Chapter 19 Other Rollovers, Business Valuation, Sale Of An Incorporated Business, And Tax Shelters

© 2007, Clarence Byrd Inc. 2 Share For Share Exchange - ITA 85.1 Application –Automatic –Can Elect Out In Tax Return

© 2007, Clarence Byrd Inc. 3 ITA 85.1 Example May Ltd. FMV = $700,000 ACB = $100,000 PUC = $100,000 Ms. May (100%) Acquirer Ltd. (A Large Public Company) May C/S 100% Acquirer C/S

© 2007, Clarence Byrd Inc. 4 ITA 85.1 Example No Capital Gain For Ms. May –POD –POD = Old ACB = $100,000 [ITA 85.1(1)(a)(i)] ACB For Ms. May’s Acquirer Shares –ACB(Old) –ACB(Old) = ACB(New) = $100,000 [ITA 85.1(1)(a)(ii)] ACB For Acquirer’s May Shares –Lesser –Lesser Of FMV And PUC = $100,000 [ITA 85.1(1)(b)] PUC Of Acquirer’s New Shares –Old –Old PUC = $100,000

© 2007, Clarence Byrd Inc. 5 Conditions For Rollover Transferred Shares: Taxable Canadian Property Purchaser: Taxable Canadian Corporation Consideration: Shares Of A Single Class Relationship: Arm’s Length Vendor: Must Not Control Purchaser No ITA 85(1) Election No Gain Or Loss Recognition

© 2007, Clarence Byrd Inc. 6 Reorganization - ITA 86 Application –Financial Distress –Estate Freeze –Takeover By Key Employee

© 2007, Clarence Byrd Inc. 7 ITA 86 Conditions Articles Of Incorporation Must Provide For All Types Of Shares To Be Used Consideration Can Include Non-Share Consideration Up To The ACB Of Redeemed Shares (Generally Does Not) Shares Must Be Capital Property Classes And Quantities All Shares Of A Particular Class Held By Shareholder

© 2007, Clarence Byrd Inc. 8 Tax Consequences Cost Of Boot - ITA 86(1)(a) –Equal To FMV Cost Of New Shares - ITA 86(1)(b) –Old ACB, Less Boot Proceeds Of Redemption - ITA 84(5)(d) –Boot, Plus PUC Of New Shares Proceeds Of Disposition - ITA 86(1)(c) –Boot, Plus ACB Of New Shares PUC Reduction - ITA 86(2.1)(a) –New LSC, Less (Old PUC - Boot)

© 2007, Clarence Byrd Inc. 9 ITA 86(1) - Example One Shirley Foley owns 100 percent of the outstanding common shares of Foley Inc. The shares have a PUC and an ACB equal to $100,000. Their FMV is $1,000,000. Foley Inc. $ 75,000 Note $925,000 P/S (LSC = FMV) Foley Inc. Shares

© 2007, Clarence Byrd Inc. 10 Example One Results ACB Of Boot –$–$–$–$75,000 ACB Of New Shares –$–$–$–$100,000 - $75,000 = $25,000 PUC Reduction –$–$–$–$925,000 - ($100,000 - $75,000) = $900,000 –N–N–N–New PUC = $925,000 - $900,000 = $25,000 Proceeds Of Redemption –$–$–$–$25,000 + $75,000 = $100,000 Proceeds Of Disposition –$–$–$–$25,000 + $75,000 = $100,000

© 2007, Clarence Byrd Inc. 11 Example One - Tax Implications ITA 84(3) Dividend – Immediate –$100,000 - $100,000 = Nil Capital Gain – Immediate –$100,000 - $100,000 = Nil Subsequent Redemption –ITA 84(3) Dividend = $925,000 - $25,000 = $900,000 Subsequent Sale –Capital Gain = $925,000 - $25,000 = $900,000

