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CHAPTER 16

Income Deferral: Rollover on Transfers to
a Corporation and Pitfalls
Solution 1 (Basic)
Land(1) .........................................................................................
Marketable securities(2) ................................................................
Building(3) ...................................................................................
Equipment(4) ................................................................................
Furniture and fixtures(5) ................................................................
Licence(6).....................................................................................

Min. elected
amount
$
60,000
60,000
70,000
45,000
7,000
80,000

Income
Nil
$
2,500
Nil
5,000
Nil
Nil

Max. boot
$
60,000
55,000
70,000
40,000
7,000
80,000

—NOTES TO SOLUTION
(1) (a) Minimum elected amount:
Greater of:
(i) FMV of boot .....................................................................................................
(ii) Lesser of:
(A) FMV of property ................................................................. $ 75,000
(B) ACB ...................................................................................

$

$

50,000

$

60,000

$

60,000
(60,000)
Nil

$

60,000

$

55,000

$
$
$

60,000
55,000
5,000
2,500

$

55,000

$

70,000

$

70,000
(85,000)
Nil

$

70,000

60,000

(b) Income:
Proceeds ..........................................................................................................................
Cost.................................................................................................................................
Capital gain/loss ..............................................................................................................
(2) (a) Minimum elected amount:
Greater of:
(i) FMV of boot .....................................................................................................
(ii) Lesser of:
(A) FMV of property ................................................................. $ 65,000
(B) ACB ................................................................................... $ 55,000
(b) Proceeds ..........................................................................................................................
Cost.................................................................................................................................
Gain ................................................................................................................................
Taxable capital gain .........................................................................................................
(3) (a) Minimum elected amount:
Greater of:
(i) FMV of boot .....................................................................................................
(ii) Least of:
(A) FMV of property ................................................................. $ 95,000
(B) UCC of class ....................................................................... $ 70,000
(C) Cost of property .................................................................. $ 85,000
(b) Taxable capital gain:
Proceeds ..................................................................................................................
Cost .........................................................................................................................
Gain/Loss.................................................................................................................
Terminal loss/Recapture:
UCC ........................................................................................................................
Less: lesser of:
(i) Capital cost ......................................................................... $ 85,000

70,000
(ii) Proceeds .............................................................................

$

70,000
Nil

269

270

Introduction to Federal Income Taxation in Canada
(4) (a) Minimum elected amount:
Greater of:
(i) FMV of boot .....................................................................................................
(ii) Least of:
(A) FMV of property ................................................................. $ 50,000
(B) UCC of property.................................................................. $ 40,000
(C) Cost of property .................................................................. $ 65,000
(b) Taxable capital gain:
Proceeds ..................................................................................................................
Cost .........................................................................................................................
Recapture:
UCC ........................................................................................................................
Less: lesser of:
(i) Capital cost ......................................................................... $ 65,000

$

45,000

$

40,000

$

50,000
(65,000)
Nil

$

40,000
45,000

(ii) Proceeds ............................................................................. $ 45,000
Recapture .................................................................................................................
(5) (a) Minimum elected amount:
Greater of:
(i) FMV of boot .....................................................................................................
(ii) Least of:
(A) FMV of property ................................................................. $ 10,000
(B) UCC of class ....................................................................... $
7,000
(C) Cost of property .................................................................. $ 15,000
(b) Taxable capital gain:
Proceeds ..................................................................................................................
Cost .........................................................................................................................
Gain/Loss.................................................................................................................
Recapture/Terminal loss:
UCC ........................................................................................................................
Less: lesser of:
(i) Capital cost ......................................................................... $ 15,000

$

5,000

$

5,000

$

7,000

$

7,000
(15,000)
Nil

$

7,000
7,000

(ii) Proceeds ............................................................................. $
7,000
Recapture
(6) (a) Minimum elected amount:
Greater of:
(i) FMV of boot .....................................................................................................
(ii) Least of:
(A) FMV of property ................................................................. $ 100,000
(B) 4/3 of CEC ........................................................................... $ 80,000
(C) Cost of property .................................................................. $ 82,500
(b) CEC ................................................................................................................................
Proceeds: 3/4  $80,000 ....................................................................................................

Nil

$

15,000

$

80,000

$

60,000
60,000
Nil

Solutions to Chapter 16 Assignment Problems

271

Solution 2 (Basic)
Section 85 rollover
Elijah has only two assets eligible for a subsection 85(1) rollover: the office equipment and the goodwill. To
ensure that no income arises on transferring these assets to the corporation, the total elected amount to be agreed
on between him and the corporation should not exceed $10,001. The maximum non-share consideration that
Elijah can receive while deferring the maximum amount of gain is $10,001.
Asset
Office equip.
Goodwill

Tax Value
$10,000
Nil
$10,000

FMV
$12,000
20,000
$32,000

Elected
Amount
$10,000
1
$10,001

Assumed
Debt
$9,000
$9,000

New
Debt
$1,000
1
$1,001

Shares
$ 2,000
19,999
$21,999

Other transferred property (non-section 85)
Asset
Cash
Accounts receivable**

FMV Transfer
$ 5,000
$15,000
$20,000

Consideration received
$ 5,000 note payable to Elijah
$15,000 note payable to Elijah
$20,000

** An election should be filed under section 22 with regard to the transfer of the receivables. Failure to file the election will
result in any bad debts realized by the company being considered capital losses rather than losses on income account.

Elijah’s income arising on the transfer
The only income realized by Elijah is the $1 from the disposition of the goodwill. The taxable portion of the
disposition of that, through the CEC account, is $0.50.
Tax Values of Assets Owned by the Corporation
Assets
Cash
Accounts receivable
Office equipment
Goodwill (¾ × $1.00)

$ 5,000.00
15,000.00
10,000.00
0.75
$30,000.75

Note that transfer of the bank loan to the corporation requires the approval of the bank. If the bank did not
approve, a note payable to Elijah can be substituted in the rollover.

....................500 $ 61..............000 less: boot .000 8.... 59.....000 $ 34...............e.............................. Total .............................................000 8..........000 Consideration Debt Shares $ 6.................. which was also the amount Pete elected for the transfer price and was the amount of non-share consideration Pete wished to assume... The transfer could be made through a direct sale........ The tax basis of all assets was $59...................000 (A) (b) elected amount ...............................000 Adjusted cost base of shares ...... —NOTE TO SOLUTION (1) Since there is no possible income to defer on a transfer to the corporation....................000 FMV $ 8.......... This nonshare consideration reduces the tax PUC of the common shares to nil................................000 30...500 $ 61.............................................Introduction to Federal Income Taxation in Canada 272 Solution 3 (Basic) The following assets cannot or should not be transferred using section 85: Cash (not eligible) .. Inventory(1) .....................................................000 39........... Cost of shares received as consideration: Elected transfer price ................... Building .............. 34............ debt and shares) was exactly equal to the FMVs of the transferred assets.000 Income Effect Nil Nil Nil There should be no adverse tax consequences on this transfer.........000 55..000 excess............... as all the tax-paid value of the assets is now in the form of the debt which Pete can withdraw tax-free as he wishes and as funds become available.000 10.....500 Minimum transfer price $ 6...............000 39.............................................000 $ 66...000 $ 2...000 $ 59.............................000 Subsection 85(2.. 59.................................1) reduction in PUC: (a) increase in LSC ....................500 Transfer price $ 22....................................000 $ 93. i...... In addition......................................................... which is a logical result.............. Tax value $ 6...000 Tax PUC after reduction ......000 $ 59..................... ........................................ if any ........000 45................................000 45.........................................500 $ 61......000 Deduct: non-share consideration......... $ 34.500) $ (4....... section 85 does not have to be used.......500) The following assets should be transferred using section 85: Furniture & fixtures ............................................................................000 45.... $ 34....000 22......... Nil Legal stated capital before reduction..........000 FMV $ 22...................................500 Income Effect Nil $ (4..000 8. $ 59..000 39. $ 59......... Nil The tax PUC after reduction reflects the fact that the tax-paid cost of the assets transferred has been recovered through the debt assumed....e.................................................. since the FMV of the consideration received (i. Tax value $ 22........ the non-share consideration did not exceed the tax values of the transferred assets.............. Land..........000 44.......................... $39.............. Nil (B) PUC reduction (A – B)......000................................500..... taking back debt consideration equal to the fair market value..........000 Debt $ 22.........000 $ 59..

.000 New Debt Nil 88...) Items transferred under section 85: Consideration Inventory ................ $ 10.....000)............................................................2)] ..600 (take back debt consideration) Items that should not be transferred to corporation: Shares If Ms............................... $ 1..................................... the consideration should be debt of $120......... Hart must transfer the business assets to Hart Ltd..000 52.. no income to defer) Total transfer price ........ $ 60....000 Nil $ 60.........000 140...................... section 74.....000 – $100... Since Mr.......000 $ 249..000) Land (inventory) ......................000 (B) Items not transferred under section 85: FMV Shares . — (do not transfer—see below) Prepaid insurance ............. — (do not transfer—see below) Accounts receivable ................ added to the adjusted cost base of the property owned by the corporation [par......... Hart is a shareholder of Hart Ltd......000 $ 101........000 Total income ...) Land inventory Not eligible for section 85 since not a capital property Do not transfer in since not needed for the business—better to postpone the realization of the $120.....000 of debt consideration..............................000 capital loss denied because it is a superficial loss............ it might be more advantageous to keep them out of the company and realize the loss personally rather than in the corporation....... qualifies as a small business corporation [ssec...............000 Land (inventory) Business income ($220............000 80................................ Tax value $ 8....... Nil Building Terminal loss denied [ssec........ 10............. 54]................000)]...000 20................................ 53(1)(f)] .....000 160. Goodwill................................................000 capital loss denied [par....... The shares should be sold for $6... as above] Nil Inventory Business income ..... 40(2)(g)]..... 40........... Nil Land (capital property) Taxable capital gain [1/2  ($160............ 1............. It may therefore make sense to keep the shares out of the corporation to ensure that Hart Ltd.000 Shares 1..................6].........................000 – 0)] ......................... Hart intends to sell the shares..000 80... $ 172....... paragraph 69(1)(b) will still deem Ms................ The shares would not be earning Canadian active business income.............................001 Assumed Debt $ 8...................000 $ Income Nil Nil $ 0........Solutions to Chapter 16 Assignment Problems 273 Solution 4 (Advanced) Note: Ms..........000 (use section 22 for full business loss of $4.............. 120...000 1 $ 148....................000 $ Elected Amount $ 8. because it is a superficial loss [sec..........000 business income (If the land inventory is to be transferred.......................... 110................ Hart’s proceeds to be FMV.000.. 248(1)] and a qualified small business corporation [sec..................4 may apply if Hart Ltd.............................................. at FMV in order to avoid the application of section 69.... If the property is transferred at less than FMV.......... 13(21........000 [$10. (A) Income for tax purposes if section 85 not used: Shares in public companies [$6......... 600 (not capital property) Building............................. It is unlikely that she would need the shares to carry on the business. Nil Accounts receivable (capital property) Include last year’s reserve ...................50 .......000 (unrealized terminal loss...................000 = $4...................000 Prepaid insurance Business income (loss) ($600 – $600) ... section 85 is not necessary because there is no gain.......................................50 $ 0....000 FMV 9... is not a small business corporation..............000 – $140.....000 = $5................................000 – $ 11............000 – $14..........................................000 Nil $ 148...000 Nil $ 88................ Land (capital property) ..... (If the shares are to be transferred..000 Goodwill Business income [2/3  3/4  ($80........ 50........000 140............................................

