Chapter 14 Other Issues In Corporate Taxation © 2011, Clarence Byrd Inc.2 Acquisition Of Control - The Problem Profit Company Loss Company Acquisition

Chapter 14Chapter 14

Other Issues In Other Issues In Corporate TaxationCorporate Taxation

© 2011, Clarence Byrd Inc. 2

Acquisition Of Control Acquisition Of Control - The Problem- The Problem

Profit

Company

Loss

Company

Acquisition

Loss Transferred To Profit Company


Meaning Of Meaning Of Acquisition Of ControlAcquisition Of Control

► Control: Ownership of Control: Ownership of shares that carry the shares that carry the right to elect a majority right to elect a majority of the board of directors.of the board of directors.

► Common Scenario: One Common Scenario: One person acquires shares person acquires shares from a different arm’s from a different arm’s length person.length person.


Meaning Of Meaning Of Acquisition Of ControlAcquisition Of Control

►Can also occur through redemption of Can also occur through redemption of sharesshares A owns 60 percent – B owns 40 percent – If A owns 60 percent – B owns 40 percent – If

all of A’s shares were redeemed, B would all of A’s shares were redeemed, B would have acquired control.have acquired control.


Deemed Year End - ITA Deemed Year End - ITA 249(4)249(4)

► Example: Dec. 31 year end, Example: Dec. 31 year end, acquisition on June 30, 2010acquisition on June 30, 2010

Deemed New Year End Deemed New Year End - June 30, 2010- June 30, 2010

Can Keep Old Fiscal Year Can Keep Old Fiscal Year EndEnd

Allowed To Establish New Allowed To Establish New Year EndYear End


Acquisition Of ControlAcquisition Of Control

► Net Capital Losses Net Capital Losses And Allowable And Allowable Business Investment Business Investment Losses – ITA 111(4)Losses – ITA 111(4)(a) & (b)(a) & (b)

Unused Carry Unused Carry Forwards DieForwards Die

New Losses Cannot New Losses Cannot Be Carried BackBe Carried Back



► Non-Capital Losses Non-Capital Losses – ITA 111(5)– ITA 111(5) Can Be Carried ForwardCan Be Carried Forward Subject To RestrictionsSubject To Restrictions

► Must Carry On Business In Must Carry On Business In Which Losses OccurredWhich Losses Occurred

► Reasonable Expectation Of Reasonable Expectation Of ProfitProfit

► Can Only Be Applied Against Can Only Be Applied Against Income Generated By The Income Generated By The Same Or A Similar Line Of Same Or A Similar Line Of BusinessBusiness


Accrued LossesAccrued Losses

► InventoriesInventories Normal Year End Normal Year End

ProceduresProcedures

► Accounts Accounts Receivable – ITA Receivable – ITA 111(5.3)111(5.3) Maximum Write-Off Maximum Write-Off

RequiredRequired



► Depreciable PropertyDepreciable Property Asset Cost = $100,000Asset Cost = $100,000

UCC = $ 60,000UCC = $ 60,000

FMV = $ 50,000FMV = $ 50,000

► ITA 111(5.1)ITA 111(5.1) Write Down To $50,000Write Down To $50,000

The $10,000 Is Deemed The $10,000 Is Deemed

CCACCA



► Eligible Capital Property Eligible Capital Property – ITA 111(5.2)– ITA 111(5.2)

CEC > 3/4 FMVCEC > 3/4 FMV

Write DownWrite Down

ITA 20(1)(b) DeductionITA 20(1)(b) Deduction



► Non-Depreciable Property Non-Depreciable Property – ITA 111(4)(c) & (d)– ITA 111(4)(c) & (d)

ACB > FMVACB > FMV

Write DownWrite Down

Capital Loss (Will disappear Capital Loss (Will disappear if not used at deemed year if not used at deemed year end.)end.)


ITA 111(4)(e) ElectionITA 111(4)(e) Election

►General RuleGeneral Rule

Can elect between ACB and FMVCan elect between ACB and FMV

FMV > ACB: Creates Capital GainFMV > ACB: Creates Capital Gain

May also create recapture on depreciable May also create recapture on depreciable assets (can’t avoid if you want the capital assets (can’t avoid if you want the capital gain.)gain.)


