# SECTION 85 SAMPLE PROBLEMS

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3 - 3 - amount? Which example demonstrates the maximum non-share consideration that Jenny can receive without triggering a gain? With respect to the transfer of capital property: (i) (ii) (iii) (iv) the elected amount cannot exceed the fair market value of the transferred property at the time of the transfer (paragraph 85(1)(c)); subject to (i), the elected amount cannot be less than the fair market value of the nonshare consideration received by the transferor (paragraph 85(1)(b)); the elected amount cannot be less than the lesser of the fair market value of the transferred property at the time of transfer and the cost amount of the transferred property to the transferor (paragraph 85(1)(c.1)); and subject to (i), where the amount in (ii) and (iii) are different, the lower limit on the elected amount is the greater of the amounts in (ii) and (iii) (paragraph (85(1)(e.3)). In this case, these amounts are: (i) (ii) (iii) \$1.5m (paragraph 85(1)(c)); varies in each scenario, as follows (a) \$900k, (b) \$1m, (c) \$1.1m, (d) \$1.5m, and (e) \$1.6m (paragraph 85(1)(b)); and \$1m (paragraph 85(1)(c.1)). (a) Jenny receives only common shares of Opco: This scenario demonstrates that the lesser of the cost amount and fair market value of the transferred property (paragraph 85(1)(c.1)) will set the lower limit of the elected amount if such amount exceeds the amount of the non-share consideration (paragraphs 85(1)(b) and (e.3)). The permitted elected amounts are between \$1m (paragraph 85(1)(c.1)) and \$1.5m (paragraph 85(1)(c)). If the elected amount is \$1m, Jenny will not realize a gain or loss. This example also demonstrates that a loss cannot be generated on the transfer. (b) Jenny receives a note of \$100k and common shares of Opco: This scenario demonstrates the maximum non-share consideration that Jenny can receive without realizing a gain. The permitted elected amounts are between \$1m (paragraphs 85(1)(b) and (c.1)) and \$1.5m (paragraph 85(1)(c)). If the elected amount is \$1m, Jenny will not realize a gain or loss. The \$100k note and the \$900k assumed mortgage (total of \$1m) is the maximum non-share consideration that Jenny can receive without realizing a gain. (c) Jenny receives a note of \$200k and common shares of Opco: This scenario demonstrates that the amount of the non-share consideration (paragraph 85(1)(b)) will set the lower limit of the elected amount if such amount exceeds the lesser of the cost amount and fair market value of the transferred property (paragraphs 85(1)(c.1) and (e.3)). The permitted elected amounts are between \$1.1m (paragraph 85(1)(b)) and \$1.5m (paragraph 85(1)(c)). If the elected amount is \$1.1m, Jenny will realize a gain of \$100k.

5 - 5 - The permitted elected amounts are between \$800k (paragraph 85(1)(d)) and \$5m (paragraph 85(1)(c)). Question 8 Jenny has forklifts that are used in her warehouse. One forklift (FL1) was acquired at a cost of \$1m and has a current fair market value of \$750k and a second forklift (FL2) is older and was acquired at a cost of \$500k and has a current fair market value of \$100k. FL1 and FL2 are depreciable property of the same class and the class has an undepreciated capital cost of \$600k. Suppose that Jenny receives a note of \$600k and common shares of Opco for FL1 and only common shares of Opco for FL2. What are the limits on the elected amount on the transfer of each asset? What are the tax consequences if FL1 was sold by Opco for \$800k? Answer (Extra not to be reviewed in small group): With respect to the transfer of depreciable capital property: (i) (ii) (iii) (iv) the elected amount cannot exceed the fair market value of the transferred property at the time of the transfer (paragraph 85(1)(c)); subject to (i), the elected amount cannot be less than the fair market value of the nonshare consideration received by the transferor (paragraph 85(1)(b)); the elected amount cannot be less than the least of the fair market value of the transferred property at the time of transfer, the cost of the transferred property to the transferor and the undepreciated capital cost of the class to the transferor (paragraph 85(1)(e)); and subject to (i), where the amount in (ii) and (iii) are different, the lower limit on the elected amount is the greater of the amounts in (ii) and (iii) (paragraph 85(1)(e.3)). Where two or more depreciable properties of the same class are being disposed of at the same time, the first step is to determine the order of disposition of the depreciable properties. Paragraph 85(1)(e.1) allows the transferor to designate the order in which the properties are disposed of. If Jenny designates that FL1 is transferred prior to FL2, the range of permitted elected amounts for FL1 is between \$600k (paragraphs 85(1)(b) and (e)) and \$750k (paragraph 85(1)(c)). The range of permitted elected amounts for FL2 is between nil (paragraph 85(1)(e) the elected amount in respect of FL1 is deducted from the undepreciated capital cost of the class for purposes of determining the elected amount for FL2) and \$100k (paragraph 85(1)(c)). If Jenny designates that FL2 is transferred prior to FL1, the only permitted elected amount for FL2 is \$100k (paragraph 85(1)(c)). The range of permitted elected amounts for FL1 is between \$600k (paragraphs 85(1)(b) and (e.3)) and \$750k (paragraph 85(1)(c)). No gain or recapture need be realized where FL1 is disposed of first. Recapture of \$100k would be realized where FL2 is disposed of first. Subsection 85(5) provides that any potential for recapture in the transferor carries forward in the transferee. This provision applies where subsection 85(1) has applied to a transfer of a

