Taxation of
Private Corporations
and Their
Shareholders
Fourth Edition
Editors:
Paul Bleiwas
John Hutson
A Canadian Tax Foundation publication by
Deloitte & Touche llp
Fraser Milner Casgrain llp
Taxation of Private Corporations
and Their Shareholders
FOURTH EDITION
Detailed Contents
Chapter 1 Introduction: The Corporation as a Person in Tax Law
I. Introduction 1:1
A. What Is a Corporation and What Is a Shareholder? 1:1
B. Corporations and Pink Elephants 1:2
C. Corporations and Legal Personality 1:2
II. The Nature of the Corporate Personality 1:3
A. Legal Personality 1:3
B. Corporate Personality 1:4
C. The Nature of a Corporation 1:8
D. The Corporate Capacity To Own Property 1:11
E. Corporate Personality and Limited Liability 1:13
F. Residence of a Corporation 1:13
G. Impact of Tax Treaties 1:16
III. Shares and Shareholders 1:17
A. The Nature of a Share 1:17
B. Rule for Hybrid Securities 1:19
C. Sham and the General Anti-Avoidance Rule 1:20
IV. Piercing the Corporate Veil 1:20
Chapter 2 The Decision To Incorporate
I. Introduction 2:2
II. Theory of Integration 2:4
A. Background 2:4
B. The Existing Integration Model 2:6
1. Investment Income 2:6
2. ABI Eligible for the SBD 2:6
3. ABI Ineligible for the SBD 2:8
III. Integration: The Real Story 2:10
A. Provincial Rates: Actual Versus Theoretical 2:10
1. Provincial Personal Rates 2:10
2. Provincial Corporate Rates on Investment Income 2:11
3. Provincial Corporate Rates on Business Income 2:11
B. Integration in Practice 2:11
1. Investment Income 2:11
2. Capital Gains 2:14
iii
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3. Dividend Income 2:14
4. ABI Eligible for the SBD 2:16
5. ABI Ineligible for the SBD 2:16
IV. Advantages of Incorporation 2:17
A. Income Tax Deferral 2:17
1. Investment Income 2:17
2. ABI Ineligible for the SBD 2:18
3. ABI Eligible for the SBD 2:18
4. Ontario’s Clawback of the SBD 2:19
B. Enhanced Capital Gains Exemption 2:19
C. Income Splitting 2:22
1. Corporate Attribution Rules 2:23
2. Tax on Split Income 2:25
3. Income-Splitting Loans for Value 2:25
4. Family Trusts 2:26
5. Professional Corporations 2:26
D. Estate Freezes 2:27
E. Deductibility of Interest on Borrowed Funds 2:29
1. Loans to a Corporation 2:29
2. Subscription for Preferred or Common Shares 2:30
3. Borrowing to Acquire Dividend-Paying Securities 2:30
F. Reduction in Capital Gains 2:31
G. Principal-Business Corporations 2:32
H. Rules Concerning Restricted Farming Losses 2:33
I. M & P Credit 2:33
J. Scientific Research and Experimental Development Costs 2:34
K. Personal Minimum Tax 2:35
L. Holding Foreign Investments 2:35
M. Employee Ownership 2:36
1. Stock Options and Grants 2:36
2. RRSP Ownership 2:36
V. Disadvantages of Incorporation 2:37
A. Double Taxation on Death When Capital Losses Are Not Used 2:37
1. How Does Double Taxation Arise? 2:37
2. Alleviation of Double Taxation: Subsection 164(6) 2:41
3. A Second Alternative: “Partial” Subsection 164(6) 2:43
4. A Third Alternative: The Subsection 88(1) Bump 2:44
B. Unused Capital Dividend Account 2:46
C. Unused RDTOH Account 2:47
D. Taxable Income in Excess of the SBD 2:47
E. Trapped Non-Capital Losses 2:49
F. Expiration of Capital Losses on Acquisition of Control 2:50
G. Transferring Assets out of a Corporation 2:50
1. Transfer of Capital Assets with Accrued Gains 2:50
2. Transfer of Capital Assets with Accrued Losses 2:50
3. Transfer of Depreciable Properties 2:51
H. Dividend Distribution 2:52
I. Capital Tax 2:52
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J. Denial of Refundable Dividend Tax 2:53
K. Potential Exclusion from the Subsection 39(4) Election 2:53
L. Personal Services Business 2:54
M. General Administrative Costs 2:55
VI. Rules To Remember 2:55
A. Loss-Disallowance Rules 2:55
1. Disallowance of Capital Loss to Corporation: Subsection 40(3.4) 2:56
2. Disallowed Loss on Share Redemption: Subsection 40(3.6) 2:56
3. Disallowance of Terminal Loss: Subsection 13(21.2) 2:57
4. Superficial Loss: Subparagraph 40(2)(g)(i) 2:57
B. PUC Reduction and Deemed Dividend: Section 84.1 2:58
Chapter 3 Capitalizing a Corporation
I. Introduction 3:2
II. Types of Capital for Corporate and Income Tax Purposes 3:3
A. Income Tax Share Capital 3:3
B. Corporate Share Capital 3:3
C. Corporate Debt 3:4
D. Preferred Shares and Other After-Tax Financing 3:5
1. The Preferred-Share Rules 3:5
a. Term Preferred Shares 3:7
b. Short-Term Preferred Shares 3:8
c. Taxable Preferred Shares 3:10
E. When Should a Corporation Be Capitalized by Shares or Debt? 3:12
III. Selecting the Capital Structure 3:15
A. Estate Freezing: Reduction of Share Value 3:15
B. Preservation of Income and Capital 3:15
C. Income Splitting 3:16
D. Control 3:16
E. Pipeline to Capital 3:16
F. Elimination of Benefits 3:17
G. Deductibility of Interest on Borrowings Used To Subscribe for Capital 3:17
H. Flexibility Without Adverse Income Tax Consequences 3:17
IV. Selecting the Share Structure 3:17
A. The Importance of Share Rights and Restrictions 3:18
1. The Valuation Dilemma: The CRA’s Concern 3:20
B. Specific Share Characteristics 3:21
1. The Right to Dividends 3:21
a. Cumulative or Non-Cumulative 3:22
b. Dividend Rate 3:23
c. Tax-Free and Taxable Dividends 3:24
2. Redemption and Purchase by a Corporation 3:25
3. Retraction Rights 3:25
4. Redemption Amount 3:27
5. Voting Rights 3:28
6. Limitation on Payment of Dividends on Common Shares 3:29
7. Price Adjustment Clauses 3:30
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8. Rights on Dissolution 3:31
9. Right of Conversion 3:31
V. Determining a Corporation’s PUC 3:32
A. The Income Tax Concept of Paid-Up Capital 3:32
B. The Corporate Concept of Share Capital 3:33
C. The Corporations Statutes 3:38
D. Share Exchanges and Internal Reorganizations of Share Capital 3:39
1. Alteration of Share Rights 3:39
2. Exchange of Shares 3:39
3. Changes to PUC 3:39
4. Reallocating PUC 3:41
VI. Income Splitting Through Share Capital 3:41
A. The Concept of Income Splitting 3:41
B. Attribution Rules 3:42
1. Legislative Background 3:43
2. Property Versus Business Income 3:45
3. FMV Transfers and Loans 3:46
4. Transfers and Loans to Corporations 3:47
5. Guarantees and Third-Party Loans 3:48
C. Indirect Payments and Benefits: Subsection 56(2) 3:48
1. Neuman, McClurg, and Other Cases 3:48
2. When Does Subsection 56(2) Apply? 3:50
D. The Tax on Split Income 3:53
E. GAAR 3:54
VII. Deductibility of Interest 3:55
A. Bronfman Trust and Proposed Subsection 20(3.1) 3:56
B. Subsequent Court Decisions 3:56
Ludco Enterprises Ltd. 3:56
Shell Canada 3:57
Singleton 3:57
C. Current State of Interest Deductibility and the CRA’s Administrative Views 3:57
D. Filling the Hole 3:58
E. Tracing 3:58
F. Exceptional Circumstances 3:59
G. Draft Legislation on Interest Deductibility 3:59
H. Other Provisions 3:60
Chapter 4 The Decision To Use a Holding Corporation
I. Introduction 4:2
II. Advantages Related to the Flow of Funds 4:2
III. Conversion to Deductible Interest 4:4
IV. Income Splitting and Estate Freezing 4:5
A. Fair Value Consideration 4:6
B. Interest Deductibility 4:8
C. The Shareholder’s Future Growth Participation 4:8
D. Alternative Freeze Method 4:8
E. QSBC Status and Other Considerations 4:9
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V. Considerations Related to Intercorporate Dividends 4:9
A. Suspension of the Tax Effects of Dividends 4:9
B. Creating Connected Corporations 4:10
VI. Multiple Ownership of a Holding Corporation 4:11
VII. Corporate Share Acquisitions 4:11
A. Advantages to the Purchaser 4:11
1. Purchaser Corporation Bears Acquisition Financing 4:11