................................ 8............................................................................001 Less: boot ............. 140..999 $ 101............................... 85(1)(a)] CEC = 3/4  $1 elected amount – 1/2  $0..............................Introduction to Federal Income Taxation in Canada 274 ACB of shares received: Elected transfer price ........ $ 101............................................000 100............... Land inventory* ................................. Capital cost is deemed to be $90.........................................................................000 1 $ 100................................ Less: Adjusted cost base ..........................000 New debt issued .......................... $ 101... 88. $ 101........ (D) Proceeds of redemption ........ Subsection 85(2........ Tax cost $ 11..... 85(5)(b)]........................ ssec....000 ACB of shares ..................................................................000 600 50.........................................................................................................500 $ 101........................................ Proceeds of disposition .....000 148.................................................................................. 53(1)(f)] Actual cost $14................000(A) (B) Elected amount ............................................................................... Tax PUC after reduction ...... 84(3)]. if any ...........001 Allocated to debt consideration Debt assumed............... Adjusted cost base..000 Accounts receivable .................1) reduction in PUC (A) Increase in LSC of all shares ................ $ 1 PUC of shares received: LSC before reduction ...........................................................................................................................999 $ 50........ Less: PUC............ 84(3)]......000 Inventory .............................. Capital gain (loss) ............................................... 85(1)(a)] FMV transfer price FMV transfer price UCC is deemed to be $50.............................................................. 85(5)(a)] elected amount [par.............................................000 Land ................... Taxable capital gain (1/2  $100....999) .............. 85(1)(a)............... 1 (B) Total PUC reduction (A) – (B).... Building.................50 Reason $6.............................................999 $ 1 1 $ Nil ..................................000 220.........................000 [par...............................50 [par....................... 148................. $ 148.................................................... 22] Elected amount [par...................000 [par...... 54(h)(x)] ......................................................................................999 1 Tax cost to corporation of assets transferred: Shares* ... $ 148.........................................000 1 $ 100............000 $ $ 100....................................... Capital gain......... Prepaid ........ Goodwill...................000.................. Deemed dividend [ssec...000 superficial loss [par......... before any reserve claimed by purchaser corporation at its year end [sec.........000 ...000 FMV transfer price plus $5........................ 14.........................................000 Excess.......... Adjusted proceeds of disposition [spar..................... $ 60................14(5)] * if these properties are transferred to the corporation (C) Proceeds of disposition ........ Less Deemed dividend [ssec...................................

........ There is no advantage to having the corporation owning these shares.... Tax value $ 90..............000 Excess............... There is also no advantage to having the corporation own these shares................... Total debt consideration to be taken ........000 4....000 Nil 42.................................000) under section 85 is greater than the total fair market value of consideration ($385............000) received by the transferor.............. At this time................ Thus..000 102...........000 (C) Items transferred under section 85: Inventories ... Shares of Clientco Ltd............................000 61......000 $ 1 ......................... If the increase had been made to the inventories or the building.................. $ 1 Tax PUC of shares received: LSC before reduction........001 57........................000(5) $ 207....000 84........... Equipment (no income to defer........000 can be considered a benefit.......000 96................1) reduction: (i) Increase in LSC of all shares .... Minimum transfer price ................... 85(1)) ....000 Minimum transfer price $ 90....... Elected transfer price after benefit ...... 40(2)(g)] and added to the adjusted cost base of the Clientco Ltd................... the elected amount must be increased by the $57............................................ should not be transferred to the corporation..................000 Nil $ 229................................000 $ 151. $ 207....000 42.............. The $57.001 Cost of share consideration received: Elected transfer price (excluding benefit) Less: debt assumed debt issued ACB of preferred shares $235...000 FMV $ 100.. if they would jeopardize the qualification of the shares of the new corporation as QSBCS......................... the full increase would be taxed..... $ 90..................... 235....000 (A) (ii) Elected amount ....... but this could change in the future................000 ACB of preferred shares .001 $151..... shares is less than 10% of the FMV of all of the assets of the new corporation........000(5) $ 84.. the excess of $57...... 1990 Acura .................000 235... Thus..........000 102......000 TCG(3) Nil Nil 0. $ 207..000 Nil Nil 90..............................000 235................................ 85(1)(e........000 Subsection 85(2......................... (B) Items not transferred under section 85: Cash (not capital property [ssec. $ 151.............000 103.......... $ 235.............................................000 102.....000(1) 40............................. The accrued loss of $900 would be denied as a superficial loss [par..................... Goodwill .......... $ 235...001 for the purpose of determining the proceeds of disposition to the transferor and cost to the corporation... Since the transferor’s children will own common shares in the corporation...............000 will have to be added to the elected amount of various assets transferred under section 85....001 Consideration Assumed liabilities Notes Prefs.....................................000 to $292...... 1 (B) Total PUC reduction (A – B) .... Increase due to benefit .......000 41.. Accounts receivable..... Note that the fair market value of assets transferred ($442..000 5..............Solutions to Chapter 16 Assignment Problems 275 Solution 5 (Advanced) (A) Shares of Supplyco Ltd........ shares held by the new corporation.... $ 12........ (206.........000 1(4) $ 235.......................50 (D) Cost of consideration received: Elected transfer price (excluding benefit) ...001 Less: boot ... but not the adjusted cost base of the consideration received..... the FMV of the Supplyco Ltd..................001 less: debt assumed ............................000 Nil $ 10.......................000 1.......000 1.............................. Total..... should not be transferred to the corporation..............000 1.........000 Effect on income Nil $3.......................000 debt issued .000 42................999) Tax PUC after reduction .000 90..000 144...............000 292............ $ 1 (E) The FMV of the assets transferred to the corporation would be greater than the consideration received and since his three children will own the common shares there is a problem with “gifting” [par... 84.... $ $ 235...................1)]) ............................... 85(1..... Land ....000(2) $ 154..........000 Nil 1.......................................................................................000 $ 442.... if any...... Buildings .... simpler not to use ssec...... the elected amount of such assets as the land and goodwill should be increased because only a portion of the increase will be subjected to tax........2].......

case law indicates that a price adjustment clause will only be recognized if the parties have reasonably. then the loss will be a capital loss which is denied as a superficial loss [sec. if any Total PUC reduction Tax PUC after reduction $150. Joe will retain a UCC of $17. The UCC of the equipment in the corporation will be $40.000 should be chosen.000 can be considered to be a tax-paid cost that was not recovered through boot received.500 realized in 1999 will be adjusted to $3.Introduction to Federal Income Taxation in Canada 276 Tax PUC of shares received: LSC before reduction Subsection 85(2.500  1/2  3/4). discussed in (E) above.00.000 $150. along with the $1 of tax-paid cost created by electing to transfer the goodwill at $1.000 (i.000 benefit. $4.000 (B) (92.000) received on the transfer.000 must be included in 2011 income in either case.000. attempted to determine values that equal fair market values.000) plus actual debts assumed ($151.1) uses the increased elected amount in item B. (2) The accrued terminal loss is denied [ssec. and in good faith.000 is reflected in the PUC after reduction because subsection 85(2.000.999) $ 57. an elected transfer price of $102.000) total $1 less than the maximum debt of $235. 54] by paragraph 40(2)(g) with an increase in the cost base of the receivables owned by the corporation after the transfer [par.2)] problem.001 The increase in the elected amount as a result of the paragraph 85(1)(e. This amount will trigger a capital gain of $6.000) transferred to the corporation would be greater than the total debt and share consideration ($90. The 2010 reserve of $10. 85(1)(e. The net capital loss of $4. In order to qualify for this election. the $57.000 57. (5) New debt issued by corporation ($84.500. In order to ensure that the subsequent valuation does not result in the benefit [par.1) reduction: (i) increase in LSC of all shares (ii) elected amount (including benefit) less boot excess.000. 13(21.000 (a taxable capital gain of $3.000 rather than an allowable capital loss of $9.000 (A) $292.000). (4) Goodwill must be transferred at a nominal amount of $1. the vendor’s loss must be taken into the purchaser’s income.e.000 to be depreciated until SEL sells the amounts to an arm’s length party. so that the total consideration reflects the newly determined value of the goodwill. (3) In order to use the net capital loss of $4. Since income is created for the transferor by the $57.2)].2) benefit of $57. —NOTES TO SOLUTION (1) Section 22 election is recommended on transfer of accounts receivable so that the purchaser is eligible for a reserve for bad debts and a bad debt write-off of these accounts and the vendor incurs a business loss of $18. As suggested in the text. 53(1)(f)]. equal to the elected amount. a price adjustment clause should be added to the documentation of the transaction. If section 22 is not elected. . (F) The newly determined fair market value of the goodwill ($120. whether or not section 85 is used for the transfer of the receivables.001. The effect is to adjust the value of the share consideration to $120.001 235..

