1. Tax Lesson 25 YOURLOGO Start Lecture
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2. Other Rollovers
Other rollovers exist, though section 85 is probably the most widely used. These other rollovers allow for an automatic tax-free sale of assets (i.e., a rollover) if certain conditions are met. These rollovers, if applicable, are automatic which means that no election form needs to be filed. Note: only one rollover will apply. For example, if the conditions of section 85 are met (including filing the election form) then only the section 85 rollover will apply since it takes precedence over the “automatic” rollovers
They are tax-free which means generally speaking the seller has a disposition at cost (and hence no gain is triggered). And, they are a rollover, which means that the tax attributes, i.e., ACB (and PUC for shares) to the seller just flow through and become ACB (and PUC for shares) to the buyer
These other rollovers include:
Convertible securities, i.e., securities that can be converted from one security to another (e.g., convertible bonds that can be converted into shares; section 51). In order to qualify as a tax-free rollover, the securities must be capital property and no cash or other assets can be received upon the conversion
Share capital reorganizations, i.e., when the share capital of a corporation is changed (section 86). For example, the company has one class of common shares but they want 2 classes of common shares so they can pay different dividends to different shareholders, or as part of an estate freeze

3. Other Rollovers (cont)
An estate freeze is a tax plan that your client can do while he/she is alive. He/she can transfer assets that will grow in value (such as common shares or investments) to a Canadian company in return for fixed value (redeemable and retractable) preferred shares (that will not grow in value). Section 85 or 86 is used so that this transfer is tax-free. Someone younger, such as the taxpayer’s child or grandchild, will subscribe for new common shares (that will grow in value). When your client eventually passes away, he/she has a deemed disposition of all assets at FMV; however, his/her assets are frozen in value (at the FMV at the time of the estate freeze). Notice how your client’s tax liability on death is also frozen in value (at a lower amount). The future growth will be taxed later, in the child or grandchild’s hands, when the child or grandchild disposes of the new common shares In order to qualify as a tax-free section 86 rollover: (a) the shares must be capital property; (b) all of the shares of the particular class owned by the taxpayer must be exchanged; and (c) new shares must be received

4. Example Problem Section 86 and Estate Freeze
Max owns all the shares of MK Investments Inc. (MKI), a private Canadian corporation. Max does not frequently buy or sell securities. MKI was incorporated in 1991 by Max’s mother, Samantha and it has a January 31st year-end. Upon incorporation, Samantha paid $2,000 into the company in return for 1,000 common shares. MKI does not have any other shares issued. On July 2, 2003 Samantha decided to retire and she sold all of her shares to Max for $3 million (which was their FMV). On February 1, 2016, when MKI had a FMV of $7 million, Max decided to do an estate freeze and the company underwent a reorganization of share capital. Max expects MKI to continue to grow in value. As part of the reorganization, Max gave up all of his 1,000 common shares and received 100 new voting preferred shares redeemable and retractable for $7 million in aggregate. Immediately after this share capital reorganization, Max’s child Fred, who is a responsible adult, used his own money to purchase 500 new common shares of MKI for $500 (in aggregate). Max does not want to file a subsection 85(1) election. Describe the tax consequences to Max.

5. Example Problem Section 86 and Estate Freeze (cont)
An arm’s length share-for-share exchange (section 85.1). A share for share exchange is when a taxpayer sells shares of one company (Company A) to another company (Company B) and Company B pays by issuing its own shares
This automatic rollover only applies if: (a) the seller and purchaser are not related (both before and after the transaction); (b) the shares are capital property; and (c) no non-share consideration (boot) is received. Note: this rollover is different from the section 85 rollover discussed above. (Section 85.1 is a separate section of the Act from section 85)
If you file a section 85 election form then section 85 applies (not section 85.1)

6. Example Problem Section 85.1
Paul is the sole shareholder and president of Softwood Inc. (SI). A purchaser is interested in purchasing Paul’s shares of SI which, in aggregate, are worth $3M, have an ACB of $100,000 and a PUC of $25,000. SI operates an active business in Ontario and has a December 31st year-end. Purchase Inc., a Canadian private company, has offered 15,000 of its own common shares in return for all of Paul’s SI shares. The deal is expected to close on August 10, Purchase Inc.’s shares have a FMV of $200 per share. Paul and Purchase Inc. have never had any prior business dealings with each other and are not related. Prior to this transaction with Paul, Purchase Inc. had 60,000 common shares issued and outstanding. Paul’s SI shares are qualified small business corporation shares; however, Paul has already used up all of his capital gains exemption on past sales of other QSBC shares. Assume that Paul does not want to use section 85 of the Act. What are the tax consequences to Paul from the proposed sale of his shares of SI?