2. Target Corporation Bears Acquisition Financing 4:13
B. Advantages to the Vendor 4:14
1. Dividends to Holdco 4:15
2. Redemption of Opco Shares 4:15
3. Transfer to Purchaser for “High-Low” Shares 4:15
4. Effect of Subsection 55(2) 4:15
VIII. Other Advantages 4:16
A. Overcoming Double Taxation on Death 4:16
B. Corporate Breakup and Distribution 4:16
C. Avoidance of Employee-Shareholder Loan Provisions 4:16
D. Updating of Losses 4:17
E. Buy-Sell Arrangements 4:17
F. Risk Management 4:17
G. A Tax Deferral for Investments? 4:18
H. Crystallizing the $750,000 Capital Gains Exemption 4:18
I. Using a Holding Corporation To Own Real Property 4:19
J. Acquiring a Canadian Corporation 4:19
1. Bumping Up the Cost Base of Non-Depreciables 4:19
2. Non-Resident’s Acquisition of a Canadian Business 4:20
IX. The Application of Section 84.1 on Share Transfers 4:21
A. Section 84.1 4:21
B. Prerequisites 4:22
C. Application of Section 84.1 4:24
1. Reduction of PUC 4:24
2. Deemed Dividend 4:25
3. Arm’s-Length ACB 4:25
D. Mechanics of Section 84.1 4:27
E. Circumstances in Which Paragraph 84.1(1)(b) Does Not Apply 4:27
F. Non-Arm’s-Length Transfers 4:28
G. Comments 4:29
Chapter 5 The Use of Professional and Personal Service Corporations
I. Introduction 5:2
II. Professional Corporations 5:3
A. The Nature of a Profession 5:3
B. Incorporating a Professional Practice 5:4
1. Review of Relevant Legislation 5:4
a. Provincial and Territorial Legislation Governing Professional Corporations 5:4
i. Ontario 5:5
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b. Relevant Federal Legislation 5:6
i. GST/HST 5:6
ii. Kiddie Tax 5:6
2. Income Tax Treatment of Professional Corporations 5:7
C. Professional Corporations for Athletes and Entertainers 5:7
III. Who Can Incorporate—and Claim the SBD? 5:8
A. SBD 5:8
B. The Basic Requirements 5:9
C. Entitlement to a Separate Small Business Limit 5:9
1. Specified Partnership Income 5:9
2. Personal Services Business 5:10
a. Incorporated Employee 5:11
b. Specified Shareholder 5:11
c. Reasonably Regarded as an Officer or an Employee 5:11
i. Common Law 5:12
ii. CRA Policy 5:15
d. Exceptions 5:16
i. More Than Five Full-Time Employees 5:16
ii. Amounts Received by an “Associated Corporation” 5:17
3. Corporations Associated Through Subsection 256(2.1) 5:17
a. The $500,000 Limit 5:17
b. The Meaning of “Associated” and Section 256(2.1) Association Rules 5:17
D. The CRA’s Advanced Tax Rulings 5:18
1. Incorporated Partnership Structure 5:21
2. Unincorporated Partnership Structure 5:24
E. Other Challenges 5:26
1. Taxing Income of a Professional Corporation in the Hands of the Professional 5:26
IV. Management and Executive Management/Personal Corporations 5:28
A. Management Business Corporations 5:28
B. Executive Management/Personal Service Corporations 5:29
C. Income Tax Treatment of EMCs 5:29
1. Active Business Income 5:29
2. Personal Services Business 5:30
V. Why Incorporate? 5:30
A. Advantages 5:30
1. Protection Against Personal Liability 5:30
2. Tax Benefits 5:32
a. Tax Rates 5:32
b. Tax Deferral 5:33
c. Income Splitting 5:33
d. Private Health Services Plans 5:34
e. Club Dues and Fees 5:34
f. Death Benefits 5:34
g. $750,000 Capital Gains Exemption 5:34
h. Changing the Cumulative Net Investment Loss Account 5:34
B. Disadvantages of Incorporating 5:35
1. Losses 5:35
2. Costs of Incorporating 5:35
3. Administrative Difficulty 5:35
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C. Other Available Structures To Limit Liability 5:35
1. Trusts 5:35
2. Limited Partnerships 5:36
3. LLPs 5:36
VI. Conclusion 5:36
Chapter 6 The Small Business Deduction and Associated Corporations
I. Introduction 6:2
II. The Relevance of Association 6:3
III. The Federal SBD 6:5
A. Eligibility 6:6
1. Canadian Corporation 6:7
2. Private Corporation 6:7
3. Public Corporation 6:7
4. Prescribed Venture Capital Corporation 6:8
5. Direct or Indirect Control 6:8
B. Active Business Income 6:8
1. Ordinary Definition 6:8
2. Pertaining To or Incident To 6:9
3. What Is a Business? 6:11
4. Specified Investment Business 6:12
5. Personal Services Business 6:16
6. Specified Shareholder 6:16
C. Carried On in Canada 6:16
D. Calculation 6:17
E. Sharing the Low Rate of Tax 6:18
IV. Associated Corporations 6:19
A. The Effect of Association 6:20
B. The Basic Rules 6:20
1. Control of One Corporation by Another 6:21
2. Control by the Same Person or Group of Persons 6:21
3. Control by Related Persons 6:21
4. Specified Class 6:23
5. Control by One Person and a Related Group of Persons 6:25
6. Control by Two Related Groups 6:26
7. De Facto Control 6:27
C. Related Persons 6:33
D. The Extended Meaning of Control and Ownership 6:36
1. Definition of “Group” 6:36
2. Control by a Group 6:36
3. The Fair-Market-Value Test 6:37
4. The Lookthrough Provisions 6:41
a. Holding Corporations 6:41
b. Partnerships 6:42
c. Trusts 6:44
5. The FMV of Shares 6:48
6. Parent Deemed To Own Shares 6:48
7. Options and Rights 6:50
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8. Exceptions for Financial Difficulty and Specified Class 6:54
9. Association with a Third Corporation 6:55
E. Association Overruled 6:59
1. Subsection 256(6) 6:59
2. Subsection 256(3) 6:60
3. Subsection 256(4) 6:61
4. Subsection 256(5) 6:61
5. Subsection 256(9) 6:62
F. Anti-Avoidance 6:63
1. The Objective of Subsection 256(2.1) 6:63
2. Criteria 6:64
3. Review of the Case Law Relating to Subsection 247(2) 6:65
V. The Corporate-Partnership Rules 6:67
A. Specified Partnership Income and the SBD 6:67
B. The Anti-Avoidance Provision 6:69
C. The Partnership Lookthrough Provision 6:69
D. Partnerships Controlled by Non-Residents or Public Corporations 6:69
Chapter 7 Remuneration of the Owner-Manager
I. Introduction 7:4
II. Capacity in Which Owner-Manager Is Remunerated: Shareholder or Employee 7:5
A. The Owner-Manager as Shareholder 7:5
B. Determining the Capacity of an Owner-Manager: Shareholder or Employee 7:6
C. Deductibility: Payments Received in the Capacity of Shareholder 7:8
D. Reasonableness of Payments 7:9
III. Salaries, Bonuses, and Management Fees 7:12
A. Introduction 7:12
B. Reasonableness of Salaries and Management Fees 7:12
C. The CRA’s Attitude to the Reasonableness Question 7:13
1. Active Owner-Managers 7:13
2. Non-Active Owner-Managers 7:14
3. Non-Resident Owner-Managers 7:15
4. Management Corporations 7:15
5. Reasonableness and Investment Income 7:16
6. Sale of Major Business Assets or Unusual Transactions 7:16
7. Summary 7:17
D. Reasonableness and the Jurisprudence 7:17
E. Bonus Accruals 7:19
1. Bonus and Contingent Liabilities 7:19
2. Unpaid Amounts 7:21
3. Impact on Source Deductions 7:21
IV. Salary or Dividends? 7:23
A. The Theory of Integration Under the Act 7:23
B. The Salary-Dividend Mix 7:24
1. Salaries 7:24
2. Dividends 7:26
3. Maintaining Qualified Small Business Corporation Status 7:27
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C. Flexible and Discretionary Dividend Distributions 7:28
1. Waiver of Dividends 7:28
2. Discretionary Dividends 7:29
3. High-Low Preferred Shares 7:33
4. Holding Corporations 7:33
5. Corporate Partnership 7:33
6. Special Shares 7:34
V. Benefits and Appropriations to Shareholders 7:34
A. Payments to Shareholders: Subsection 15(1) 7:35
B. Conferral of a Benefit 7:36
1. Stock Dividends 7:36
2. Rights To Acquire Shares 7:37
3. Forgiveness of Loans 7:37
4. Automobiles 7:37
5. Additions or Improvements to a Shareholder’s Building 7:38
6. Private Health Services Plan 7:38
7. Commitment on Acquisition of Shares 7:39
8. GST Impact 7:39
9. Review of Selected Cases 7:40
