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SOLICITOR – BUSINESS LAW – TAX TIDBITS

Purchase and Sale of a Business

To acquire a business, a purchaser may acquire either (1) the underlying assets of the business, or
(2) the shares of the corporation that owns the assets (447(L)).

1. Vendors generally prefer to structure the sale as a share sale (447(R)-448(R) at 3.1.1 &
3.1.2)):

a) No recapture of capital cost allowance (CCA) on depreciable assets or profit realized

on sale of inventory

b) If shares are qualifying small business corporation shares, the Vendor may be able
to claim the $971,190.00 capital gains exemption. The definition of qualifying small
business corporation shares is complicated, but essentially, they are shares of a
Canadian controlled private corporation where (194(L), 448(L)):

a. At the time of sale, at least 90% of the assets (measured in fair market value)
of which are used to primarily carry on an active business in Canada
(primarily = at least 50%)

b. In the preceding 24-month period of the sale, at least 50% of the FMV of the
assets of the corporation must have been used principally in an active
business carried on primarily in Canada

c. Vendor must have owned the shares in the same 24-month period prior to the
sale of shares

2. Purchasers generally prefer to structure the purchase as an asset purchase (448(R)-449(L) at

3.1.3):

a) No hidden liabilities.

b) Stepped up cost base for assets (therefore a larger depreciation/CCA claim).

c) Usually has to pay a higher price than when purchasing shares because of the
tax advantage.

*BUT see exceptions - where preferences of each vendor and purchaser may change (449(LR) at
3.1.4)

3. A sale of non-depreciable assets (e.g. land, shares) to a third party gives rise to a capital gain
to the extent that the proceeds of disposition (PD) exceed the adjusted cost base (ACB) +
selling costs. Capital gain is ½ taxed (190(L), 448(L)).

PD $100
CG = $75 (1/2 taxed)
ACB $25
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SOLICITOR – BUSINESS LAW – TAX TIDBITS
4. A sale of depreciable assets (e.g. buildings and equipment) to a third party will give rise to a
capital gain to the extent that the proceeds of disposition exceed the original cost, and to
recapture of capital cost allowance (which is then fully taxed) to the extent that the original
cost exceeds the undepreciated capital cost (UCC) of the asset (if it is depreciable).
Recapture brings back into income the capital cost allowance (the tax equivalent of
depreciation) that has been claimed where the sale price shows that the asset has not actually
depreciated. See “Undepreciated capital cost” at 195(L).

PD $100 CG = $25 (1/2 taxed)

Original cost $75
UCC $25 Recapture = $50 (fully taxed)

Corporate Share Repurchases:

1. Paid up capital is the tax equivalent of corporate stated capital. It is the amount that a private
corporation may return to its shareholders free of income tax. However, there are
circumstances where PUC will be less than stated capital (eg. where shares of a corporation
are issued in exchange for the corporation receiving property – see 193(L), 234(R)-236(R) at
5.1-5.3)

2. Creates a deemed dividend, to the extent that the repurchase price exceeds paid-up
capital (PUC), regardless of what the adjusted cost base is (234(L) at 5.1).

3. A repurchase/redemption/purchase of share for cancellation is treated as a sale or

disposition of property by the shareholder for income tax purposes (237(LR) at 5.6).

4. The capital gain or loss that will be realized by the selling shareholder is equal to the amount
by which the proceeds of disposition (sale price) exceed or are exceeded by the aggregate
of the selling shareholder’s ACB of their shares + costs/expenses of disposing shares
(237(LR) at 5.6). Where there is also a deemed dividend (i.e. repurchase price > paid up
capital), the proceeds of disposition will be decreased by an amount equal to the amount of
the deemed dividend in order to prevent double taxation (237(LR) at 5.6).

5. If ACB is higher than PUC there could also be a capital loss (which can only be offset against
capital gain, not ordinary income), because the amount of the deemed dividend is deducted
from proceeds of disposition for tax purposes so as not to create double taxation.

For example, this would happen if shares were issued to A for $1, he later sold them to B for
$50, and later still, when the shares were worth $100, the corporation repurchased them from
B. (237(LR) at 5.6).
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SOLICITOR – BUSINESS LAW – TAX TIDBITS
Calculation of B’s capital loss

Redemption proceeds (or proceeds of $100

disposition)
Less: Deemed dividend* (calculated by formula in bullet 2)
$99
Adjusted proceeds of disposition $1
Less: ACB $50
Capital loss $49
*Because the amount of deemed dividends ($99) is deducted from the proceeds ($100) in calculating
capital gain or loss, there is no double taxation

6. Similarly, if “hi-lo” (high redemption value, low PUC) shares, such as those issued on many
rollovers, are redeemed, there will be a deemed dividend to the extent that the redemption
price exceeds PUC.

