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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.

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Presentation on theme: "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."— Presentation transcript:

1 An actual receipt

2 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.mooncakewhatever 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.

3 Chapter 16 - Rollovers

4 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

5 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

6 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

7 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.

8 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

9 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

10 Elected amount Concept of elected amount –Transfer assets and elect the PoD –Cannot create a loss –Elect between tax value and FMV

11 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)

12 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

13 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.

14 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

15 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

16 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

17 3 – lets look at it this way Stated capital (FMV of land is 50,000 less boot of 18,000 32,000 Minus elected amount18,000 Less boot18,000NIL PUC reduction32,000 PUC = FMV – PUC reduction (32,000 – 32,000)NIL

18 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

19 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

20 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

21 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 LOWER LIMIT par 85(1)(e.3) Greater of Par 85(1)(b)FMV of non-share consideration received and Lesser of par 85(1)(c.1) Least of par 85(1)(e) Least of par 85(1)(d) 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

22 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

23 Range of Elected Amounts Range 123 100FMV TV 75TVBOOTFMV 60BOOTTVBOOT 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

24 Application ConsiderationABC Cash etc01,0001,300 Preferred shares (FMV and legal stated capital) 1,000300180 Common shares (FMV and legal stated capital) 50020020 TOTAL1,500 Election range High1,500 Low1,000 1,300 Election price (assume lowest)1,000 1,300 ACB1,000 Capital gain00300 Taxable capital gain00150 Transfer of property with ACB of $1,000 and FMV of $1,500

25 YOUR TURN Tax valueFMV Short term investments15,00018,000 Inventory45,00046,000 Machinery (cost 54,375)26,25038,500 Goodwill030,000 86,250132,500 Liabilities10,000 76,250122,500 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

26 Solution – determine elected amounts FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,000 Invent.45,00046,000 Machine26,25038,500 GoodwillNIL30,000 TOTAL86,250132,500

27 Solution – determine elected amounts FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,000 Invent.45,00046,00045,000 Machine26,25038,50026,250 GoodwillNIL30,0001 TOTAL86,250132,50086,251

28 Solution – allocate boot FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,00010,0005,000 Invent.45,00046,00045,000 Machine26,25038,50026,250 GoodwillNIL30,0001 TOTAL86,250132,50086,25110,0005,000

29 Solution – allocate boot FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,00010,0005,000 Invent.45,00046,00045,000 Machine26,25038,50026,250 GoodwillNIL30,0001 TOTAL86,250132,50086,25110,00050,000

30 Solution – allocate boot FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,00010,0005,000 Invent.45,00046,00045,000 Machine26,25038,50026,25020,000 GoodwillNIL30,0001 TOTAL86,250132,50086,25110,00070,000

31 Solution – allocate preferred shares FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,00010,0005,0003,000 Invent.45,00046,00045,000 Machine26,25038,50026,25020,000 GoodwillNIL30,0001 TOTAL86,250132,50086,25110,00070,0003,000

32 Solution – allocate preferred shares FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,00010,0005,0003,000 Invent.45,00046,00045,000 1,000 Machine26,25038,50026,25020,000 GoodwillNIL30,0001 TOTAL86,250132,50086,25110,00070,0004,000

33 Solution – allocate preferred shares FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,00010,0005,0003,000 Invent.45,00046,00045,000 1,000 Machine26,25038,50026,25020,00018,500 GoodwillNIL30,0001 TOTAL86,250132,50086,25110,00070,00022,500

34 Solution – allocate preferred shares FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,00010,0005,0003,000 Invent.45,00046,00045,000 1,000 Machine26,25038,50026,25020,00018,500 GoodwillNIL30,000112,500 TOTAL86,250132,50086,25110,00070,00035,000

35 Solution – allocate common shares FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,00010,0005,0003,000 Invent.45,00046,00045,000 1,000 Machine26,25038,50026,25020,00018,500 GoodwillNIL30,000112,50017,500 TOTAL86,250132,50086,25110,00070,00035,00017,500

36 Solution – income inclusion FMV of consideration Tax valueFMVElectedAssumed debt New debtPreferred shares Common shares Income Short term invest. 15,00018,00015,00010,0005,0003,0000 Invent.45,00046,00045,000 1,0000 Machine26,25038,50026,25020,00018,5000 GoodwillNIL30,000112,50017,500$0.50 TOTAL86,250132,50086,25110,00070,00035,00017,5000.50

37 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

38 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

39 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

40 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

41 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 5,000A Elected amt10,000 Less boot10,000 ExcessNILB Grind(A-B)5,000 Tax PUCNIL

42 The effect With reductionNo reduction Proceeds5,000 Less PUCNIL5,000 Deemed dividend5,000NIL Proceeds5,000 Deemed dividend5,000NIL ProceedsNIL5,000 ACBNIL Capital gainNIL5,000 The PUC reduction converts the capital gain into a deemed dividend

43 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

44 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

45 Summary of Rules Property transferredFMV of non share consideration FMV of total consideration >FMVElected 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 FMVOptimal FMV of total consideration Tax valueMinimum 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 0

46 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

47 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

48 Example

49 Worksheet setup

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56 Examples Problem 3 Problem 5

57 Next week Read Chapter 17 Do the following from chapter 16: –Problem 6 Assignment #2: problem 8


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