Transfers to a Corporation - Law Society of Saskatchewanredengine.lawsociety.sk.ca/inmagicgenie/documentfolder/... · 2010-06-22 · TAXATION OF TRANSFERS TO A CORPORATION Humphrey

TAXATION OF

TRANSFERS TO A CORPORATION

Humphrey Tam Deloitte & Touche LLP

Suite 400, 122 – 1st Avenue South Saskatoon, SK S7K 7E5

May 2001 Not to be used or reproduced without permission – Saskatchewan Legal Education Society Inc.

Saskatchewan: Bar Admission Program i Corporate Commercial - Taxation of Transfers to a Corporation

TABLE OF CONTENTS

I. BACKGROUND ............................................................................................................1

II. SECTION 85...................................................................................................................2

III. SECTION 85 ROLLOVER REQUIREMENTS.............................................................4

A. GENERALLY...........................................................................................................4 B. PARTIES TO THE TRANSFER ..............................................................................4 C. ELIGIBLE PROPERTY: 85(1.1).............................................................................5 D. CONSIDERATION RECEIVED..............................................................................5 E. JOINT ELECTION FILED BY PARTIES ...............................................................6

IV. SELECTION THE ETP..................................................................................................7 A. GENERAL LIMITATIONS ON EPT ......................................................................7 B. SPECIFIC LIMITATIONS ON ETP ........................................................................8 C. SELECTING ETP FOR PURE TAX DEFERRAL ..................................................9 V. RESTRICTIONS ON CONSIDERATION RECEIVED .............................................12

A. EXCESS CONSIDERATION ................................................................................12 B. UNAUTHORIZED SHARES .................................................................................14

VI. EFFECT ON TRANSFEREE CORPORATION..........................................................15 VII. EFFECT ON TRANSFEROR ......................................................................................15 VIII. VALUATION CONCERNS.........................................................................................17 A. THE INDIRECT BENEFIT RULE: 85(1)(e.2) .....................................................17 IX. PRICE ADJUSTMENT CLAUSES .............................................................................19 X. STOP LOSS RULES ....................................................................................................23 A. ELEMENTS OF DOUBLE TAXATION...............................................................24 XI. STATED CAPITAL ACCOUNT AND PAID UP CAPITAL ADJUSTMENTS........24


ii Saskatchewan: Bar Admission Program Corporate Commercial - Taxation of Transfers to a Corporation

XII. GST CONCERNS.........................................................................................................27 XIII. PST CONSIDERATIONS ............................................................................................28 XIV. SAMPLE ROLLOVER AGREEMENT.......................................................................29 XV. ACKNOWLEDGEMENT AND SELECTED BIBLIOGRAPHY...............................41 APPENDICES: Appendix A – Application of Section 69, Income Tax Act (Canada)..................................A – 1


Saskatchewan: Bar Admission Program 1 Corporate Commercial - Taxation of Transfers to a Corporation

I. BACKGROUND

Where a person transfers property to a corporation that person realizes a gain to the extent

proceeds exceeds the cost of that property. Such gain is included in that person’s income in the

year of transfer. The nature of the gain to be reported will depend upon the type of property

disposed of (i.e., gain on sale of inventory will result in an income amount, gain on sale of non-

depreciable capital property is a capital gain and a gain on sale of depreciable capital property is

capital gain and possibly recaptured capital cost allowance).

When a person transfers property to another person (including a corporation) with which that

person does not deal at arm’s length, certain anti-avoidance rules come into play. Section 69 of

the Income Tax Act (Canada) (referred to in this paper as “ITA”. Note that all section references

in this paper refer to the ITA unless specified otherwise.) will operate to penalize the parties to

the transfer when the terms of the transfer are considered inappropriate such as transferring the

property for amounts other than fair market value. Where the transfer is at a value in excess of

fair market value, 69(1)(a) will limit the transferee’s cost of the property to its fair market value

even though the transferor will be taxed on the entire proceeds. Where the transfer is at an

amount less than fair market value 69(1)(b)(i) will limit the transferee’s cost of the property to

the amount paid and tax the transferor as if fair market value was received. In circumstances

where the transferor gifts the property to the transferee 69(1)(b)(ii) deems the transferor to have

disposed of the property at fair market value and the transferee to have acquired the property at

its fair market value. See Appendix A for examples of the application of this section.

Subsection 85(1), however, provides relief from the above consequences where property is being

transferred to a taxable Canadian corporation provided the requirements under that section are

met. That subsection allows a pure tax deferral if desired on a transfer of assets commonly

referred to as a tax deferred rollover. However, immediate income taxes can be triggered either

deliberately or inadvertently and one should be wary of this. This provision has been invaluable

in corporate reorganizations, transfers on the incorporation of a proprietorship or partnership,


2 Saskatchewan: Bar Admission Program Corporate Commercial - Taxation of Transfers to a Corporation

estate planning, division of family assets and a variety of other purposes. Nevertheless, federal

Goods and Services Tax (“GST”) and Saskatchewan Education and Health Tax (“PST”)

considerations should also be addressed early on in the planning to minimize surprises upon

closing the transaction.

II. SECTION 85

In explaining rollovers under 85 Beam & Laiken in “Introduction to Federal Income Taxation in

Canada” illustrate the basic concept of a pure tax deferral by relating it to changes in economic

interest. That is, on a tax deferred rollover, a transferor should end up with consideration which

leaves the transferor in the same economic position. In turn, the transferee corporation will

assume the property with the same characteristics as the transferor.

The following circumstances will be utilized throughout the paper to illustrate the operation of

the section:

Lauren Ashley is transferring land to a corporation, Lauren Enterprises Ltd., which she presently controls through ownership of common voting shares. The land has a fair market value of $10,000 and a cost of $5,000. Lauren Ashley will accept shares of the corporation as part or full payment of the land.

In order for a pure tax deferral to occur such that Lauren Ashley remains in a similar economic

position:

a. the disposition of land would have to occur at cost (or $5,000) in order that there is no capital gain;

b. the cost of the land to the corporation should be the same as Lauren Ashley’s cost, $5,000, in order that the corporation assume her position in relation to the land; and

c. the value of the package (share and non-share consideration) received for the land must equal the land’s fair market value, $10,000, whereas the cost of the package must still remain at her cost of the land, $5,000. On the assumption that she only takes back share consideration, the shares must have a fair market value of $10,000 and a cost of $5,000. (Also taking back only shares appears to be preferential from a PST perspective. This is addressed in detail later in the paper.)



To maintain a similar economic position when shares are issued the stated capital and paid up

capital of the shares must be considered. Under the Business Corporations Act (Saskatchewan)

(“BCA”) the stated capital of the shares would normally be equal to the fair market value of the

transferred property (i.e., $10,000): BCA s. 26(1.1). Paid up capital is the tax equivalent of legal

stated capital. It represents the amount which a taxpayer holding shares of a company can

extract tax free from the company without payment of tax. It represents a contribution of capital

that should be removable without cost. It would make sense that the paid up capital be $5,000 as

this represents the amount that is tax free if the land were sold. Without adjustment, paid up

capital would equal stated capital (i.e., $10,000). However the ITA requires adjustments to

ensure that paid up capital will be reduced to equal cost in this instance $5,000. See the detailed

discussion in “Stated Capital Account and Paid Up Capital Adjustments” later in this paper.

A summary of the transaction is set below illustrating how the economic position remains similar

throughout:

Before Transfer After Pure Tax Deferral Transfer

Lauren Ashley holds land with the following characteristics:

Lauren Ashley holds shares with the following characteristics:

Fair Market Value $ 10,000 Fair Market Value $ 10,000Cost $ 5,000 Adjusted Cost Base $ 5,000 Paid Up Capital $ 5,000 Lauren Enterprises Ltd. now holds land: Fair Market Value $ 10,000 Adjusted Cost Base $ 5,000



III. SECTION 85 ROLLOVER REQUIREMENTS

A. GENERALLY

In order for 85(1) to apply to a transfer the following conditions must be met:

a. the transferee must be a taxable Canadian corporation;

b. the property being transferred is either capital property (other than real property owned by a non-resident), eligible capital property, inventory (other than real property inventory) or certain resource properties: 85(1.1);

c. the consideration received by the transferor must include at least one share of the transferee corporation: Revenue Canada Information Circular IC 76-19R2: Transfer of Property to A Corporation Under Section 85; and

d. the transferor and transferee file a joint election with Canada Customs and Revenue Agency (“CCRA”) electing that 85(1) applies to the transfer within the prescribed time.

B. PARTIES TO THE TRANSFER

Subsection 85(1) refers to the transferor being a “taxpayer” which is defined in 248(1) as

including any person. Therefore, an individual and corporation could utilize this provision

whether or not they are Canadian residents. Trusts are also considered persons under the ITA

such that they too can utilize 85. In addition, under 85(2) partnerships can transfer their assets to

a taxable Canadian corporation on a tax deferred basis.

The transferree corporation must be a taxable Canadian corporation. Paragraph 89(1) defines a

“taxable Canadian corporation” as a corporation resident in Canada that was either incorporated

in Canada or resident here continuously after June 18, 1971 and that was not exempt from Part I

tax: 89(1) “Canadian corporation”, “taxable Canadian corporation”.

