Taxation of Private Corporations - Fondation …. Rule for Hybrid Securities 1:19 ... vi / Taxation of Private Corporations and Their Shareholders ... Advantages Related to the Flow

Taxation ofPrivate Corporationsand TheirShareholdersFourth EditionEditors:Paul BleiwasJohn Hutson

A Canadian Tax Foundation publication by

Deloitte & Touche llpFraser Milner Casgrain llp

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Taxation of Private Corporations and Their Shareholders

FOURTH EDITION

Detailed Contents

Chapter 1 Introduction: The Corporation as a Person in Tax Law

I. Introduction 1:1A. What Is a Corporation and What Is a Shareholder? 1:1B. Corporations and Pink Elephants 1:2C. Corporations and Legal Personality 1:2

II. The Nature of the Corporate Personality 1:3A. Legal Personality 1:3B. Corporate Personality 1:4C. The Nature of a Corporation 1:8D. The Corporate Capacity To Own Property 1:11E. Corporate Personality and Limited Liability 1:13F. Residence of a Corporation 1:13G. Impact of Tax Treaties 1:16

III. Shares and Shareholders 1:17A. The Nature of a Share 1:17B. Rule for Hybrid Securities 1:19C. Sham and the General Anti-Avoidance Rule 1:20

IV. Piercing the Corporate Veil 1:20

Chapter 2 The Decision To Incorporate

I. Introduction 2:2II. Theory of Integration 2:4

A. Background 2:4B. The Existing Integration Model 2:6

1. Investment Income 2:62. ABI Eligible for the SBD 2:63. ABI Ineligible for the SBD 2:8

III. Integration: The Real Story 2:10A. Provincial Rates: Actual Versus Theoretical 2:10

1. Provincial Personal Rates 2:102. Provincial Corporate Rates on Investment Income 2:113. Provincial Corporate Rates on Business Income 2:11

B. Integration in Practice 2:111. Investment Income 2:112. Capital Gains 2:14

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3. Dividend Income 2:144. ABI Eligible for the SBD 2:165. ABI Ineligible for the SBD 2:16

IV. Advantages of Incorporation 2:17A. Income Tax Deferral 2:17

1. Investment Income 2:172. ABI Ineligible for the SBD 2:183. ABI Eligible for the SBD 2:184. Ontario’s Clawback of the SBD 2:19

B. Enhanced Capital Gains Exemption 2:19C. Income Splitting 2:22

1. Corporate Attribution Rules 2:232. Tax on Split Income 2:253. Income-Splitting Loans for Value 2:254. Family Trusts 2:265. Professional Corporations 2:26

D. Estate Freezes 2:27E. Deductibility of Interest on Borrowed Funds 2:29

1. Loans to a Corporation 2:292. Subscription for Preferred or Common Shares 2:303. Borrowing to Acquire Dividend-Paying Securities 2:30

F. Reduction in Capital Gains 2:31G. Principal-Business Corporations 2:32H. Rules Concerning Restricted Farming Losses 2:33I. M & P Credit 2:33J. Scientific Research and Experimental Development Costs 2:34K. Personal Minimum Tax 2:35L. Holding Foreign Investments 2:35M. Employee Ownership 2:36

1. Stock Options and Grants 2:362. RRSP Ownership 2:36

V. Disadvantages of Incorporation 2:37A. Double Taxation on Death When Capital Losses Are Not Used 2:37

1. How Does Double Taxation Arise? 2:372. Alleviation of Double Taxation: Subsection 164(6) 2:413. A Second Alternative: “Partial” Subsection 164(6) 2:434. A Third Alternative: The Subsection 88(1) Bump 2:44

B. Unused Capital Dividend Account 2:46C. Unused RDTOH Account 2:47D. Taxable Income in Excess of the SBD 2:47E. Trapped Non-Capital Losses 2:49F. Expiration of Capital Losses on Acquisition of Control 2:50G. Transferring Assets out of a Corporation 2:50

1. Transfer of Capital Assets with Accrued Gains 2:502. Transfer of Capital Assets with Accrued Losses 2:503. Transfer of Depreciable Properties 2:51

H. Dividend Distribution 2:52I. Capital Tax 2:52

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J. Denial of Refundable Dividend Tax 2:53K. Potential Exclusion from the Subsection 39(4) Election 2:53L. Personal Services Business 2:54M. General Administrative Costs 2:55

VI. Rules To Remember 2:55A. Loss-Disallowance Rules 2:55

1. Disallowance of Capital Loss to Corporation: Subsection 40(3.4) 2:562. Disallowed Loss on Share Redemption: Subsection 40(3.6) 2:563. Disallowance of Terminal Loss: Subsection 13(21.2) 2:574. 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 3:2II. Types of Capital for Corporate and Income Tax Purposes 3:3

A. Income Tax Share Capital 3:3B. Corporate Share Capital 3:3C. Corporate Debt 3:4D. Preferred Shares and Other After-Tax Financing 3:5

1. The Preferred-Share Rules 3:5a. Term Preferred Shares 3:7b. Short-Term Preferred Shares 3:8c. Taxable Preferred Shares 3:10

E. When Should a Corporation Be Capitalized by Shares or Debt? 3:12III. Selecting the Capital Structure 3:15

A. Estate Freezing: Reduction of Share Value 3:15B. Preservation of Income and Capital 3:15C. Income Splitting 3:16D. Control 3:16E. Pipeline to Capital 3:16F. Elimination of Benefits 3:17G. