TX 2
Advanced Personal and
Corporate Taxation
Module 3
Corporate Reorganizations (Part 1)
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Module 3
Part 1 – 3.1 Non-arm’s Length Sale
of Shares
Part 2 – 3.2 Reorganization of Capital
Part 3 – 3.3 Convertible Property
Part 4 – 3.4 Share for Share Exchange
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Topic 3.1 Non-arm’s Length Sale of
Shares (s. 84.1)
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s. 84.1 is a tax trap!
Similar to s. 85(2.1)
The purpose of s. 84.1 is to prevent the removal
of corporate surplus as a tax-free capital gain
where there is a non-arm's length transfer of
shares.
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s. 84.1
100 common shares
ACB = PUC= $100
FMV = $1,000
X
Opco
$1,000 cash
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s. 84.1
X sells Opco shares to Holdco
for $1,000 note
X claims CGE
X
Holdco
Due to X
$1,000
Opco
$1,000 Cash
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s. 84.1
Holdco and Opco amalgamate
Cash goes to Mr X tax-free
as repayment of note
X
$1,000 Cash
New
Opco
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Conditions for s. 84.1 to Apply
•
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Shares of a corporation resident in Canada,
which are capital property must have been
disposed of to another corporation (purchaser)
The transferor (vendor) must be a taxpayer
other than a corporation, i.e., an individual or
trust
The transferor must not deal at arm's length
with the purchaser corporation
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Conditions for s. 84.1 to Apply
•
•
Immediately after the transfer, the subject
corporation and purchaser corporation must be
connected within the meaning of subsection
186(4)
Connected – s.186(4): 10% votes and value
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Two Consequences of s. 84.1
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Share consideration: s. 84.1(1)(a) PUC grind
reduces the PUC of the new shares to equal the
greater of the ACB or PUC of the shares
transferred
Non-share consideration: s. 84.1(1)(b) deemed
dividend to the transferor (vendor) if the nonshare consideration exceeds the greater of the
ACB and PUC of the shares transferred
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Consequences to Mr X of s. 84.1
Immediate $900 deemed dividend to X
as $1,000 NSC exceeds $100 ACB/PUC
of original Opco shares
X
$1,000 Cash
New
Opco
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Section 84.1 Traps
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Crystallization of Capital Gains Exemption:
cannot extract crystallized amount tax-free
unless arm’s length sale to third party or on
death of shareholder
Capital Gains Exemption and Sale of Shares to
Non-arm’s Length Person: Two related persons
may not each claim the capital gains exemption
on the same shares
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Non-Resident Sale of Shares
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s. 212.1: Non-resident sale of shares to a nonarm’s length corporation resident in Canada
Similar provision to s. 84.1
Prevents non-residents from converting a
dividend (subject to non-resident withholding) to
a capital gain which may be exempt from tax in
Canada
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Topic 3.2 Reorganization of Capital
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“Freeze”
s. 86: rollover where a taxpayer disposes of all
the shares of any particular class of a
corporation (old shares) and as consideration,
receives property from the corporation that
includes other shares of the capital stock of the
corporation (new shares)
Applies automatically – no election form to file
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Conditions for Application of S. 86
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The shares disposed of must be capital property
of the shareholder
The shareholder must dispose of all his shares
of a particular class
The shareholder must receive property from the
corporation that includes other shares of the
corporation's capital stock
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Rules of s. 86
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Permits share exchanges to take place without
the realization of a capital gain
The ACB/PUC of the old shares carries over as
the ACB/PUC of the new shares if no non share
consideration received
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Rules of s. 86
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s. 86(2) gifting provision - may apply to give rise
to an immediate capital gain or a reduction in
the ACB of the new shares received
Applies if FMV of new shares and non-share
consideration is less than the FMV of the old
shares, and it is reasonable to consider the
difference as being a gift to a person related to
the taxpayer
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Rules of s. 86
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PUC Computation: S. 86(2.1) - similar in
application to S. 85(2.1)
PUC of the new shares limited to the PUC of
the old shares less any non share consideration
(nsc)
Watch out for S. 84(3) deemed dividend if the
FMV of the nsc received plus the PUC of the
new shares exceeds the PUC of the old shares
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Topic 3.3 Convertible Property
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s. 51(1) permits certain convertible securities to
be exchanged for shares without creating a
disposition for capital gains purposes
Only share consideration may be issued
Convertible Security - a share, bond, debenture
or note provided that the instrument contains a
right for the holder to exchange for shares of the
same corporation
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Convertible Property
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S. 51(1) can be used in debt to equity
conversions or partial ‘freezes’
The ACB of the convertible security flows
through to the shares issued on the conversion
S. 51(2) – prevents gift or benefit conferred on
related person
S. 51(3) – PUC reduction of shares issued on
exchange if PUC exceeds PUC of exchanged
shares
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Topic 3.4 Share for Share Exchange
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Corporate take-over technique usually involving
public companies
S. 85.1 allows a taxpayer who holds shares of a
taxable Canadian corporation (Target) as
capital property to dispose of them to a second
Canadian corporation (Purchaser) in exchange
for treasury shares of the purchaser on a
rollover basis
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Share for Share Exchange
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Vendor and Purchaser must deal at arm’s length
The rollover is not mandatory: the vendor may
choose to recognize a gain or loss in the year of
disposition - otherwise, the rollover is automatic
and no election is necessary
S. 85.1(1)(b) determines the purchaser’s cost of
the shares without regard to the treatment
selected by the vendor
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Reorganization Techniques
Some transactions may qualify for a rollover
under a number of provisions. For example, any
of sections 86, 85 or 51 may apply to a share
for share exchange. See Exhibit 3-2 in readings.
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