ITA 111(4)(e) ElectionITA 111(4)(e) Election► Case 1Case 1

Capital Cost = $ 50,000Capital Cost = $ 50,000 FMV = 100,000FMV = 100,000 UCC = 20,000UCC = 20,000

► Elect $100,000Elect $100,000 Capital Gain Capital Gain $ 50,000$ 50,000 Recapture Recapture 30,00030,000 New Capital CostNew Capital Cost 100,000100,000 New UCCNew UCC 75,00075,000

[$50,000 + (1/2)($100,000 - $50,000)][$50,000 + (1/2)($100,000 - $50,000)]



► Case 2Case 2 ACB = $ 50,000ACB = $ 50,000 FMV = 30,000FMV = 30,000 UCC = 20,000UCC = 20,000

► Elect $30,000Elect $30,000 Capital Gain Capital Gain

$ Nil $ Nil Recapture Recapture

10,00010,000 New ACBNew ACB

30,00030,000 New UCCNew UCC

30,00030,000



► Case 3Case 3 ACB = $ 50,000ACB = $ 50,000 FMV = 5,000FMV = 5,000 UCC = 20,000UCC = 20,000

► Write down to $5,000 is Write down to $5,000 is required by ITA 111(5.1)required by ITA 111(5.1) The $15,000 is deemed The $15,000 is deemed

CCACCA


Profits In The Loss BusinessProfits In The Loss Business

During 2011, Loss Leader experiences an overall Net Loss of $150,000, with all of the loss arising in their shoe division. Their hat division broke even for the year. In 2012, the shoe division broke even, while the hat division showed a profit of $200,000.

• No Acquisition in 2011: 2012 Income = $50,000

• Acquisition in 2011: 2012 Income = $200,000



Related Individuals - 251(2)Related Individuals - 251(2)(a)(a)

Individual


►Related CorporationsRelated Corporations One Corporation - ITA 251(2)(b)One Corporation - ITA 251(2)(b) Two Corporations - ITA 251(2)(c)Two Corporations - ITA 251(2)(c)

►Control - ITA 256(1.2)(c)Control - ITA 256(1.2)(c) More Than 50% FMV - All Shares - OrMore Than 50% FMV - All Shares - Or More Than 50% FMV - Voting SharesMore Than 50% FMV - Voting Shares

►Group – ITA 256(1.2)(a)Group – ITA 256(1.2)(a)►Specified Class – ITA 256(1.1)Specified Class – ITA 256(1.1)

Other DefinitionsOther Definitions


► Deeming RulesDeeming Rules ITA 256(1.2)(d) – Holding CompaniesITA 256(1.2)(d) – Holding Companies

► Shareholder of holding company is deemed to own held Shareholder of holding company is deemed to own held shares.shares.

ITA 256(1.3)ITA 256(1.3)► Children under 18Children under 18► Shares deemed to be owned by parentShares deemed to be owned by parent

ITA 256(1.3) - Rights and optionsITA 256(1.3) - Rights and options► Options to ownOptions to own► Right to force redemption or cancellationRight to force redemption or cancellation

ITA 256(1.5)ITA 256(1.5)► Persons are related to himself, herself, or itself Persons are related to himself, herself, or itself



► ITA 256(2)ITA 256(2)► A associated with BA associated with B► C associated with BC associated with B► A and C have deemed associationA and C have deemed association



Association RulesAssociation RulesITA 256(1)(a) One of the corporations controlled, directly or indirectly in any manner whatever, the other;

Company A Company B

More than 50%


Association RulesAssociation RulesITA 256(1)(b)Both of the corporations were controlled directly or indirectly in any manner whatever, by the same person or group of persons;

Company A Company B

More than 50%

Ms. Smith

More than 50%


Association RulesAssociation RulesITA 256(1)(c) Each of the corporations was controlled, directly or indirectly in any manner whatever, by a person and the person who so controlled one of the corporations was related to the person who so controlled the other, and either of those persons owned, in respect of each corporation, not less than 25% of the issued shares of any class, other than a specified class, of the capital stock thereof;