The section does not require the existence or absence of a prior relationship between the parties.

Therefore, the parties can be at arm’s length or related. Where the parties are unrelated note an

anti-avoidance rule may apply to deny the rollover if the main purpose of the transaction(s) were

to utilize certain losses of the transferee corporation: 69(11) and (12).



Where a non-corporate taxpayer transfers shares of one corporation to another corporation which

is not at arm’s length with the taxpayer the transaction should be carefully scrutinized in terms of

the consideration package received and the Elected Transfer Price (“ETP”) selected. If

immediately after the transfer, the two corporations are connected within the meaning of 186(4),

then immediate tax results can be inadvertently trigger such as deemed dividends as well as a

reduction in the paid up capital of the shares received: 84.1.

C. ELIGIBLE PROPERTY: 85(1.1)

Subsection 85(1.1) lists the properties that are eligible for transfer on a tax-deferred basis. They

include:

a. capital property (except real property owned by a non-resident);

b. eligible capital property (i.e., intangibles, goodwill, customer lists);

c. inventory (except real property inventory); and

d. Canadian and foreign resource properties.

Note when an unincorporated business is transferred consideration should be given to including

at a minimum, a nominal amount in respect of goodwill of that business, even where the same is

internally generated.

D. CONSIDERATION RECEIVED

The consideration received by the transferor must include at least one share. Although this rule

applies to each property transferred, the ITA defines a share to include a fraction such that it is

not necessary to issue one share for each particular property. That is, provided it is clear that the

one share is issued in respect to a group of properties being transferred, CCRA considers the

share requirement to have been met.



The ITA does not impose any restrictions on the type of shares issued or any rights associated

with such shares. Consequently, the shares issued can be common shares, preferred shares or a

combination of such shares. The restrictions and rights associated with the shares will often

depend on the purpose of the transfer. For example, where an estate freeze is being effected, the

transferor may be willing to accept fixed value shares in exchange for the property transferred in.

Consideration invariably includes non-share consideration which is often referred to as boot.

This can include cash, promissory notes and assumption of debt.

E. JOINT ELECTION FILED BY PARTIES

A joint election in prescribed CCRA Form T2057 must be made by the transferor and transferee

corporation. (The transferee corporation should also have minutes authorizing entering the

election.)

The election form must be filed on or before the first day on which any of the taxpayers making the

election are required to file a tax return in respect of the year in which the transfer occured: 85(6).

A late filing of the form can also be done if it is within three years; however the election will be

subject to penalties: 85(7). The penalty is described in 85(8) as the lesser of 1/4 of 1% of the

excess of fair market value of the property over the elected amount for each late month or part

thereof or $100 for each late month or part thereof up to a maximum of $8,000.

Provided the filing is within three years and the prescribed penalties have been paid the

Department must accept the election as valid unless the other conditions under 85 have not been

met.

A late filing of the form may also be made outside the three year period in special cases where

the Minister finds it just and equitable to permit the election: 85(7.1)(a) and 85(9).



Amendments in respect of valuation adjustments or clerical errors are also considered special

cases. Where the Minister finds it just and equitable the amendment will be accepted provided

the penalties, if any, are paid: 85(7.1)(b) and 85(9).

IV. SELECTING THE ETP

Tax deferral is accomplished by allowing the transferor and transferee corporation to jointly set

the ETP for each property transferred subject to prescribed limits. The ETP is important in that

it represents:

a. the proceeds of disposition to the transferor;

b. the aggregate cost of shares and any non-share consideration received by the transferor; and

c. the cost of the property to the transferee corporation.

A. GENERAL LIMITATIONS ON EPT

Two general limitations are imposed on the selection of the ETP:

a. at a minimum, the ETP must equal the fair market value of the non-share consideration (boot) received: 85(1)(b). If the ETP is less than the fair market value of the boot the ETP will automatically be increased to the fair market value of the boot. This is one instance where non-observance of the rules can create an unintended taxable transaction; and

b. at a maximum, the ETP cannot exceed the fair market value of the property being

transferred: 85(1)(c). If the ETP is greater than the fair market value of the property transferred in the ETP will automatically be reduced to the fair market value of the property.



Should the value of the boot exceed the value of the property being transferred in, the deemed

proceeds to the transferor and the deemed cost to the transferee corporation will automatically

reduced to the fair market value of the property transferred in. In addition, there will be an

immediate income inclusion to the transferor: 15(1). See the discussion in “Restrictions on

Consideration Received” later in this paper.

B. SPECIFIC LIMITATIONS ON ETP

In addition to the overall general limitations there are specific limitations applicable to certain

types of properties:

a. with respect to inventory and non-depreciable capital property (i.e., includes land or shares held as capital property), the ETP cannot be less that the lesser of its fair market value and its cost: 85(1)(c.1). This rule prevents the creation of an artificial loss by selecting a low ETP;

b. with respect to eligible capital property (i.e., goodwill, customer lists), the ETP cannot be less than the lesser of 4/3 of the cumulative eligible capital of the business immediately before the transfer, its cost and its fair market value: 85(1)(d). This rule prevents a terminal loss except to the extent its fair market value is less than the remaining balance in the transferor’s cumulative eligible capital pool;

c. with respect to depreciable capital property, the ETP cannot be less than the lesser of the undepreciated capital cost of all depreciable property of the class immediately before the disposition, its cost and its fair market value: 85(1)(e). This rule creates an artificial terminal loss by selection of an ETP which is less than fair market value; and

d. with respect to inventory of a farmer using the cash method of reporting income, certain special rules apply.

As well where depreciable capital property or eligible capital property is being transferred a

technical problem exists which could inadvertently trigger immediate tax consequences by way

of recaptured capital cost allowance. Accordingly, Revenue Canada Interpretation Bulletin

IT-218 sets out ordering rules when selecting ETPs for a group of depreciables or eligible capital

properties to facilitate a tax deferred rollover (where desired).



C. SELECTING ETP FOR PURE TAX DEFERRAL

To effect a pure tax deferral the ETP selected will typically be equal to the tax cost of the

property transferred.

In our example, an ETP of $5,000 would accomplish a pure tax deferral. Lauren Ashley

transferred land which she held as capital property with a fair market value of $10,000 and an

adjusted cost base of $5,000 for shares of the transferee corporation. The capital gain on the

transfer is entirely deferred where ETP = the adjusted cost base of the land or $5,000. The

application of 85 would deem the proceeds of disposition to the transferor to be $5,000 such that

there is no capital gain. The corporation will then have land on its records with a cost of $5,000

(even though its fair market value is $10,000). The individual transferor will have shares worth

$10,000 with an adjusted cost base of $5,000. If the individual sold any of the shares the

individual would then realize a capital gain on the sale.

In the typical situation the ETP selected is the tax cost of the property to the transferor. Tax cost

is not a defined term under the ITA; rather, it is merely a term of reference between practitioners

to refer to the value that would achieve a pure tax deferral. Tax cost in respect to different types

of property are as follows:

a. for non-depreciable capital property, its adjusted cost base;

b. for depreciable capital property, the undepreciated capital cost;

c. for inventory, its cost amount (note for grain inventory of a farmer the cost of this inventory is often nil because the various farm expenses that go into growing the grain are expensed); and

d. for eligible capital property (assuming there is a cost) 4/3 times the cumulative eligible capital amount. (Note, however, that in most cases eligible capital property such as goodwill is internally developed such that there is no cost base).

Generally, where ETP is taken at the tax cost, no capital gains, capital losses, recapture or other

income will arise on the transfer to a corporation.



The original example illustrated a pure tax deferral. However, in some cases it may be

advantageous to select an ETP that will trigger capital gains and income. If a transferor has

unutilized net capital or non-capital losses or has not fully used her capital gains exemption,

Lauren Ashley might consider selecting an ETP higher than her cost base so as to trigger a

capital gain on non-depreciable capital property. The transferee corporation (usually related to

the individual) will have an increased cost base which could reduce future capital gains if it was

subsequently resold by the corporation.

Section 85 can only be utilized to deliberately trigger capital gains of a determined amount by

selecting an ETP above the tax cost:

Lauren Ashley is transferring land to a corporation, Lauren Enterprises Ltd., which she presently controls through ownership of common voting shares. The land has a fair market value of $10,000 and a cost of $5,000. Lauren Ashley will accept shares of the corporation as part or full payment of the land. Lauren Ashley has a net capital loss carryforward from prior year of $2,000 which she wishes to utilize.

If Lauren chooses an ETP of $9,000, a taxable capital gain of $2,000 will result (i.e., ($9,000 -

$5,000) x 50%) which will offset the net capital loss carryforward. The end result of selecting

an ETP above tax cost can be summarized as follows:


Lauren Ashley holds land with the following characteristics:


Fair Market Value $ 10,000 Fair Market Value $ 10,000Adjusted Cost Base $ 5,000 Adjusted Cost Base $ 9,000 Paid Up Capital $ 9,000 Lauren Ashley has a $2,000 net capital loss carryforward

Lauren Ashley’s taxable capital gain of $2,000 is offset by the net capital loss carryforward



By selecting an ETP of $9,000:

a. Lauren Ashley will have proceeds of disposition on the land of $9,000 (which will trigger the deliberate gain);

b. the tranferee corporation will have a cost to the land of $9,000; and

c. Lauren Ashley will have a cost to her shares received in exchange equal to $9,000.

