Tax II Chapter 12 Spring 2013

Notes

Chapter Twelve Lecture Notes

Liquidations

David Christian Spring Term 2013

Thorsteinssons LLP UBC Faculty of Law

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Notes

A good place to start from is where you are.

Charles Wolf

  1. Take John and Sam again, before the merger. Change the facts. Sam had his company buy the real estate in a subsidiary ($25k cash, $100k bank debt). Assume no CCA has been taken in the Subco.

Real Estate
Land / Building / Subco
Total
FMV / $400k / $50k / $450k
ACB / $75k / $50k / $125k
UCC / $50k / $50k
Loan / ($100k)
  1. KDL has operated at a loss (first few years). As noted, no CCA has been taken in Subco. Sam is tired of operating Subco, and wants to wind-up Subco into KDL.
  1. Corporate law. Voluntary or court ordered. Voluntary: commence the wind-up (transfer assets), then dissolve the company (terminate its existence at the Corporate Registry in Victoria). Here: the land and building are transferred to KDL on the “wind-up” of Subco.
  1. What is the tax result? Read s.88(1)(a) and (b).

·  Notice s.88(1): taxable Canadian corporation, not less than 90% shares of each Class are owned by another taxable Canadian corporation (“Parent”), and any minority shareholders owned by persons “at arm’s length” with that Parent. If these pre-conditions are met, special rules apply (below).

  1. Subsection 88(2) applies to all other wind-ups of a taxable Canadian corporation. It is a “fair market value realization event”: in other words, fully taxable. Read s.69(5). The company is deemed to sell its property at fair market value. The shareholder(s) have fair market value proceeds of disposition. The rules in s.84(2) will apply (recall the deemed dividend rules). Special rules in s.88(2) ensure the CDA of the company can be used for the deemed dividend on a s.88(2) wind-up.
  1. Subsection 88(1) is generally a roll-over transaction, but not always. What is disposed of? By which party? What is acquired? Take the example above.
  1. Subco’s proceeds of disposition. Read s.88(1)(a)(iii): the “cost amount” of the property transferred to KDL. (the Parent) is deemed to be its proceeds of disposition. “Cost amount” is defined in s.248(1).

·  “depreciable property”: pro rata portion of UCC of the whole Class (read: UCC of the Class).

·  “capital property”: ACB.

·  “inventory”: the cost (value for tax in s.10 is cost).

·  “eligible capital property”: pro rata portion of 4/3rd of the cumulative eligible capital account.

The result is that Subco has no gain, or loss, arising when its land and building are transferred to the Parent on the wind-up.

  1. KDL (the Parent) disposes of its shares of Subco. Read s.88(1)(b). Its proceeds are the greater of:

·  an amount that is the lesser of:

·  the tax PUC of the shares, and

·  the total “cost amounts” of Subco’s property (s.88(1)(d)(i)), and

·  the ACB of shares:

  1. Apply this to KDL: the greater of: (i) (lesser of $25k and $125k), and (ii) ($25k) = $25k.

·  Notice: the Parent can have a capital gain: This can happen where the Parent purchased the Subco shares at a low cost. The Subco shares could have high tax PUC, and Subco could have high tax cost amount in its assets. No gain here on our facts.

·  Note the deemed dividend rules in s.84 do not apply on a s.88(1) wind-up (s.88(1)(d.1)).

  1. The Parent’s tax cost of the Subco property acquired by it on the wind-up? Read s.88(1)(c):

·  The general rule: the tax cost is equal to the proceeds of disposition to Subco, being the tax cost amounts of the property (s.88(1)(c)).[1]

·  Plus, you add a possible “bump amount” = an amount to be added to Parent’s tax cost of Subco property acquired on the wind-up (discussed below).

·  Apply this to KDL. The ACB of the land, and the UCC of the building, become the tax cost to KDL.

  1. There is a flow-through of certain other accounts, similar to what we saw for amalgamations (CDA, RDTOH, etc.).

·  Assume Subco had losses. We examine the use of corporate losses in a later chapter.

  1. Continuity rules: paragraph 88(1)(e.2) applies a number of the amalgamation rules in subsection 87(2) to windings-up, with the necessary changes in language. This avoids having to repeat rules that give identical results.

The Bump

  1. Consider the s.88(1)(d) bump. Purpose: the Parent may have previously bought Subco at a time when the fair market value of Subco’s capital property may have exceeded its tax cost. The “bump” preserves the ACB in the share purchase price to a limited extent.
  1. Take John and Sam again – but change the facts. John wants to buy-out Sam.

·  John now wants to buy Sam out for $600k. He does not need or want to keep Sam’s real estate. Sam will only sell shares of KDL (QSBC share capital gains exemption in Chapter 13). He will not cause KDL to sell its assets. John’s Drugs can borrow $600k. John does not have the money personally. But the bank expects John’s Drugs to sell Sam’s real estate to pay down the loan by $300k after John’s Drugs has acquired it.

