Topics. Corporate Rollovers to Defer Tax

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1 Corporate Rollovers to Defer Tax Federated Press Conference: Tax Planning for the Sale of a Business L. David Fox November 11, 2010 Topics 1 Tax-Deferred rollovers Capital Gains Reserve Safe Income Planning Tuck Transactions Small Business Share Rollover Summary Problems 1

2 Tax-Deferred Rollovers 2 Section 85 Section 85.1 Section 86 Triangular amalgamations subsection 87(9) 3 Tax-Deferred Rollovers-s.85 Disposition by taxpayer of eligible property to a taxable Canadian corporation Consideration includes shares of purchaser Joint election filed (Form T2057) Elected amount (as adjusted)=proceeds of disposition to vendor and cost of property to purchaser Cost to vendor of purchaser shares=elected amount less FMV of non-share consideration 2

3 Tax-Deferred Rollovers-s.85 Examples of Eligible Property Capital property (other than real property owned by a nonresident) Canadian resource property Eligible capital property Inventory (other than real property) Tax-Deferred Rollovers-s.85 4 General Limits on elected amount can t be less than FMV of non-share consideration can t exceed FMV of property sold can t be less than lesser of FMV of property sold and ACB of the property Specific limits on elected amount for depreciable assets and eligible capital property Conflict in deeming rules (para. 85(1)(e.3)) 3

4 5 Tax-Deferred Rollovers-s.85.1 Vendor s shares must: be capital property of taxable Canadian corporation Vendor s shares can be of any class (i.e., common or preference) Vendor must take back shares of a Canadian corporation Vendor must take back previously unissued shares of one class of the purchaser corporation 6 Tax-Deferred Rollovers-s.85.1 When will s.85.1 Not Apply? Vendor and purchaser non-arm s length immediately before the exchange Vendor (and/or non-arm s length persons) immediately after the exchange either controlled purchaser; or owned shares representing more than 50% of the FMV of all shares of purchaser 4

5 7 Tax-Deferred Rollovers-s.85.1 When will s.85.1 Not Apply? Vendor includes any portion of gain/loss in income Vendor and purchaser file a section 85 election Non-share consideration received by vendor for exchanged shares 8 Tax Deferred Rollovers-s.85.1(2)(d) Non-Share Consideration IT-450R vendor must be able to clearly identify which shares exchanged for cash and which exchanged for shares IT-450R tracking X shares for cash Y shares for shares Rollover for Y shares Similar CRA position for different classes of shares of purchaser corporation 5

6 Tax-Deferred Rollovers-s Fractionalization Offer must specify the fractions Formula based on relative FMV of consideration taken back for determining how many shares exchanged for cash and how many for shares No Rollover Cash Cash & FMV Shares X Exchanged Shares Rollover FMV Shares Cash & FMV Shares X # Exchanged Shares Tax-Deferred Rollovers-s Consequences to Vendor Vendor may choose to report the gain or loss Otherwise rollover at ACB If exchanged shares TCP, so are acquired shares ITAR 26(26) preserves tax-free zone, and non-crystallization of pre-1972 capital surplus, probably requires only one class No election required 6

7 Tax-Deferred Rollovers-s Consequences to Purchaser ACB to purchaser is lesser of FMV and PUC of shares of vendor Not impacted by vendor electing to recognize gain/loss on exchange Tax-Deferred Rollovers-s.85.1(2.1) 12 PUC Reduction PUC reduction equal to increase of PUC as a result of share exchange over PUC of exchanged shares received from vendor 7

8 Tax-Deferred Rollovers-s.85 vs. s.85.1 (assuming no non-share consideration) s.85 Applies to inventory and capital property ACB of old shares equal to vendor s ACB (provided joint election) PUC of new shares ground to ACB of old shares not PUC of old shares (provided joint election) Joint election required s.85.1 Applies only to shares of a Canadian company which are capital property ACB of old shares equals lesser of PUC and FMV PUC of new shares ground to PUC of old shares Applies automatically (no joint election required) Problem Tax-Deferred Rollovers Is s.85 or s.85.1 more tax efficient? 8