7. Example Problem Section 85.1 (cont)
An amalgamation, i.e., where two or more corporations legally become one. This triggers deemed year-ends in the predecessor corporations and a new company is formed. The new company picks a new year-end (it cannot exceed 53 weeks)
The deemed year-ends could lead to a short taxation year and could lead to 2 taxation years in one calendar year. With a short taxation year, certain things like CCA and the $500k annual business limit for the small business deduction are prorated. With 2 taxation years in one calendar year, loss carryovers expire one calendar year earlier
All assets including tax losses (and liabilities) just flow through to the new corporation (at cost, i.e., a tax-free rollover) [section 87]
Hence, if you have 2 companies, one profitable and the other with tax losses you should consider amalgamating the 2 so that the losses from one can be used against future profits in the new amalgamated company

8. Example Problem Section 85.1 (cont)
Hence, if you have a Parent and Subsidiary and one is profitable and the other has tax losses you should consider winding up the Subsidiary into the Parent (or amalgamating the 2) so that the losses from one can be used against future profits of the Parent
With an amalgamation or a wind-up of a 90% owned (or more) subsidiary, the shareholders are deemed to dispose of their old shares at cost (hence no capital gain is triggered) and if they receive new shares they have the same tax attributes (i.e., ACB/PUC) as their old shares
Note: an amalgamation or a wind-up is not an acquisition of control (discussed below)
Also, if there is a vertical amalgamation (i.e., an amalgamation of a 100% owned subsidiary and its parent) or a wind-up of a 90% owned (or more) subsidiary into its parent then an 88(1)(d) bump is available
Paragraph 88(1)(d) allows an increase in the ACB of non-depreciable capital property (i.e., land and/or marketable securities) owned by the subsidiary prior to the amalgamation/wind-up. Increasing ACB will lead to lower future capital gains and less tax in the future

9. Example Problem Amalgamation
Patty owns 100% of the shares of PR Inc. (PRI) a CCPC. PRI owns 100% of the shares of Y Inc., which is also a CCPC. Both PRI and Y Inc. operate an active business in Toronto and both have August 31 year-ends. In order to simplify things, and to reduce costs, Patty has decided to amalgamate the two companies on September 1, When PRI bought all the shares of Y Inc. it paid $265,000 in aggregate for the shares. A balance sheet for Y Inc. is given below. Assume that the balance sheet values (below) have remained constant from the day that PRI purchased the shares of Y Inc. until the amalgamation. Y Inc. has never paid any dividends. Discuss the tax consequences of the amalgamation.

10. Example Problem Amalgamation (cont)
Y Inc. (in ‘000s)
Tax Cost FMV
Equipment $59 $75
Marketable securities $100 $125
Land (capital property) $101 $105
Total assets $260 $305
Liabilities $40 $40
Net assets $220 $265

11. Acquisition of Control (AOC)
An AOC occurs when more than 50% of the voting shares of a corporation are acquired from an unrelated person. If shares are purchased from a related person then there will not be an AOC. An amalgamation is not an AOC as long as the shareholders of the old companies become shareholders of the new (amalgamated) company. A wind-up is not an AOC
There will be a deemed AOC when more than 75% of the FMV of all shares of a corporation have been acquired from an unrelated person, and there has not been an AOC, and one of the main reasons that control was not acquired was to avoid the AOC loss restrictions. A deemed AOC has the same tax consequences as an AOC
If there is an AOC several tax consequences will automatically occur. These tax consequences happen to the company whose control has been acquired. The company whose control has been acquired will have the following occur:
A deemed year-end the day before the AOC. This will typically trigger a short taxation year. The company can pick a new year-end which cannot exceed 53 weeks (this can lead to 2 tax years in one calendar year)

12. Acquisition of Control (AOC) (cont)
Unrealized losses are deemed to be realized. Note: typically assets have to be disposed of (at a loss) for a loss to be realized
Most losses (e.g., capital losses, property losses) will expire immediately after the deemed year-end. Non- capital losses (i.e., business losses) will not expire immediately if they meet the following conditions: (a) the same business is carried on; and (b) there is a reasonable expectation of profit (at the time of acquisition). (Non-capital losses that meet this condition will eventually expire, if not used, since non-capital losses have a 20 year carryforward period)
An election exists that allows a taxpayer (whose control has been acquired) to elect to dispose of capital property that has increased in value for a chosen elected amount
The minimum elected amount is the tax value of the asset and the maximum elected amount is the FMV of the asset. This election allows taxpayers to trigger capital gains to use up some (or all) of the capital losses that will otherwise expire due to the AOC

13. Example Problem Acquisition of Control
Your client, Pat Co., has purchased 100% of the shares of Matt Inc. from an unrelated person on October 1, Matt Inc. is a CCPC that was incorporated on January 1, 2015 and it has a December 31st year-end. Matt Inc. has the following loss carryforwards: Net-capital loss Non-capital loss December 31, 2015 $50,000 $100,000

14. Example Problem Acquisition of Control (cont)
Matt Inc.’s financial statements show that the company lost $160,000 from business operations from January 1 to September 30, Matt Inc. had the following assets as of September 30, 2016: Cost/ACB UCC/CEC FMV Marketable securities $55,000 $45,000 Accounts receivable $110,000 $103,000 Inventory (valued at cost) $2,035,000 $3,050,000 Land $220,000 $300,000 Building $350,000 $343,500 $340,500 Equipment $600,000 $540,000 $580,000 Cumulative eligible capital $109,000 $76,000 $80,000 Calculate Matt Inc.’s net-capital and non-capital losses as of September 30, 2016 and state when these losses will expire. Is there any election that can assist with losses that may expire? Assume that Pat Co. wants Matt Inc. to keep its December 31st year-end. Assume also that Pat Co. and Matt Inc. operate a similar business and Matt Inc. will continue to operate and it has a reasonable expectation of profit.