7. PUC and stated capital are averaged across the share class, so if shares of the same class
are issued at different times with different stated capital, the whole class is affected (234(R) at
5.1).

Section 85 Rollovers to a Taxable Canadian Corporation

1. “Rollover” means a transfer on a tax deferred basis without triggering capital gain or
recaptured CCA. A rollover does not avoid income tax but defers recognition of this tax to a
later date. The transferee takes the asset at the same tax values as they had in the hands of
the transferor (179(R)-180(L), 259(LR)).

2. Can roll eligible property which includes the following: any capital property, Canadian and
foreign resource properties, inventory (except real property that is inventory, an interest in real
property, or an option in respect of real property) and real property (or an interest in real
property/an option in real property owned by a non-resident used in a business carried on in
Canada) to a taxable Canadian corporation under section 85 of the Income Tax Act (ITA)
(260(LR) at 8.2). As of January 1, 2017, goodwill and incorporation costs are no longer eligible
capital property for rollovers (261, Figure 1). Taxpayer transferring assets or property to the
corporation must receive at least one share as part of the consideration (260(R) at 8.3).

3. Parties must make a joint election as to the proceeds of disposition for tax purposes by jointly
executing and filing the election form (Form T2057) with the CRA within the prescribed time
(260(R) at 8.4). The election form must specify the elected amount for each asset transferred.
See 261(L)-262(L) at 8.5 for limits on the elected amount. Generally, to fully achieve a tax-
deferred rollover (neither income, recapture, nor capital gain), parties would select an elected
amount equal to the vendor’s cost amount in the transferred assets (260(R)-261(L) at 8.4).
See 255, Figure 1 for a cost amount table.
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SOLICITOR – BUSINESS LAW – TAX TIDBITS
a. e.g. Roll shares with a fair market value of $100 and an adjusted cost base of $25 into a
holding company and elect $25 as the transfer price. Take as consideration redeemable
preferred shares of the holding company with a redemption value of $100 and the same
stated capital as the shares that were rolled in (cannot step-up the stated capital on a
non-arm’s length sale like this without creating tax problems). There will be no capital
gain to report. The adjusted cost base of the rolled shares will still be $25 in the holding
company’s hands and the adjusted cost base of the preferred shares issued to the
transferor will be $25. When those preferred shares are redeemed, there will be a
deemed dividend of $75.

b. e.g. Roll land (capital property) with a fair market value of $1,000,000 and adjusted cost
base of $25,000 into the corporation. Take as consideration a promissory note of
$24,999 and one redeemable preferred share with a redemption value of $975,001 and
paid-up capital of $1. The elected amount is $25,000 and no capital gain needs to be
reported.

4. Usually, the elected amount equals tax cost (ACB or UCC) of the transferred asset, but the
transferor and transferee may choose an elected amount different than cost (but see 261(L)-
262(L) at 8.5 for limits). The paid-up capital (PUC) of the shares received plus the amount of
non-share consideration cannot exceed the elected amount (263(L) at 8.7.3).

5. On a purchase of a business the Vendor could receive share consideration and the parties
could do it as a section 85 rollover (see 259(LR)-260(L) at 8), but the corporation (purchaser)
would inherit the Vendor’s tax cost of the asset (see 448(L) at 3.1.3).

Section 86 Share Exchanges

1. In the course of a reorganization of the capital of a corporation, a shareholder can exchange all
his shares of a class for property of the corporation for consideration that must include other
shares of the same corporation (and may include non-share consideration) without triggering
tax (tax is deferred – see 254(LR)-255(L) at 5.2).

2. Often used for estate freezes (180(R) at 6.4.2): e.g. fixed value redeemable preferred shares
are created in the authorized capital (so that it qualifies as a “reorganization”), Dad exchanges
his common shares for fixed value preferred shares of equal value and with a stated capital
(PUC) equal to that of the shares that he gives up, and then the adult children (or a trust for
them) subscribe for new common shares that will increase in value as the corporation
increases in value above the value of Dad’s preferred shares.