Suppose Lauren Ashley also owned a building which she proposes to transfer with a fair market

value of $10,000, a cost of $5,000 and a undepreciated capital cost of $1,000. Will an election of

$9,000 have the same result? If depreciable capital property is used to trigger capital gains, a

recapture of capital cost allowance can occur and in those circumstances it may not be advisable

unless the transferor had business losses or non-capital losses that she wished to offset the

recapture with. As noted above the undepreciated capital cost is considered the tax cost of

depreciable capital property and it is this amount to elect for a pure tax deferral. The end result

of selecting an ETP for a depreciable capital property for a pure tax deferral can be summarized

as follows:


Lauren Ashley holds a building with the following characteristics


Fair Market Value $ 10,000 Fair Market Value $ 10,000Cost $ 5,000 Cost $ 1,000Undepreciated Capital Cost $ 1,000 Paid Up Capital $ 1,000 Company now owns the building with these

characterisics: Fair Market Value $ 10,000 Cost $ 1,000 Undepreciated Capital Cost $ 1,000



Furthermore, since Lauren Ashley is transferring in the depreciable capital property into a

corporation which she does not deal at arm’s length with, selecting an ETP higher than her

original cost will not allow the corporation to use the higher ETP amount for calculating future

capital cost allowance. Where the property transferred was depreciable capital property a

transferee corporation will not have the benefit of the increased cost base for capital cost

allowance purposes. Paragraph 13(7)(e) restricts a related transferee’s claim of capital cost

allowance to the amount of cost base which was subject to tax. Where the cost of the property to

the corporation (assuming a $9,000 ETP) exceeds the cost to the transferor Lauren Ashley

(i.e., $5,000), 13(7)(e) applies on the related party transfer of depreciable property to deem the

capital cost of the property to the corporation to be the aggregate of the transferor’s original

capital cost ($5,000) and the taxable capital gain (50% x ($9,000 - $5,000) = $2,000) or $7,000.

Prior to the repeal of the $100,000 capital gains exemption in 1994, the aggregate amount would

be reduced by the amount of capital gains deduction claimed. That is, if Lauren Ashley used her

capital gains exemption to shelter the $2,000 taxable capital gain, 13(7)(e) would reduce the

corporation’s cost from $7,000 to $5,000. In any event, the deemed cost to the corporation will

form the new base on which it is entitled to compute capital cost allowance. For other purposes;

however, the corporation’s cost will be deemed to be the ETP of $9,000.

V. RESTRICTIONS ON CONSIDERATION RECEIVED

A. EXCESS CONSIDERATION

To the extent consideration is received in excess of the fair market value of the property

transferred in, the ITA penalizes the transferor by way of triggering immediate tax consequences:

“Where non-share consideration is in excess of the fair market value of the property transferred in, the transferor is viewed as having appropriated property from the corporation. Accordingly, the transferee would be assessed a subsection 15(1) benefit equal to the excess that is then included in income in the year of transfer. As partial relief, subsection 52(1) will allow such amount to be added to the cost base of the non-share consideration.”


Saskatchewan: Bar Admission Program 13 Corporate Commercial - Taxation of Transfers to a Corporation In the example, 15(1) will apply where the transferor takes back consideration in excess of the

value of the property transferred to the corporation:

Lauren Ashley is transferring land to a corporation, Lauren Enterprises Ltd., which she presently controls through ownership of common voting shares. The land has a fair market value of $10,000 and a cost of $5,000. Lauren Ashley will accept shares and a $12,000 promissory note of the corporation as full payment of the land. The end result of taking excessive consideration can be summarized as follows:

Before Transfer After Transfer

Lauren Ashley holds land with the following characteristics


Fair Market Value $ 10,000 Fair Market Value $ 10,000Cost $ 5,000 Cost $ 1 Paid Up Capital $ 1

Lauren Ashley holds a promissory note with the following characteristics:

Fair Market Value $ 12,000 Cost $ 10,000 Revised cost * $ 12,000

Lauren Ashley has taken back consideration of $12,000 such that the ETP must be $10,000 thereby triggering a $5,000 capital gain and a income inclusion under 15(1) as follows:

Fair market value of boot $ 12,000 Fair market value of shares nominal Total fair market value of

consideration received $ 12,000

Less fair market value of transferred land

$(10,000)

15(1) Income Inclusion $ 2,000

*This income amount would be added to the cost of the note as a result of 52(1).



Where the paid up capital of a particular class of shares exceeds the net increase in assets as a

result of the transfer an immediate deemed dividend under 84(1) will be triggered in the

transferor’s hands. As partial relief, 53(1)(b) operates to allow the amount of the dividend to be

added to the cost base of the shares received under the transfer.

If the share and non-share consideration received is less than the fair market value of the

property transferred in the ITA penalizes the transferor in certain instances. Paragraph 85(1)(e.2)

operates in certain instances where a benefit is conferred on the other shareholders. In such

instances the ETP will be increased by the amount of the gift (which could then destroy the pure

tax deferred transfer). The adjusted cost base of the transferor’s shares however remain

unchanged.

See the detailed discussion under “Valuation Concerns” later in this paper.

B. UNAUTHORIZED SHARES

Invariably, there will be time restrictions on completing the transfer. A problem that sometimes

arises is that the transferor requires shares of a nature that the corporation is not authorized to

issue. Consequently the corporation must still attend to amending its articles to create the

desired class of shares which will be issued after the effective transfer date. Although this is not

a desirable situation, can a valid transfer under 85 be made in such circumstances? This issue

has been raised in a tax appeal, Dale 94 DTC 1100 (TCC). Until the appeal to federal court was

rendered, CCRA took the following administrative position:

“Question 42: Section 85—Issue of Shares Pending the decision of the Federal Court in the appeal of Dale et al v. The Queen, 94 DTC 1100 (T.C.C.), the following conditions must be met for subsection 85(1) to apply to a transfer of property, where the share consideration is not authorized: 1. there exists an agreement between the transferor and the transferee and the said

agreement requires, inter alia, that the transferor issue the shares required; 2. the transferor immediately undertakes the steps necessary to issue the shares, i.e.,

files an application for supplementary letters patent or articles of amendment, whichever is appropriate;

3. when the necessary changes to the articles of incorporation have been made, the transferor issues the shares promptly.”

Round Table—Association De Planification Fiscal et Financière 1994 Revenue Canada File Number: 5M08340



The Federal Court of Appeal (97 DTC 5252) ruled in favour of the taxpayer in allowing shares to

be retroactively issued such that the election under 85 was valid. In that case the taxpayer

obtained a court order from the Supreme Court of Nova Scotia retroactively authorizing the

issuance of preferred shares (i.e., when the transaction was completed seven years earlier the

corporation purported to issue shares which its authorized capital didn’t permit).

VI. EFFECT ON TRANSFEREE CORPORATION

The ETP becomes the corporation’s cost of the property acquired: 85(1)(a). Where the

corporation acquired depreciable capital property from the transferor, it assumes the position of

the transferor:

a. the capital cost of the property to the corporation deemed to equal to the capital cost of the property to the transferor: 85(5)(a);

b. the corporation deemed to have taken capital cost allowance for amount equal to excess of capital cost over ETP: 85(5)(b);

c. the half year rule generally applicable when a taxpayer acquires a depreciable property may not be applicable: Regulation 1100(2.2); and

d. the depreciable property remains in the same capital cost allowance pool in non-arm’s length transfers: Regulation 1102(14).

VII. EFFECT ON TRANSFEROR

The cost to be allocated to the shares and non-share consideration received is made in prescribed

order as follows:

a. first, to non-share consideration up to its fair market value: 85(f) (i.e.,any excess of fair market value of non-share consideration over the fair market value of the property transferred will be taxed as a 15(1) appropriation);

b. second, to the extent any unallocated cost base remains, it is allocated to any preferred shares issued up to their fair market value: 85(1)(g) (i.e., allocate to preferred shares up to their fair market value provided it does not exceed ETP - boot); and



c. finally, any remainder in unallocated cost base is allocated to the common shares, if any, received: 85(1)(h) (i.e., allocate to common shares for any excess of ETP over cost allocated to boot and preferred shares).

This following example illustrates the allocation of cost on typical tax deferred transfers:

Lauren Ashley is transferring land to a corporation, Lauren Enterprises Ltd., which she presently controls through ownership of common voting shares. The land has a fair market value of $10,000 and a cost of $5,000. Lauren Ashley and the corporation jointly elect at an ETP of $5,000 under 85(1). Lauren Ashley is considering two different consideration packages:

a. preferred shares redeemable and retractable for $10,000; and b. cash and/or promissory notes of $3,000 and preferred shares of $6,000 and common

shares of $2,000.

