3/6/2011

Advanced Personal & Corporate Taxation

Module 4
Corporate Reorganizations (Part 2)
Prepared by:
Nancy Swan, CFP, CGA

Module 4
Corporate reorganizations (Part 2)
Part 1 4.1: Amalgamation ITA 87
Part 2 4.2: Winding up a subsidiary owned 90% or
more ITA 88(1)
4.3: Winding up a Canadian corporation ITA 88(2)
Part 3 4.4: Deemed proceeds or capital gain under
ITA 55(2)
2

Topic 4.1: Amalgamation

(continued)

Purpose:
ITA 87 allows the combination of corporations that are
governed by the Canadian Business Corporations Act with
little or no tax consequences.
Anti-avoidance provisions.
Horizontal amalgamations: occurs when two corporations
with shares owned by third parties combine.
Vertical amalgamations: occur when a wholly owned
subsidiary is combined with its parent corporation.
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Topic 4.1: Amalgamation (continued)

ITA 87 requirements:
Listed in ITA 87(1).
Merger of two or more taxable Canadian corporations.
Purpose is to form a new corporate entity.
Property held by the existing corporations generally
becomes property of the new corporation.
Liabilities of the existing corporations generally become
liabilities of the new corporation.
All shareholders of the existing corporations must receive
shares of the new corporation.
Not an acquisition or purchase. See ITA 256(7)(a) and
256(7)(b).
4

Topic 4.1: Amalgamation

(continued)

ITA 87(1.1):
Provides for short-form amalgamation between wholly
owned subsidiaries.
Provides some exemptions of the aforementioned
conditions.
Requires that the subsidiary wholly-owned corporation
adheres to the definition set out in ITA 87(1.4).
5

Topic 4.1: Amalgamation

(continued)

ITA 87 Consequences:
Tax accounts, assets, and liabilities of the predecessor
corporations are generally transferred without tax
consequences.
The new corporation is generally considered a new
corporation, although it may be considered a continuation of
the previous corporation for certain purposes. See ITA
87(1.2), 87(2)(f), 87(2)(j) through 87(2)(j.93), 87(2)(1),
87(2)(z.1), and 87(2.1) for examples.
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Topic 4.1: Amalgamation

(continued)

ITA 87(2)(a) Taxation years:

The taxation year for each predecessor corporation is
deemed to have ended at the time immediately before the
amalgamation.
The new corporations year end starts immediately after
the amalgamation and their year end can be chosen
without CRAs authorization, pursuant to p.10 of IT-474R2.

Topic 4.1: Amalgamation

(continued)

ITA 87(2)(b) Inventory:

The closing inventory of the predecessor corporations is
the opening inventory of the new corporation (the tax values
remain the same).
Some exemptions for farming businesses, change of
accounting methods from cash to accrual. See ITA 28.

Topic 4.1: Amalgamation

(continued)

ITA 87(2)(d) and 87(2)(d.1):

The UCC of all classes of property for the new
corporation is deemed to have a capital cost equal to that
of its predecessor corporation. No half-year rule!
CCA recapture is deemed to be the original cost, and
CCA claimed by the predecessor is considered to be
claimed by the new corporation.
In non arms length transactions REG 1102(14) applies
and property acquired remains in its prescribed class.
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Topic 4.1: Amalgamation

(continued)

ITA 87(2)(d) and 87(2)(d.1) Cont:

The new corporation may begin depreciation of property
acquired from its predecessors immediately.
Recapture of CCA is calculated as if the original cost,
and CCA claimed by the predecessor is considered to be
claimed by the new corporation.
CCA is prorated in the case of shortened year ends
arising from both the new corporations choice of a year
end and the predecessors potential partial year end.
See REG 1100(3).
10

Topic 4.1: Amalgamation (continued)