............. 1 (B) Total reduction (A – B).. 180....... Nil Retractable pref.......000 (C) Reduction in each class [(A – B)  C/A] $200... 84(3)] .......000 86. $ 46...........000 FMV 20.................... shares.. $ 259.001 $ 46......000 35............................... it cannot be transferred on a tax-free basis on section 85 [ssec.......................................... if any .............000 85.................000 $ 60....000 — 11....000) Comment not eligible net of reserve no inc........ 85(1.......000 $ Transfer price $ 20... (60............ These shares should be held personally so that capital loss can be realized on their disposition to a third party..................... Any other form of transfer must be at fair market value since Mr........................................000 5....................000 Nil 85..... Building ...000 $ 46.....000 11..................000) has been recovered through assumed liabilities and new debt received.................................999  ................ Tax value $ 20......... A New debt shares $ 154.....000 60.......... to defer no inc....................................... Equipment............................................................999) $260.......000 Redeemable pref........ 84(3)] ... to defer (C) Items transferred under section 85: Asset Land: Parcel I..........001 Less: Boot ........ Tax value $ 200....................... Inventory ................ (B) Items which cannot or should not be transferred under section 85: Asset Cash.................... $226.............000 FMV $ 339...........000 15........... $259.. B shares — — — 60............... $ 1 PUC of share consideration taken: Subsection 85(2...............000 Consideration Elected Assumed amount liabilities $ 200. 1 Deemed dividend [ssec...................... $ 260.... $226.000 .......000 — 1 — $ 226... $ 1 Adjusted cost base (total) ...............999 Proceeds of disposition ............................000 12..1) reduction in PUC: Increase in LSC of all shares ($200.000 $60.............................000 — — $180..........................................................000 11.......e.................. the land (Parcel II) should not be transferred to the corporation.........000)... Schminkie and the corporation do not deal at arm’s length..... Goodwill .... 259. shares.............000(C) $ 60.........50 (D) Cost of consideration taken on section 85 transfer: Elected amount.000 Income effect Nil Nil Nil ..000 Less: PUC (total) .000 $ 200................... Recommend that this parcel of land be held personally............................000 15....................000 $ 196.....000 $ (5........................................ and will result in triggering an income inclusion..........................................000 $ (5..000(3) $ 139................... $ 259................... $ 1 Nil The $1 total PUC after the reduction reflects the fact that all of the tax-paid cost in the assets transferred (i.000 85... $ 200..000 — new debt.............................................000 $ 196.............................000 Consideration Assumed Income debt effect $ 20......000 Tax PUC after reduction for each class ............ $ 260..........000 86.000) $260.......000 Less: deemed dividend [ssec...................... 1 Capital gain (loss)(3)......Solutions to Chapter 16 Assignment Problems 277 Solution 6 (Advanced) (A) The shares in Public Co.......000 226....000)(1) 86.....1)]......................000 86...000 Cl..000 $ 486......................000 + $50... $259.............000 Nil 5........000 Cost of share consideration ............... $ 260................ (E) Proceeds of redemption ....000 15............ A/R ........000 5......000 Cl.999  ...001 Allocation of non-share consideration — assumed debt ...........$ 226.....000 Nil $ 226..... Since this land would be land inventory.... should not be transferred to the corporation since the capital loss would be denied under paragraph 40(2)(g) and the section 54 definition of “superficial loss” whether or not section 85 is used on the transfer........................ Similarly......000 1..........999 Redeemable preferred Retractable preferred Increase in LSC for each class. Auto ....000(A) Less: Elected amount .....................000 60....... (199..................999 Adjusted proceeds of disposition ...000 $ 237................000 75..................000 Nil(2) $ 196.....000 96......000) Excess... (226.............

that $196.. $242........... Schminkie will retain a UCC in that class of $30... The result is an increase in the elected amount... — can write off bad debts............e........... to avoid a benefit under paragraph 85(1)(e....... ..000 Corporation Accounts receivable .2)..000 Consideration .. Schminkie and his wife are affiliated with the corporation........ $ 6.. 85... — can take a reserve. $ 6. had there been a capital loss....000 in proprietorship liabilities were assumed as consideration for assets not transferred under section 85. This leaves $46............... the capital loss would have been denied and added to the cost base of the common shares held by Mr... $ 96.000 of new debt should be taken to balance the FMV of assets transferred with total FMV of consideration......000 Business loss on transfer 11.000 96......... (3) Since Mr.000 – $196.000) to be assumed as consideration for the land....000 is not allowed to Mr.......000....Introduction to Federal Income Taxation in Canada 278 (F) An additional $10.6)...... Schminkie by virtue of subsection 40(3.........000 of the $242..... Income ..000...... —NOTES TO SOLUTION (1) Section 22 election: Proprietorship Reserve...2) because of the wife’s shares..000 (2) A terminal loss of $30..000 11.000 Income .. also....... The gain should be triggered on capital property or eligible capital property which would result in an amount that is only taxable at ½.. Schminkie by virtue of subsection 13(21.000 Accounts receivable . Note...... Consideration........ and Mr. $ 85......000 (i.... The corporation will have a UCC of $5.....

...........................000......................000 (b) Modified ACB of Plummer .........................................000 Less: FMV of boot ............................. ....................... This represents the $200. Therefore.......... Plummer and VHL are connected as VHL controls Plummer..............000.000 200........................................................ Mrs................ After the transaction Plummer and VHL must be connected..000........................... 54] .......... Andrews will be able to reduce the potential capital gain on such a sale by $400.................................. resident in Canada (i...................... PUC after reduction ($800......................... (2) FMV of boot ............... if any ...................000 Deemed dividend.............................000 200...000 200..................... Adjusted proceeds of disposition [sec...... with the adjusted cost base as determined above............. Deemed dividend equals: Sum of: (1) Increase in LSC of VHL shares ...................000 Less: the sum of: (3) Greater of: (a) PUC of Plummer.................................1(1)(b)] .........000 Nil The nil PUC after reduction reflects the fact that all of the “hard cost” of the Plummer shares has been recovered by the $200................ Andrews has an adjusted cost base for the VHL shares of $400...............000 – $800. $ 200..............000) as shown below............1 to apply are met.............1.... Mrs..... PUC reduction (A – B) .... Mrs.......000 Excess......... Andrews takes back from VHL............................000 Nil Mrs....000 Nil 600.. As Mrs.............................................1(1)(a) will apply to reduce the tax PUC of the shares Mrs...000 400..... 1......................000 $ 200............................................ within the meaning assigned by subsection 186(4)........... In order for this section to apply.......e.......................000 Modified ACB of Plummer .................000)........ Less: boot or non-share consideration ............. Paragraph 84...............000 note taken back as consideration on the transfer...............000 (A) $ Nil (B) 800.. all the conditions for section 84...............000 $ 1.................................................. Elected amount ................ Capital gain equal to capital gains exemption .....1(1)(a)] ...................................................................... $ 800.................................. Mrs....... Less: greater of: PUC of Plummer shares ...........................000...........................................000 (4) PUC reduction [par.......1(1)(b)]................ Adjusted cost base ...... Elected amount (deemed proceeds of disposition) ..... $ 1.000 600.. Andrews and VHL do not deal at arm’s length....... 84. This reduction is calculated as follows: Increase in LSC of VHL shares ............................ $ 800.................................. 84........ Andrews) does not deal at arm’s length............................................................Solutions to Chapter 16 Assignment Problems 279 Solution 7 (Basic) This transaction will be subject to the provisions in section 84...........000 cost base plus the $400.......... $ $ $ $ $ 600...................................................................................... 800................................................000..........000 400... a number of conditions must be met........e.... since they are related [spar......................... Andrews should elect to transfer the Plummer shares to VHL for $600.................... $ 200.................................................................000 $ 200........... Plummer) to another corporation (VHL) with which the individual (i............... Adjusted cost base of VHL shares ....... $ 1......... An individual..............e.... 84...........................000 If an arm’s length purchaser can be found..... No deemed dividend will arise [par............................. 200................................ Mrs..... must dispose of shares of a corporation resident in Canada (i.....000) or modified ACB ($200...... Andrews)........................ Less: deemed dividend [par....... Andrews owns 100% of the shares of VHL....000 inherent capital gain that she wishes to crystallize to utilize her capital gains deduction for qualified small business corporation shares............. 251(2)(a)(i)].. since the non-share consideration did not exceed the greater of the PUC ($1.......................