The above transfer is fully tax deferred as the ETP is at the tax cost to the transferor. Lauren

Ashley’s cost of the various consideration received under the two alternatives are summarized

below:

Alternative Consideration Packages

Shares only Shares /Boot

Elected Transfer Price $ 5,000 $ 5,000

Cost following 85(1) election:

Cash/Promissory Notes 0 $ 3,000

Preferred Shares $ 5,000 $ 2,000

Common Shares 0 0

Total $ 5,000 $ 5,000



VIII. VALUATION CONCERNS

A. THE INDIRECT BENEFIT RULE: 85(1)(e.2)

A benefit is deemed to have been conferred on a related person where:

a. the fair market value of the property immediately before its transfer exceeds the greater

of

ii. the fair market value of the consideration received from the corporation for the transfer, and

ii. the ETP; and

b. it is reasonable to regard any of the above excess as a benefit that the transferor desired to have conferred on a related person (other than a corporation that was a wholly owned corporation of the transferor immediately after the transferor): 85(1)(e.2).

In such cases, the ETP will be increased by the amount of the gift. The provision is penalizing in

nature similar to that in 69(1)(b). It triggers an immediate income inclusion; however there is no

recognition or increase in the cost base of the shares received on the transfer.

Continuing our example:

Lauren Ashley is transferring land to a corporation, Lauren Enterprises Ltd., which her spouse presently controls through ownership of common voting shares. The land has a fair market value of $10,000 and a cost of $5,000. Lauren Ashley and the corporation jointly elect at an ETP of $5,000 under 85(1). Lauren Ashley takes back consideration worth only $8,000 by way of cash and/or promissory notes of $5,000 and preferred shares of $3,000.

As Lauren Ashley owns none of the common shares of the transferee corporation after the

transfer and because a related person, her spouse owned the common shares, arguably, Lauren

Ashley has conferred a benefit on her spouse equal to the excess of fair market value of the land

over the consideration package she received (i.e., $2,000 = ($10,000 - $5,000 - $3,000)). As

Lauren Ashley only extracted or holds entitlements to $8,000 the balance or surplus will fall

within the residual to which the common shareholders are entitled on a liquidation or dissolution.

Note a benefit could be conferred even if Lauren Ashley held some (but not all) of the common

shares in the corporation. If she held a 20% common shareholding, then 80% of the excess



would be the benefit conferred or $1,600 ($2,000 x 80%) and the capital gain would only be

$1,600. In any event, the benefit in the original example of $2,000 would be added to the ETP

thereby triggering a capital gain of $2,000. The cost of the land to the corporation will be the

adjusted ETP or $7,000 (original ETP plus benefit).

As previously noted, the provision is penalizing in that Lauren Ashley’s shares will still have a

cost base of nil even though the ETP was adjusted upwards from $5,000 to $7,000 and under the

normal rules the $2,000 would be allocated to the cost of the shares. Furthermore, Lauren’s

spouse, the common shareholder will have common shares that are worth an additional $2,000;

however his cost base of such shares remains unadjusted. Consequently, the capital gain will be

taxed twice: once when Lauren Ashley sells her shares (for which no cost base was given) and a

second time when her spouse sells his common shares (which increased in value from the

rollover for which no adjustment was given to the cost base of his shares). It is therefore

imperative that the transferor always take back consideration equal to the fair market value of the

property transferred in.

When a transferor is transferring to a corporation of which he or she is not the sole shareholder

(i.e., see exception where transferor holds all shares) there is a risk of invoking this section when

part or all of the consideration taken back is common equity shares. The reason is that such

shares are difficult to value (i.e., valuation is an art). Consequently fixed value preference shares

are commonly issued (as opposed to common shares) in conjunction with non-share

consideration for the property transferred. Furthermore (as illustrated above in the example) to

maximize the ability to extract the cost base without immediate tax, non-share consideration

such as a promissory note is taken up to the ETP. Preferred shares having a fixed value are taken

for the difference between the ETP and fair market value of the property transferred in.


Saskatchewan: Bar Admission Program 19 Corporate Commercial - Taxation of Transfers to a Corporation CCRA, however, has concerns as to whether the fixed value ascribed to the preference shares

have an equivalent fair market value. For that reason, CCRA requires the preference shares to

have certain characteristics which were initially outlined during the 1980 Revenue Canada

Roundtable:

“Department's Response: The Department is concerned that the value (redemption amount) of the preferred shares issued plus other consideration given is equal to the fair market value of the property transferred. • Our position is that the preferred shares must be redeemable at the option of the

holder. • The preferred shares should be entitled to a dividend. In any case, the dividend must

not exceed a reasonable amount. [But note the Department's response at the 1981 Revenue Canada Round Table Q.45 was that while it would “prefer” that such shares bear a “reasonable” dividend rate, the absence of a dividend entitlement would not, in and of itself, result in the application of paragraph 85(1)(e.2) of the Act. ]

• The shares may or may not have voting rights; however, such shares should at least have voting rights on any matter involving a change to the rights, conditions, or limitations attaching to them, sufficient to protect those rights, etc.

• It is essential that the value is maintained and, accordingly, there are other rights which must be attached to the preferred shares, such as a preference on any distribution of the assets of the corporation on any liquidation, dissolution, or winding-up, and no restriction on the transferability of the shares (other than restrictions required by corporate law to qualify the company as a private company).

• In addition, the corporation must undertake that no dividends will be paid on the other classes of shares which would result in the corporation having insufficient net assets to redeem its preference shares at their redemption amount.”

Consideration should be given to whether the various restrictions in the BCA are sufficient to

meet CCRA’s guidelines as above stated or whether the articles of the corporation must be

amended to conform to these guidelines.

IX. PRICE ADJUSTMENT CLAUSES

The rollover agreement under 85 will indicate the parties best estimate of the fair market value of

the property transferred. However, CCRA may take issue with the value which could trigger

immediate tax consequences. Where CCRA asserts that the estimated fair market value in the

agreement is understated, there is a potential benefit conferred resulting in capital gains,

recapture and or other income to the transferor.



Price adjustment clauses are utilized to deal with the problem of incorrect values. The clause

will usually provide that should the true fair market value be different than the estimated fair

market value in the agreement, then the value of the consideration given will be adjusted

accordingly.

CCRA has a published Interpretation Bulletin outlining their position on when they will

recognize price adjustment clauses. It adopts principles outlined in Guilder News Co. (1963)

Ltd. et al 73 DTC 5048 (FCA) and also goes further in adding the Agencies position. The

bulletin is reproduced below:

“IT-169 Price adjustment clauses (August 6, 1974) Reference: Section 3 (also section 69 and subsection 15(1)) a) Where property is transferred in a non-arm's length transaction, the parties

sometimes include a price adjustment clause in the covering agreement. This bulletin deals with those agreements which state that if the Department determines that the fair market value of the property is greater or less than the price otherwise determined in the agreement, that price will be adjusted to take into account the excess or the shortfall. The Department is only concerned in the valuation for purposes of administering the Act and determining the tax consequences. It is neither a valuator nor an arbitrator for the parties. If the parties have agreed that, if the Department's value is different from their's, they will use the Department's value in their transaction, that is their choice and the Department will recognize that agreement in compuLauren the income of all parties, provided that all of the following conditions are met:

i) The agreement reflects a bona fide intention of the parties to transfer the property at fair market value and arrives at that value for the purposes of the agreement by a fair and reasonable method. ii) Each of the parties to the agreement notifies the Department by a letter

attached to her return for the year in which the property was transferred a) that she is prepared to have the price in the agreement reviewed by the

Department pursuant to the price adjustment clause, b) that she will take the necessary steps to settle any resulting excess or

shortfall in the price, and c) that a copy of the agreement will be filed with the Department if and when

demanded. iii) The excess or shortfall in price is actually refunded or paid, or a legal

liability therefor is adjusted. b) Whether the method used by the parties to determine fair market value is fair and

reasonable in the Department's view will depend on the circumstances in each case.



c) In recognizing the price adjustment clause, appropriate adjustments in computing the income of all parties to the agreement will be made in their taxation years in which the property was transferred. If the purchaser has filed returns and claimed capital cost allowances, deductions from income based on cumulative eligible capital, or exploration and development expenses in respect of the property for taxation years subsequent to that in which it was transferred, any necessary adjustments will be made in those subsequent years. Likewise, any reserves claimed by the vendor to defer the reporLauren of income will be adjusted.

d) Amended Forms T2022 on the sale of accounts receivable or amended agreements on the price paid for inventory may be required.

e) If all the conditions mentioned in paragraph 1 are met, the Department will not apply subsection 15(1) to tax a benefit to shareholders.

f) Where taxpayers have included price adjustment clauses in agreements that relate to transactions reported in tax returns already filed, they should notify the District Office immediately if they wish to have the clause considered in the light of the comments in this bulletin.”