ITA 87(2)(e) Non-depreciable capital property:
The ACB value of non-depreciable properties is deemed
to be that of the predecessor.
ITAR 26(5.1) deals with property owned prior to 1972.
ITA 87(2)(f) Eligible property:
If the new company continues to carry on the business
of its predecessor, the new company is deemed to be a
continuation of the predecessor for CEC, CECA, ECE, or
ECP purposes.
Predecessor corporations may claim a prorated CECA
deduction for the period immediately prior to the
amalgamation.
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Topic 4.1: Amalgamation (continued)

ITA 87(2.1) Losses carried forward:
The following are transferred to the new corporation:
Non-capital losses.
Net capital losses.
Farm losses.
Restricted farm losses.
Limited partnership losses.
The new corporation is deemed to be a continuation of
its predecessors for such purposes.
To avoid reduction in carry forward years, the effective
date of the amalgamation should be the day after the
predecessors year end, see IT-474-R2 p. 10.
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Topic 4.1: Amalgamation

(continued)

ITA 87(2) Other:

Amalgamations cannot be used to reduce or eliminate
installments, see REG 5301(4).
Debts settled without full repayment may be subject to
ITA 80 through 80.04.
Many other rules for specific circumstances. As a
general rule the new corporation is deemed to be a
continuation of its predecessor and all tax consequences
applicable to the latter are applied to the former.
13

Topic 4.1: Amalgamation

(continued)

ITA 87(3) Computation of PUC:

The PUC of the new corporation cannot exceed that of
its predecessors.
Generally the legal PUC is used, unless PUC reductions
had previously occurred. In this scenario the reduced
PUC must be used in determining the PUC of the new
corporation.
The PUC of each class will remain the same if
conditions are met and the election in ITA 87(3.1) is
made.
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Topic 4.1: Amalgamation

(continued)

ITA 87(4) Rollovers:

To avoid capital gains or losses from being realized, there
is a rollover if:
The old shares were capital property of the shareholder.
The shareholder received no consideration other than
shares of the new corporation (or up to $200 in a
payment for partial shares See IT-474R2 for further
details).
In such cases it is deemed that:
The shareholder disposed of their old shares at their
ACB immediately before the amalgamation and receives
new shares at a cost equal to the ACB of the old shares.
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Topic 4.1: Amalgamation

(continued)

Gifts or deemed benefits:

Rollover may not apply if the benefit is conferred on a
related person.
If the FMV of the new shares is less than the FMV of the
old shares, and it is reasonable to assume that the
difference was intended to be a benefit conferred on a
related person ITA 87(4)(c), (d), and (e) apply.
The rules are identical to those previously covered in ITA
51(2).
16

Topic 4.1: Amalgamation

(continued)

Bonds and other claims:

Any bonds, debentures, notes, mortgage loans
receivable, or other similar obligations held are rolled
over at their ACB, or the amount that would have been
paid by the predecessor on maturity.

17

Topic 4.1: Amalgamation (continued)

Vertical Amalgamations:
For parent and wholly owned subsidiary ITA 87(2.11)
allows for the carrying back of losses of the new
corporation against the income of the predecessor.
The following may be carried back:
Losses carried back [ITA 111].
Foreign tax credits [ITA 126].
Investment tax credits [ITA 127(5) to (26)].
Unused surtax credits that can be used to reduce
Part I.3 tax [ITA 181.1(4) to (7)].
Unused Part I tax credits that can be used to reduce
Part VI tax [ITA 190.1(3) to (6)].
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Topic 4.1: Amalgamation (continued)

Vertical Amalgamations- Disposition of shares:
ITA 87(11), very similar to winding up corporations owned
90% or more.
Parent corporation deemed to be have disposed of
shares of the wholly owned subsidiary to the greater of:
1) The lesser of: the PUC of the shares held, or the
subsidiaries property held less debts and certain reserves.
2)The ACB of the shares for the parent corporation
immediately before the amalgamation.
Capital gains may be realized, but not capital losses.
Provisions for ACB adjustments laid out in ITA 87(11)(b).
These ACB increases are often known as bump-ups.
-End of Topic 4.119