C. Amount or Value of the Benefit 7:42
1. The CRA’s Assessing Practice 7:43
2. Review of Selected Cases 7:43
3. Administrative Relief for Sole-Purpose Corporation 7:47
D. Other Applicable Provisions 7:48
1. Subsection 69(4) 7:49
2. Subsection 69(1) 7:49
VI. Loans to Shareholders and Employees 7:49
A. Loans to Shareholders and Connected Persons: Subsection 15(2) 7:49
1. Who Is Caught by Subsection 15(2)? 7:51
a. Connected Persons 7:51
b. Canadian Corporations 7:51
c. Non-Shareholders 7:51
d. Employees 7:51
e. Others 7:53
2. Loans and Indebtedness Excluded from Income 7:53
a. Loans Between Non-Residents 7:53
b. Loans or Indebtedness Made in the Ordinary Course of Business 7:53
c. Non-Specified Employees: Paragraph 15(2.4)(a) 7:55
d. Loans To Acquire a Dwelling: Paragraph 15(2.4)(b) 7:55
e. Treasury Shares: Paragraph 15(2.4)(c) 7:57
f. Automobiles: Paragraph 15(2.4)(d) 7:58
3. Bona Fide Arrangements for Repayment 7:58
4. Indebtedness Incurred Because of Employment 7:59
5. Repayment 7:60
6. Series of Loans and Repayments 7:60
7. Repayments of Loan Previously Included in Income 7:62
8. Meaning of “Loan or Indebtedness” 7:63
9. Loans to Shareholders Under Corporate Law 7:63
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10. Right of Setoff 7:63
B. Interest-Free and Low-Interest Loans: Section 80.4 7:64
1. Application of Section 80.4 7:64
2. Taxable Benefit and Exclusions 7:65
3. Home Purchase Loans 7:66
4. Home Relocation Loans 7:66
5. Relief for Income-Earning Loans 7:67
6. Relationship of Section 80.4 to Subsection 15(2) 7:68
7. Deductibility of Outside Financing Charges by Employer 7:68
VII. Other Benefits Available to an Owner-Manager 7:69
A. Company-Owned Automobiles 7:69
1. Applicability of Standby Charge 7:69
2. Restricted Deductions 7:70
3. Automobile Allowances 7:71
4. Implications for the Owner-Manager 7:72
B. Entertainment and Other Benefits 7:73
1. Club Memberships and Recreational Facilities 7:73
2. 50 Percent Restriction on Entertainment 7:74
3. Frequent Flyer Programs 7:75
C. Moving Expenses 7:75
D. Retiring Allowances 7:76
1. Meaning of “Retiring Allowance” 7:76
2. Determining the Amount of a Retiring Allowance 7:78
E. Death Benefit Programs 7:79
1. Tax-Free Receipt 7:79
2. Taxable Amounts 7:79
3. Qualifying Payments 7:80
VIII. Deferred Income Plans 7:81
A. Background on Pension Reform 7:81
B. RRSPs 7:82
1. Comprehensive Retirement Savings Limits 7:82
a. Unused RRSP Deduction Room 7:82
b. RRSP Dollar Limit 7:83
c. Earned Income 7:83
d. PA 7:84
e. The Factor of Nine 7:85
f. Net PSPA 7:85
g. PARs 7:85
2. Planning Considerations 7:86
a. Alternative to Pension Plans 7:86
b. Early and Excess Contributions 7:86
c. Spousal RRSPs 7:87
d. Group RRSPs 7:87
e. Children’s RRSP Deduction Room 7:87
C. RPPs 7:88
1. Registration 7:88
2. Pension Plans for Significant Shareholders 7:88
3. Designated Plans 7:89
4. RPP Contribution Limits 7:91
5. Maximum Retirement Benefits 7:93
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6. Early Retirement 7:93
7. Past Service Contributions 7:94
8. IPPs Versus RRSPs 7:94
9. Advantages of an IPP 7:95
a. More Tax Sheltering 7:95
b. Protection if Plan Does Not Perform 7:95
c. Creditor Proofing 7:95
d. Suitability for Owner-Managers 7:96
e. Maximum Benefits 7:96
10. Advantages of an RRSP 7:96
a. Ability To Split Income 7:96
b. Locking In 7:96
c. Flexibility in Retirement Options 7:96
d. Administration 7:96
e. Early Termination 7:97
f. Plan Surpluses 7:97
g. Simplicity 7:97
h. Flexibility in Annual Contributions 7:97
D. DPSPs 7:97
1. Eligibility 7:98
2. Contribution Limits 7:98
3. Effect on RRSP Contributions 7:99
4. Allocations and Vesting 7:99
5. Taxation of Withdrawals 7:99
6. Qualified Investments 7:101
E. Salary Deferral Arrangements 7:102
F. RCAs 7:103
G. Employee Benefit Plans 7:106
Chapter 8 Transferring Assets to a Private Corporation
I. Introduction 8:3
II. Transfers Pursuant to Section 85 8:3
A. Who Can Use Section 85? 8:3
B. Eligible Assets 8:3
1. Non-Resident Transferors 8:4
2. Real Property 8:4
C. The Elected Amount 8:5
1. General Limitations 8:6
2. Specific Limitations 8:6
D. Restrictions on the Consideration Received 8:7
1. Benefit-Conferral Rules: Paragraph 85(1)(e.2) 8:7
2. Valuation 8:9
3. Consideration Received: Other Issues 8:11
E. Selecting the Elected Amount 8:12
F. Flowthrough of Income Tax Characteristics of Transferred Property 8:12
1. Flowthrough of Cost for Depreciable Property: Subsection 85(5) 8:12
2. Retention of CCA Characteristics 8:13
3. Preserving the Tax-Free Zone: ITARs 26(5.2) and 20(1.2) 8:13
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4. Surplus Accounts: Foreign Affiliates 8:13
5. Loss of Flowthrough of Tax Characteristics: The 50-Percent Rule 8:13
G. Consequences to the Transferee Corporation 8:14
1. CCA 8:14
2. Income or Capital 8:14
H. Implications of Non-Income Tax Legislation 8:15
1. Goods and Services Tax 8:15
a. Election Under ETA Section 167 8:16
b. Election Under ETA Section 156 8:16
c. Sale of Receivables 8:17
d. Transfer of Real Property 8:17
e. Sale of Shares 8:17
2. Provincial Sales Tax 8:17
3. Land Transfer Tax and Fees 8:18
4. Canada Pension Plan 8:18
I. The Stop-Loss Rules 8:18
1. Non-Depreciable Property 8:18
2. Depreciable Property 8:19
a. Application 8:19
b. Effect 8:19
c. Ordering 8:20
3. Anti-Avoidance Rules: Subsections 69(11) to (14) 8:20
J. Form of Consideration Received 8:21
1. Extracting the Cost Base 8:21
2. Extent to Which Paid-Up Capital Should Be Created 8:22
3. The Effect of Section 84.1 8:24
4. Restrictions on Paid-Up Capital 8:25
a. Disposition of Shares by a Non-Resident: Section 212.1 8:25
b. Amalgamations 8:25
K. Transfer from a Partnership 8:25
1. Cost of Non-Share Property Received 8:26
2. Cost of Preferred Shares Received 8:26
3. Cost of Common Shares 8:26
4. Proceeds of Partnership Interest 8:27
5. Disposition of Partnership Property 8:27
L. Filing Requirements 8:27
1. Who Files? 8:27
2. Filing Deadline 8:28
3. Mistakes 8:28
4. Late and Amended Elections 8:28
5. Valuation Problems 8:29
6. Description of Property 8:30
M. Section 116 Clearance Certificates 8:31
N. The General Anti-Avoidance Rule: Section 245 8:32
III. Transfers Outside Section 85 8:34
A. Claiming Reserves 8:34
B. When an Election Under Section 85 May Not Be Advisable 8:34
1. Available Losses 8:34
2. Use of Section 85.1 8:34
Detailed Contents / xv
IV. Accounting Ramifications 8:35
Appendix 8:36
Checklist for a Subsection 85(1) Rollover 8:36
General 8:36
Requirements 8:36
Assets 8:37
Paid-Up Capital 8:38
V-Day 8:38
Employees 8:38
GST and Provincial Taxes 8:38
Non-Residents 8:38
Other Consequences of Election 8:39
Election 8:39
Chapter 9 Removing Assets from a Private Corporation
I. Introduction 9:4
II. Appropriations of Corporate Property to Shareholders 9:4
A. Tax Consequences to the Corporation: Subsection 69(4) 9:4
B. Tax Consequences to the Shareholder: Subsection 15(1) 9:5
C. Price Adjustment Clauses 9:6
D. Shareholder Appropriations as Dividends 9:7
1. What Is a Dividend? 9:7
2. Tax Consequences of a Dividend to an Individual 9:7
E. Capital Dividends 9:7
1. The Capital Dividend Account 9:7
2. Payment of a Capital Dividend 9:10
F. Transfers for Less Than FMV Consideration 9:10
III. Winding Up a Corporation 9:11
A. Subsection 69(5) 9:11
B. Subsection 84(2) 9:12
C. Subsection 88(2) 9:12
D. Adjustments to the Capital Dividend Account 9:14
E. Pre-1972 CSOH 9:15
F. Timing 9:16
G. Additional Comments 9:16
IV. Intercorporate Dividends 9:17
A. The Use of Intercorporate Dividends To Reduce Capital Gains 9:18
1. The Purpose Test 9:20
2. Significant Reduction 9:22
