chap17 - CHAPTER 17 Income Deferral: Other Rollovers and...

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CHAPTER 17 Income Deferral: Other Rollovers and Use of Rollovers in Estate Planning Problem 1 [ITA: 85; 85.1] Jason purchased all of the common shares of Quality Appliances Ltd., a Canadian-controlled private corporation, in 1987 for $50,000. The paid-up capital of the shares was $25,000. These shares have recently been valued at $125,000. Big Distributors Ltd., a Canadian, arm’s length corporation, has offered to buy all of Jason’s shares. The following alternatives have been presented to Jason: (a) $25,000 in cash and $100,000 of F.M.V. in common shares of Big Distributors Ltd. (b) $125,000 of F.M.V. in Big Distributors Ltd.’s common shares. Jason is at arm’s length with Big Distributors Ltd. and, after acquiring its shares, will neither control Big Distributors Ltd. nor own more than 50% of the F.M.V. of its shares. REQUIRED (A) What are the tax consequences to Jason if these transactions are conducted using the provisions of section 85.1? (B) What are the tax consequences to Jason if these transactions are conducted using the provisions of section 85? 163
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Introduction to Federal Income Taxation in Canada Solution 1 Part (A) If Jason accepts the first alternative, section 85.1 will not apply, since one of the conditions (see (c) below) of this provision has not been met: (a) the vendor’s shares (Jason’s shares of Quality Appliances) must be capital property to him (consistent with the facts in this case); (b) these shares must be shares of a Canadian corporation (i.e., Quality Appliances, which fits the definition); (c) the consideration for this exchange must be only issued shares of the purchaser (i.e., Big Distributors Ltd.); (d) there can be no capital gain on this exchange; (e) the vendor (Jason) and the purchaser (Big Distributors Ltd.) must be at arm’s length before the share exchange (given); (f) after the share exchange the vendor may not control ( de jure ) the purchaser or may not own more than 50% of the F.M.V. of the shares (given). For section 85.1 to be operative, only share consideration can be received [par. 85.1(2)( d )]. Since cash is received under this alternative, Jason will realize a capital gain of $75,000 ($125,000 – $50,000). One half of this gain, $37,500, will be a taxable capital gain. This gain may be eligible for the capital gains deduction if the shares are qualified small business corporation shares. If Jason does not have his capital gains deduction available, he will be required to pay tax on this capital gain, even though he has received cash of only $25,000 on this disposition. Note that Jason is not eligible for a capital gains reserve, since he has received F.M.V. consideration in total [par. 40(1)( a )]. Jason may be able to minimize his tax cost under the first option if he could negotiate the restructuring of
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chap17 - CHAPTER 17 Income Deferral: Other Rollovers and...

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