.....................000 minus boot $750.250..................................................................... $ 250........000 $ 250................250.......000................................................ increase in LSC of Sam Pickings shares..000 PUC after reduction ($1............................750.................. 1.............000 500... 84................250..750.........000 Deemed dividend .. 84........000 in cash and $1......... 750.... Nil (B) PUC reduction (A – B) . if any ............... increase in LSC of Sam Pickings ... Taxable income of Mrs.................750.1(1)(b) deemed dividend .....000 in preferred shares of Sam Pickings Limited....000) ...................................000 (A) Less: (b) Greater of: (i) PUC of Low-Cal shares ........................... 54 exclusion for par............1(1)(a) .................. Domm from capital gain: Cost of Sam Pickings shares after allocation to “boot” [par...250.....................................000 Less: FMV of boot ..000 of hard cost in the Low-Cal shares has been recovered by cash from Sam Pickings..000 (ii) Modified ACB of Low-Cal shares .. Deemed dividend [par..................000 250........... Adjusted proceeds of disposition for Low-Cal shares .......................000 (A) Nil (B) $ 1..000 of boot received in excess of the $250.............................500....000 (D) (A + D) $ 2..000 $ 250..........250..........................000 $ Nil The nil PUC after reduction reflects the fact that all of the hard cost of the shares of Low-Cal Limited has been recovered through boot received from Sam Pickings Limited............ $ 250.........000 less: FMV of boot.................... Capital gain on Low-Cal shares: Elected under section 85 for Low-Cal shares (proceeds of disposition) ........................... (B) Transfer the shares of Low-Cal Limited to Sam Pickings Limited and elect an amount of $750.........Introduction to Federal Income Taxation in Canada 280 Solution 8 (Advanced) (A) PUC reduction [par...............000 Excess........ $ 250...........................750........ 250.......................... ........................ greater of: (a) PUC of Low-Cal shares .................. $ 1............000 (b) modified ACB of Low-Cal shares ...................................... PUC reduction under par...............000 (A) 2................... Less: sec.................................. $ $ 750.... greater of: (a) PUC of Low-Cal shares .. FMV of boot ... Less: ACB of Low-Cal shares ........................... 84.000 (E) (b) modified ACB of Low-Cal shares..000 (F) (E + F) 1....................000 under section 85.................................................... 750....000) ............................ PUC after reduction ($1.............000 Nil Nil Note how there is no capital gain eligible to offset the QSBC share capital gains deduction as a result of section 84............................................... 84........... $ 250.................................1(1)(a)]: (a) Increase in LSC of Sam Pickings shares ...................1(1)(a)]: 1.....................1..............000 of hard cost of the Low-Cal shares transferred..................................... Less: 2............000 $ 250................................... $ 1.................000 – $1..................................... $ 1....... 85(1)(g)] (elected amount $750.......... The following will result: PUC reduction [par..............................000 The deemed dividend is effectively equal to the $750........... PUC reduction (A – B)............ if any ..............000 4........................ $ 250............. $ 1................ Nil The nil PUC reflects the fact that all $250............000 – $1...................................000 Excess.. $ 250.................................250..............000 Less sum of: 3....................................................000 250..........000) ............................ Take back $250................ Capital gain (loss) .................................................. (A + D) – (E + F) $ 500...........1(1)(b)]: Sum of: 1..............750............... 84..........

.... ACB of Sam Pickings shares: Cost of Sam Pickings shares after par... 85(1)(g) allocation to boot (elected amount of $750...500 $ 507...........................000.500 of deemed dividend reflects the $580...................... 84............... However.........000 250...000 – $250....... Capital gain ............................................................ Domm would have to sell 29 shares to realize a capital gain which would utilize all of the remaining $500...................................................................000 500.000 in the fair market value of the Sam Pickings shares in excess of their cost...........................000 (A) 250. she has protected $500...............000 QSBC share exemption: ($2................ there will be an immediate deemed dividend computed as follows: Sum of: (a) Increase in LSC of Sam Pickings shares ........000 (d) PUC reduction [par.................. Nil (A) $ 580..................................000 on the shares of Low-Cal Limited.................................................................. 84..........................500 $ 72................................ Less sum of: (c) Greater of: (i) PUC of Low-Cal shares (29 shares @ $2................................................000 per share) ..................000......... no PUC reduction will occur.............. Adjusted proceeds of disposition for Low-Cal shares ...............................................................000) .......... 1..................... Domm from capital gain: Elected amount [sec.................500 Again.........Solutions to Chapter 16 Assignment Problems 281 Deemed dividend [par..........250................ Taxable capital gain (1/2  $500............................... 54 exclusion for par.500 (d) PUC reduction [par... (A + D).000 250...................1(1)(b) deemed dividend ......000 Nil 500...... Deemed dividend (A + D) – (E + F) .......750.......500) $ 72..............000 – boot of $250..................000 $ 250...................... Less: Sec........1 would still be met by this outright sale to the non-arm’s length corporation................. $ $ $ $ $ 750......000 Nil 750... Sam Pickings Limited..........................000 from future taxation as a capital gain when the shares of Sam Pickings Limited are sold and deferred the other $1.......................... $ 1......750.......1(1)(a)] ..... (C) Mrs.... (b) FMV of boot (29 shares @ $20.................000 2.................... She has done so without immediate tax consequences..............................000 and a fair market value of $1...................................... Of the accrued gain of $1...............000 crystallization of the capital gains exemption.................000 (F) (E + F) ................... hence... ... no shares of Sam Pickings Limited are issued and... Deemed dividend (A + D) – (E + F) .......000... Mrs......................000) ........000 and a fair market value of $2......................... $ 250....000.500 = 29 shares (rounded) The conditions of section 84.............................. Less sum of: (c) Greater of: (i) PUC of Low-Cal shares........ 84......... Nil (F) (E + F) .......................... Domm ............ $ 250....... Domm has given up shares in Low-Cal Limited with a cost base of $250................. Less: ACB of Low-Cal shares . Taxable income of Mrs....... Less: capital gains deduction ....000 $ 72....................000)  100 shares = $17.... The $500.500 in the Low-Cal shares. Since the holding corporation is paying only cash for the shares of LowCal Limited.......000 Nil There is no deemed dividend because the boot received from Sam Pickings does not exceed the hard cost of the Low-Cal shares.........................................................................................750..000  $17............................ She has acquired cash of $250............................................................000.000 (E) (ii) Modified ACB of Low-Cal shares ...............000 cost base of the shares of Sam Pickings Limited represents the $500..........................000.....................................................................000 (D) $ 580...000 250......000 of boot received in excess of the hard cost of $72.. 85] for Low-Cal shares ...............500  $500.......500 (E) (ii) Modified ACB of Low-Cal shares (29 shares) $ 72..... the $507...000 and shares with a cost base of $500............. (b) FMV of boot .......... Effect on taxable income of Mrs..................1(1)(b)]: Sum of: (a) Increase in LSC of Sam Pickings shares .................................................................750.. (A + D)..........000 (D) $ 2.....000 Note what has occurred in this situation...................................................1(1)(a)] ................ 84.....

.................................................................................. Capital loss .....500 (72.................................................. Less: adjusted cost base .......000 Note how the full accrued capital gain on the Low-Cal Limited shares is subject to tax as a deemed dividend......................... capital gain — Sam Pickings . Less: adjusted cost base .......000 $ 1..........000 $ 1.....250......750........... as follows: Consideration in cash received on sale — Proceeds of disposition . Deemed dividend [ssec...............750.............................500) Nil Note how $500.................750.................................... capital gain — Low-Cal ..........250....... Capital gain .....000 1.................................................000 Note that the $1....000 1.... 85 transfer — Low-Cal .............................. 54 exclusion from proceeds for sec..................... Summary of income effects: .................1 deemed dividend .............................750............000 $ 1.............000 $ 1............ (ii) Ultimate sale of shares of Sam Pickings: ............................. 84.............. 84(3)].......750...........000 500..............................250............................................................... Proceeds of disposition ...... $ 580............250................................................... capital gain (loss) on redemption — Sam Pickings .........................................................000 (500.................... Nil 500....................................... Summary of income effects: sec...... 84(3) deemed dividend .................................000 Nil 1..................................................................... ACB of Low-Cal shares ..... Adjusted proceeds of disposition [sec.........282 Introduction to Federal Income Taxation in Canada Proceeds of disposition for the Low-Cal Limited shares will be reduced under section 54 so that there will be no capital gains against which to offset the capital gains deduction..... net economic effect ................................................ Part A Part B $ 1................................................ 84...........................1 deemed dividend .................... sec.......750........000 Nil $ 1.......................... Proceeds of disposition ......000 1..........................000 Nil $ 1...... ssec..........250....... Part A $ 1.......000) $ Nil 1.250......................... 54] ..................750...............1 deemed dividend .........................000 $ .... Less: PUC ................ 84........................000 500.....000 Nil $ 1....................250..... Less: deemed dividend .......... is taxed as a deemed dividend on the sale of the shares for cash.............000 Nil Nil Nil Part B $ 1.............................................250.....................................250...........................000 1................................................................................. Adjusted proceeds of disposition ...000 Nil Nil $ 1....000) $ 1............................000 of the gain on the shares..... which would have resulted from a direct redemption of the Low-Cal shares by Low-Cal Limited itself...000 $ 1........750.............................. capital gain (loss) on sec......................000 507................750............500 $ 72............................. Less: sec...................... which should have been protected by the capital gains exemption.......750..... net economic effect ............750......... (D) (i) Ultimate redemption of shares of Sam Pickings: Proceeds on redemption..000 $ (500............000 represents the accrued capital gain on the Low-Cal shares.000 $ 500........................... Capital gain..........000 Nil $ 500..000 $ 1...............250..........000 500........................