3. Safe-Income Determination Time 9:23
4. Part IV Exception 9:24
5. Effect and Timing of a Subsection 55(2) Assessment 9:25
B. The Concept of Safe Income 9:26
1. Definition 9:28
2. Income Earned or Realized 9:28
3. Portion of Gain Attributable to Income 9:30
4. Losses 9:32
5. Holding Period 9:33
xvi / Taxation of Private Corporations and Their Shareholders
6. Shares Acquired on a Rollover 9:33
7. Safe Income That Relates to Fixed-Value Preference Shares 9:33
a. Acquired on a Rollover 9:34
b. Implications for Common Shares 9:36
c. Access to Safe Income 9:37
8. Stock Options and Splits 9:37
9. Stub Period 9:38
10. Consolidation of Safe Income 9:38
11. Income Earned Before 1972 9:40
12. Separate Dividend Designation 9:40
13. Allocation of Safe Income to Different Shares 9:41
14. Additional Comments 9:43
C. When Subsection 55(2) Does Not Apply 9:44
D. Series of Transactions or Events 9:45
E. Share Redemptions 9:48
V. The Paragraph 55(3)(a) Exemption 9:49
A. Unrelated Persons: Timing of Relationship 9:49
B. Significant Increase in Total Direct Interest 9:49
C. First Type of Triggering Event: Disposition of Property to an Unrelated Person 9:51
D. Second Type of Triggering Event: Significant Increase in the Interest of an
Unrelated Person 9:54
E. Third Type of Triggering Event: Disposition of Shares of the Dividend Payer 9:54
1. Disposition of Shares of the Dividend Payer 9:54
2. Disposition of Property That Derives Its Value from Shares of the
Dividend Payer 9:55
F. Fourth Type of Triggering Event: Disposition of Shares of the Dividend Recipient 9:57
1. Disposition of Shares of the Dividend Recipient 9:57
2. Disposition of Property That Derives Its Value from Shares of the
Dividend Recipient 9:58
3. After the Time the Dividend Was Received 9:58
G. Fifth Type of Triggering Event: Significant Increase in the Direct Interests
in the Dividend Payer 9:59
H. Interpretation Rules for Paragraph 55(3)(a) 9:60
I. Continuity Rule Under Paragraphs 55(3.01)(b) and (c) 9:61
J. Presumption Under Paragraph 55(3.01)(d) 9:62
K. Paragraph 55(3.01)(e) 9:63
L. Application Rules for Paragraph 55(3)(a) and Subsection 55(3.01) 9:65
M. The Clause 55(3)(a)(iii)(B) Trap 9:66
N. The Department of Finance’s Responses to Paragraph 55(3)(a) Uncertainties 9:67
VI. Butterfly Reorganizations 9:68
A. Basic Steps 9:69
B. The Use of Subsection 85(1) 9:69
C. The Application of Subsection 55(2) 9:71
D. Failure To Comply with Paragraph 55(3)(b) 9:71
1. Capital Dividend Account 9:72
2. Refundable Dividend Tax on Hand 9:73
3. Safe Income 9:73
Detailed Contents / xvii
E. Dividends to Which Paragraph 55(3)(b) Applies 9:74
1. The Meaning of “Reorganization” 9:75
2. The Meaning of “Distribution” and “Direct or Indirect Transfer” 9:77
3. The Types of Butterflies and Other Requirements Under
Paragraph 55(3)(b) 9:79
a. Spinoff Butterfly (Single-Winged) 9:79
b. Split-Up Butterfly (Single-Winged) 9:79
c. Split-Up Butterfly (Multi-Winged) 9:80
F. The Pro Rata Test 9:81
G. Types of Property 9:84
1. Investments in Other Corporations 9:85
2. The Impact of Liabilities 9:86
H. Certain Rules That Affect Share Transactions 9:87
1. Transactions That Affect Shares of the Distributing Corporation Before the Butterfly
Distribution 9:87
a. Reorganization of Capital 9:87
b. Transfer of Shares of a Distributing Corporation to a Transferee
Corporation 9:88
c. Redemption of Shares of a Specified Class and Permitted Exchange That Involves
Shares of a Specified Class 9:90
2. Transactions That Affect Shares of the Distributing and Transferee Corporations
After the Butterfly Distribution 9:92
3. Sequential Butterfly 9:94
I. Application of Subsection 55(3.1) 9:95
1. Paragraph 55(3.1)(a): Acquisitions of Property in Contemplation of a
Butterfly 9:96
a. The Meaning of “Property Became Property Of ” 9:96
b. The Meaning of “In Contemplation Of ” 9:97
c. Exceptions 9:98
i. Subparagraph 55(3.1)(a)(i) 9:98
ii. Problems with subsection 251(3.1) 9:99
iii. Subparagraph 55(3.1)(a)(ii) 9:100
iv. Subparagraph 55(3.1)(a)(iii) 9:100
v. Clause 55(3.1)(a)(iv)(A) 9:101
vi. Clause 55(3.1)(a)(iv)(B) 9:102
vii. Clause 55(3.1)(a)(iv)(C) 9:103
2. Paragraph 55(3.1)(b): Demise of the Purchase Butterfly 9:103
a. Subparagraph 55(3.1)(b)(i) 9:106
b. Subparagraph 55(3.1)(b)(ii) 9:107
c. Subparagraph 55(3.1)(b)(iii) 9:108
d. Paragraph 55(3.2)(h) 9:110
3. Paragraphs 55(3.1)(c) and 55(3.1)(d): Continuity of Interest in the
Properties 9:111
J. Other Butterfly-Related Issues 9:112
1. Part IV Tax and RDTOH 9:112
2. Parts IV.1 and VI.1 9:113
3. The Capital Gains Exemption 9:114
xviii / Taxation of Private Corporations and Their Shareholders
Chapter 10 Transferring Share Ownership to Employees or Other Shareholders
I. Introduction 10:2
II. Non-Tax Issues Concerning Equity Participation 10:3
A. Minority Interests 10:3
B. Lack of a Secondary Market 10:3
C. Financing Aspects 10:4
III. Employee Stock Option Plans 10:4
A. The Advantages of Stock Option Plans 10:5
B. The Income Tax Implications of Stock Option Plans 10:5
1. Application of Paragraphs 110(1)(d) and (d.1) 10:6
2. Transfers and Dispositions of Stock Options 10:7
3. Death of an Employee Who Owns a Stock Option 10:8
4. Application of Benefit Provisions 10:8
5. Cost Base Considerations 10:9
6. Miscellaneous Points Regarding Section 7 10:9
C. Non-Residents and Stock Options 10:13
D. Stock Option Plans Granted by CCPCs 10:16
E. Potential Tax Trap with Stock Options 10:17
IV. Employee Share Purchase Plans 10:18
A. The Income Tax Implications of Financing Arrangements 10:18
1. Loans Received by Shareholders or Employees 10:19
2. When Share Values Decrease 10:22
B. Corporate Law Considerations 10:25
C. Creation of Special Shares for Employees 10:25
1. Convertible Equity and Convertible Debt 10:25
2. Freeze Shares 10:26
3. The $750,000 Capital Gains Exemption 10:26
V. Phantom Stock Purchase Plans 10:27
VI. Transferring Equity Through a Reorganization 10:29
A. Corporate Joint Venture 10:29
1. Is It a Partnership? 10:29
2. The Nature of the Employee Corporation 10:30
B. Creation of a New Corporation 10:30
VII. Alternative Arrangements 10:31
A. Purchase Through a Holding Corporation 10:31
1. Application of Subsection 7(1.1) 10:31
2. Application of Subsection 15(2) 10:32
3. Application of Section 80.4 10:32
B. Purchase Through Family Members 10:33
C. Purchase Through a Registered Retirement Savings Plan and a
Deferred Profit-Sharing Plan 10:34
Chapter 11 Alternative Buy-Sell Arrangements for Shareholders
of Private Corporations
I. Introduction 11:2
II. Alternative Buyout Arrangements: An Overview 11:3
A. Purchase by Other Arm’s-Length Shareholders 11:3
Detailed Contents / xix
B. Purchase by Target Corporation 11:4
C. Estate of Deceased Shareholder 11:5
III. Funding a Buy-Sell Agreement 11:5
A. Cash Savings of the Parties 11:6
B. Sinking Fund Contributions 11:6
C. External Financing of the Share Purchase 11:6
D. Retarding the Growth and the Value of the Shares 11:6
E. Life Insurance 11:6
F. Combination of Insurance and Current Earnings 11:7
G. Payment over Time 11:7
H. Sale of Assets 11:7
IV. The Effect of a Shareholders’ Agreement on the Valuation of a Corporation’s Shares 11:8
A. Some Basic Considerations 11:8
B. Position of the CRA: IT-140R3 and IC 89-3 11:8
C. The Position of the Courts 11:10
D. Alternatives When the Buy-Sell Price Is Less Than FMV 11:12
1. Subsection 164(6) 11:12
2. Spousal Rollover 11:13
3. Price Adjustment Clause 11:14
E. Corporate-Owned Life Insurance 11:14
V. The $750,000 Capital Gains Exemption for Qualified Small Business
Corporation Shares 11:16
A. QSBC Share Defined 11:16