In constructing or reviewing price adjustment clauses consider reviewing “Use of Adjustment

Clauses in Non-arm’s Length Reorganizations” by Douglas Ewens. Having regard to Guilder

Ewens suggests that the price adjustment should be deemed by the parties to be retroactive to the

date of the original transaction. In addition the price adjustment clause should outline precisely

how the consideration paid/issued is increased or decreased in the event the price changes

retroactively. The value of the share consideration issued can be adjusted by either adjusting the

number of shares received by the transferor or adjusting the redemption amount of the shares

received by the transferor. In the first case, a change in the value of the property transferred will

trigger a retroactive cancellation or issuance of preferred shares. The latter case is the method

preferred by CCRA. In Revenue Canada Document No. 9829125, dated March 10, 1999 the

Department suggests that price adjustment clauses should not involve the canceling of issued

shares or issuance of additional shares. Yet this is a common method used in Saskatchewan to

deal with the price adjustment. Under the alternative method (which is preferred by the

Department and according to Ewens, less troublesome) the number of shares issued remains

unadjusted rather the redemption price of each preferred share is adjusted to reflect the

adjustment to the true value of the property transferred in. An issue, however, arises as to

whether this alteration in redemption amount is a disposition under the ITA. Ewens concludes at

page 727:



“… where a price adjustment clause is contained in the share conditions themselves and the redemption amount of the shares is altered pursuant thereto, no change in the shareholder’s “bundle of rights” occurs and that therefore no disposition of the shares takes place. Where a price adjustment clause contained in a contract requires that the redemption amount of preference shares be altered in order to implement the adjustment, no disposition of the shares should, it is submitted, be regared by Revenue Canada as taking place because the shareholders’ rights, viewed in light of the contract, remain unchanged. To reinforce that argument, the shares issued by the purchasing corporation should comprise all the shares of a separate class, and all certificates evidencing those shares should bear a legend stating that their redemption amount is subject to being altered in accordance with the contract.”

Should the Department not accept the validity of the price adjustment clause and proposes to

assess a shareholders benefit, Melvin Gerspacher in “Aspects of Share Valuation in Income Tax”

indicates that the Department’s reimbursement policy as outlined in section 13(15)1.4 of the

Taxation Operations Manual Audit Applications Guide can reduce the adverse tax consequences.

Should a price adjustment clause come into operation, CCRA takes the position that an amended

return must be filed under 85(7.1). In a technical interpretation summarized in Windows - CCH

Canadian Limited, the following was noted:

“[¶2039] Amended Section 85 Elections—Price Adjustment Clauses Subsection 85(7.1) sets out the circumstances in which amended section 85 elections will be accepted outside the three-year grace period in subsection 85(7). The election must be made in the prescribed form and an estimate of the penalty must be paid when the election is filed.

It is Revenue Canada's belief that the penalty imposed by subsection 85(7.1) cannot be avoided by the use of a price adjustment clause. The agreed amount set out in a section 85 election is a key term of the election. Consequently, any change to the agreed amount, whether from a price adjustment clause or not, will require an amended election.”

Memorandum, Legislative and Intergovernmental Affairs Branch July 29, 1992

Income Tax Act: 85(7.1) Canadian Tax Reporter: ¶10,614

Revenue Canada File Number: 2M01530”



X. STOP LOSS RULES

Capital losses arising on the transfer of property to a corporation can be subject to restrictions.

This is the case where the transfer is between certain non-arm’s parties defined as affiliated

persons. How the loss is restricted depends on the type of affiliated person involved, (i.e.,

individual, corporation, trust, etc.):

a. if a person holds capital property with an unrealized capital loss that loss will be denied immediate recognition if it is being transferred to an affiliated person;

b. if an individual transfers property (other than certain shares) to an affiliated corporation the denied capital loss is added to the tax cost of the property to the corporation: 53(1)(f), 54, 40(2)(g), and 251.1;

c. if a corporation, trust or partnership transfers property (other than certain shares) to an affiliated person the denied capital loss is suspended: 40(3.3) and 40(3.4) The transferor will be entitled to recognize the loss on the earliest of three events:

i. the property is subsequently transferred to a person that is not the transferor or a person affiliated with the transferor (provided the property or rights to it are not acquired within 30 days of this subsequent disposition);

ii. the transferor becomes a non-resident of Canada thereby triggering a deemed disposition; or

iii. there is an acqusition of control of the corporation; and

d. for all taxpayers, where the property is a share of the capital stock of a corporation and is disposed of to that corporation, any capital loss will be denied: 40(3.6). Provided that the corporation acquiring its own shares is affiliated with the shareholder immediately after the acquisition any loss that would otherwise arise with respect to the transaction is denied and the amount of that loss is instead added to the adjusted cost base to the shareholder of other shares owned by it in the acquiring company:” ITA Explanatory Notes.

In summary, although these stop loss rules are discussed in this paper in the context of elections

under 85 and transfers, they have general application to losses arising on transfers between

affiliated persons and will apply regardless of whether an election under 85 is made. In fact, in

some cases there will be no need for a transfer electing under 85, particularly an individual

transferor. Where a property transferred under 85 will be subject to these stop loss rules, you

have to question whether to transfer the property as the loss will not be recognized until sale of

the shares or the property is subsequently resold.



A. ELEMENTS OF DOUBLE TAXATION

Transfers on a tax-deferred basis under 85 will always introduce an element or potential for

double taxation. As illustrated above, the transferor receives shares and non-share consideration

with a fair market value in excess of their adjusted cost basis. Upon disposition of the shares the

transferor will recognize a capital gain. The same transaction will have the transferee

corporation taking the property at the original cost base well below their fair market value.

Should the corporation subsequently sell such assets a second capital gain would be recognized.

How can the multiplication of capital gains be justified?

Generally, the tax deferral arising on the transfer to the corporation more than offsets the

exposure for double taxation. In addition from a small business context a Canadian controlled

private corporation has significant tax advantages over an individual. The first $200,000 of

active business income earned by a Canadian controlled private corporation is taxed at only

21.12%. The tax savings from retained earnings in the corporation over an individual provides

another basis for accepting the exposure to double taxation. In any event, consideration should

be given to whether the anticipated benefit from the deferral exceeds the cost of double taxation

in the future.

XI. STATED CAPITAL ACCOUNT AND PAID UP CAPITAL ADJUSTMENTS

Corporations maintain separate stated capital accounts for each class and series of shares that it

issues: BCA s. 26(1). The stated capital account’s tax equivalent under the ITA is often referred

to as paid up capital. Generally, when a corporation issues shares it will add an amount to its stated capital account for

that class of shares equal to the value of the consideration received: BCA s. 26(1.1).

Accordingly, where a transferor transfers property to a corporation electing under 85 and

receiving shares, the full fair market value of the transferred property (less any boot taken) is

added to the stated capital account of the shares issued.


Saskatchewan: Bar Admission Program 25 Corporate Commercial - Taxation of Transfers to a Corporation Subsection 26(1.2) of the BCA provides that:

“... where a corporation issues shares in exchange for: a) property of a person who immediately before the exchange does not deal with the

corporation at arms length within the meaning of that term in the Income Tax Act (Canada); or

b) shares of a body corporate that, immediately before the exchange or, because of the exchange, immediately after the exchange does not deal with the corporation at arms length within the meaning of that term in the Income Tax Act (Canada); or

c) property of a person who immediately before the exchange deals with the corporation at arms length within the meaning of that term in the Income Tax Act (Canada), if the person, the corporation and all the holdes of shares in the class or series of shares so issued consent;

the corporation may, subject to subsection 1.3, add to the stated capital accounts maintained for the shares of the classes or series issued the whole or any part of the amount of the consideration it received in the exchange. Subsection 1.3 restricts the addition to the stated capital account to the value of the consideration received for the shares.”

Consequently, where the parties are not dealing at arm’s length or where all arm’s length parties

consent there is flexibility in selecting amount to the stated capital account. Transfers in the past

utilized this section and the shares were commonly referred to as hi-low shares. That is, the

shares had a low stated capital account and low paid up capital but had a high redemption value.

Upon redemption these shares trigger a deemed dividend equal to the difference between the

redemption price and the paid up capital.

If 26(1.2) is not utilized to reduce the stated capital then the addition to stated capital will

continue to equal the fair market value of the transferred property. In turn the paid up capital

would remain high (unless otherwise adjusted under the ITA). Unless the ITA adjusted paid up

capital a subsequent redemption of the shares a capital gain would be triggered (as opposed to a

deemed dividend). You will note that the ITA does address paid up capital.

When the capital gains exemption was introduced in 1985 additional provisions were introduced

such as 85(2.1) and 84.1. In particular, 85(2.1) operates as an anti-avoidance rule in several

ways:



a. it prevents the conversion of a deemed dividend on redemption into a capital gain qualifying for the capital gains exemption; and

b. it prevents a taxpayer from transferring property to a corporation which has appreciated in value for shares of the corporation with a paid up capital in excess of the tax cost of the assets. This provision reduces the paid up capital to the amount of the ETP less any boot received. It effectively restricts the tax free extraction to that of the tax cost and no more.