© 2007, Clarence Byrd Inc. 12 ITA 86(1) - Example Two Shirley Foley owns 100 percent of the outstanding common shares of Foley Inc. The shares have a PUC of $100,000 and an ACB equal to $75,000. Their FMV is $1,000,000. Foley Inc. $ 75,000 Note $925,000 P/S (LSC = FMV) Foley Inc. Shares

© 2007, Clarence Byrd Inc. 13 Example Two Results ACB Of Boot –$75,000 ACB New Shares –$75,000 - $75,000 = Nil PUC Reduction –$925,000 - ($100,000 - $75,000) = $900,000 –New PUC = $925,000 - $900,000 = $25,000 Proceeds Of Redemption –$25,000 + $75,000 = $100,000 Proceeds Of Disposition –Nil + $75,000 = $75,000

© 2007, Clarence Byrd Inc. 14 Example Two - Tax Implications ITA 84(3) Dividend – Immediate –$100,000 - $100,000 = Nil Capital Gain – Immediate –$75,000 - $75,000 = Nil Subsequent Redemption –ITA 84(3) Dividend = $925,000 - $25,000 = $900,000 –Capital Gain = ($925,000 - $900,000) - Nil = $25,000 Subsequent Sale –Capital Gain = $925,000 - Nil = $925,000

© 2007, Clarence Byrd Inc. 15 ITA 86(1) - Example Three Shirley Foley owns 100 percent of the outstanding common shares of Foley Inc. The shares have a PUC of $50,000 and an ACB equal to $100,000. Their FMV is $1,000,000. Foley Inc. $ 75,000 Note $925,000 P/S (LSC = FMV) Foley Inc. Shares

© 2007, Clarence Byrd Inc. 16 Example Three Results ACB Of Boot –$75,000 ACB Of New Shares –$100,000 - $75,000 = $25,000 PUC Reduction –$925,000 - ($50,000 - $75,000) = $925,000 –New PUC = $925,000 - $925,000 = Nil Proceeds Of Redemption –Nil + $75,000 = $75,000 Proceeds Of Disposition –$25,000 + $75,000 = $100,000

© 2007, Clarence Byrd Inc. 17 Example Three Tax Implications ITA 84(3) Dividend – Immediate –$75,000 - $50,000 = $25,000 Capital Loss – Immediate –($100,000 - $25,000) - $100,000 = ($25,000) Subsequent Redemption –ITA 84(3) Dividend = $925,000 - Nil = $925,000 –Capital Loss = $925,000 - $925,000 - $25,000 = ($25,000) Subsequent Sale –Capital Gain = $925,000 - $25,000 = $900,000

© 2007, Clarence Byrd Inc. 18 ITA 86(2) Gifting Rule Conditions –FMV of old shares is greater than FMV of new shares plus boot –Excess can be regarded as a gift (A related party is a shareholder)

© 2007, Clarence Byrd Inc. 19 ITA 86(2) – Gifting Results POD (Old) - ITA 86(2)(c) - Lesser Of –Boot, Plus Gift –FMV Of Old Shares Loss On Old –Deemed Nil Under ITA 86(2)(d) –Gain Will Be Taxed ACB (New) - ITA 86(2)(e) –ACB (Old), Less (Boot + Gift)

© 2007, Clarence Byrd Inc. 20 ITA 86(2) Example Mr. Stern owns 80 percent of the outstanding common shares of Stern Ltd. The remaining 20 percent are held by his son. The common shares have a PUC and an ACB of $600,000. Their fair market value is $1,000,000. Stern Ltd. $200,000 Cash $500,000 P/S (LSC = FMV) 80% Of Stern Ltd. C/S

© 2007, Clarence Byrd Inc. 21 ITA 86(2) Example One PUC Reduction –$500,000 –$500,000 - ($480,000 - $200,000) = $220,000 –New –New PUC = $500,000 - $220,000 = $280,000 Gift –$800,000 –$800,000 - $700,000 = $100,000 Non-Share Consideration –$200,000 –$200,000 Cash