B. The Holding-Period Tests 11:18
C. The Effect of Corporate-Owned Insurance on QSBC Status 11:19
D. Subsection 110.6(8) 11:20
VI. Shares That Are Purchased for Cancellation 11:20
A. Advantages 11:21
1. Cash Flow Saving When Insurance Funding Is Used 11:21
2. Mitigation of Insurance Cost Inequalities 11:21
3. Simplifying the Agreement 11:21
4. Potential Reduction of Income Tax on Death 11:21
a. The Pre-1995 Tax Regime 11:22
b. The Current Tax Regime 11:23
5. Payment over Time 11:25
B. Potential Disadvantages and Traps 11:26
1. Insufficient CDA 11:26
2. Capital Gains Exemption Not Used 11:26
3. Potential Denial of Capital Losses 11:26
4. Timing of Share Purchase 11:27
5. Shares with a Low PUC and a High ACB 11:27
6. Last Surviving Shareholder: Left Holding the Bag? 11:27
7. Realizing the Capital Loss 11:28
8. Insurance-Related Issues 11:28
VII. Survivor Buyout Shareholders’ Agreements 11:29
A. Tax Consequences to the Deceased Shareholder and the Estate 11:29
B. Tax Consequences to Surviving Shareholder 11:29
C. Tax Consequences to an Operating Corporation 11:30
xx / Taxation of Private Corporations and Their Shareholders
VIII. Hybrid Arrangements: Combination Shareholder Buy-Sell and Purchase for
Cancellation 11:30
IX. The Use of Holding Corporations Under Buy-Sell Arrangements 11:31
1. Is the Corporate Purchase Workable in the Light of Subsection 55(2)? 11:31
2. Potential for Double Taxation in Cross-Purchase 11:33
X. Implications of the Rules Governing Preferred Shares 11:33
XI. Shareholders’ Agreements and the Deemed Control Provisions:
Paragraph 251(5)(b) and Subsection 256(1.4) 11:34
XII. Conclusion 11:37
Chapter 12 Tax Considerations in Buying or Selling a Business
I. Introduction 12:6
A. Assets Versus Shares 12:6
1. Some Important Issues 12:6
2. Biases 12:7
II. Collecting the Necessary Information 12:8
III. The Purchase and Sale of Shares 12:9
A. Using Holding Corporations To Make an Acquisition 12:9
1. Deductibility of Interest on Money Borrowed To Buy Shares 12:10
2. Deductibility of Interest Incurred To Redeem Shares 12:10
3. Interest Expense: Maximizing the Value of the Deduction 12:11
4. Unnecessarily Increasing Provincial Capital Taxes 12:11
5. Scientific Research and Experimental Development 12:12
6. Provincial Allocation 12:12
B. Corporate Rollovers To Defer Tax 12:12
1. Introduction 12:12
2. Illustration of Corporate Rollovers 12:13
3. Some General Comments on Corporate Reorganizations 12:13
4. Section 85: Transfer of Property to a Corporation 12:14
5. Section 85.1: Share-for-Share Exchange 12:14
a. Conditions Necessary for Section 85.1 To Apply 12:14
b. Tax Treatment of the Vendor 12:15
c. Tax Treatment of Acquireco 12:15
d. The CRA’s Administrative Practices 12:16
6. A Section 85.1 Share-for-Share Exchange Versus a Subsection 85(1)
Transaction 12:17
7. Section 86: A Reorganization of Share Capital 12:17
8. A Statutory Amalgamation (Section 87) Versus the Windup of a Wholly Owned
Subsidiary (Subsection 88(1)) 12:18
a. Application 12:18
b. Tax Results Generally 12:18
c. Legal Feasibility 12:18
d. Bumping Non-Depreciable Assets Under Subsection 88(1) 12:19
e. The Meaning of “Control” When a Chain of Corporations Is Acquired 12:20
f. Possible Taxable Capital Gains 12:21
g. Taxation Year 12:21
h. When a Property Is Treated as a Capital Property 12:22
Detailed Contents / xxi
i. The Paragraph 88(1)(d) Bump and Pre-Acquisition Dividends 12:22
j. Maximizing the Paragraph 88(1)(d) Bump 12:22
k. Property Ineligible for the Paragraph 88(1)(d) Bump 12:23
l. Preventing the Backdoor Butterfly: Paragraph 88(1)(c.3) 12:23
i. Example 1 12:24
ii. Example 2 12:24
m. Pre-Acquisition Planning 12:25
9. Tendering Shares of One Corporation for Shares of Another Corporation:
Section 85.1 Versus Subsection 87(9) 12:25
a. Section 85.1 12:26
b. Subsection 87(9) 12:26
10. Corporate Tax Instalments 12:26
a. Short Fiscal Period 12:27
b. Amalgamations 12:27
c. Windups 12:27
d. Transfers 12:27
11. When the Vendor Is Prepared To Take Back Shares 12:27
12. Reducing a Capital Gain Through a Tax-Free Intercorporate Dividend 12:28
13. Selling Shares of a Corporation and Gaining Access to Safe Income 12:29
14. Pre-Sale Dividends and Safe Income 12:30
C. An Instalment Sale: Deferring Taxable Gains by the Vendor 12:30
D. QSBC Shares and the Lifetime Capital Gains Exemption 12:33
1. The 24-Month-Holding-Period Test 12:33
2. The Qualified-Assets Test 12:34
a. Direct Ownership 12:34
b. Indirect Ownership 12:35
3. Planning Strategies 12:35
4. GAAR and QSBC Shares 12:36
5. Safe Income Exemption Versus the Capital Gains Exemption 12:36
6. Purchase of Shares from Retiring Shareholders 12:37
E. Capital Gains Deferral for Eligible Small Business Shares: Section 44.1 12:38
F. Proper Timing of an Acquisition 12:39
1. Timing of Acquisition and Disposition 12:40
2. Non-Arm’s-Length Transactions 12:41
3. ABIL in a Share Redemption 12:41
G. Why a Non-Resident Acquiror Should Consider Using a Holding Corporation
To Make an Acquisition 12:42
1. Thin Capitalization 12:42
2. The Use of a Quebec Financing Corporation 12:43
3. Exchangeable Shares: Exchanging Canadian Shares for Foreign Shares on a
Tax-Deferred Basis 12:43
4. The Death of the Cross-Border Butterfly 12:44
5. Non-Resident Share Acquisition Structuring 12:44
6. Unlimited Liability Corporation 12:45
7. Minimizing Canadian Taxes on the Disposition of a Canadian Subsidiary:
A Capital Gains Strip 12:45
8. Minimizing Canadian Taxes on the Disposition of a Canadian Subsidiary:
Changing Residence of Vendor 12:46
xxii / Taxation of Private Corporations and Their Shareholders
9. Dispositions by Non-Residents and Exposure to Provincial Taxes and
Double Taxation 12:46
10. Structuring Acquisitions by Non-Residents and Capital Taxes 12:47
11. One Approach to Avoiding Problems Under Section 212.1 12:47
12. Where Should a Foreign Acquiror Incur Its Financing Obligation? 12:48
H. The SBD: Financing an Acquisition Through a Reduced Tax Burden 12:48
1. The Saving Provision in Section 256 12:48
2. Financing an Acquisition Through Tax Savings 12:48
I. Salary to the Vendor Under a Personal Services Contract: Tax Considerations 12:49
J. Financing an Acquisition Through a Retiring Allowance 12:49
1. Retiring Allowance Defined 12:50
2. Tax Deferral 12:50
3. Deduction at Source 12:50
K. Upgrading of Pension Plans 12:51
L. Terminated Employees and Retirement Compensation Arrangements 12:51
M. Unexercised Stock Option Rights and Corporate Takeovers 12:51
N. When Shares of a Target Corporation Are Held by the Target’s DPSP 12:52
O. “Underwater” Loans to Employees 12:52
P. Change of Control of a Loss Corporation 12:53
Q. Debt Parking in Acquisition of Shares and Debt 12:53
R. Reverse Takeovers: Tax Considerations 12:53
S. Warranty Payments Arising Under the Purchase Agreement 47 12:54
IV. The Purchase and Sale of Assets 12:54
A. Allocating the Purchase Price in a Bulk Asset Purchase 12:54
1. Section 68 and the Allocation of Purchase Price 12:55
2. Instalment Sale Reserves: How To Optimize the Purchase Allocation 12:56
3. Sale of Assets: Provincial Sales Tax Implications 12:56
B. Tax Consequences of Selling a Business for Instalments Carrying No Apparent
Interest 12:57
C. Accounts Receivable: Making a Section 22 Election on Transfer 12:57
D. Sale of Inventory 12:59
1. Instalment Sale: Allocation to Inventory 12:59
E. Depreciable Property 12:60
1. Recapture of CCA 12:60
2. Capital Gains and Losses 12:60
3. Recapture of Depreciation: Is It Active Business Income? 12:60
4. Property Used in More Than One Business: An Increased Exposure to