Advanced Personal and Corporate Taxation

Topic 4.2: Winding up a subsidiary

owned 90% or more
ITA 88(1):
Contains rollover provisions for winding up a subsidiary
corporation owned 90% or more, often to utilize losses.
Deemed to be wound up (IT-126-R2 p.3) if either of the
following occur:
1. The procedures have been followed for winding up
and dissolution provided by the appropriate federal or
provincial companies or winding up acts.
2. Has carried out a winding up through means other
than those set forth above, and has been dissolved
under the incorporation of the statute.
20

Topic 4.2: Winding up a subsidiary

owned 90%+ (continued)
ITA 88(1) conditions:
Involved corporations must both be taxable Canadian
corporations.
90% or more of the shares of each class of the capital
stock of the subsidiary are owned by the parent.
The remaining shares must all be held by a person with
which the parent company was dealing at arms length.
NOTE: On the winding up for the purposes of this
section normally means the period of time in which the
winding up takes place. See p. 7 and 8 of IT-126-R2.
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Topic 4.2: Winding up a subsidiary

owned 90%+ (continued)
ITA 88(1)(a)(a.2) tax consequences:
Deemed transfer amounts:
Canadian foreign resource property: Nil.
Other property: Cost amount defined in ITA 248(1).
Inventory: value for tax purposes.
Depreciable property: UCC.
Non-depreciable capital property: ACB.
ECP: 4/3 CEC.
Transfers to minority shareholders are deemed to occur
at FMV See ITA 69(5).
22

Topic 4.2: Winding up a subsidiary

owned 90%+ (continued)
ITA 88(1) subsidiary tax consequences:
Generally no tax effect.
When there is indebtedness to the parent extinguished
upon the merger ITA 80 rules may be avoided by making
an election under ITA 80.01(4).
Election made by filing Form T2027 on or before the
date in which the parent corporations income tax return
for the year in which the debt is settled is due to be filed.
The year end is not the date of the winding-up, but rather
the usual fiscal year end date of the corporation.
23

Topic 4.2: Winding up a subsidiary

owned 90%+ (continued)
ITA 88(1) parent tax consequences:
Normally acquires assets at the subsidiaries POD,
unless the capital costs exceed the POD in which case
the assets are deemed to be acquired at their capital
costs and the difference is claimed as CCA.
If the subsidiary recaptures any portion of the CCA the
parent will be responsible for the resulting tax due.
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Topic 4.2: Winding up a subsidiary

owned 90%+ (continued)
ITA 88(1) parent tax consequences continued:
Disposition of the subsidies shares is handled similarly to
those previously discussed in ITA 87(11).
Provisions for ACB adjustments laid out in ITA 88(1)(d).
Transfers for losses very similar to ITA 87(2.1).
See ITA 88(1.1) and 88(1.2) for transfer of losses to parent.
-End of Topic 4.2 25

Advanced Personal and Corporate Taxation

Topic 4.3: Winding up a Canadian

corporation
ITA 88(2): Used to wind-up corporations.
Proper planning can reduce tax consequences.
Often shares are wound-up into a personal corporation
under ITA 85(1) to avoid part I tax.
Part IV tax may be avoided on all or part of the proceeds
if the corporations are connected before the winding-up
and the wound-up corporation does not receive dividend
refunds.
Be wary of the winding-up being viewed as a series of
transactions or events causing application of ITA 55(2).
26

Topic 4.3: Winding up a Canadian

corporation (continued)
Tax consequences for the corporation:
Property distributed to shareholders is disposed of at FMV.
Resulting capital gains, losses, CCA recapture, terminal
losses, or any other losses or gains will be deductible, even
if distributed to a shareholder that controls the corporation.