Example: Computation of Paid Up Capital Reduction A. If Lauren Ashley takes back preferred shares redeemable for $10,000, no boot taken Legal Paid Up Capital: BCA s. 26(1.1) (Net fair market value increase)

$ 10,000 $ 10,000

Reduction Elected Transfer Price $ 5,000 Less Boot 0

Excess (if any) $ (5,000) Total Reduction under 85(2.1) $ (5,000)Paid Up Capital of Shares $ 5,000

Example: Computation of Paid Up Capital Reduction B. If Lauren Ashley takes back preferred shares redeemable for $5,000 and a $5,000 note Legal Paid Up Capital: BCA s. 26(1.1) (Net fair market value increase)

$ 10,000 $ 10,000

Reduction Elected Transfer Price $ 5,000 Less Boot $ (5,000)

Excess (if any) 0 Total Reduction under 85(2.1) $ (10,000)Paid Up Capital of Shares Nil

The above adjustments ensure that the transferor will not receive capital gains treatment on a

subsequent redemption, rather a taxable dividend will arise.


Saskatchewan: Bar Admission Program 27 Corporate Commercial - Taxation of Transfers to a Corporation XII. GST CONCERNS

Property subject of a rollover may be subject to tax under the Excise Tax Act (“ETA”)(Part IX -

GST) if the transferor used such property in a commercial activity. In situations of a transfer on

an incorporation of a proprietorship or partnership GST will apply; however, an election may be

available to exempt the transaction from GST. Subsection 167(1) of the ETA can apply where a

supplier makes a supply of a business , an acquired business or part thereof that was established

or carried on by the supplier or a previous owner. Provided the recipient acquires ownership

possession or use of all or substantially all of the property that can reasonably be regarded as

being necessary for the recipient to carry on the business or part thereof, no GST is payable on

the supply. GST Form 44 would be completed by the parties and filed with CCRA by the

purchaser no later than the due date for the purchaser’s GST return for that reporting period. Generally, the transfer of real property constitutes a taxable supply on which GST must be

collected. However, provided the recipient is a registrant that is using the acquired land in a

commercial activity, subsection 221(2)(b) of the ETA may excuse the supplier from collecting

GST. Note if none of the elections are available the general rules of the GST legislation would apply to

the transfer of property. The GST would be based on the fair market value of the consideration

paid or payable for the property. Under 153(1)(b) of the ETA the value of the consideration

received is deemed to be equal to the fair market value of the consideration received at the time

of the transfer. Consequently, the value of the consideration will be equal to the value of the

share and non-share consideration received by the transferor. If the transferree corporation is using the property in commercial activity it may be entitled to

claim input tax credits to the extent the property relates to such activities. If the transferree

corporation is using the property in making exempt supplies then no input tax credits can be

claimed. If the transferor and transferee are both corporations, an election under s. 156 of the

ETA may be available to defer any GST.



XIII. PST CONSIDERATIONS

In the March 2000 Saskatchewan Budget sweeping changes were made to reduce income taxes

to Saskatchewan residents. Funding for these tax reductions came in part by broadening the tax

base for PST. Transfers of business assets could now be subject to PST. Although the amending

legislation has not been available, Saskatchewan Finance Information Bulletin EH-60:

Information on Transfers of Business Assets Between Closely Related Parties is instructive. It

provides for exemptions from PST for certain transfers of business assets. The bulletin outlines

seven basic transactions:

a. Transfers among parent corporations and wholy owned subsidiaries:

Parent corporation and wholly owned subsidiary are defined terms in the bulletin. Apparently, transfers as between parent and subsidiary or between sister corporations can be tax exempt provided the assets being transferred are already tax paid and the parent-subsidiary relationship is maintained for at least eight months from the date of transfer. Where the transfer is by lease the payments are tax exempt while the parent sub relationship is maintained.

b. Transfers to a new company wholly owned and controlled by the transferors: “The transfer of tax paid business assets is exempt from tax when a new company is incorporated by a person, partnership or corporation which wholly owns and controls the new corporation and the intention is to have the same principals operate the business.”

The qualifications for this exemption are quite stringent. At first sight, this exemption appears intended to allow incorporation of a proprietorship or partnership. However, questions arise as to whether a shelf corporation incorporated by a law office can be a new company to which the assets are transferred (i.e., the law firm is the incorporator as opposed to the person transferring in the business assets). It is also unclear as to the requirement that the transferor continue to control the new company (i.e., what if two partners were transferring their partnership units into the new company, neither would control?). A final question relates to use of business assets. Transfers after the date the corporation carried on business are not exempt. Yet, in some instances a proprietor, in planning his transition to corporate form, may want to transfer assets to the company in stages. In such cases, this exemption will not assist.



c. Transfers to a new company which the transferor does not wholly own or control:

This exemption is similar to the exemption where the transferor controls. A distinction, however, which is important particularly on tax deferred transfers is the bulletin’s requirement that “The transferor receives shares of the purchasing corporation equal in value to the tax-paid assets transferred.” That requirement for exemption of PST would suggest that on a transfer under 85 you would not take back non-share consideration. Rather you would take back only shares of equivalent value (which would have paid up capital and adjusted cost base equal to the tax cost of the transferred assets). Perhaps at some later date the paid up capital could be reduced and put you in the same position as if you had received boot in the first instance. Clearly, more guidance is needed from Saskatchewan Finance and perhaps amendments are needed in their bulletin to reflect how typical transfers are accomplished.

The other four categories are Amalgamations, Partnerships, Winding Up of a Company and

Dividend in Kind and Return of Capital. Please see the Information Bulletin for application or

non-application of PST exemption in those circumstances.

XIV. SAMPLE ROLLOVER AGREEMENT

The following is a sample Rollover Agreement under 85 and typical minutes of the transferee

corporation authorizing the transfer. It is basically a sale agreement with certain provisions

geared at qualifying under 85 such as an agreement between the parties to elect under 85 in

respect of the transaction including executing the prescribed CCRA Form T2057. In addition, it

would usually include additional information such as the ETP of the transferred property, the

consideration received and price adjustment clause should CCRA disagree with the valuations of

the parties.



The following facts are assumed in the sample Rollover Agreement which are put in the form of

a letter of instruction that accountants typically provide to the lawyer preparing the legal

documentation.

Dear Lawyer:

Re: Lauren Ashley and Lauren Enterprises Ltd. We have been asked by Lauren Ashley to contact you to prepare the necessary legal documentation to effect the following transaction. Step one: We understand that a number company has been set aside for Lauren Ashley in order that she can incorporate her beanie baby manufacturing business. It is also our understanding that on January 31st, Lauren Ashley will subscribe for ten Class A shares from treasury for $1 per share. Lauren Ashley has indicated that she wishes to change the name of the corporation to Lauren Enterprises Ltd. Please confirm that the corporation is registered for GST purposes effective January 31, 2001. Step two: Lauren will transfer land as detailed in Schedule A with a fair market value of $2,000,000 and an adjusted cost base of $750,000 to Lauren Enterprises Ltd. under the provisions of subsection 85(1) of the Income Tax Act. The effective date is January 31, 2001. The consideration to be received for the transfer will include assumption of indebtedness, a promissory note and Class C preferred shares as follows:

1. Land Mortgage $500,000; 2. Promissory Note $250,000; and 3. 1,250,000 Class C Preferred Shares each redeemable and retractable for $1

The transfer agreement should be subject to a price adjustment clause. The price adjustment clause should relate the fact that the promissory note and the number of Class C preferred shares issued as consideration is based upon the estimated fair market value of the land transferred. If Canada Customs and Revenue Agency or some other competent authority determines that the value of the land is an amount other than that determined by the shareholders, the parties would agree to make appropriate adjustment to the promissory note and/or the number of Class C shares issued. If, in the meantime, any or all of the promissory note has been repaid or any or all of the Class C preferred shares have been redeemed the parties would agree to make appropriate cash adjustment. We would appreciate an opportunity to review the documents from a tax perspective prior to the parties signing the final copies. . . . . . . . . . .



AGREEMENT FOR SALE OF CERTAIN

ASSETS ON A ROLLOVER BASIS

THIS AGREEMENT made effective the 31st day of January , A.D. 2001. B E T W E E N: Lauren Ashley, of Saskatoon, Saskatchewan (hereinafter referred to as the "Vendor") OF THE FIRST PART

- and -

Lauren Enterprises Ltd., a body corporate duly incorporated pursuant to the laws of the Province of Saskatchewan, with head office in the City of Saskatoon, in the Province of Saskatchewan,

(hereinafter referred to as the "Purchaser") OF THE SECOND PART NOW THEREFORE THIS AGREEMENT WITNESSETH AS FOLLOWS:

ARTICLE I - INTERPRETATION

1.1 This Agreement and all schedules attached hereto and forming part hereof and all duly executed amendments are hereinafter collectively referred to as "this Agreement" and constitute the entire agreement between the parties relating to the subject matter hereof and supersede all previous agreements and undertakings. 1.2 In this Agreement, the following terms shall have the following meanings:

"Act" means the Income Tax Act (Canada), as amended from time to time;

"Assets" means the Land as herein described;

"Class "C" shares" means the redeemable, preferred, non-cumulative, no par value, non-voting shares of the Purchaser, each redeemable at the redemption price of $1 per share, such redemption being at the option of the Purchaser or the holder thereof;



"Consideration" means the assumption of Mortgage, the Promissory Note and

the Class "C" share or shares issued by the Purchaser to the Vendor pursuant to Article IV of this Agreement;

"Effective Date" means the 31st day of January, A.D. 2001;

"Elected Transfer Price" means in respect of the Assets being transferred hereunder, the amount agreed to by the parties for the purposes of the joint election required pursuant to the provisions of the Act, which Elected Transfer Price in respect of all the Assets sold herein is the aggregate amount referred to in Article III herein;

"Fair Market Value" means the best estimate by the parties hereto as to the dollar value of the Assets transferred as of the Effective Date;

"Land" means the land of the Transferor more particularly described in the attached Schedule "B";

“Mortgage” means the CIBC Mortgage 90512456 registered against the Land;

"Permitted Encumbrances" means those encumbrances registered against the Land, which encumbrances are more particularly set forth in the attached Schedule "C"; and

"Sale Price" means with respect to all of the Assets the aggregate sum of $2,000,000, and with respect to each asset transferred herein, the amount as set

forth beside such asset in Schedule "A" attached hereto.