Recapture 12:61
5. Regulation 1103(1): A Special Election To Avoid Recapture 12:61
6. Changes in CCA Classes 12:62
7. Depreciables: Impact of the Half-Year Rule 12:62
8. Sale of Land and Buildings 12:62
9. Analyzing the Real Nature of the Assets Being Purchased 12:63
10. Class 13: Leasehold Interests 12:63
11. The Available-for-Use Rule 12:64
12. The Replacement-Property Rules 12:64
13. Non-Arm’s-Length Sales of Depreciable Property and Eligible Capital
Property 12:65
14. Preventing the Realization of Losses in Certain Affiliated-Party Transactions 12:65
Detailed Contents / xxiii
F. Valuation of CCA Claims 12:65
G. Intangible and Eligible Capital Property 12:67
1. Depreciable Versus Non-Depreciable Intangibles 12:67
2. ECEs Defined 12:67
3. Goodwill as an ECE 12:67
4. Disposal of Eligible Capital Property 12:68
5. Recapture of Eligible Capital Amount as Active Business Income 12:68
6. Capital Dividend Account and Disposition of Eligible Capital 12:68
7. Bad Debts Arising from the Sale of Eligible Capital Property 12:68
8. Amount Not Due Until a Later Year in Respect of Eligible Capital Property 12:69
9. Eligible Capital Property and the Replacement-Property Rule 12:69
H. Capital Property Other Than Depreciable Property 12:69
1. Capital Property Owned on December 31, 1971: The Median Rule 12:69
2. The FMV of Publicly Traded Securities: ITAR 26(11) 12:70
3. Tax Treatment of Capital Gains and Capital Losses 12:70
4. Instalment Sales of Capital Property 12:71
5. Life Insurance Policies 12:71
I. Prepaid Expenses 12:71
1. Administrative Practice 12:71
2. Deferred or Prepaid Expenses 12:72
3. Consistency Desired: Changes Permitted 12:72
J. Reserves, Foreign Exchange, and Settlement of Debt 12:72
1. Reserves and Warranties 12:72
2. Foreign Exchange Gains and Losses 12:73
3. Debtor’s Gain on Settlement of Debt 12:73
K. Deferring Taxation Through Sections 99 and 25 12:74
L. Taxation Year Planning 12:74
M. The CDA: Be Very Careful 12:75
V. Other Considerations 12:76
A. Dividends Versus Capital Gains: Which Should a Shareholder Choose? 12:76
1. Some General Observations 12:76
2. Deemed Dividends Versus Capital Gains for Shareholders of Acquired
Corporations 12:77
3. Squeezing Out the Minority Shareholders in a Takeover 12:77
4. Dissenting Shareholders: Tax Treatment 12:78
B. Price Adjustment Clauses 12:79
1. Purpose 12:79
2. Interpretation Bulletin IT-169 12:79
3. Effect of IT-169 on Price Adjustment Clauses 12:80
C. Earnouts: What and Why 12:80
1. General Considerations in Structuring an Earnout 12:81
2. Different Approaches to an Earnout 12:81
a. The Base-Period Earnout 12:82
b. The Increment Earnout 12:82
c. The Cumulative Earnout 12:82
d. The Reverse Earnout 12:82
3. Tax Issues 12:83
4. Tax Treatment of Shares Sold Subject to an Earnout Agreement 12:84
5. Problems Under Section 55: Tax-Free Intercorporate Dividends 12:86
xxiv / Taxation of Private Corporations and Their Shareholders
D. Non-Competition Clauses 12:87
1. Default Income Inclusion: Subsection 56.4(2) 12:87
2. Non-Application of Section 56.4 12:88
a. Employment Income Exception: Paragraph 56.4(3)(a) 12:88
b. Asset Sale Exception: Paragraph 56.4(3)(b) 12:88
c. Share Sale Exception: Paragraph 56.4(3)(c) 12:90
3. Reasonable Allocation of Purchase Price to Restrictive Covenant: Section 68 12:91
a. Exceptions to Application of Section 68 12:91
i. Employee-Provided Covenant Exception: Subsection 56.4(6) 12:92
ii. Goodwill Amount Exception: Subsection 56.4(7) 12:92
iii. Disposition of Property Exception: Subsection 56.4(8) 12:94
b. Capital Gains Election: Subsection 56.4(9) 12:95
4. Treatment of the Purchaser 12:96
5. Anti-Avoidance Rules 12:96
6. Clarification Rules 12:97
7. Filing Prescribed Form 12:97
8. Restrictive Covenant Rules: Problems and Anomalies 12:97
E. Structures to Consider 12:99
1. Incorporating a Division: An Alternative to a Purchase and Sale 12:99
2. A Partnership of Corporations 12:99
F. Interest and Other Financing Costs 12:100
1. Interest Expense 12:100
2. Expenses of Issuing Shares and Borrowing Money 12:103
3. When the Parent Borrows 12:105
4. Aborted Financing 12:105
5. Withholding Tax 12:105
6. Purchase and Sale of Shares 12:106
7. Purchase and Sale of Assets 12:106
8. Appraisal Costs 12:106
9. Tax Treatment of Costs Incurred in Resisting a Takeover 12:107
G. Tax Treatment of Interest on the Purchase Price 12:108
H. Discounts and Premiums on Corporate Debt 12:109
I. Dispositions of Capital Property by Non-Residents 12:110
1. Taxable Canadian Property 12:110
2. Liability of Purchaser in Certain Cases 12:111
3. Disposition of Taxable Canadian Property by Non-Residents 12:112
4. Capital Gains Incurred by Non-Residents: The Canada-US Tax Treaty 12:115
J. How To Use RRSPs To Assist in Acquiring a Business 12:115
VI. Tax Clauses in Acquisition Agreements 12:115
VII. Application of GST to the Purchase and Sale of a Business 12:117
A. Special Elections 12:117
B. The Application and Impact of GST 12:118
C. Financial Institutions and Other Exempt Users 12:118
D. Application of Retail Sales Tax to the Purchase and Sale of a Business 12:119
VIII. Shares Versus Assets: An Example 12:119
Detailed Contents / xxv
Chapter 13 Utilization of Corporate Losses
I. Introduction 13:3
A. Ordering of Deductions 13:3
B. Losses: Some General Comments 13:3
II. Non-Capital Losses 13:4
A. Carryover of Non-Capital Losses 13:4
B. Using Non-Capital Losses To Reduce Part IV Tax 13:5
C. Using Foreign Tax Credits While Increasing Non-Capital Losses 13:6
D. Ontario Harmonization’s Impact on Non-Capital Losses 13:6
III. Net Capital Losses 13:6
IV. Allowable Business Investment Losses 13:7
V. Acquisition of Control: Impact on Losses Carried Forward 13:10
A. Introduction 13:10
1. Sale of Current-Year Losses 13:10
2. ABILs and Property Losses 13:10
3. Sale of Accrued but Unrealized Losses 13:11
B. When Does an Acquisition of Control Occur? 13:11
C. Changes in Ownership That Are Deemed Not To Be an Acquisition of Control 13:12
1. The Transfer of Loss Corporations Within a Related Group 13:13
2. Change in Executor 13:14
3. Distribution to a Beneficiary 13:14
D. Circumstances in Which an Acquisition of Control Is Deemed To Occur 13:14
E. Restrictions on Losses That Arise on an Acquisition of Control 13:15
1. Deemed Year-End on an Acquisition of Control 13:15
2. Effect of an Acquisition of Control on the Carryover of Net Capital Losses 13:16
3. Effect of an Acquisition of Control on the Carryover of Non-Capital Losses 13:17
4. Reasonable Expectation of Profit 13:18
5. Depreciable Property 13:19
6. Eligible Capital Property 13:19
7. Additional Tax Implications 13:20
VI. Offsetting Profits and Losses Within a Related Group 13:20
VII. Amalgamations: Flowthrough of Losses 13:20
A. General Comments 13:20
B. Timing Problems: Effective Date of Amalgamation 13:21
VIII. Liquidations: Flowthrough of Losses 13:22
IX. Other Loss-Consolidation Strategies 13:24
A. Group Loss-Consolidation Techniques 13:24
1. Transfer of Assets Within an Affiliated Group 13:24
2. Transfer of a Profitable Business Within an Affiliated Group 13:26
3. Implementation of Intercorporation Charges 13:26
4. Transfer of a Profitable Business to a Partnership 13:26
5. Preferred Share/Loan Transactions 13:27
B. Preserving Losses 13:28
1. Revising Discretionary Deductions 13:28
2. Other Loss-Preservation Strategies 13:29
xxvi / Taxation of Private Corporations and Their Shareholders
X. Other Loss-Restriction Rules 13:30
A. Using Third-Party Losses on Asset Sales: Subsection 69(11) 13:30
B. Restrictions on Transferring CCA to a Third Party: Subsection 13(24) 13:31