9 Problem Tax-Deferred Rollovers Offer by XYZ Co. to purchase shares of ABC Co. $5.00 cash Class A share of XYZ Co. Promissory Note (boot) Values Determined ABC Co. share $10.00 Class A share of XYZ Co. $4.00 Promissory Note $1.00 ACB of ABC Co. share is $6.00 Problem-Tax-Deferred Rollovers Shareholders Vendors Shareholders Vendors XYZ Co. ABC Co. XYZ Co. Class A Share ABC Co. 9

10 Problem Tax-Deferred Rollovers Section 85.1 $6.00/($5.00+$4.00+$1.00)=60% 60% of ABC Co. shares will be exchanged for cash and note Problem Tax-Deferred Rollovers Section 85 (a) Range of possible elected amount: can t exceed FMV of ABC Co. shares ($10.00) can t be less than cash and note ($6.00) (b) Cost of Note=FMV of Note=$1.00 (c) Cost of Class A Share=ACB of ABC Co. share ($6.00) - Cost of Note ($1.00) - Cash ($5.00) Therefore, cost of Class A Share is $0 10

11 Problem Tax-Deferred Rollovers s.s.85(1) Election Proceeds= $6.00 ACB= $6.00 Capital Gain= $0 s.85.1 (no s.s.85(1) election) Taxable Proceeds= $6.00 ACB= $3.60 Capital Gain= $2.40 ACB of Note= $1.00 ACB of Class A Share= $0 ACB of Rollover Class A Share= $2.40 (tax-deferred rollover share) Tax-Deferred Rollovers-s.86 In the course of a reorganization of capital Taxpayer disposes of capital property All the shares of particular class of shares owned by taxpayer Property receivable includes other shares of the corporation No election required 11

12 Tax-Deferred Rollovers-s.86 ACB of new shares= excess of ACB of old shares over FMV of non-share consideration Deemed proceeds of old shares = cost of new shares and non-share consideration No deemed TCP rule Capital gain if non-share consideration exceeds ACB of old shares Generally, PUC of old shares flows through to new shares Tax-Deferred Rollovers-s.s.87(9) 18 Triangular Mergers CBCA and OBCA permit shares of a non-amalgamating corporation to be issued on an amalgamation s.s. 87(9) introduced to make such an amalgamation qualify under para. 87(1)(c) and to give rollover to shareholders who take shares of such third party corporation 12

13 Tax-Deferred Rollovers-s.s.87(9) 19 Preconditions to s.s.87(9) Merger of taxable Canadian corporations New corporation must be controlled by a taxable Canadian corporation (the parent) Shares of parent issued by parent to shareholders of predecessor Tax-Deferred Rollovers-s.s.87(9) 20 Shares of parent deemed to be shares of Amalco so that amalgamation qualified under para. 87(1)(c) and eligible for rollover in s.s. 87(4) and benefit of ITAR 26(21) Reduction of PUC of shares of parent to extent the increase in PUC of shares of parent exceeds PUC of shares of predecessor exchanged for parent s shares and owned by third parties 13

14 Tax-Deferred Rollovers-s.s.87(9) 21 If more than one class of shares of parent issued on the merger, then the reduction of PUC is allocated based on the relative PUC s of such classes Cost to parent of shares of Amalco is ACB of shares of predecessor owned by parent plus bump in certain circumstances Bump available where parent owns all of Amalco immediately after merger Tax-Deferred Rollovers-s.s.87(9) 22 Amount of bump is net asset value at tax values over ACB to parent of shares of predecessor immediately before the merger Amount may be allocated by parent among different classes of shares of Amalco except that amount allocated in respect of a particular class cannot result in cost exceeding FMV of shares of the particular class Allocation made in Parent s return of income for year in which the merger occurred 14

15 Tax-Deferred Rollovers-s.s.87(9) Vendor Vendor Buyer Co. Buyer Co. ABC Co. XYZ Co. Amalco Capital Gains Reserve Not a rollover but method of tax deferral Not exceeding 5 years Reasonable reserve (IT-236R4) Minimum 20% reported each year Reserve in one year is capital gain for next year Planning--Take back debt on sale with proceeds payable over 5 years 15