ARTICLE II - SALE OF ASSETS

2.1 The Vendor does hereby sell, transfer and assign to the Purchaser, and the Purchaser hereby purchases from the Vendor, the Assets at and for the Sale Price, which Sale Price shall be paid at the time and in the manner as hereinafter set forth. 2.2 The parties agree that the Sale Price shall be allocated between the Assets in such amounts as are set forth opposite such described Assets in Schedule "A" herein. 2.3 The parties acknowledge and agree that the said Sale Price of the Assets and the allocation of the Sale Price between the Assets is and represents the Fair Market Value of such Assets as of the Effective Date.



ARTICLE III - ELECTED TRANSFER PRICE

3.1 For the purpose of Subsection 85(1) of the Income Tax Act (Canada), the Vendor and Purchaser hereby elect and agree to sell, transfer and assign the Assets at the Elected Transfer Price of $750,000, which Elected Transfer Price the parties agree shall be allocated between the Assets in such amounts as are set forth opposite such described Assets in Schedule "A" herein.

ARTICLE IV - SATISFACTION OF SALE PRICE

4.1 The Sale Price of the Assets shall be satisfied by the Purchaser:

a) assuming the obligations of the Vendor under the Mortgage in the amount of $500,000;

b) executing and delivering, immediately following the execution and delivery of this Agreement a promissory note, in the amount of $250,000 due on demand, substantially in the form attached hereto as Schedule “D”; and

c) issuing to the Vendor concurent with the execution and delivery of this Agreement 1,250,000 Class "C" Shares.

The Vendor agrees to accept such Consideration in full satisfaction of the payment of the Sale Price of the Assets. The execution and delivery of this Agreement shall operate and be deemed to be an actual sale of the Assets to the Purchaser as and from the Effective Date.

ARTICLE V - PRICE ADJUSTMENT

5.1 It is the express desire and intention of the parties hereto that as at the Effective Date, the Fair Market Value of the Assets owned by the Vendor shall equal the Fair Market Value as of the Effective Date of the Consideration issued by the Purchaser to the Vendor pursuant to the provisions of Article IV hereof, subject to the adjustments referred to in this Article V, and that the Sale Price shall be the Fair Market Value of the Assets. 5.2 If it is determined at any time hereafter to the satisfaction of the professional advisors for the Vendor, the professional advisors for the Purchaser and the Department of National Revenue for the Government of Canada, or in the event of their disagreement, as evidenced by the judgment of a Court of competent jurisdiction that the actual Fair Market Value of the Assets exceeds the actual Fair Market Value of the Consideration issued pursuant to the provisions of Article IV hereof, then:



a) such excess shall be satisfied by the Purchaser issuing to the Vendor additional

Class "C" shares; and

b) in the event the actual Fair Market Value of the Assets as of the Effective Date is understated, the Sale Price required to be paid by the Purchaser to the Vendor for such Assets shall be increased by the amount necessary to eliminate the difference between the Sale Price hereunder and the actual Fair Market Value of the Assets.

If it is determined at any time hereafter to the satisfaction of the professional advisors for the Vendor, the professional advisors for the Purchaser and the Department of National Revenue for the Government of Canada, or in the event of their disagreement, as evidenced by the judgment of a Court of competent jurisdiction that the actual Fair Market Value of the Assets is less than the actual Fair Market Value of the Consideration issued pursuant to the provisions of Article IV hereof, then:

a) the difference shall be compensated for by the Vendor surrendering an appropriate number of its Class "C" Shares (fractional shares shall be surrendered if necessary) which were issued to the Vendor by the Purchaser, and the Purchaser hereby agrees to cancel the same upon such surrender; and

b) in the event the actual Fair Market Value of the Assets as of the Effective Date is less than the Sale Price required to be paid by the Purchaser to the Vendor for such Assets, such Sale Price shall be decreased by the amount necessary to reduce the Sale Price hereunder to the actual Fair Market Value of the Assets.

5.3 The parties hereto will complete and file in a timely manner all forms and filings required by Canada Customs and Revenue Agency pursuant to the provisions of the Act. If it is determined that the Elected Transfer Price of any parcel of land exceeds the revised selling price on any parcel of land, the parties hereto agree that the promissory note payable or the assumption of debt, as the case may be, with respect to that particular parcel of land shall be reduced by the amount of the excess. The parties have estimated the adjusted cost base to the Vendor of the Assets, and the Elected Transfer Price is intended to reflect the Vendor's adjusted cost base and/or undepreciated capital cost thereof. Each party agrees to indicate and identify in the forms and filings referred to in this paragraph such intention so that the Department of National Revenue may adjust, subject to the provisions of the Act, the Elected Transfer Price in the event it is subsequently determined or is subsequently agreed between all the parties and the Department of National Revenue that the adjusted cost base and/or undepreciated capital cost of the Assets was other than the estimated amount elected hereunder.



ARTICLE VI - TRANSFER AND POSSESSION

6.1 All right, title and interest of the Vendor in the Assets shall transfer and vest in the Purchaser as at the Effective Date. 6.2 All taxes, rents, utilities, insurance and all other income and outgoings with respect to the Property or any other property shall be adjusted as at the Effective Date.

ARTICLE VII - REPRESENTATIONS AND WARRANTIES

7.1 The Vendor represents and warrants to the Purchaser: a) that it is the registered owner of the Assets, and the Vendor has full and absolute

right and power to cause to be transferred to the Purchaser as of the Effective Date a good and marketable title to the Assets, and that the assets are free and clear of any and all mortgages, liens, charges, pledges, security interests, encumbrances or other claims whatsoever; and

b) that no person, firm or corporation other than the Purchaser has an agreement for

the purchase from the Vendor of any or all of the Assets.

ARTICLE VIII - GST

8.1 The Purchaser shall be liable for and shall pay all federal and provincial sales tax, if any, realized in connection with the transfer and conveyance of the Assets to the Purchaser by the Vendor. To the extent a joint election is available, the Vendor will also execute such documents as may be required by the Purchaser in order that a valid joint election can be made by the parties as provided for by subsection 167(1) of Part IX of the Excise Tax Act (Canada).

ARTICLE IX - GENERAL

9.1 The parties agree that they shall execute such further documents and assurances as may be required to give effect to this Agreement or as counsel may advise. 9.2 The parties hereto covenant and agree to do and perform such further and other acts as may be necessary or desirable in order to give full force and effect to this Agreement and every part hereof. 9.3 In this Agreement, all statements and references to dollar amounts shall mean dollars of Canada.



9.4 This Agreement shall be construed, interpreted and governed in accordance with the laws of the Province of Saskatchewan, and the parties covenant and agree that all proceedings taken in respect of this Agreement shall be taken in the Courts of the Province of Saskatchewan and the parties hereby irrevocably attorn to the jurisdiction of the Courts of Saskatchewan. 9.5 If any of the terms or conditions of this Agreement are ruled or found invalid, illegal or unenforceable by any Court, agency, commission or other entity having jurisdiction in respect hereof, the remainder of this Agreement and the application of such invalid provisions to the parties or in circumstances other than those in which such provisions have been found to be invalid shall not be affected. Each term and condition so declared invalid, illegal or unenforceable shall be valid and enforced to the fullest extent permitted by law, and the rights and obligations of the parties shall be construed and enforced as though a valid and commercially reasonable provision consistent with the intent of the parties as set forth in this Agreement had been substituted in place of such invalid, illegal or unenforceable term or condition. 9.6 No amendment to this Agreement shall be of any force and effect unless executed in writing by all parties hereto. 9.7 Time is of the essence of this Agreement and every part hereof. 9.8 This Agreement and the terms and conditions hereof shall be binding upon and enure to the benefit of the parties hereto and their respective heirs, executors, successors and any permitted assigns, provided however, that the parties acknowledge and agree that neither party hereto may assign this Agreement or any part hereof without the prior written consent of the other party. 9.9 The parties acknowledge and agree that there are no agreements, undertakings, representations, warranties or conditions collateral to this Agreement. IN WITNESS WHEREOF, the Lauren Enterprises Ltd. has hereunto affixed its corporate seals attested to by the hands of its duly authorized officers in that behalf on the 31st day of January, A.D 2001. Lauren Enterprises Ltd. Per: _________________________ IN WITNESS WHEREOF, Lauren Ashley has hereunto set her hand and seal as of the 31st day of January, A.D 2001. _________________________ Lauren Ashley



