquired in 20X6
– Operates a canning business
– Unused business losses of $150,000 and unused CL of $40,00
in 20X7 with further operating loss of $250,000. There are no
significant assets
68
What to do?
– Review the existing financial structure of the
Mavis Group and discuss what steps might be
taken to enhance the company’s growth
potential.
69
Mavis
– Three specific problems
• Four separate companies 2 are profitable and 2
are not
• Accumulated losses of Double A and Bean run the
risk of expiring
• Management wants to do something about Bean to
stop further losses
70
The Group
– Ignoring accumulated
losses, current year
results are as follows
– Mavis
600,000
– Triple A 100,000
----------700,000
Double A ( 50,000)
Bean
(250,000)
-----------GROUP 400,000
– Taxes payable on
$700,000
– Assuming tax rate of
33%, excess cost of
$99,000
71
Double A
– No accumulated
losses at acquisition
– $400,000 incurred
after control
– Similar business to
Mavis and Triple A but
irrelevant as losses
are after control
– Further losses
expected
– Possibility that they
will expire in 20X0
– Will take a long time to
generate tax savings
under current structure
72
Bean Ltd
– Loss status is different
• Accumulated losses at
time of acquisition
• CL expired on change
of control and $150,000
is restricted to Bean or
similar business
(111(5))
– Not similar therefore a
reorg will not permit
$150,000 to be used
– Post control losses of
$250,000 are
completely
unrestricted and can
be offset against any
source of income
– A reorg would permit
these losses to be
used
73
Alternatives
– Sell Double A assets to Triple A
• Sell all or some
• Expected future losses of $50,000 can be offset
against Triple A profit of $100,000 creating
additional cash flow of $16,500
• Assets include land and buildings that have
appreciated
• Recapture and CG will offset some of the LCF
• Prevents losses from expiring does not generate
substantial immediate cash flow because not offset
against any profits.
• If loss not fully utilized, lost because Double A has
no income
74
Alternatives
– Sell Triple A assets to Double A
• Triple A profits of $100,000 offset by $50,000 loss
• Total losses of $550,000 or tax savings of $31,000
annually (M&P deduction of 2%)
• Triple A must sell assets and elect to use cost
amounts
75
Alternatives
– Amalgamate Triple A and Double A
• Identical as last option
76
Alternatives
– Wind up Double A into Mavis
• Transfer business operations as well as
accumulated losses of $400,000 into Mavis.
• Mavis will operate a wholesale and mfg business
• Two advantages
– Unused losses of $400,000 used in first year – tax
savings of $148,000 and tax savings of $16,500 in years
two and three (50k x 33%)
– This is the preferred option because
• Large amount of cash savings over short time
• Can also be done by amalgamation
77
Bean
– Can sell or close
• If closed, then $150,000 of precontrol losses will
expire
• Can only continue if business that incurred losses
continues to operate (111(5))
• $250,000 of post control losses remain in Bean.
• After closure, can amalgamate with Mavis and use
$250,000 of unrestricted losses creating savings of
$82,500
• May also recover cash from sale of assets, but
would not be significant
78
Bean
– If sell
• Sell as going concern operation
• Losses of $400,000 (250 + 150) remain with
company and valuable to a purchaser who is in
same line of business
• Create tax savings of $132,000
• Purchaser may be prepared to pay premium as a
result of the expected tax savings
79
End of lecture!
• Next week:
• Do chapter 17
– Problem 5
– Problem 6
• Presentations begin
next week
80

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