Tax II Chapter 8
Spring 2013
Notes
Chapter Eight Lecture Notes
Section 85.1 Share-for-Share Mergers
David Christian
Spring Term 2013
Thorsteinssons LLP
UBC Faculty of Law
______________________________________________________________________________
Notes
The [tax] lawyer’s passion for technical analysis of the statutory language
should always be diluted by distrust of a result that is too good to be true.
Boris I. Bittker and James S Eustice
1.
This part of the course looks at “corporate reorganization” rules. They
arise frequently in practice. Some apply to narrow, discrete situations.
Others are broad, and overlap more specific rules.
2.
We begin with s.85.1 because it is a narrow rule, and is a good example of
the concept of a “roll-over”.
3.
Consider the Quadra Mining Ltd. and FNX Mining Company Inc.
transaction, which completed in May 2010. Numbers are for illustration.
QM SHs
market value
$1.8 billion
TSX
12 million shares
($150 per share)
Quadra
Business 1
$1.8 billion
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FNX SHs
market value
$1.2 billion
TSX
8 million shares
($150 per share)
FNX
Business 2
$1.2 billion
(a)
Management has decided it is a good idea to “combine” the
businesses. Neither has the cash to buy the other. The
shareholders of both vote in favour of the transaction.
Quadra uses its own shares as “currency” in the transaction, and
changes its name to “Quadra FNX Mining Ltd.”
(b)
Quadra FNX acquires FNX shares, paying with Quadra FNX
shares. Here the ratio is one for one.
FNX SHs
Quadra
SHs
$1.2 billion
8 million shares
$ 1.8 billion
12 million shares
Quadra
FNX
Business 1
$1.2 billion
8 million shares
FNX
$1.8 billion
Business 2
$1.2 billion
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4.
Consider the consequences of this transaction.
5.
Firstly, who is affected?
6.

The shareholders of FNX (not Quadra shareholders). Why? The
Quadra shareholders continue to hold shares of the same legal
entity (just the name changed).

Quadra FNX (former Quadra). It has acquired the shares of FNX..

FNX. There has been an “acquisition of control” of this company.
This is examined in a later Chapter.
The tax questions are:

Do the FNX shareholders realize a capital gain or loss?

What is Quadra FNX’s tax cost of the FNX shares it has acquired?

What is the tax PUC of the Quadra FNX shares issued to the FNX
shareholders?
The FNX Shareholders (Transferors)
7.
Do each of the shareholders of FNX have a gain or loss?
The basic principle: there has been an exchange of one property (share of
one legal entity) for another property (share of another legal entity). The
FNX shareholders each dispose of FNX shares, and their proceeds of
disposition are the value of the Quadra FNX shares received. Each of the
FNX shareholders’ capital gain or loss is computed with reference to their
ACB of FNX shares disposed of.
Now read s.85.1(1)(a).
Each FNX shareholder is “deemed”, automatically, to realize proceeds of
disposition equal to the ACB of their FNX shares (i.e. no gain or loss).
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Each FNX shareholder is “deemed” to acquire the Quadra FNX shares at
an amount equal to the ACB of the FNX share disposed of. This is
referred to as “rollover”. Unless:

“subsection 2 applies” (see below); or

the FNX shareholder includes any portion of the
gain or loss in income when the shareholder files a
tax return. In this event, there is no rollover.
“Subsection 2 applies”? The rollover does not apply (i.e., this section is
not available) if one of four alternate circumstances is present.

The FNX shareholder and Quadra FNX are “not dealing at arm’s
length” before the transfer. When would this apply in such a
transaction? Consider a significant shareholder of both public
companies (de facto control issues in lesser known companies).

If, after the transfer, the FNX shareholders (and persons not at
arm’s length with the FNX shareholders) control Quadra FNX or
own more than 50% of the fair market value of all Quadra FNX
stock. Consider the “reverse take-over”.

The FNX shareholders receive consideration other than shares of a
particular class of Quadra FNX shares “for exchanged FNX share”.
Problems and solutions on this last circumstance:
What if two classes of Quadra FNX shares were issued? Solution:
transfer some shares for one class, and transfer the rest of the
shares for the other class. Each shareholder does this. Therefore,
each share is transferred for only one class of shares in acquirer.
What if the deal is shares “plus cash”? (It is not uncommon for
large takeover deals to have a cash element.) The transfer is fully
taxable. Solution? Again, parcel the consideration. Allocate the
consideration: i.e., cash for “X number or percentage of shares”,
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and shares for “Y number or percentage of shares”. Section 85.1
tests the tax result to a shareholder for each share transferred.
Note: The CRA administratively allows cash to be paid for what
would otherwise be “fractional share” in the acquirer. The cash
does not “taint” s.85.1. The cash reduces the cost base of the other
shares received on the exchange.

A joint “election” is filed under s.85(1) – the broad rollover rule
(discussed next chapter). This joint election “trumps” s.85.1. That
is, s.85.1 will not apply if Quadra FNX and the FNX shareholder
were to elect under the rollover rules in s.85(1).
Tax Cost to Quadra FNX (Acquiring Company)
8.
What is Quadra FNX’s tax cost of the FNX shares it has acquired?
Read s.85.1(1)(b). The cost of each FNX share acquired by Quadra FNX
is deemed to be the lesser of:

the fair market value of the FNX share before the exchange;

the tax PUC in respect of the FNX share before the exchange;
unless any of the four circumstances apply in s.85.1(2) as above –
then s.85.1(1)(b) does not apply at all. In that event, the cost is
equal to the amount under basic principles, which the cases say is
the amount added to Quadra FNX’s own corporate share capital as
a result of issuing the new Quadra FNX shares.
9.
Consider an example.
Tax PUC of Quadra FNX Shares Issued to FNX Shareholders
10.
What is the tax PUC of the Quadra shares issued to the FNX shareholders?
Read s.85.1(2.1)(a)(i) and (ii). This is one of the sections that can cause a
“PUC grind” to arrive at tax PUC (s.89(1)).
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The opening PUC of the shares is the amount added to the corporate share
capital of Quadra FNX. However, to arrive at the tax PUC, you must
reduce the PUC of the Quadra FNX shares by an amount = X – Y:
X:
is the increase in PUC of shares of Quadra FNX as a result of
issuing Quadra FNX shares to FNX shareholders (corporate
stated capital addition).
minus
Y: is the tax PUC of the FNX shares acquired,
The effect is that there is no increase in tax PUC in the new “corporate
group” as a result of the acquisition of the one company by the other under
the roll-over rules in s.85.1.
11.
The rules that apply upon an “acquisition of control” of a company will be
discussed in a later Chapter.
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