SCHEDULE “A”

Description

Elected Transfer Price

Sale Price/ Fair Market Value

NE 27-75-7 W3rd 250,000 670,000

SW 26-75-4 W3rd 250,000 670,000

SE 32-24-2 W3rd 250,000 660,000

Total 750,000 2,000,000

SCHEDULE “B”

Land

The North East Quarter of Section 27 Township 75

Range 7 West of the Third Meridan, Saskatchewan 160 Acres

Minerals in the Crown

The South West Quarter of Section 26 Township 75

Range 4 West of the Third Meridan, Saskatchewan

160 Acres Minerals in the Crown

The South East Quarter of Section 32 Township 24

Range 2 West of the Third Meridan, Saskatchewan

160 Acres Minerals in the Crown



SCHEDULE “C”

Permitted Encumbrances

CIBC Mortgage registered as No. 90512456

Notice pursuant to the South Saskatchewan River Irrigation Act registered as No. 84S 13911

SCHEDULE “D”

PROMISSORY NOTE

AMOUNT: DATE: January 31, 2001 FOR VALUE RECEIVED, Lauren Enterprises Ltd., as maker, hereby promises to pay on demand

to the order of Lauren Ashley at Saskatoon, Saskatchewan the sum of $__________________ with

interest thereon calculated and payable after demand of payment. The rate of interest is to be fixed

at a rate of eight per cent per annum.

Lauren Enterprises Ltd. Per: _____________________



DIRECTORS MINUTES OF PURCHASER

RESOLUTION IN WRITING OF THE DIRECTORS OF LAUREN ENTERPRISES LTD. PURSUANT TO SECTION 112 OF THE BUSINESS CORPORATIONS ACT

(SASKATCHEWAN) __________________________________________

WHEREAS it is desirable for the Directors of Lauren Enterprises Ltd. to approve the matters hereinafter set forth and acknowledge that this resolution, when signed by all of the Directors of the Company, is as valid as if it had been passed at a meeting of the Directors and satisfies all the requirements of the Business Corporations Act (Saskatchewan) relating to meetings of Directors. WHEREAS it is desirable to approve the purchase by the Company from Lauren Ashley of certain assets, for the purchase price and on the terms and conditions all as more particularly described and set forth in the Agreement for Sale of Certain Assets on a Rollover Basis, substantially in the form submitted to this meeting and filed with these minutes, between the Company, as Purchaser, and Lauren Ashley, as Vendor. WHEREAS Lauren Ashley, having regard to the proposed Agreement with the Company, disclosed to the meeting that she is interested in and/or a shareholder, officer or director of the Vendor and requested that her disclosure be entered. Inasmuch as the directors of the Company shall vote on the adoption and approval of the said Agreement, it is necessary for the Agreement to be approved by the Shareholders of the Company in accordance with the provisions of s. 115(5) of the Business Corporations Act (Saskatchewan). In connection with the foregoing, on motion duly made, seconded and unanimously carried, the following resolution was passed: "NOW THEREFORE BE IT RESOLVED:

1. That the Agreement for Sale of Certain Assets on a Rollover Basis, substantially in the form submitted to this meeting and filed with these minutes, between the Company, as Purchaser, and Lauren Ashley, as Vendor, wherein the Company has agreed to purchase from the Vendor, certain assets for the purchase price and on the terms and conditions all as more particularly described and set forth in the said Agreement, be and is hereby approved;

2. That any director or any one of the President or Secretary of the Company be and is hereby authorized to do all things necessary, desirable or useful to give effect to this resolution and the terms and conditions of the said Agreement, including without limitation, execution of behalf of the Company of the said Agreement; and



3. That subsequent to execution of the Agreement, as aforesaid, the officers of the Company

be and are hereby authorized to issue to the aforesaid Vendor, a Share Certificate of the Company representing 1,250,000 Class "C" shares of the Company" and a promissory note in the amount of $250,000.”

The undersigned, being all the Directors of the Company, have executed this Resolution as of the day and year set forth opposite their respective names. ____________________ ______________________________ Date Lauren Ashley



XV. ACKNOWLEDGMENT AND SELECTED BIBLIOGRAPHY In preparation of this paper, the following papers and publications were greatly relied on: The Continuing Legal Education, Society of British Columbia, Professional Legal Training Course 1993-94, Practice Material: Tax Law, “Transfers of Property to Corporations, Corporate Reorganizations and Estate Planning”, S.M. Cook as updated by the author and David Christian to 1993.

Kellough, Howard J. and McQuillan, Peter E., “Taxation of Private Corporations and Their Shareholders”, 2nd Edition, Canadian Tax Paper No. 95, Canadian Tax Foundation, 1992.

Plume, Clifford, “Rollovers and Elections under the Income Tax Act” looseleaf service, 1984 Canadian Institute of Chartered Accountants.

Beam, R.E. and Laiken, S.N., “Introduction to Federal Income Taxation in Canada - 16th Edition 1995-96”, CCH Canadian Limited.

Beam, R.E. and Laiken, S.N., “Introduction to Federal Income Taxation in Canada - 20th Edition, 1999-2000”, CCH Canadian Limited.

Hopkins, Nancy, “Understanding Rollovers”.

CCH Canadian Limited, “Electronic Tax Library”, 2001.

Gerspacher, Melvin, “Aspects of Share Valuation in Income Tax”, 99 PPC, Canadian Tax Foundation.

Ewens, Douglas, “Use of Adjustment Clauses in Non-arm’s Length Reorganizations”, Canadian Tax Journal, Vol. 29, September-October 1981, p. 718 – 728. Revenue Canada Interpretation Bulletins, Revenue Canada Information Circulars and CCRA

Forms referenced throughout this paper can be found on the Canada Customs and Revenue

Agency internet site at www.ccra.gc.ca or can be obtained at no charge through your local office of

Canada Customs and Revenue Agency.

Saskatchewan Finance Information Bulletins referenced throughout this paper can be found on

the Government of Saskatchewan internet site at www.gov.sk.ca/finance


http://www.ccra.gc.ca/

http://www.gov.sk.ca/finance

APPENDICES


Saskatchewan: Bar Admission Program A - 1 Corporate Commercial – Taxation of Transfers to a Corporation Appendix A – Application of Section 69, Income Tax Act (Canada)

APPLICATION OF SECTION 69, INCOME TAX ACT (CANADA) Assume: Property has a fair market value of $1,000 and a cost of $100 Non-arms Length Transfer for More than Fair Market Value (i.e., $1,500):

Transferor

Proceeds

$ 1,500

Cost

$ (100)

Gain to report

$ 1,400

Transferee Actual Acquisition Cost $ 1,500 Deemed Acquisition cost reduced by s. 69(1)(a) $ 1,000

Therefore, on subsequent sale by the transferee, there is double taxation in that not all of thecost base will be recognized in determining the gain, if any (i.e., a sale of the property at theactual acquisition cost of $1,500 will trigger a gain of $500.


A - 2 Saskatchewan: Bar Admission Program Corporate Commercial - Taxation of Transfers to a Corporation

Appendix A – Application of Section 69, Income Tax Act (Canada) Assume: Property has a fair market value of $1,000 and a cost of $100 Non-Arms Length Transfer Below Fair Market Value (i.e., $200):

Transferor

Actual Proceeds $ 200 Deemed Proceeds to fair market value under s. 69(1)(b)(i)

$ 1,000

Cost $ (100) Gain to report $ 900

Effectively a double tax in that the transferor received less than fair market value and yet must pay tax as if fair market value was received.

Transferee Acquisition Cost $ 200

Section 69 doesn't adjust the cost from $200 to $1,000 even though the transferor was taxed as if sold for $1,000. If transferee subsequently resells at fair market value a second gain must be reported.


Saskatchewan: Bar Admission Program A - 3 Corporate Commercial – Taxation of Transfers to a Corporation Appendix A – Application of Section 69, Income Tax Act (Canada) Assume: Property has a fair market value of $1,000 and a cost of $100 Gift between Non Arms Length Parties:

Transferor

Actual Proceeds Nil Deemed Proceeds under s. 69(1)(b)(ii) $ 1,000 Cost $ (100) Gain to Report $ 900

Transferee Acquisition Cost Nil Deemed Acquisition Cost under s. 69 $ 1,000

Application is not as penalizing in that although the transferee is taxed as if fair market value proceeds were received, the transferee does get recognition of that in a upwards adjustment to cost base.


Documents

Transfers to a Corporation - Law Society of Saskatchewanredengine.lawsociety.sk.ca/inmagicgenie/documentfolder/... · 2010-06-22 · TAXATION OF TRANSFERS TO A CORPORATION Humphrey