Company A Company B

More than 50% More than 50%

Mrs. Smith Mr. Smith

Not less than 25%


Association RulesAssociation RulesITA 256(1)(d)One of the corporations was controlled, directly or indirectly in any manner whatever, by a person and that person was related to each member of a group of persons that so controlled the other corporation, and that person owned, in respect of the other corporation, not less than 25% of the issued shares of any class, other than a specified class, of the capital stock thereof;

Company A Company B


Mr. GohMrs. Goh

Mr. Goh’s Brother

Not less than 25%


Association RulesAssociation RulesITA 256(1)(e) Each of the corporations was controlled, directly or indirectly in any manner whatever, by a related group and each of the members of one of the related groups was related to all of the members of the other related group, and one or more person who were members of both related groups, either alone or together, owned in respect of each corporation, not less than 25% of the issued shares of any class, other than a specified class of the capital stock thereof;

Company A Company B


Mr. BrownMrs. Brown

Mr. FortinMrs. Fortin

40%


Investment Tax CreditsInvestment Tax Credits

► Credit Vs. DeductionCredit Vs. Deduction Value Of Credit = 100%Value Of Credit = 100% Value Of Deduction = [(100%)(tax rate)]Value Of Deduction = [(100%)(tax rate)]



►Current ExpendituresCurrent Expenditures A credit against Tax Payable during the A credit against Tax Payable during the

current yearcurrent year

Added back to income in the following Added back to income in the following year.year.



►Capital ExpendituresCapital Expenditures A credit against Tax Payable in the current A credit against Tax Payable in the current

yearyear

Credit deducted from capital cost in the Credit deducted from capital cost in the following periodfollowing period

Lose CCA on amount of investment tax Lose CCA on amount of investment tax creditcredit


Eligible PropertyEligible Property

► Eligible Eligible ExpendituresExpenditures Salaries of an Salaries of an

eligible apprenticeeligible apprentice Costs of creating Costs of creating

eligible child care eligible child care spaces spaces

Qualified PropertyQualified Property Qualified SR&EDQualified SR&ED


RatesRates

► Apprentice salariesApprentice salaries 10% on maximum of $20,000 per apprentice10% on maximum of $20,000 per apprentice

► Child care spacesChild care spaces 25% on a maximum of $10,000 per space25% on a maximum of $10,000 per space

► Qualified property - 10%Qualified property - 10%► SR&ED (CCPC)SR&ED (CCPC)

$3 million at 35%$3 million at 35% Excess at 20%Excess at 20%

► SR&ED (non-CCPC)SR&ED (non-CCPC) 20%20%


RefundabilityRefundability

► General RulesGeneral Rules No Tax PayableNo Tax Payable Can’t Use CreditsCan’t Use Credits Government Writes Cheque To The BusinessGovernment Writes Cheque To The Business


RefundabilityRefundability

► Current SR&EDCurrent SR&ED 100 percent on current 100 percent on current

amounts that qualify for the amounts that qualify for the extra 15%extra 15%

40 percent on other current 40 percent on other current SR&EDSR&ED

► Other (including SR&ED Other (including SR&ED capital expenditures)capital expenditures) 40 percent for CCPCs and 40 percent for CCPCs and

individualsindividuals No upper limit No upper limit


Carry OversCarry Overs

► Back Three YearsBack Three Years

► Forward Twenty Forward Twenty YearsYears

► Must Take All Other Must Take All Other Credits For The Year Credits For The Year And Reduce Tax And Reduce Tax Payable To Nil Payable To Nil Before UsingBefore Using



►Unused investment tax Unused investment tax credits may create credits may create attractive takeover targetsattractive takeover targets

►Given this, there are rules Given this, there are rules similar to those that apply similar to those that apply to loss carry forwards.to loss carry forwards.