.......900.........000 Less: post-1971 earnings(1) .............................. therefore..................... $1.000 [par........000 can be attributed to post-1971 earnings........................000 Remaining deemed dividend under ssec......000 500. 84(3)] calculated as: Redemption/retraction price ...000 900... only part of the dividend would be a deemed dividend under subsection 84(3) on the redemption of the Corporate Raider Inc... has only active business income................... $1........000............................................ Plan B Under this alternative..........000....................... 84(3)......000 dividend would not be deemed to be proceeds of disposition since subsection 55(2) excludes post-1971 earnings..........000..000 Total proceeds of disposition ..................000).................000 $ 1...........................000 equal to the adjusted cost base of the transferred shares... Less: Amount deemed not to be a dividend but proceeds of disposition . Subsection 55(2) would deem the other $1............................................... (2) The definition of proceeds of disposition in section 54 would exclude the subsection 84(3) deemed dividend on the redemption of shares................................................................... are not related.....900. Capital gain ..................................000 Less: post-1971 earnings .. Subsection 55(2) applies in both of these scenarios because: (a) Holden Limited and Corporate Raider Inc.......... $1........................900...... and (c) one of the purposes of the dividend in Plan A and one of the results of the dividend in Plan B was to effect a significant reduction in the capital gain on the ultimate sale of the shares of Profits Galore Inc.......................000 $ 1..... The balance of the dividend (i.................500................. the special shares of Corporate Raider) will also be $500...............900............e...........000 (i. Therefore.. 55(5)(f)].........000. The results of these two proposed transactions would be: Plan A Of the $1......... Less: Paid-up capital ................. (b) Holden Limited received a dividend that was deductible under section 112.. shares...............000 $ 2......... these $900........................ converting what would have been a tax-free intercorporate dividend or a deemed dividend into proceeds of disposition for capital gains purposes................................ 84(3) deemed dividend as determined above(2) .............000 to be proceeds of disposition......... Less: Adjusted cost base ..000 – $500............................................000 —NOTES TO SOLUTION (1) Holden Limited would have to designate a separate dividend of $900.................................................000) will be deemed part of the proceeds of disposition and added to the actual proceeds of $500... As a result............. redeems these shares from Holden Limited there will be a deemed dividend [ssec................. for their then fair market value of $1......... Less: Remaining ssec....................000 dividend received by Holden Limited from Profits Galore Inc..000...... the Profits Galore shares are to be transferred to Corporate Raider using section 85 and electing a transfer price of $500..........000 (equal to the sheltered post-1971 earnings) and then selling the shares to Corporate Raider Inc.. Deemed dividend [ssec.. Since Profits Galore Inc... there is no income subject to Part IV tax which would further shelter the dividend paid to Holden Limited from the effects of subsection 55(2).......000 $ 1................... Add: Deemed proceeds of disposition: Dividend received .......................000 1.... ............................500........................ Capital gain on the disposition of the shares: Proceeds of disposition (redemption price) ..000................................. the adjusted cost base of the shares accepted as consideration (i....................................e..................500....... Less: Adjusted cost base ..000 500..............000 900....000......Solutions to Chapter 16 Assignment Problems 283 Solution 9 (Advanced) Both Plan A and Plan B would result in an application of subsection 55(2) by the CRA.............. $ 500...... The $900.........400...........000 of dividends are excluded from the calculation of the deemed proceeds of disposition of the Profits Galore Inc. $900................000 $ 1.000............... the following capital gain on the disposition of the Profit Galore shares would be computed: Actual proceeds of disposition..................... $ 1..........000 These results are equivalent to Holden Limited receiving a dividend from Profits Galore of $900... shares for purpose of subsection 55(2).........400................................000 $ 1........................ giving rise to a capital gain of $1..... Capital gain ..e.000.................... 84(3)] ..................000..........000 500.................. $ 2........... When Corporate Raider Inc... 900................................... Deemed proceeds of disposition ........500.........000 $ 1. 900...................................... Under Plan B.........

below) of this provision has not been met: (a) the vendor’s shares (Jason’s shares of Quality Appliances) must be capital property to him (consistent with the facts in this case). through the PUC reduction mechanism [ssec. This gain may be eligible for the capital gains deduction if the shares are qualified small business corporation shares.) must be at arm’s length before the share exchange (given). The remaining shares. since he has received FMV consideration in total [par. Note that Jason is not eligible for a capital gains reserve. Quality Appliances. (c) the consideration for this exchange must be only issued shares of the purchaser (i. Big Distributors’ PUC of the shares issued to Jason would be $25. Under the second alternative. If Jason does not have his capital gains deduction available.e. of the Quality Appliances shares acquired will be equal to the lesser of their fair market value on the exchange ($125. Part (B) Under the first alternative.000). The first disposition would be a cash sale of shares for $25.). no capital gain or loss to Jason arises. 85(2. Big Distributors’ addition to paid-up capital for the shares issued to Jason will be limited to the PUC of the Quality Appliances shares ($25.1 will apply to the share exchange offered. which fits the definition). The ACB to Jason of the new shares in Big Distributors Ltd.000 – boot of $25.000 [ssec. One half of this gain. (d) there can be no capital gain on this exchange. The elected amount could be set at $50.e. In this way.1 to be operative. he will be required to pay tax on this capital gain.e.000.1(2)(d)]. $37. elected amount of $50.1)]. since one of the conditions (see (c). would be set at $25. For section 85.000. 85. Jason may be able to minimize his tax cost under the first option if he could negotiate the restructuring of the transaction as two separate dispositions.1)]. Therefore.000. Jason will realize a capital gain of $75. it is relatively easy to comply with the administrative requirement of filing the joint election form. only share consideration can be received [par.500.000.000 ($125. This amount is calculated as: . while their FMV would be $100. any tax on the capital gain would not exceed the cash realized..1 will not apply. section 85. even though he has received cash of only $25.000 (i. section 85.000) and their PUC ($25. a subsection 85(1) election would be advisable if Jason wishes to defer the capital gain.. Since cash is received under this alternative. 40(1)(a)]. exchanged for shares of Big Distributors Ltd. A proportionate amount of the ACB would be allocated to these shares.. (e) the vendor (Jason) and the purchaser (Big Distributors Ltd. 85.1. As Jason is the only vendor.000 to fully defer the capital gain. Jason’s proceeds of disposition for the Quality Appliances shares.1(2. The ACB to Big Distributors Ltd. (b) these shares must be shares of a Canadian corporation (i.000)..000).000 – $50.Introduction to Federal Income Taxation in Canada 284 CHAPTER 17 Income Deferral: Other Rollovers and Use of Rollovers in Estate Planning Solution 1 (Advanced) Part (A) If Jason accepts the first alternative. Therefore.000 on this disposition. Big Distributors Ltd. (f) after the share exchange the vendor may not control (de jure) the purchaser or may not own more than 50% of the FMV of the shares (given). will be a taxable capital gain.000). the ACB will be $25. would qualify for the rollover under section 85. and the ACB of the Big Distributors shares received will be $50.

.........000 Elected amount ... $ 50..Solutions to Chapter 16 Assignment Problems LSC before reduction .............................. reflecting the amount of the cost (i....000... Less: Increase in PUC of all shares..... .000 (25......000 $ (75............ 25....................... issued to Jason...................................000) of the Quality Appliances Ltd..................... The ACB to Jason of Big Distributors’ shares................000) 25.....................................................................000 Less: Boot ........................... The PUC of Big Distributors’ shares would be $50.....000) PUC after reduction .. 285 $ 100............................... $50................................. shares not recovered by boot from Big Distributors Ltd........................... the accrued capital gain on the Quality Appliances shares transferred would be fully deferred. $ 100.000 If a subsection 85(1) election is made for the second alternative.................................. would be equal to the elected amount of $50............e.000 after the reduction................

................................................................................................................................................... PUC reduction: $600........................................................................ Proceeds of disposition of old shares ..... Deemed dividend [ssec.............................................. Net economic effects: Deemed dividend on reorganization .......000 Reduced PUC by class .............................. Less: PUC of old shares .000 Allocation of reduced PUC: LSC increase by share class .....000 $ $ $ 155..........................000 ACB .................... does not exceed the PUC of the old shares of $300............................. Cost of non-share consideration (=FMV) ..........000 Nil Nil Nil $ 600. Less: ssec.............................................................. 84(3)]: Redemption proceeds ....000  Class A preferred shares: $600.............................................. 84(3) deemed dividend .......................................... Accrued CG on new shares: FMV .................000 Less: Cost of boot... 90....................444 90....................................................................................444 $ 210......000/$810......... CG (CL) on disposition of old shares .................................. Boot ................... CG/CL ............................................................... $ 810.................000  $210................................................. FMV of non-share consideration (boot) .........................000) 155........................................ There is also no deemed dividend [ssec........................... 84(3)].............000 Less: boot ($10K + $80K) ........... $ 810...............444 $210............000  $810.............................................................................................. Reduced PUC of all shares ($810K – $600K) .....................................000 $ $ 300................................................................................................................................000 Preferred shares $ 600...Introduction to Federal Income Taxation in Canada 286 Solution 2 (Advanced) (a) There is no deemed dividend [ssec.............................................000 $ $ $ 300.........................000 300......... 84(3)] because the redemption amount paid......................................000) Nil $ 210.....................000 Nil 300....................................................000 (300..............................................000 PUC reduction........................... ...1)(a)] to give a total reduced PUC of $210..........000... PUC of old shares..........................................000 90..........556 54...000 and total reduced PUC of shares issued........000 ..............000/$810...000 90.000 210..................000 600................................................................ 86(2...................... $ 300............................................................... $ 155.............................000 .556 (2) Cost of all new shares: ACB of old shares ...................................... Class B preferred shares: $600.........................000 $ 210.....................000 $ $ 210.................000 which is less than the PUC of the old shares of $300.............................................................000  $810....................................... (2) Proceeds of disposition of old shares: Cost of all new shares .................................000 300. Redemption proceeds ...........000 300.......................................000.. Issuance of New Shares (1) PUC of new shares: LSC increase for all new shares ............................. Total ........................ consisting of boot of $90......... 90...................................................000............................ 84(1)] because of the PUC reduction [par.......................000 Common shares $ 210.................000  $210.........000 444.....556 $ 54............................... $ 300........ Class B preferreds: $210. Deemed dividend [ssec...................... (210..... ACB ......................................................................000  Redemption of Old Shares (1) Proceeds of redemption of old shares: Reduced PUC of new shares ........................000 Allocation of cost of new shares: Class A preferreds: $600....000 The accrued gain on the new shares reflects the same accrued gain on the old shares before the reorganization. $210................... CG or CL on disposition of old shares: Proceeds .................