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Topic 4.3: Winding up a Canadian

corporation (continued)
Tax consequences for the shareholders:
Deemed to acquire property at its FMV, pursuant to ITA
69(5)(b) and (c) which prevent any increases in the cost of
property.
When computing the CDA [defined in ITA 89(1)] and
CSOH, the taxation year of the corporation is deemed to
have ended at the time immediately before the final
distributions at FMV. See ITA 88(2)(a).
28

Topic 4.3: Winding up a Canadian

corporation (continued)
Tax consequences for the shareholders:
Conditions as specified in ITA 88(2)(b) for taxing the
deemed dividend under ITA 84(2).
An amount not exceeding the CDA of the corporation may
be considered as a separate dividend provided form T2054
is properly filed to make the election in ITA 83(2).
Each shareholder deemed to receive a separate dividend
from the CDA or a taxable dividend proportional to the
number of shares held.
29

Topic 4.3: Winding up a Canadian

corporation (continued)
Tax consequences for the shareholders:
Deemed to have disposed of shares cancelled on the
winding-up for the value of the property received less the
CDA and taxable dividends.
Dividends may be designated as eligible if requirements
are met.

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Topic 4.3: Winding up a Canadian

corporation (continued)
Final distributions:
Persons involved in the distribution of assets (other than a
trustee involved in a bankruptcy) must request and obtain a
clearance certificate before distributing assets, or face
personal liability for any unpaid taxes, interest, or penalties.
See ITA 159(2) and 159(3).
The clearance certificate is requested using Form TX19,
and is issued on Form TX21. See IC 82-6R6 for more
details.
- End of Topic 4.3 31

Advanced Personal and Corporate Taxation

Topic 4.4: Deemed proceeds or

capital gain under ITA 55(2)
ITA 55(2):
Intention: eliminate the ability that would otherwise exist to
avoid capital gains tax by converting it to a tax-free intercorporate dividend.
When the effect of the transaction would lead to surplus
stripping ITA 55(2) prevents this.
The transaction is treated as proceeds of disposition of
shares which gives rise to a capital gain.
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Topic 4.4: Deemed proceeds or

capital gain under ITA 55(2)
ITA 55(2) Conditions:
Taxable dividend must be received by a resident Canadian
corporation.
Dividend must be deductible under ITA 112(1).
Received as part of a transaction or series of events of
which one of the purposes was to significantly reduce the
capital gain that would have otherwise been realized.
Capital gain attributable to non Safe Income.
33

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Topic 4.4: Deemed proceeds or

capital gain under ITA 55(2) (continued)
ITA 55(2), if the previous conditions were met:
The taxable dividend is deemed not to be: a dividend
received by the corporation.
Where the corporation disposed of shares, the amount of
the dividend is deemed to be the POD of the shares.
Where shares were not disposed of, the amount of the
dividend is deemed to be a capital gain of the corporation
for the year in which the dividend was received.
34

Topic 4.4: Deemed proceeds or

capital gain under ITA 55(2) (continued)
Exceptions:
Per ITA 55(3)(a) & 55(3)(b) does not apply to dividends
received as part of certain transactions by related parties.
According to ITA 55(2)(e), for the purposes of ITA 55 only,
brothers and sisters are deemed not related.
The persons are considered unrelated if the relation is
solely a result of ITA 251(5)(b).
ITA 55(4) designed to nullify the structuring of transactions
made solely for the purposes of causing a relationship, or
control between parties.
35

Topic 4.4: Deemed proceeds or

capital gain under ITA 55(2) (continued)
Applies when any of the following occur:
Disposition of property, except money as payment for
dividends or property for POD not less than its FMV to an
unrelated person or partnership.
Significant increases in total direct interest from any
corporation who is unrelated, unless the increase resulted
from a disposition of shares for POD not less than the FMV.
36

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Topic 4.4: Deemed proceeds or

capital gain under ITA 55(2) (continued)
Applies when any of the following occur (continued):
After the dividend was received, a subsequent disposition
to an unrelated person or partnership of shares of the
dividend recipient or property more than 10% of the FMV of
which was at any time during the series derived from shares
of the dividend recipient.
Or, where there is a significant increase in the direct
interests in the dividend payer of one or more unrelated
persons or partnerships.
37

Topic 4.4: Deemed proceeds or

capital gain under ITA 55(2) (continued)
The intention of section 55:
The intention is to prevent surplus stripping, it achieves
this by disallowing the transaction at a corporate level;
where there is an non taxable intercompany dividend and
convert it to a sale of shares which will result in a personal
level sale of shares which gives rise to taxable capital gains.