Tax Basis Shareholders’ Tax Basis Shareholders’ EquityEquity

► Paid Up Capital Paid Up Capital (PUC)(PUC) Based On Legal Based On Legal

Stated CapitalStated Capital ITA 89(1)ITA 89(1) Similar To Similar To

Contributed Capital Contributed Capital in Accountingin Accounting


Tax Basis Shareholders’ Tax Basis Shareholders’ EquityEquity

► Retained EarningsRetained Earnings Pre-1972 Capital Surplus On HandPre-1972 Capital Surplus On Hand

► Capital Gains Accrued Before 1972Capital Gains Accrued Before 1972► Realized After 1971Realized After 1971

Pre-1972 Undistributed SurplusPre-1972 Undistributed Surplus Post-1971 Undistributed SurplusPost-1971 Undistributed Surplus Capital Dividend AccountCapital Dividend Account

► Treatment Of RDTOH (an asset Treatment Of RDTOH (an asset from a tax point of view)from a tax point of view)


Paid Up CapitalPaid Up Capital

► ImportanceImportance An investment of after tax An investment of after tax

fundsfunds Can be distributed tax freeCan be distributed tax free Note: PUC is not equal to ACBNote: PUC is not equal to ACB

► DefinedDefined Legal Capital (as per corporate Legal Capital (as per corporate

law)law) Limited number of adjustmentsLimited number of adjustments


Paid Up CapitalPaid Up Capital

Example: J & J issues 1,000 shares of stock on January 1, 2011 for $10,000 ($10 Per Share) and an additional 3,000 shares on December 31, 2012 for $60,000 ($20 Per Share).

1/1/11: PUC = ACB = $10 Per Share

31/12/12: PUC = $70,000 ÷ 4,000 = $17.50 Per Share

Individual buying on December 31, 2012

PUC = $17.50/Share

ACB = $20.00/Per Share


Capital Dividend AccountCapital Dividend Account

► General IdeaGeneral Idea

Like RDTOH - A Tracking Like RDTOH - A Tracking MechanismMechanism

Private Companies Only Private Companies Only (including non-Canadian (including non-Canadian controlled)controlled)

With election, balance can With election, balance can be distributed tax freebe distributed tax free


Capital Dividend AccountCapital Dividend Account

► ComponentsComponents Untaxed Portion Of Net Untaxed Portion Of Net

Capital GainsCapital Gains Capital Dividends ReceivedCapital Dividends Received Untaxed Portion Of CEC GainsUntaxed Portion Of CEC Gains Untaxed Life Insurance Untaxed Life Insurance

ProceedsProceeds Reduced By Capital Dividends Reduced By Capital Dividends

PaidPaid


Use Of Corporate SurplusUse Of Corporate Surplus

►Cash dividendsCash dividends Subject to gross up and Subject to gross up and

tax credit procedures tax credit procedures (Individuals)(Individuals)

Not deductible in Not deductible in determining corporate determining corporate income of payorincome of payor


Use Of Corporate SurplusUse Of Corporate SurplusStock DividendsStock Dividends

Common Stock (100,000 Shares) $1,000,000

Retained Earnings 4,000,000

Total Shareholders’ Equity $5,000,000

A 10 percent stock dividend is declared (FMV = $70 per share)

Transfer To PUC - [(100,000)(10%)($70)] = $700,000


Use Of Corporate SurplusUse Of Corporate SurplusStock DividendsStock Dividends

Common Stock (110,000 Shares) $1,700,000

Retained Earnings 3,300,000

Total Shareholders’ Equity $5,000,000

Holder of 100 shares at $60 gets 10 new shares at $70

Taxable Dividend = $700

ACB = ($6,000 + $700)/110 = $60.91


Dividends In KindDividends In Kind

Example: Distribute An Investment With A Cost Of $1 Million And A FMV Of $1.5 Million.