C. Loss-Denial Provisions 13:31
XI. Debtor’s Gain on Settlement of a Debt: Preventing Taxpayers from Avoiding a
Forgiveness 13:33
A. Overview of the Debt-Forgiveness Rules 13:33
B. Implications of the Debt-Forgiveness Rules 13:33
C. Debt Parking 13:34
XII. When To Recognize Capital Debts Established To Be Bad Debts 13:35
XIII. Loan Guarantees and Non-Interest-Bearing Loans: Deductibility of Debts Gone Bad 13:36
A. Capital or Income Loss 13:36
B. Deductibility of Interest on Funds Borrowed To Honour a Guarantee 13:38
XIV. Nil Assessments: Confirming the Amount of Available Losses 13:40
XV. Carrying Back Losses 13:42
XVI. The Impact of Bankruptcy on Losses 13:42
XVII. How Dividends Received May Reduce the Amount of a Loss 13:43
A. Shares That Are Capital Property 13:43
B. Shares That Are Non-Capital Property 13:44
XVIII. Taxable Preferred Share Financing 13:44
A. Term Preferred Shares 13:45
B. Guaranteed Shares 13:46
C. Collateralized Preferred Shares 13:46
D. Taxable Preferred Shares 13:46
E. Additional Points To Be Noted 13:48
XIX. Limited Partnership Losses 13:49
XX. A Review of the Concept of Control 13:49
A. Income Tax Act Provisions 13:49
B. Review of the Jurisprudence 13:50
C. Control by a Group of Persons 13:58
D. The CRA’s Position 13:59
E. Summary of the Current Law 13:60
Chapter 14 Provincial and Territorial Taxation of the Private Corporation
I. Constitutional Power 14:3
II. History of Provincial Taxation 14:4
III. Differences in Provincial and Territorial Tax Rates 14:5
A. Overview 14:5
B. The SBD 14:5
1. Ontario 14:6
2. Quebec 14:6
C. Manufacturing and Processing Deduction 14:6
D. Provincial and Territorial Tax Holidays 14:6
1. Overview 14:6
a. Newfoundland and Labrador 14:7
b. Nova Scotia 14:7
Detailed Contents / xxvii
c. Ontario 14:7
d. Quebec 14:8
2. General Planning for Tax Holidays 14:8
IV. Allocating Taxable Income Among Federal and Provincial or Territorial Jurisdictions 14:10
A. Significance of Permanent Establishment 14:10
1. Federal Taxation 14:10
2. Provincial/Territorial Taxation 14:10
B. Definition of “Permanent Establishment” Under the Federal Regulations 14:11
C. The Allocation of Income to a Permanent Establishment 14:13
1. What is Included in “Salaries and Wages Paid”? 14:14
2. What Is Gross Revenue? 14:16
3. Where Should the Gross Revenue Be Allocated? 14:16
4. Double Taxation 14:17
D. Allocation of Investment Income 14:17
V. Provincial and Territorial Income Tax Differences: An Overview 14:18
A. Scientific Research and Experimental Development 14:19
B. M & P Tax Incentives 14:19
1. Manitoba 14:20
2. Newfoundland and Labrador 14:20
3. Nova Scotia 14:20
4. Ontario 14:20
5. Prince Edward Island 14:20
6. Quebec 14:20
7. Saskatchewan 14:21
8. Yukon 14:21
C. CCA 14:22
1. CCA in Year of Acquisition 14:22
2. Computation of Capital Cost 14:22
a. Ontario 14:22
b. Quebec 14:22
D. Non-Residents’ Withholding Taxes 14:22
E. Charitable Donations 14:23
F. Political Contributions 14:23
G. Availability of Non-Capital Losses 14:23
1. Alberta 14:24
2. Quebec 14:24
H. Planning with Non-Capital Losses 14:24
I. Loss Carryforward or Carryback in the Year of Startup or Shutdown 14:25
VI. Other Provincial and Territorial Tax Credits 14:25
A. Political Contributions 14:25
B. Film, Television and Media Incentives 14:26
C. Venture Capital and Small Business Financing Incentives 14:27
1. Labour-Sponsored Venture Capital Corporations 14:27
2. British Columbia Venture Capital Tax Credit 14:27
D. Alberta 14:28
E. British Columbia 14:28
1. Logging Tax Credit 14:28
xxviii / Taxation of Private Corporations and Their Shareholders
2. Mining Exploration Tax Credit 14:28
3. Book-Publishing Tax Credit 14:28
F. Manitoba 14:29
1. Book-Publishing Tax Credit 14:29
G. Ontario 14:29
1. Cooperative Education Tax Credit 14:29
2. Apprenticeship Training Tax Credit 14:29
3. Book-Publishing Tax Credit 14:29
4. Ontario Mineral Exploration Program 14:30
H. Quebec 14:30
1. On-the-Job Training Tax Credit 14:30
2. Design Credits 14:30
3. Book-Publishing Tax Credit 14:30
I. Saskatchewan 14:31
VII. Ontario Corporate Minimum Tax 14:31
VIII. Payroll Tax 14:32
A. Newfoundland and Labrador 14:33
1. Meaning of “Employee” and “Employer” 14:33
2. “Remuneration” and “Establishment” 14:33
B. Manitoba 14:34
1. Meaning of “Employee,” “Employer,” and “Remuneration” 14:34
2. Meaning of “Permanent Establishment” 14:34
C. Ontario 14:35
1. Meaning of “Employee” 14:35
2. Meaning of “Employer” 14:36
3. “Permanent Establishment” 14:36
D. Quebec 14:36
1. Meaning of “Employee,” “Employer,” and “Wages” 14:37
2. Meaning of “Establishment” 14:37
3. Quebec Vocational Training Tax 14:37
E. Northwest Territories 14:37
1. Meaning of “Employee,” “Employer,” “Remuneration,” and
“Fixed Place of Business” 14:38
F. Nunavut 14:38
IX. Elective Provisions 14:38
A. Interprovincial Asset Transfers 14:39
X. Provincial General Anti-Avoidance Rules 14:39
A. Alberta 14:39
B. British Columbia 14:39
C. Manitoba 14:39
D. Ontario 14:40
E. Quebec 14:40
F. Saskatchewan 14:40
XI. Provincial Capital Tax 14:40
A. Overview 14:40
B. Determination of Taxable Capital 14:41
XII. Provincial and Territorial Recognition of Canada’s Tax Treaties 14:41
Detailed Contents / xxix
Chapter 15 Passage of Shares of a Private Corporation on Death
I. Introduction 15:2
II. The Trustee’s Discretionary Powers 15:3
A. Discretionary Powers and the Rules of Equity 15:3
1. The Prudent-Person Rule 15:4
2. The Even-Hand Rule 15:5
B. The Fales Case 15:5
C. Billes: The Canadian Tire Case 15:6
D. The Rules of Equity 15:8
III. The Estate’s Holding of Private Corporate Shares 15:9
A. Trustee’s Duty To Be Appointed Director 15:9
B. Trustee’s Duties as Trustee and as Director 15:9
C. Trustee’s Duties as Trustee and as Shareholder 15:10
D. Selection of Beneficiaries 15:11
E. Distribution of Corporate Earnings: Income or Capital? 15:11
F. Duty Not To Profit 15:14
G. Some Income Tax Considerations 15:15
1. Residence of Trust 15:15
2. Associated Corporations 15:15
H. Delegation of Administrative Powers 15:16
IV. Farm Corporation Rollover 15:16
V. Spousal Rollover 15:17
A. Requirements for Rollover 15:18
B. Meaning of “Vested Indefeasibly” 15:19
C. Untainting the Spousal Rollover 15:19
VI. Income Tax Elections 15:19
VII. Term of the Trust 15:20
A. The 21-Year Rule 15:20
B. The Rule Against Perpetuities 15:20
C. The Rule Against Accumulations 15:21
VIII. Conclusion 15:21
Chapter 16 Tax Planning and Tax Avoidance
I. Introduction 16:3
II. Common Types of Avoidance Transactions 16:5
A. Benefits and Loans to Shareholders 16:6
B. Indirect Payments or Transfers 16:9
C. Attribution of Income (Imputed Interest Income) 16:12
D. Indirect Transfer of Value 16:12
E. Bumping the Cost Base of Property (Including Shares) 16:14
1. Paragraph 69(1)(a) 16:15
2. Paragraph 13(7)(e) and Subsection 14(3) 16:15
3. Section 84.1 16:15
F. Creating Losses 16:16
1. Subsection 40(3.4) and Subsection 14(12) 16:16
2. Subsection 13(21.2) 16:17
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3. Subsections 112(3) to (3.32) 16:18
4. Subsections 112(4) to (4.22) 16:19
G. Increasing PUC 16:19
1. Subsection 84(1) 16:19
2. Section 84.1 16:20
3. Subsection 85(2.1) 16:20
H. Converting Capital Gains into Intercorporate Dividends: Subsection 55(2) 16:21
I. Lifetime Capital Gains Exemption 16:21
1. Converting Corporate Capital Gains into Individual Capital Gains:
Subsection 110.6(7) 16:22
2. Increasing Value by Dividend Blocking: Subsection 110.6(8) 16:22
3. Circumventing the 24-Month Rule: Paragraph 110.6(14)(f ) 16:23
4. Former Subsection 245(1.1) and GAAR 16:23