16 Safe Income Planning 9 Individual Shareholder Target Adjusted Cost Base $100,000 Retained Earnings $600,000 assume = Safe Income Fair Market Value $1,000,000 Safe Income Strips 10 Shareholder 100% Adjusted Cost Base $100,000 Fair Market Value $1,000,000 Holdco #1 Target 16

17 Safe Income Strips 11 Shareholder 100% Adjusted Cost Base $100,000 Fair Market Value $1,000,000 Holdco #2 100% Adjusted Cost Base $100,000 Fair Market Value $1,000,000 Holdco #1 Target Safe Income Strips 12 Shareholder 100% Adjusted Cost Base $100,000 Fair Market Value $1,000,000 Increase capital by $600,000 84(1)/53(1)(b) Holdco #2 100% Holdco #1 Adjusted Cost Base $700,000 Fair Market Value $1,000,000 Target 17

18 Safe Income Strips 13 Tuck alternative Vendor holds shares of target through a holding corporation Cost base to Vendor is greater than cost base to holding corporation Tuck Transaction 14 Shareholder 100% Adjusted Cost Base $100,000 Fair Market Value $1,000,000 Holdco X% Adjusted Cost Base $20,000 Fair Market Value $1,000,000 Target 18

19 Tuck Transaction 15 Rollover of Holdco shares to Target in exchange for shares of Target Shareholder 100% Holdco X% Target Adjusted Cost Base $100,000 Fair Market Value $1,000,000 Adjusted Cost Base $20,000 Fair Market Value $1,000,000 Tuck Transaction 16 Shareholder Adjusted Cost Base $100,000 Fair Market Value $1,000,000 Target Target and Holdco to merge X% 100% Holdco 19

20 Tuck Transaction and s.85.1 Tremblay Tremblay Family Public MHT Vidéotron Télésag Tuck Transaction and s.85.1 Tremblay Tremblay Family Public MHT Vidéotron Télésag 20

21 Tuck Transaction and s.85.1 Tremblay Tremblay Family Public 8855 Vidéotron MHT Télésag Tuck Transaction and s.85.1 Tremblay Tremblay Family Public Share-for-Share Exchange Vidéotron 8855 MHT Télésag 21

22 Tuck Transaction and s.85.1 Tremblay Tremblay Family Public Vidéotron shares are taxable Canadian property, but are excluded property for purposes of s.116 Vidéotron MHT Télésag Tuck Transaction and s.85.1-tremblay Minister reassessed under s.s.84(2) Vidéotron is a facilitator 8855 convertible securities transformed into Vidéotron common shares transferred to Tremblay Family s.s.84(2) doesn t require active participation by 8855 TCC added extra condition requiring transferred property to be identical Permit retention of Vidéotron shares without incurring departure tax 22

23 Tuck Transaction and s.85.1 Tremblay where funds or property of a corporation resident in Canada Vidéotron shares were newly issued/never property of retained its assets until wound-up No recharacterization of Vidéotron shares Sham not alleged No proceeding under GAAR Tuck Transaction and s.85.1 Tremblay FCA didn t decide whether s.85.1 and s.s.84(2) can apply concurrently Different outcome if Minister alleged sham or proceeded under GAAR? 23

24 Small Business Share Rollover Individual (not a trust) Qualifying disposition of shares Eligible small business corporation share Common share of active business corporation Ownership by individual (185 days before disposition) Capital gain deemed to be amount which exceeds permitted deferral Designation in tax return required Small Business Share Rollover-ESBC Share Common share issued by a corporation Eligible small business corporation Immediately before and after share issued carrying value of assets of corporation (and related corporations) did not exceed $50 million 24

25 Small Business Share Rollover-ESBC CCPC All or substantially all of assets attributable to: assets used principally in an active business carried on primarily in Canada share issued by or debt owing by other related eligible small business corporations combination of above assets Small Business Share Rollover Carrying Value of Assets Value of assets for balance sheet purposes Prepared in accordance with GAAP Shares or debts issued by related corporation deemed to have carrying value of nil 25