Recipient: Taxable Dividend Of $1.5 Million

Payor: Disposition At $1.5 Million, Capital Gain Of $500,000


ITA 83(2) Capital DividendITA 83(2) Capital Dividend

► All Dividends Are Taxed If No All Dividends Are Taxed If No ElectionElection

► Election (Form T2054) Allows Election (Form T2054) Allows Any Dividend To Be Treated As Any Dividend To Be Treated As A Capital Dividend (If Balance A Capital Dividend (If Balance Available In Capital Dividend Available In Capital Dividend Account)Account) Penalty For Excess ElectionPenalty For Excess Election Does Not Reduce ACB Of SharesDoes Not Reduce ACB Of Shares Does Not Reduce PUC Of SharesDoes Not Reduce PUC Of Shares


ITA 84(1) Deemed DividendITA 84(1) Deemed Dividend

► General IdeaGeneral Idea► PUC Increase In Excess Of Net PUC Increase In Excess Of Net

Asset Increase Asset Increase ► Creates Added Tax Free Creates Added Tax Free

DistributionDistribution► ITA 53(1)(b) - Addition To ACB ITA 53(1)(b) - Addition To ACB

Of SharesOf Shares

► ExceptionsExceptions► Stock DividendsStock Dividends► Shifts Between ClassesShifts Between Classes► Conversion Of Contributed Conversion Of Contributed

SurplusSurplus


ITA 84(2) Deemed DividendsITA 84(2) Deemed Dividends

► With winding-up under ITA 88(2):With winding-up under ITA 88(2): ITA 84(2) Deemed Dividend Equals The Excess Of ITA 84(2) Deemed Dividend Equals The Excess Of

The Amount Distributed Over PUCThe Amount Distributed Over PUC


Components Of 84(2) Components Of 84(2) DividendDividend

► ITA 88(2)(b)ITA 88(2)(b) Indicates That ITA 84(2) Indicates That ITA 84(2)

Deemed Dividend Is Made Up Deemed Dividend Is Made Up Of:Of:

►Capital Dividend (If Elected)Capital Dividend (If Elected)►Distribution Of Any Pre-Distribution Of Any Pre-

1972 CSOH [Deemed Not To 1972 CSOH [Deemed Not To Be A Dividend By 88(2)(b)Be A Dividend By 88(2)(b)(ii)](ii)]

►Residual Is A Taxable Residual Is A Taxable DividendDividend


ITA 84(3) Deemed DividendITA 84(3) Deemed Dividend

On Redemption, Acquisition By On Redemption, Acquisition By Corporation, Or Cancellation Of Corporation, Or Cancellation Of SharesShares

General Idea: If Payment To General Idea: If Payment To Shareholder Exceeds PUC, The Shareholder Exceeds PUC, The Excess Is A Deemed DividendExcess Is A Deemed Dividend

If Payment Exceeds ACB, The If Payment Exceeds ACB, The Excess Is A Capital GainExcess Is A Capital Gain

Remove ITA 84(3) Deemed Remove ITA 84(3) Deemed Dividend From POD under ITA Dividend From POD under ITA 5454


ITA 84(3) ExampleITA 84(3) Example

Mr. Jones owns all 5,000 shares of L&L Ltd. The shares have a PUC of $75,000 and his ACB is $40,000. One-half of the shares are redeemed for $55,000.

Redemption Price $55,000

PUC [(1/2)($75,000)] ( 37,500)

ITA 84(3) Deemed Dividend $17,500


ITA 84(3) Example ITA 84(3) Example (Continued)(Continued)

Redemption Price $55,000

ITA 84(3) Dividend ( 17,500)

POD $37,500

ACB ( 20,000)

Capital Gain $17,500


ITA 84(4) Deemed DividendsITA 84(4) Deemed Dividends►A Liquidating Dividend A Liquidating Dividend

Involving a PUC ReductionInvolving a PUC Reduction

► If Amount Distributed If Amount Distributed Exceeds PUC, The Excess Exceeds PUC, The Excess Is A Deemed DividendIs A Deemed Dividend


ITA 84(4) ExampleITA 84(4) Example

Company distributes $80 per share. The shares have a PUC Of $60 Per Share.

• ITA 84(4) Deemed Dividend Of $20 Per Share

• PUC Down By $60 To Nil

• ACB Down By $60


ITA 84(4.1) ExampleITA 84(4.1) Example

• If Public Company

• Entire distribution is treated as deemed dividend

• Exception if transaction considered to be outside the normal course of business (e.g., company sold business segment and distributed the proceeds)


Documents

Chapter 14 Other Issues In Corporate Taxation © 2011, Clarence Byrd Inc.2 Acquisition Of Control - The Problem Profit Company Loss Company Acquisition