© 2007, Clarence Byrd Inc. 22 ITA 86(2) Example Cost Of New Shares –$480,000 - ($200,000 + $100,000) = $180,000 Proceeds Of Redemption - Old Shares –$200,000 + $280,000 = $480,000 ITA 84(3) Deemed Dividend –Proceeds Of Redemption Equals Old PUC: No ITA 84(3) Deemed Dividend

© 2007, Clarence Byrd Inc. 23 ITA 86(2) Example One Proceeds Of Disposition –$200,000 + $100,000 = $300,000 Capital Gain - A Disallowed Loss –$300,000 - $480,000 = Nil [ITA 86(2)(d)] Net Economic Effect –No ITA 84(3) Dividend Or Capital Gain –Deferred Gain = $500,000 - $180,000 = $320,000 –Son’s Shares Up $100,000 (No Increase In ACB)

© 2007, Clarence Byrd Inc. 24 Amalgamations - ITA 87 Automatic, No Election Required A Type Of Business Combination

© 2007, Clarence Byrd Inc. 25 Basic Procedure A Ltd. & B Ltd. Shareholders Company A Company B AB Ltd. A And B Ltd. Shares AB Shares Assets

© 2007, Clarence Byrd Inc. 26 Conditions Predecessor Corporations –Must Be Taxable And Canadian – ITA 87(1)(a) Property To Corporation –All Assets And Liabilities Of Both Companies - ITA 87(1)(a) And (b) Consideration –All Shareholders Must Receive Shares – ITA 87(1)(c)

© 2007, Clarence Byrd Inc. 27 Economic Outcome Assets And Liabilities Carried Over At Old Tax Values New Shares At ACB Of Old Shares

© 2007, Clarence Byrd Inc. 28 Position Of New Corporation Asset Transfers –Inventory At Cost –Depreciable Property At UCC Retain Old Capital Cost For Recapture And Capital Gains –Non-Depreciable Capital Property At ACB –Eligible Capital Property At 4/3 CEC

© 2007, Clarence Byrd Inc. 29 Position Of New Corporation Tax Accounts –Capital Dividend Accounts Transferred –RDTOH Balances Transferred –Both Corporations Must Be Private

© 2007, Clarence Byrd Inc. 30 Position Of New Corporation Deemed Year End –Old Corporations Likely To Be Short Fiscal Year For CCA And SBD Counts As A Year For Loss Carry Forward Purposes –New Corporation Can Choose Any New Fiscal Year May Also Be Short

© 2007, Clarence Byrd Inc. 31 Position Of New Corporation Loss Carry Forwards - ITA 87(2.1) – Number Of Available Years Not Changed –Deemed Year End Counts As One Year –There May Or May Not Be An Acquisition Of Control (Usually Not) GRIP carried forward

© 2007, Clarence Byrd Inc. 32 Position Of Shareholders Transfer Values –POD (Old) = ACB (Old) –ACB (New) = POD (Old) –Therefore: ACB (Old) = ACB (New) Conditions –Consideration Is Shares Of Successor Corporation –Original Shares Are Capital Property –Gift To Related Parties Prohibited

© 2007, Clarence Byrd Inc. 33 Asset Bump Up A bump up of non- depreciable asset values is possible (see discussion under ITA 88(1) wind up)

© 2007, Clarence Byrd Inc. 34 Tax Planning Utilization Of Losses Utilization Of UCC Balances Enhanced M&P Deduction Change In Fiscal Year Carry Forward Of Losses, Capital Dividend, RDTOH, and GRIP

© 2007, Clarence Byrd Inc. 35 Winding-Up Of A Subsidiary - ITA 88(1) Subsidiary Parent Company Assets At Tax Values Sub shares cancelled

© 2007, Clarence Byrd Inc. 36 Conditions 90 Percent Owned Subsidiary Both Are Taxable Canadian Corporations Consistent With Relevant Legislation