6 - 6 - depreciable property and the transferor s capital cost of the property exceeds the transferor s proceeds of disposition of the property. The provision provides that, for purposes of sections 13 and 20 and the regulations, the transferee s capital cost of the depreciable property is deemed to be the transferor s capital cost of the property, and the amount by which the transferor s capital cost of the property exceeds the transferor s proceeds of disposition of the property is deemed to have been claimed as capital cost allowance by the transferee. Assuming the elected amounts in respect of FL1 and FL2 are the least of the amounts set out above, where FL1 is disposed of prior to FL2, subsection 85(5) would provide that the capital cost to Opco of FL1 is \$1m and \$400k would be deemed to have been claimed by Opco as capital cost allowance. The capital cost to Opco of FL2 would be deemed to be \$500k and \$500k would be deemed to have been claimed by Opco as capital cost allowance. If Opco sells FL1 for \$800k, \$200k of recapture would be realized. Where FL2 is disposed of prior to FL1, subsection 85(5) would provide that the capital cost to Opco of FL2 is \$500k and \$400k would be deemed to have been claimed by Opco as capital cost allowance. The capital cost to Opco of FL1 would be deemed to be \$1m and \$400k would be deemed to have been claimed by Opco as capital cost allowance. If Opco sells FL1 for \$800k, \$100k of recapture would be realized. PROBLEM 2 Suppose that the fair market value of all of the properties transferred by Jenny to Opco under subsection 85(1) is \$10m and that the aggregate of the elected amounts in respect of all transferred properties is \$6m. Suppose that Jenny receives as consideration for the transfer only shares of Opco and that the shares she receives are made up of two different classes of preferred shares (Class A and Class B) of Opco and a class of common shares of Opco. She envisions that she will receive Class A preferred shares with a value of \$5m, Class B preferred shares with a value of \$3m and common shares with a value of \$2m. Question 1 What is the cost to Jenny of the Class A preferred shares, the Class B preferred shares and the common shares of Opco? The cost of property that is non-share consideration is generally the lesser of (a) the fair market value of the particular property, and (b) the proportion of the fair market value of the transferred property that the fair market value of the particular property is of the fair market value of all nonshare consideration (paragraph 85(1)(f)). The cost of preferred shares of a class received as consideration is generally the lesser of (a) the fair market value of the preferred shares of such class, and (b) the proportion of the amount by which the proceeds of disposition (i.e., the aggregate of elected amounts) exceed the fair market value of the non-share consideration, that the fair market value of the preferred shares of such class is of the fair market value of the preferred shares of all classes received as consideration (paragraph 85(1)(g)).

8 - 8 - consideration, the reduction is to all classes of shares received as consideration, pro rata to what would otherwise be the increase in PUC of the various classes of shares. In this case, absent subsection 85(2.1), the increase in the PUC of all classes of shares received as consideration would be \$10m. This exceeds the amount by which the cost to Opco of the transferred properties (\$6m) exceeds the fair market value of the non-share consideration (nil). The PUC reduction is the amount by which the amount that would otherwise be the increase in the PUC of all classes of shares received as consideration (\$10m) exceeds this maximum permitted increase in PUC (\$6m). Accordingly, the PUC reduction is \$4m. This PUC reduction is applied pro-rata to the amounts that would otherwise be the increases in PUC of the various classes of shares received as consideration. The PUC reduction in respect of the Class A Preferred shares is the proportion of the amount of the PUC reduction of all classes of shares received as consideration (\$4m) that the amount that would otherwise be the increase in PUC of the Class A Preferred shares as a result of the transfer (\$5m) is of the amount that would otherwise be the increase in PUC of all classes of shares as a result of the transfer (\$10m). Accordingly, the amount of the PUC reduction in respect of the Class A Preferred shares is \$2m and the net increase in PUC of the Class A Preferred shares as a result of the transfer becomes \$3m. The PUC reduction in respect of the Class B Preferred shares is the proportion of the amount of the PUC reduction of all classes of shares received as consideration (\$4m) that the amount that would otherwise be the increase in PUC of the Class B Preferred shares as a result of the transfer (\$3m) is of the amount that would otherwise be the increase in PUC of all classes of shares as a result of the transfer (\$10m). Accordingly, the amount of the PUC reduction in respect of the Class B Preferred shares is \$1.2m and the net increase in PUC of the Class B Preferred shares as a result of the transfer becomes \$1.8m. The PUC reduction in respect of the common shares is the proportion of the amount of the PUC reduction of all classes of shares received as consideration (\$4m) that the amount that would otherwise be the increase in PUC of the common shares as a result of the transfer (\$2m) is of the amount that would otherwise be the increase in PUC of all classes of shares as a result of the transfer (\$10m). Accordingly, the amount of the PUC reduction in respect of the common shares is \$800k and the net increase in PUC of the common shares as a result of the transfer becomes \$1.2m. Question 3 Suppose that the amount added by Opco to the stated capital for corporate law purposes of the various classes of shares is \$4.5m for the Class A Preferred shares, \$1.5m for the Class B preferred shares and nil for the common shares. What will the PUC be of the Class A Preferred shares, the Class B Preferred shares and the common shares of Opco? There will be no reduction in PUC under subsection 85(2.1). The increase in the PUC of all classes of shares received as consideration (\$6m) does not exceed the maximum permitted increase in PUC (\$6m). The PUC will be equal to the corporate law stated capital (subject to any

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