38

Part 3: Review Question

On May 31, 2005, Beast Inc. wound up its wholly-owned
subsidiary, Beauty Ltd. The year end of Beast is September 30
and that of Beauty was October 31. Beauty had a deductible noncapital loss balance, of which $40,000 was from 2001 and
$60,000 from 2002. What is the first fiscal period in which the
non-capital loss balance could be used by Beast, assuming it
would have sufficient taxable income?
1)
2)
3)
4)

May 31, 2005

September 30, 2005
September 30, 2006 correct answer
The non-capital loss balance cannot be transferred to Beast.
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Part 3: Review Question

Tulip Ltd. owns 100% of the common shares of Daffodil Ltd. The
2 corporations were created under federal jurisdiction. Daffodil
has incurred operating losses for several years, whereas Tulip
has realized sizable profits. Tulip wants to shut Daffodil down but
would like to use Daffodils net loss carryforwards. The assets of
Daffodil that cannot be used for the operations of Tulip will be
sold by Daffodil to an unrelated corporation. Daffodils fiscal
period ends April 30.
Additional information
1. Tulip had advanced funds to its subsidiary to finance its
operating losses. On April 30, 2007, the amount advanced stood
at $175,000.
2. On April 30, 2007, Daffodils net non-capital loss carryforwards
are : 2001: $13,000 2002: $22,000 2005: $23,000 2007: $19,000
40

Part 3: Review Question

3. Tulip has a June 30 year end; its business is seasonal, and
this date was chosen for practical reasons. Tulip does not wish to
change this date, and if it must choose a year end as a result of
the reorganization,
that year end will still be June 30.
4. Tulips profits for a month are high enough to use the
subsidiarys entire net loss carryforward.
5. The reorganization could take place on either May 1 or July 1,
2007.

41

Part 3: Review Question

Required a. Name 2 ways by which Tulip could make use of
Daffodils net loss carryforward. Explain the consequences of
the parent companys use of the losses for each scenario for
each of the possible dates. State which scenario should be
chosen and explain why.
Section 87 When there is an amalgamation, the taxation year of
each of the predecessor corporations is deemed to end
immediately before the amalgamation and the new corporation is
deemed to have commenced its taxation year on the date of the
amalgamation . If the amalgamation takes place on May 1, 2007,
their fiscal period end for Tulip and Daffodil on April 30, 2007. The
1st fiscal period of Tulip following the amalgamation will end June
30, 2007, and Daffodils losses will be deducted in computing the
taxable income.
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Part 3: Review Question

Required: b. What tax treatment should be used for the
$175,000 advance?
Under subsection 80.01(3), an indebtedness that is extinguished
in an amalgamation is deemed to have been settled immediately
before the amalgamation for an amount equal to the cost amount
of the indebtedness. No form needs to be completed.
Under subsection 80.01(4), the debt is deemed to have been
paid (or settled) for an amount equal to its cost amount on the
winding-up if an election to do so is made on the prescribed form
T2027. This election must be filed in order to avoid the
application of the debt forgiveness rules contained in ITA 80.
43

Part 3: Review Question

Required: c. Compare the arguments that Daffodil and the
unrelated corporation will use in determining the price of each of
the depreciable and non-depreciable assets of Daffodil that will
be sold.
c. For a non-depreciable property, the vendor will want to allocate
the maximum amount, the purchaser will prefer a minimum
amount, since he or she will not be able to claim any deduction
(for example, capital cost allowance) on this property.
For a depreciable property, the vendor will want to allocate a
minimum amount in order to reduce the potential recapture of
capital cost allowance, the purchaser will want to allocate the
maximum amount of the purchase price to classes of property
that have a high depreciation rate, since he or she will be able to
claim the deduction for capital cost allowance.
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- End of Module 4 -

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