26 Small Business Share Rollover Active Business Corporation Corporation that is a taxable Canadian corporation All or substantially all of the FMV of the assets attributable to assets of corporation that are: Used principally in an active business carried on by corporation or related corporation Shares issued by or debt owing by other active business corporations related to the corporation Combination of assets described above Small Business Share Rollover Permitted Deferral (G/H) * I G= lesser of: Proceeds of disposition; and Cost of replacement shares H= proceeds of disposition I= capital gain 26

27 Small Business Share Rollover ACB Adjustment ACB reduction from ACB of replacement share Replacement Share Eligible small business corporation share Acquired in the year or within 120 days of year end Designated (in return) to be replacement share Small Business Share Rollover ACB Adjustment, cont d D * (E/F) D= permitted deferral of individual on qualifying disposition E=cost to individual of replacement share F=cost to individual of all replacement shares in respect of qualifying disposition 27

28 Small Business Share Rollover Deemed Taxable Canadian Property If qualifying disposition was disposition of TCP Replacement share deemed to be TCP Application of s.116 withholding/reporting requirements Small Business Share Rollover Continuity Rules Preserves availability of s.44.1 relief where shares transferred on rollover basis under certain provisions of Act s.s.44.1(4)-esbc share of deceased individual acquired as consequence of death by spouse, common-law partner or child 28

29 Small Business Share Rollover Continuity Rules cont d s.s.44.1(5)-esbc shares acquired from former spouse or common-law partner as a consequence of settlement of rights arising from breakdown of relationship (s.s.73(1) must apply) Small Business Share Rollover Continuity Rules, cont d s.s.44.1(6)-esbc share of one corporation exchanged for ESBC shares of another corporation. s.s.44.1(7)-common share of one corporation exchanged for common shares of another corporation and a qualifying disposition Distinctions between s.s.44.1(6) and (7) 29

30 Small Business Share Rollover Interaction with Capital Gains Exemption Small business share rollover takes priority over capital gains exemption If both apply and capital gains exemption desired, take steps to ensure small business share rollover relief provisions not applicable Problem Small Business Share Rollover Shares disposed of for $1,000 ACB of Shares is $500 Replacement shares cost $5,000 Capital Gain is $500 Permitted deferral is $500 30

31 Problem Small Business Share Rollover Shares disposed of for $5,000 ACB of Shares is $500 Replacement shares cost $2,000 Capital Gain is $4,500 Permitted deferral is $1,800 40% of gain deferred Replacement shares cost is 40% of proceeds Summary Problem Basic Structure Katie Opco Facts Canadian resident Active business carried on CCPC ACB of shares $100 FMV of shares $1,000 ABC Co. wants to acquire Opco ABC Co. is Canadian corporation 31

32 Summary Example How could Katie structure the sale? Summary Example #1 Katie ABC Co. Analysis Simple share sale for cash Capital gain-50% included in income If requirements met, capital gains exemption Opco 32

33 Summary Example #2 Katie Promissory Note ABC Co. Analysis Share sale for promissory note payable over 5 years Capital gain realized but reserve claimed in respect of amount due after year-end If requirements met, capital gains exemption Opco Summary Example #3 Katie Canco Replacement Shares ABC Co. Opco Analysis Share sale Acquire replacement shares in year of disposition of Opco shares or within 120 days of year end Deferral of all or portion of gain on sale of Opco shares 33

34 Summary Example #4 Katie Katie Katie ABC Co. Opco Holdco Opco Safe income dividend Holdco Opco Summary Example #5 Katie Katie ABC Co. Opco Bid Co. Opco 34

35 Summary Example #6 Katie Sharefor-share exchange Katie ABC Co. Opco Opco Presenter L. David Fox Fasken Martineau DuMoulin LLP 333 Bay Street, Suite 2400 Bay Adelaide Centre, Box 20 Toronto, Ontario M5H 2T6 Tel: Fax:

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