........ This is because the redemption amount paid................ 84(3) deemed dividend [par............................................... Less: PUC of old shares ................... Issuance of New Shares (1) Reduced PUC: LSC increase for all shares............................................................... Boot ..................000 $ $ $ 500.............. since all of the PUC of the old shares of $300.............................000 $ $ Nil 500............. 86(2..... 54]...........................................................000 – $300.. Less: Boot ....... Less: Ssec........................... Cost of boot (= FMV) ..................... Capital gain (loss) on old shares .......................... Cost of new shares................................................................................................. (2) Proceeds of disposition of old shares: Boot . however............................ These PUC values reflect the remaining tax-paid cost which has not been returned to the shareholder in the form of non-share consideration (i............... Capital gain (loss) on disposition of old shares: Adjusted proceeds of disposition ..............000 $ (200................................................................000 Nil $ $ 300... Less: PUC of old shares ........... Proceeds of disposition of old shares ................ cash of $10............................. Deemed dividend [ssec................... Deemed dividend [ssec................... 84(3)]....................000).................................................................................................... $ 300..................................................................... consisting of boot of $500................1)]...................................... 84(3)] ............. Nil Net economic effect .. (b) In this case........................................................................................................ (2) Cost of new shares received: ACB of old shares .....000 300...................................000 200............................................ 84(1)]......................000 and a bond of $80........ $ 400................................................... Redemption of Old Shares (1) Redemption proceeds of old shares: Reduced PUC of new shares .................. Prior to the reorganization..e............................................................ 84(3)]: Redemption proceeds .... exceeds the PUC of the old shares of $300...000 Nil 400.............................................................................................. Accrued capital gain on new shares: FMV ................................................000 and total reduced PUC of shares issued of nil......... Total reduced PUC ($400K – $400K) ..........000 $ 500.......000 $ 300................000) Nil The PUC will be nil [ssec.............................................. $ 400.................................................................................... ACB of old shares ...........................000....... A deemed dividend does arise...............................................000 The net economic effect is equal to the capital gain inherent in the old shares ($900..Solutions to Chapter 16 Assignment Problems 287 The PUC of the new preferred shares and common shares will be equal to the reduced PUC calculated above... $ $ 200............................................................................................................................... “proceeds of disposition” in sec......000 600...000 Nil 500........................................ the PUC of the corporation was $300.........................000 (300..................................................................................000 PUC reduction. 500................................ under subsection 84(3).................................................................................. .............000 500......000.... Capital gain (loss) ........................................................ there will be no deemed dividend [ssec...............................000 ACB ................................000 has been recovered through the cash consideration of $500.............................000 and after the reorganization PUC is nil..000 Nil 500........................................................000)...... Total ..................................................000 500......................... Redemption proceeds ....000 $ Nil 400......................................................................................................................................... Net economic effect: Deemed dividend [ssec.... The PUC of the corporation has not increased..................................... Cost of new shares....000 Less: boot ........................000) 300........... (j) of def...........

............000 50...... $ 90............................ $ 90..................................... Adjusted proceeds of disposition .............000 .......... plus: benefit ............................000 The final PUC after the exchange will be nil [ssec...000 500......e....000 Less: boot ......................................................... the retraction value) of the new shares ($300......................... as shown by the following calculation: (1) Redemption proceeds: Cash ..........000 $ 200.......................................................................................000 $ PUC $ $ 50. The following results from the application of subsection 86(2): (2) Deemed proceeds of disposition of old shares [par.......... 86(2)(e)]: Adjusted cost base of old shares...000 (50.................. if any) ...................000 PUC reduction . $ 40.................................000 40...........................................000 40.......000 $ Nil 300................................. Less: Cost of non-share consideration ................................. Redemption of Old Shares There is a deemed dividend [ssec............................ Fresser’s daughter...........................1)].......000 $ 200................000 200........................... Reduced PUC ($300K – $300K) . $ 300...............................................000 110.................................000 Cost of preferred shares (excess...........000 Nil $ 50..................... 84(3)].............................000 300............................... $ 50...... Capital gain....000 125....000 625....000 cash. 110.. (2) Cost of new preferred shares received on reorganization [par..............................000 Reduced PUC of preferred shares received .000 12.....................000 390................000 12............ above) ...... Adjusted cost base of old shares.............................................000 has been recovered through the boot of $90.......................... Fresser Daughter Proposed Consideration: Cash Pref shares 80% $ 20% $ 50...500 FMV $ $ 500.500 62........................500 62........ ACB Current Position: Mr.................000 $ 160........................000 $ $ $ $ $ 90. Fresser and his daughter................... 86(2)(c)]: Lesser of: (1) cost (equal to FMV) of non-share consideration ............... Issuance of New Shares (1) Reduced PUC: LSC increase in respect of new shares.........500 $ 90.................. 84(3)] ......................................................................................000 Benefit ... Deemed dividend [ssec.............................................................................. Nil Less: PUC of old shares .. Cost of new-share consideration (equal to its FMV) ...................................................................................................................................................000 Nil 90.000 excess as a benefit to a related person.................................. since all of the PUC of the old shares of $50............. Capital gain on disposition of old shares on reorganization: Deemed proceeds of disposition (lesser of (1) and (2).........................000 = 80% × $625............... (2) fair market value of old shares ........ 84(3) deemed dividend .................... 90............................................... 84(3)] .........................................................000 (A) Subsection 86(2) will apply to this situation because: (i) the fair market value of the old shares ($500............. Less: PUC of old shares ...000) $ 110.....000 110................000)............................000 90...................................................Introduction to Federal Income Taxation in Canada 288 Solution 3 (Advanced) The following is a summary of the information for Mr......000) is greater than the sum of the cost of the non-share consideration (equal to its fair market value of $90.............................................................. 86(2............ Less: Ssec..... Mr.... Capital gain (loss) on disposition of common shares .......... and (ii) it is reasonable to regard the $110.. The following net economic effect can be aggregated from the foregoing: Deemed dividends [ssec......000) plus the fair market value (i.......................................

........ Note how Mr........... Fresser has lost the ability to recover $60.... Proceeds of disposition ..........000 will be taxed as a capital gain..... $ $ $ 300...000 (i............ $ 300........Solutions to Chapter 16 Assignment Problems 289 Potential accrued capital gain on new preferred shares: FMV.......000 300... Nil Net economic effect ........ where the shares acquired in the reorganization are redeemed..000).....................................000 but only received $390................... 84(3)] ......................................................... (B) Redemption of preferred shares Redemption proceeds ................................. Deemed dividend [ssec...... $ 300.................................... he only received on the exchange a total fair market value consideration of $390....... Less: adjusted cost base...... Therefore...................e............000 300....................... However.............................. In addition. the amount of the benefit) and there is no offsetting increase in the adjusted cost base of these shares....000 Nil Nil Nil Note how the deemed dividend of $300................................. $300.......... Adjusted proceeds of disposition ..............000 in value............................................e......000)................................ because he was or will be taxed on $450.... she will realize an added $110............... Therefore...........000 – Nil = $300...... The penalty inherent in subsection 86(2).......................... in essence.............. the $110...000 Nil 300...000 ACB ........000 (i......................... again............000 in tax-paid cost......................000 with no offsetting ACB increase...................... This result is... Less: deemed dividend ........................000 in capital gain on her disposition of the shares................ .. the same as the result if the shares acquired on the reorganization are ultimately sold................... Less PUC .............. on the disposition of the daughter’s shares..........................000 and the common shares held by the daughter have increased in value by $110........................................................................................000 reflects the accrued gain of $450........... This is another penalty inherent in subsection 86(2)..........000 equals the potential accrued gain on the new preferred shares (i................................................000 450...000 – $50............ Note also that the value of the common shares held by his daughter has increased by $110............ $500.......... the original tax-paid cost of $50. is the potential taxation of the same amount of the capital gain twice..................................000 is lost due to the benefit......000 This net economic effect of $450................... Capital gain ..e......................................

000 bump should first be allocated to the marketable securities to the $500........ Goodwill (4/3  Nil CEC balance)........................................... Bump allocated ............ Accounts receivable ($800...............830...000 1..................000 830........409.................................200............ ACB of land ..............000 $ 1...000) Loans payable.............................000 700.........000) $ 2.............. $ 800................... (709..................................000 Add: dividends paid by Subco to Parentco.......... Marketable securities at cost ............ the $1.................................................................. Building at UCC ...... ACB after bump .............000 $ 500............ ACB after bump ......000 limit..........000 920................... This results in the land and marketable securities having new ACBs as follows: Land: ACB before bump ................ Fair market value of land at time Normpar Ltd... plans to sell Jonsub Ltd...000 reserve) .............................................................. Limit of bump on marketable securities ........................................200.............. (30........409............................................... 300..................000 $ 1........................ Land at cost ...000 limit...........................Introduction to Federal Income Taxation in Canada 290 Solution 4 (Advanced)  Jonsub Ltd......................200......... is deemed to have acquired the property at a cost equal to the deemed proceeds of the subsidiary....................900...000 300.........................000 $ 1............... ACB of marketable securities ........................................000 1..................... 1............................................................................................................................. 200..... the bump cannot be allocated to these two assets.............................000 plus $30.................. $ 1....................000 Whether the two companies are amalgamated or Jonsub Ltd.................................................000 Limit of bump on non-depreciable capital property: Fair market value of marketable securities at time Normpar Ltd................... Reserve ............................................................. Inventory at lower of cost or market ...................000 800..000 500............................................................ Bump allocated ...............000 300...........................  $ 80..................591................ since the “bump” is also available on vertical amalgamations....................................... (1.......................................000 bump ($1.................. 920....000 Building at UCC .......000 reserve)..................................................................... acquired control .........................000 Land at cost ........000 Marketable securities at cost ....................000 plus $30....................................................................................................................... Limit of bump on land .............000 Because the building and the goodwill are not non-depreciable capital properties.......900...........’s ACB of Jonsub Ltd......................................000) should be allocated to the land to the $700...............000 Equipment at UCC ...000 – $500........................................................000 $ 700...............................000................ Marketable securities: ACB before bump....................................................... 830................000) Accounts payable and accrued liabilities .............................................................. $ 80... is wound up into Normpar Ltd.............................................................000 2.................000 Inventory at lower of cost or market ......................000 “Bump” in ACB of non-depreciable capital property Normpar Ltd.......... 500...... .............................000 Maximum bump  $ $ 4..000 200......... is deemed to have disposed of its assets for proceeds equal to the cost amount of the assets immediately before the amalgamation or the winding-up and Normpar Ltd........................409..............................000 Nil 3...091.........................................................000 300.... Equipment at UCC... 300.........................................000 $ $ 300......... Cash ......................’s marketable securities in the next few years...’s shares ..................................................................................200..............000 Nil Goodwill (4/3  Nil CEC balance) ........................ acquired control ................. Less cost amount of subsidiary net assets: Cash ....................................................................................  Allocation of “bump” to securities and land Since Normpar Ltd....................................................................... The remaining $909....................000......................................................................000 Accounts receivable ($800............ the results should be the same....................................................