© 2007, Clarence Byrd Inc. 37 POD To Subsidiary Inventory At Cost Non-Depreciable At ACB CEC At 4/3 Balance Depreciable At UCC (Capital Cost Retained) Reserves - Carried Forward

© 2007, Clarence Byrd Inc. 38 Cost To Parent Equal To The POD To The Subsidiary

© 2007, Clarence Byrd Inc. 39 Bump-Up In Asset Values Non-Depreciable Owned Since Acquisition Bump-Up = Lesser of: –[FMV (At Acquisition) – Cost] –ACB Of Shares, Less Cost Of Subsidiary’s Net Assets Dividends Paid To The Parent Since Acquisition

© 2007, Clarence Byrd Inc. 40 Subsidiary Losses Deduct In Parent’s First Year Following Year Of Wind-Up Based On Parent’s Year In Which The Subsidiary’s Year End Falls

© 2007, Clarence Byrd Inc. 41 POD Of Shares Greater Of: –Lesser Of PUC Cost Of Net Assets –ACB Of The Shares No Loss Is Possible

© 2007, Clarence Byrd Inc. 42 Convertible Properties ITA 51 Conversion Of Bond Or P/S To C/S General Rules –ACB Of C/S = ACB Of Debt Or P/S –No Non-Share Consideration –PUC - Increase On C/S Equals Carrying Value Of Debt To Avoid ITA 84(1) Dividend Gifting Rules

© 2007, Clarence Byrd Inc. 43 Valuation Of A Business Asset Based Methods Income Based Methods –Gross Revenues –Earnings

© 2007, Clarence Byrd Inc. 44 Sale Of An Incorporated Business Alternatives –Sale Of Assets With Wind-Up Following –Sale Of Shares (Corporation Continues)

© 2007, Clarence Byrd Inc. 45 Restrictive Covenants (a.k.a. Non-Competition Agreements) Taxpayer Agrees To Have His Ability To Provide Goods Or Services Restricted In General, Included In Income [ITA 56.4(2)] Exceptions –ITA 56.4(3)(a) – Employment Income –ITA 56.4(3)(b) – Cumulative Eligible Capital –ITA 56.4(3)(c) – Sale Of An Eligible Interest

© 2007, Clarence Byrd Inc. 46 Asset Dispositions Accounts Receivable - ITA 22 Inventories - ITA 23 Prepayments - No specific rules

© 2007, Clarence Byrd Inc. 47 Asset Dispositions Non-Depreciable Assets –Capital Gain Or Loss With No Reserves Depreciable Assets –Recapture, Terminal Loss, Or Capital Gain –General Rules Goodwill –3/4 Of Proceeds To Income

© 2007, Clarence Byrd Inc. 48 Proceeds > PUC ITA 84(2) Deemed Dividend –Capital Dividend (If Elected) Not Taxed –Pre-1972 CSOH Distribution Deemed Not To Be A Dividend ITA 88(b)(ii) –Taxable Dividend

© 2007, Clarence Byrd Inc. 49 Wind-Up Procedures Liquidate Or Distribute Assets Pay Liabilities Determine Pre-1972 CSOH, RDTOH, And Capital Dividend Account Distribute Proceeds [Elect Under ITA 83(2)] Establish Dividend Refund On Taxable Dividends

© 2007, Clarence Byrd Inc. 50 Sale Of Shares Pay Out Capital Dividend And RDTOH Prior To Sale POD - ACB = Gain Or Loss On Sale

© 2007, Clarence Byrd Inc. 51 Advantages - Sale Of Shares Single stage transaction - no corporate tax All income is capital gains –1/2 Taxable –ITA (Lifetime capital gains) Loss carry forwards can survive Payment for restrictive covenant can be included in POD No real estate transfer taxes

© 2007, Clarence Byrd Inc. 52 Advantages - Sale Of Assets Bump-Up In Asset Values Goodwill Recognized Redundant Assets Can Be Left Out Vendor Can Get Losses On Individual Assets No Reassessments

© 2007, Clarence Byrd Inc. 53