J. Laundering Gains: Subsection 69(11) 16:24
III. Specific Statutory Avoidance Tests 16:24
A. The Purpose Test 16:25
1. Introduction 16:25
2. The Canadian Approach 16:26
a. “Principal Purpose” 16:28
b. “One of the Main Purposes” 16:29
c. “One of the Purposes” 16:30
B. The Reasons Test 16:32
C. Principal Business 16:34
D. The Reasonableness Test 16:35
E. The Deeming Test 16:36
F. The “Knowingly” Test 16:37
IV. Judicial Anti-Avoidance Doctrines 16:37
A. What Is Tax Avoidance? 16:38
B. Judicial Doctrines 16:41
1. Business-Purpose Test 16:41
2. Sham 16:44
3. Incomplete Versus Illegal Transactions 16:47
a. Incomplete Transactions 16:47
b. Illegal Transactions 16:49
4. Agency 16:54
5. Piercing the Corporate Veil 16:56
6. Step Transactions 16:57
a. What Is a Composite Transaction? 16:60
b. The Step Transaction Doctrine in Canada 16:60
7. Abuse of Law 16:65
8. Object and Spirit 16:66
9. Substance over Form 16:69
a. What Is Form and What Is Substance? 16:69
b. Substance over Form in Canada 16:71
C. Conclusions 16:74
V. GAAR: Canada’s Answer to Tax Avoidance 16:75
A. Introduction 16:75
Detailed Contents / xxxi
B. Analysis of Section 245 16:77
1. The Coming-into-Force Provisions 16:77
2. The “Charging” Provision: Subsection 245(2) 16:77
3. The McNichol and RMM Canadian Cases 16:77
a. McNichol 16:78
b. RMM Canadian 16:78
c. Comments on McNichol and RMM Canadian 16:79
4. The Tax Benefit Definition: Subsection 245(1) 16:81
5. The Definition of Tax Consequences: Subsection 245(1) 16:82
6. The Definition of Avoidance Transactions: Subsection 245(3) 16:82
a. Bona Fide Purpose 16:83
b. Meaning of “Purpose” 16:84
c. Primary Purpose 16:85
d. Non-Tax Purpose 16:85
e. Series of Transactions 16:86
7. Misuse or Abuse 16:88
a. Background 16:88
b. Is Subsection 245(4) a Rule of Interpretation? 16:89
c. Is Subsection 245(4) an Exempting Provision? 16:90
d. The CRA’s Position 16:91
e. When Should Subsection 245(4) Be Applied? 16:91
f. What Do the Terms “Misuse” and “Abuse” Mean? 16:91
g. Interpretive Approach 16:92
h. Selected Supreme Court of Canada Cases 16:93
i. Selected Cases Decided by Other Courts 16:97
8. Determination of Tax Consequences 16:102
a. Recharacterizing the Transaction 16:102
b. Applying for a Determination 16:103
c. Third-Party Adjustments 16:104
C. Application of GAAR: A Summary 16:105
1. Conceptual Application of GAAR 16:105
2. The GAAR and Specific Anti-Avoidance Rules 16:105
3. Judicial Considerations 16:106
a. General Rules of Statutory Interpretation 16:106
i. The use of extrinsic materials as interpretive aids 16:107
b. Onus of Proof 16:109
4. The Department of Finance’s Approach 16:109
5. The CRA’s Approach 16:111
a. GAAR Assessments and Rulings 16:111
b. Information Circular 88-2 and Supplement I 16:112
6. Selected Jurisprudence 16:113
a. GAAR Assessments Upheld 16:113
b. GAAR Assessments Overturned 16:114
D. Planning for GAAR 16:116
1. Developing Tax Plans 16:116
2. Documenting Transactions 16:117
3. Warranties and Indemnities 16:117
xxxii / Taxation of Private Corporations and Their Shareholders
4. Advance Income Tax Rulings 16:117
5. Transitory Transactions 16:118
6. Resisting an Assessment 16:118
Chapter 17 Scientific Research and Experimental Development
and Investment Tax Credit Incentives
I. Introduction 17:3
A. History of the Program 17:3
II. The Incentives 17:3
A. Deduction 17:3
B. ITCs: A Two-Tiered System 17:4
III. Filing Requirement 17:4
IV. Definition of SR & ED 17:5
A. Carried On in Canada 17:6
B. Deduction of SR & ED Expenditures 17:7
1. Salaries or Wages of Employees 17:7
a. Incurred 17:8
b. Computation of Salaries or Wages Under the Proxy and Traditional
Methods 17:8
c. Specified Employees 17:9
d. Work Performed Outside Canada 17:10
e. Unpaid Salaries or Wages 17:10
2. Contract Payments 17:10
3. Third-party Payments 17:12
4. Materials 17:12
5. Leases 17:13
6. Election for Overhead 17:13
a. Proxy Election 17:13
b. Traditional Method 17:14
c. Expenditures Directly Attributable to SR & ED 17:15
7. Capital Expenditures 17:16
V. Concept of Pooling SR & ED Expenditures 17:17
A. Components of the SR & ED Pool 17:17
B. Acquisition of Control 17:18
VI. ITCs for Qualifying SR & ED Expenses 17:19
A. General Rules 17:19
B. Eligibility for the 35 Percent Small Business Credit Rate 17:19
C. Refundable ITC 17:21
1. Qualifying Corporation 17:21
2. Qualified Expenditures 17:22
3. Refund on SR & ED Credits 17:22
D. Anti-Avoidance Provisions 17:22
E. Qualifying Expenditures 17:22
1. General 17:22
2. Prescribed Proxy Amount 17:23
3. Prescribed Current Expenditures 17:24
4. Prescribed Capital Expenditures 17:24
Detailed Contents / xxxiii
a. Capital Assets Available for Use 17:25
5. Government and Non-Government Assistance 17:25
6. Contract Payments 17:27
7. Unpaid Amounts 17:28
F. Shared-Use Capital Equipment 17:28
G. Subcontracting Payments to Non-Arm’s-Length Parties 17:29
H. Recapture of SR & ED Credits on the Sale or Conversion of Property 17:30
VII. Offsetting Refund Against Other Taxes 17:33
VIII. Assignment of ITCs to Third Parties 17:33
IX. Carryover of ITCs 17:34
A. Reorganization of Corporations Through Amalgamation and Windup 17:34
B. Acquisition of Control 17:34
X. Partnerships and ITCs 17:35
A. Filing Due Dates 17:35
B. Specified Members of a Partnership 17:36
C. Allocation of Unused ITCs 17:36
XI. Provincial and Territorial Incentives 17:37
A. Ontario 17:37
1. Ontario Innovation Tax Credit 17:37
2. Ontario Business-Research Institute Tax Credit 17:38
3. Ontario Research and Development Tax Credit 17:39
4. Harmonization Between Federal and Ontario SR & ED Regimes 17:40
B. Alberta R & D Tax Credit 17:41
C. British Columbia R & D Tax Credit 17:41
D. Manitoba R & D Tax Credit 17:42
E. New Brunswick R & D Tax Credit 17:42
F. Newfoundland and Labrador R & D Tax Credit 17:43
G. Nova Scotia R & D Tax Credit 17:43
H. Prince Edward Island Innovation and Development Tax Credit 17:43
I. Quebec Credit for R & D Wages 17:44
J. Saskatchewan R & D Tax Credit 17:44
K. Yukon R & D Tax Credit 17:45
Appendix 1: Organizations Designated as Eligible Research Institutes for the Purposes of the
OBRI Tax Credit 17:45
A. Ontario Universities 17:45
B. Ontario Colleges of Applied Arts and Technology 17:45
C. Ontario Centres of Excellence 17:46
D. Networks of Centres of Excellence 17:46
E. Hospital Research Institutes 17:47
F. Other Organizations 17:48
Appendix 2: Case Study 17:48
Chapter 18 Dividend Taxation: The Eligible Dividend Regime
I. Introduction 18:2
II. Impact on Shareholders 18:3
A. Federal Tax Treatment 18:3
B. Provincial and Territorial Tax Rates 18:3
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III. Impact on Corporations 18:4
A. Eligible Dividends 18:5
1. Definition of “Eligible Dividend” 18:5
2. Designation Requirement 18:5
3. Administrative Guidance 18:5
B. Part III.1 Tax and the EEDD 18:7
1. Tax and Designation 18:7
2. Status of Corporation 18:7
3. Calculation of Tax 18:7
4. Anti-Avoidance 18:7
5. Shareholder Liability 18:8
6. Election for Separate Dividend 18:8
7. Corporate Filing Obligation 18:9
C. GRIP 18:9
D. LRIP 18:11
IV. Examples 18:11
A. GRIP 18:12
B. LRIP 18:13
V. Implications in Selected Situations of Interest 18:14
A. Basics of the Opening GRIP Calculation: Transitional Relief 18:14
B. Asset Sale Versus Share Sale 18:16
C. Non-Resident Shareholders 18:17
D. Subsection 55(2) and GRIP 18:18
E. CCPC Status Changes 18:18
1. GRIP of a New CCPC 18:19
2. LRIP of a New Non-CCPC 18:19
F. Impact of Losses 18:19
G. Election Not To Be a CCPC 18:20
H. Selected Observations About CCPCs 18:20
VI. Conclusion 18:21