. since PUC of the Jonsub Ltd.000 } (4. Shares would have to be greater than their ACB to Normpar Ltd.000 } } $4.000 } $ 1. (ii) cost amount of net assets (b) ACB of shares held by Normpar Ltd.091. because proceeds cannot be less than ACB.000.000 } $2.Solutions to Chapter 16 Assignment Problems 291  Deemed disposition of shares by Normpar Ltd.000. Proceeds equal to greater of: (a) lesser of: (i) PUC of shares of Jonsub Ltd .000) Nil Note from this formula that a gain will be rare.000 $4.000. ACB Capital gain (loss) $ 1. A loss is impossible from this formula.

both provisions allow for the same deductions. 31.. 31. the carryforward period is 10 years. (C) Other factors (i) The ACB “bump” on non-depreciable capital property is available on either an amalgamation or a winding-up. although the amalgamation may allow faster absorption of losses if the new corporation sets an early fiscal year-end for its first year. (ii) Rose and Tetley are deemed to have a taxation year-end on June 30.e. ’09 ’12 X X X ’13    Available for deduction by parent for fiscal years ended January 31 ’14 ’15 … ’28 ’29 ’30 ’31 ’32 … expired       … expired      … expired     losses not available in year of wind-up (ii) The 2008 and following losses of Rose would have been deductible in the 2012 taxation year which is the year following the year of the beginning of the winding-up (2011). (ii) The short taxation years for Rose and Tetley on amalgamation will advance the period for loss carryovers. i. on the basis of the deductibility of losses. (iii) Therefore. investment tax credit carryovers. ’10 Jan. — all of the net capital losses will also be deductible. ’08 Jan. ’10 Dec. (B) Winding-up under subsection 88(1). and for taxation years that end after 2005. capital cost allowance. 2009. etc. ’11 Dec.1) provides that for the purposes of determining non-capital and net capital losses of Tetley it shall be deemed to be a continuation of Rose. — this will count as one of the years available for the carryforward of non-capital losses. the first taxation year of the amalgamated company) and subsequent taxation years until expiry under the 20-year limitation. the carryforward period is 20 years. 2013. 2011. — the 2008.Introduction to Federal Income Taxation in Canada 292 Solution 5 (Advanced) (A) Amalgamation under section 87. 31. Losses of Losses of Rose for its Tetley for its fiscal year fiscal year ended become ended1 Dec. (i) subsection 87(2. but not until the first taxation year of the parent commencing after the wind-up. 31. 1 For non-capital losses incurred in a taxation year that ends after March 22. unpaid amounts. 31. 2004.e. the taxation year commencing February 1. — any provision that depends on a taxation year will be affected in an amalgamation.. . 31. (i) Rose’s non-capital losses and net capital losses are available to Tetley.. (iii) A winding-up under subsection 88(1) is generally more expensive to implement administratively than an amalgamation under section 87. ’09 Jan. and 2010 non-capital losses will be available to Tetley in its 2012 (i. 2012 and ending January 31.

000........................................................000 (E) (ii) modified ACB of KML shares .......................................... Proceeds of disposition for KML shares ..... $ 1.. 84.. 85(1) for KML shares* ..000..........800....000 $ 800.................000 Elected amount .................................. Capital gain/loss............Solutions to Chapter 16 Assignment Problems 293 Solution 6 (Advanced) (A) Transfer of shares under sec....................... $ Less: sec...............................000 $ 1..................................000(A) Nil (B) $ 1..........000 Nil * Cannot be less than the boot consideration.........000 $ 400...................................000 (F) (E + F) Deemed dividend (A + D) – (E + F) $ 1............................. 1................ Knight has not used all of her exemption and the shares meet the tests for qualifying small business corporation shares........800 TV $ 400 EA $ 800 Debt $ 800 Pref $ Income 1.................................................................. 800......... $ 400.................... (B) (i) If these KHL preferred shares are sold in an arm’s length transaction for their fair market value of $1......... Allocated to debt ........ Capital gain/loss: Elected amount under ssec..... $ 800.............000..000 less: FMV of boot .......................................... $ 100............ 800.............................000 (ii) ACB of shares transferred (KML) ...................................................................................000 400.......000(A) 800........ $ Less: adjusted cost base . (b) lesser of: (i) fair market value of shares transferred (KML) .......................................... $ 1.........000......000.............................. (A – B) PUC of KHL shares after reduction ................................ the following would result: Proceeds of disposition .............1(1)(b) deemed dividend ...................... Cost of preferred shares (KHL) .......................... $ 400....................................... $ 100.........400.......1(1)(b)]: Sum of: (a) increase in LSC of holding company (KHL) ..000 This deemed dividend could have been avoided by taking no more than $400............ $ 1.....................000 CG $400 ACB of KHL preferred shares Elected amount equal to: Greater of: (a) fair market value of boot........................................... (A + D) less sum of: (c) greater of: (i) PUC of KML shares ....................000 Less: adjusted cost base (see the first calculation under Part (A)) ....... PUC reduction ......................... 84..................000 $ 400......... 85 The following represents the normal section 85 chart used to reflect the transfer of assets to a corporation....... FMV KML common $ 1..000(D) $ 1................ Nil Capital gain........................................................................000 excess..........000.......................................... 84....000 in non-share consideration.............................. if Mrs...............000 400.......... 84.........................000..........................000 Nil $ 1........000 (800.....000 (ii) modified ACB of KML shares ..........................................................................................000 This capital gain may be eligible for the QSBCS capital gains exemption...............000 (d) PUC reduction [par........... ............................................... if any.............. $ 400............................ 54 exclusion for par......................000 400.....................................................800.........................1(1)(a)]: (a) increase in LSC of holding company (KHL) ......1(1)(a)] ..............000 $ 400.......................000) Nil Paid-up capital of KHL preferred shares PUC reduction [par.........................000 400..............................000.. Deemed dividend [par... (b) FMV of boot ... less: (b) greater of: (i) PUC of KML shares........

.............................................................................. 86(2.......... $ 1............. of P of D .................................................... 84(3)]: Proceeds of redemption...... Less: ACB ..................................................................................................................................................................................................................................................... Redemption proceeds .....000...........000 700................Introduction to Federal Income Taxation in Canada 294 (ii) If..................... (2) Proceeds of disposition of KML common (old) shares [par...............000 $ $ $ $ $ $ $ $ 800..... Deemed dividend ..................................... Capital loss of $300..........................................................................................000 800................. the following would result: Proceeds of disposition .. Less: PUC of old shares ................................ PUC of old common shares .....6)] ................ ACB of preferred shares .......... $ 1.......................................... 84....................... Add: denied capital loss on disposition of old shares [par......................... FMV of non-share consideration ..................................000.............. 54] .... 84(3) deemed dividend in sec...........................000 Adjusted proceeds of disposition [sec........................................................................ the same shares were redeemed for $1.............................................. This capital gain may be eligible for the QSBCS capital gains exemption......000..................... if Mrs.................................................................000 Nil 800.............000......................................................................................................... Deemed dividend [ssec............................... Less: exclusion for ssec......................................000 Proceeds on redemption .. Total...........................000 100.............000..000 Nil(1) Nil 300............................ Capital gain or loss on disposition of KML common (old) shares: Proceeds of disposition ....1(1)(a) calculation above) ............ Knight has not used all of her exemption and the shares meet the tests for qualifying small business corporation shares.. Less: FMV of non-share consideration ... Cost of preferred shares [par............................................. the following would result: Redemption proceeds .................................................. 800...........................................................................................000 PUC reduction .......................................000............000K) .........000 Less: PUC (see par......................................................................000.........000...............000................................... 40(3.......... Nil (C) Insurance of New Shares (1) Reduced PUC [par...............................................000...............................................000 Nil 800.................................. 84(3)] ................................................................................................................................................................................... Nil Capital gain/loss ............................................................................000 300...............................................000 Nil $ $ 400.....................................................000 800.......... (2) Cost of new KML preferred shares: Adjusted cost base of old shares .................. Reduced PUC ($1........................................................................................................1.......................... Less: adjusted cost base ...............................000 300..........2)] ..000 700................................. Nil Less: adjusted cost base ..........................000 ........................ Add: cost of non-share consideration ......... 54 def...................... 84(3)] ..000 100..............................................000 has been recovered through the debt consideration of $800............................................... $ 1................................................................................................................................................ (3) ACB of KML preferred shares (after denied loss): ACB of preferred shares (above) . (D) (i) If the KML preferred shares are sold in an arm’s length transaction for their fair market value of $1............................................... $ 1...........................000 400.........................000K – $1................... Redemption of Old Shares (1) Proceeds of redemption of old common shares: Reduced PUC of new shares .............. $ 1....................................................................... 86(1)(b)] .000 The PUC (final) of the new preferred shares will be nil since all the PUC of the old common shares of $100..........000 Less: deemed dividend [ssec........................................................ Cost of non-share consideration (equal to FMV) ..................................................000.........000 800.........000 Less: boot ........................................ instead....1)(a)]: LSC .......000 $ $ Nil 800.........000 $ 700.............000 100......000............................................................................... Nil Deemed dividend [ssec.............................................000 denied [ssec..................................................................................................................................... 53(1)(f....................$100................. Proceeds of disposition ......................... 86(1)(b)] ..................................000 Nil $ 1.......................... Capital gain........................ 86(1)(c)]: Cost of preferred shares [par...................