·  Thus, the proposal is for John’s Drugs to buy shares of KDL for $600k. John’s Drugs will wind-up KDL. John’s Drugs will then sell the Pandosy St. property for $300k. What are the tax consequences of this to John’s Drugs?

  1. First step: John’s Drugs buys Sam’s KDL shares for $600k cash:

·  John now wants to sell the Pandosy St. property. Look at the accrued gain ($225k) on the land. This cannot be sold without tax, right? But John’s Drugs paid $600k for the shares. Part of this purchase cost represents the indirect cost of buying the land ($300k). How does John’s Drugs get credit for that purchase cost?

  1. John’s Drugs winds-up KDL. No gain arises in KDL. (s.88(1)(a)). No gain arises to John’s Drugs (s.88(1)(b)). What about John’s Drugs’ tax cost of the property received on wind-up?

·  We know the ACB of land to KDL is $75k. If this becomes John’s Drugs’ cost, then the land cannot be sold without tax, right?

·  Read s.88(1)(c) as before: PLUS an amount determined under s.88(1)(d) in respect of “capital property” of Subco other than “ineligible property”.

·  “capital property” here includes the land and assume, for the moment, it is not “ineligible” property.

·  What is the “amount” under s.88(1)(d)?

·  Paragraph 88(1)(d) “amount” is such portion of the amount, if any, by which the total in s.88(1)(b)(ii) (i.e., the ACB of the Parent’s shares of Subco – here, the ACB of John’s Drugs’ shares of KDL: $600k) exceeds the total of: (i) and (i.1).

·  (i) and (i.1) represent: (i) Subco’s total tax cost amount of all its properties less its debt, and (i.1) dividends previously paid to Parent.

·  in this case, the tax cost amounts of KDL assets are $165k + $50k + $75k. KDL has no debts and assume no dividends were paid to Parent. Thus, the total of (i) and (i.1) is $290k.

·  Thus, the s.88(1)(d) bump is the amount that Parent’s ACB of the Subco shares ($600k) exceeds $290k, or $310k. Notice what this number reflects: the gain in Subco’s assets before the wind-up.

·  Also read s.88(1)(d)(ii): in no case can you bump the Parent’s cost of any particular property up to more than the fair market value of that property at the time of acquisition of control of the Subco by Parent. In our case, the land’s fair market value was $300k.

  1. So, work this through. What is John’s Drugs’ (Parent) cost of the land acquired on wind-up of KDL (Subco)?

·  s.88(1)(c): the basic amount is $75k (Subco’s tax cost).

·  PLUS:

·  the “88(1)(d) bump” amount: such portion of $310k, up to the fair market value of the land at the time Parent acquired control of Subco.

·  That is, you can only “bump” Parent’s tax cost of the land by $225k from its s.88(1)(c) cost of $75k – up to the $300k FMV of the land.

·  Thus, John’s Drugs’ total cost of the land, after the wind-up, is $75k “plus” $225k (designated in tax return as the s.88(1)(d) bump): $300k total tax cost after the wind-up.

  1. John’s Drugs then sells the land for $300k. No gain arises. Sells the building ($50k) with the land, no recapture or gain on our facts. John’s Drugs uses the $350k proceeds to pay back the bank loan to that extent.
  1. Recall the “s.88(1)(d) bump” gives credit for the ACB in shares to the extent it reflects the underlying gain in capital property of the Subco – provided that property is not “ineligible property”.
  1. What is “ineligible property”? Read s.88(1)(c): the definition is buried in the mid-amble:

·  Focus on s.88(1)(c)(iii): “depreciable property”, i.e., you cannot “bump” depreciable property.

·  ss.88(1)(c)(iv) to (vi), other types of “ineligible” property (important, beyond the scope of this course).

  1. Why the exclusion for depreciable property? Share cost is not depreciable.

Vertical Amalgamations

  1. Consider:

·  They simply amalgamate, rather than wind-up Subco into Parent.

·  Most corporate statutes allow this - no new shares are issued in Parent to the shareholder.

  1. Is this an “amalgamation”? Read s.87(1)(c): “all shareholders of a predecessor receive shares of the new corporation because of the merger”.

·  Has this condition been met? No. The shareholder of the Parent does not receive any new shares.

·  However, these are deemed to be shares of the new amalgamated corporation received by the shareholder (s.87(1.1)). Thus, a vertical amalgamation qualifies for the roll-over rules in s.87. Note that a horizontal amalgamation of corporations owned by individuals will not qualify, an historical anomaly that is due to the form of the amalgamation rules in the CBCA.

  1. An old problem: if you did an amalgamation and not a wind-up, you could not access the s.88(1)(d) bump, if you had excess ACB on the Parent’s shares and had qualifying capital property in Subco.

·  This was fixed: read s.87(11).

·  The cost of capital property to Amalco is the cost that would have been available to Parent if s.88(1) had applied (i.e., liquidation) instead. So the bump is available for a vertical amalgamation, by reason of s.87(11).

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[1] Notice the recapture continuity rule in s.88(1)(f).