.....000 Ssec.... (ii) The deemed dividend in alternative (I) [par... 54]....................400.000 in non-share consideration and preferred shares with one cent in PUC and fair market value of $1....000 $ 1.......400..000) Net economic effect ........000 $ 400...................... $ 400.... $ 1.................. Then...........000 $ 1..000 (300. 84(3) deemed dividend ..........000 (400.........000 since the section 84...... If the above steps are taken the following comparison would result: (I) Holdco Freeze Ultimate arm’s Ultimate length sale redemption Summary of income effects Capital gain on initial reorganization..................................... hence.... 84.............000 Nil Net economic effect ....000 —NOTE TO SOLUTION (1) This capital loss of $300.....000.000 and would thereby trigger a capital gain of $400.....400....000) $ 1... $800........400................ the same shares were redeemed for $1.......000.......000) (E) (i) Comparison of alternatives (I) Holdco Freeze Ultimate arm’s Ultimate length sale redemption Summary of income effects Par................. N/A N/A Capital gain (loss) on KHL/KML new shares .. because Ms... Adjusted proceeds of disposition [sec.000 – $400... instead.......... It is not possible to elect to create a capital gain to use up the capital gains deduction............000......000 is denied by subsection 40(3.... The adjusted cost base of the preferred shares would be $300...... Less: deemed dividend [ssec............. Consideration in the reorganization could consist of $100.........000 $ 1.........000 $ Nil Nil Nil $ 700. the net economic effect is the same and it is equal to the accrued gain on the original shares.......... Capital loss ..1(1)(b)] can be avoided by limiting the non-share consideration to $400... Their PUC for tax purposes would be reduced to nil [par.......000............................000.. the denied loss can be added to the adjusted cost base of the preferred shares she receives as consideration in the reorganization [par..400...... 84...000 Ssec.000.000......................................... $ 400. However........................ 84(3) deemed dividend on KML (new) shares....000 $ 1.. $ 1.............000).......000....000.......2)]........... 1..... Knight controls the corporation after the reorganization and..........700...... $ 1......................................... . the following would result: Proceeds on redemption .............. Deemed dividend [ssec... 84(3) deemed dividend on KML old common shares...................1(1)(b) deemed dividend ...400...1(1)(a)]......000........000) 1..... The deemed dividends in alternative (II) [ssec..000 (II) Internal Freeze Ultimate arm’s Ultimate length sale redemption N/A N/A $ 700.400.........000 $ (300...................................................000 [ssec..........000 700.000 (i........... 1.................6)..............000. The adjusted cost base of the preferred shares would be $400......... Less: adjusted cost base .........................000 $ 400..400.........000 Nil $ 300.......700................... preferred shares with a fair market value of $1..... the corporation is affiliated with her.........................000 While the nature and the timing of the income differ........... 53(1)(f..............000 $ (300.......Solutions to Chapter 16 Assignment Problems 295 (ii) If..000 1.........000 Capital gain (loss) ..000 $ 1.....400........400....... Less: PUC ..000 Capital loss on KML common (old) shares ....000..............000 should be taken as consideration.........................................000 1.......... 86(1)]......... 84(3)] .... N/A N/A Ssec........ N/A 1............................................000 1.400.................000 (II) Internal Freeze Ultimate arm’s Ultimate length sale redemption N/A N/A N/A $ 1.. the elected amount under subsection 85(1) could remain at $800..000.............................. However..... 84......000 Nil $ 1...................... 84(3)] .......1 deemed dividend has been eliminated.....e....... Proceeds on redemption ......... 84(3)] can be avoided by limiting the sum of the PUC of the preferred shares and the non-share consideration to $100...................................... N/A 1........................

Since Georgette is not ready to retire.000 of taxable income is 11%. Crystallization As part of the estate freeze. a crystallization (see below) cannot be accomplished using section 86. Any future growth will then accrue to other family members. As her three children are all over the age of 18. she would also have effective control over those shares by being the trustee. the tax will be 1/3 under Part IV. all future growth in those shares will accrue to her daughters. Her personal tax rate on that salary would be less than that on any additional salary to Georgette. it would be appropriate to increase her salary to an amount that recognizes her economic contribution to the company. she retains control over the company. While the dividend income from those shares will be taxed to the company. —ADVISORY CASE DISCUSSION NOTES Memo to file: Georgette & Vitality Plus Canada Ltd. Issues:  Income splitting — salary to Candice and corporate tax  Estate freeze and transfer of ownership  Accrued capital gains  RRSP Corporate tax rate/Salary to Candice Since Vitality Plus Canada Ltd.000 of taxable income. Georgette should first perform an estate freeze. the danger in combining the investment shares with the shares of Vitality Plus Canada Ltd. To conduct the estate freeze. In this way. using a section 86 capital reorganization. is that the shares of the holding company may not qualify under the QSBCS tests. The federal tax rate on the first $500.000 is subject to the general federal tax rate of 18%. A similar result can be achieved with an internal freeze. Additionally. Georgette should crystallize the capital gains deduction available on the Vitality Plus Canada Ltd shares. Georgette would incorporate a holding company and transfer her shares of Vitality Plus to the holding company in exchange for non-participating. Even at the federal tax rate of 18% on income above $500.000 of capital gain. The use of a trust. The estate will not be taxed on up to $750. The objective for Georgette is to maximize her after-tax returns from her business and capital gains and allow the transfer of ownership of her business to her children. as it would empower Georgette (the trustee) to eventually distribute the shares to one or more of the children in any proportion she desired. could then subscribe for common shares of the holding company at a nominal amount. There are a few ways that she can complete this task. and this is (likely) approximately the same tax Georgette currently pays on those shares. she will want to retain control of the corporation until her daughter(s) are ready to take over the business. However. may be preferred as there is some uncertainty about the interest of the two younger children in the business. By locking in the capital gains deduction. Georgette may also want to consider including the public utility shares she owns as part of the estate freeze. If the common shares are held by a family trust. As Georgette’s shares are voting. is a Canadian-controlled private corporation with active business income. Estate freeze and transfer of growth Georgette is interested in transferring the business to her daughters. Vitality Plus Canada Ltd. Her daughters.296 Introduction to Federal Income Taxation in Canada Advisory Cases Case 1: Georgette & Vitality Plus Canada Ltd. the “kiddie tax” would not apply to dividends received by the trust and then paid out by the trust. it may not be tax effective to remove that income by dividends. voting. the company qualifies for the small business deduction on the first $500. A discretionary trust might be ideal. she ensures that the taxes to her estate are minimized on any deemed disposition of her shares. Taxable income in excess of $500.. The most effective way to accomplish this is to transfer those shares to the holding company and file a joint section 85 election with the company. non-cumulative. This option has the advantage of having only one corporation. yet. Candice could then maximize her RRSP contribution. However.000. she is not ready to retire. rather than having the children hold the shares directly. As Candice is working for a nominal salary. or a family trust. . to contend with. with the objective of freezing the value of her shares so that further increases in the value of the company accrue to the children. retractable preferred/special shares.

That way. Georgette’s husband will have certain entitlements as her spouse. At age 71. to name her new spouse as the RRSP beneficiary. Under family law. This will provide her with a predictable and certain minimum level of retirement income. eligible for the dividend tax credit. A recommendation as to annuity or RRIF cannot be made at this time. the redemption will result in dividend income.Solutions to Chapter 16 Assignment Problems 297 Retirement After Georgette retires. it can be rolled over to him on a tax-deferred basis. It would be most unfortunate if these took precedence over her daughters’ entitlements. In the meantime. Marriage Georgette should visit a family law lawyer to settle a marriage contract prior to her marriage. Georgette must convert her RRSP into either an annuity or a RRIF. For tax purposes. . as it would be premature. should Georgette die holding the RRSP. she can redeem her preferred/special shares gradually over time. she might wish to consider. depending on her wishes. The RRIF offers the advantage of capital retention and minimizes income in the early years after conversion.

given that the value of the shares is based on the value of the underlying real estate? o Compare to the sale of shares versus assets type of problem. Section 84. 3. Associated corporations  Will Holdco and Orillia Resorts Inc.Introduction to Federal Income Taxation in Canada 298 Case 2: Orillia Resorts Inc. .2)(c)]. 1. be associated to prevent the personal service business rules from applying? Initially they will be associated regardless of the voting features of the preference shares since Holdco owns virtually all of the value of Orillia and is therefore deemed to control [par. Connected corporations  Will Holdco and Orillia Resorts Inc.  What gives the preference shares their value? o The fact that they are retractable. Corporate attribution  If dividends are accumulated in Holdco causing it to cease to qualify as a small business corporation then the corporate attribution rules may apply. Valuation  How was the value of the shares arrived at. be connected to avoid Part IV tax on the dividends? It will depend on whether the preference shares are voting which is not clear. 6. Small business corporation  Do we know that Orillia Resorts Inc. 2.1  He took too much cash and this will result in a deemed dividend of $749. 5. —ADVISORY CASE DISCUSSION NOTES The main focus of this case is on an estate freeze that doesn’t work.900. is an SBC? 4. 256(1.

2. suppliers. The following are the major topics within succession planning.  Without life insurance.  The tax on the Whyte Co. Inc.035. Business survival  An important issue with all family-owned business is.500.  They might consider an estate freeze on Whyte Co. perhaps. employees and bankers? 7. which includes both retirement and estate planning.  Rent from the real estate.Solutions to Chapter 16 Assignment Problems 299 Case 3: Whyte Co. either the real estate used in the business will have to be sold or the company will have to be sold. will the business survive when the current owner(s) die? o Will the departure of Bill and Betty cause the business to decline in value due to a lack of confidence in the successor by the customers. then Sandra will be out-voted on business decisions by Paul and Joan who are not active in the business.  Life insurance could be taken out to cover this tax liability. It also includes non-tax issues.  Retiring allowance. Tax minimization  The tax that has accrued to this point cannot be avoided except for the tax on the capital gain eligible for the capital gain exemption. there will be little choice but to leave business assets to the two children who are not active in the business.  Consider an estate freeze to limit the tax liability. Retirement income  Relying on the company for retirement income. 3. the land and building could be left to Paul and Joan with a long-term lease in place. there will be a significant tax liability on the second death. o This will set up a conflict that will be difficult to avoid.5 million in cash? 5.  Can you equate the value of private company shares with cash. o As a result. o There will not be enough liquid assets in the estate to pay the tax. shares alone could be approximately $1. Asset protection  Try to reduce or eliminate personal guarantees. 1.. since all the other assets will be used up to pay the tax on death. and even the real estate to limit tax to the amount accrued to date.5 million worth the same as $4. —ADVISORY CASE DISCUSSION NOTES This case deals with succession planning for the business owner. Estate liquidity  Assuming that the cost base of the shares and the real estate is low. i. .  You will need to calculate the potential tax on all accrued gains to determine the extent of tax liability.e. 6.  Consider a holding company to accumulate dividends away from the risks of the business. then.  Salary continuation in retirement. Opportunities  The opportunity centres around the need for succession planning in all private business in order to address the needs of the owner. the family and the business.000 − $100) × 50% × 46%].  If the tax on death can be provided for. Estate equalization  If the shares are divided equally. 4.000 [($4. are shares valued at $4.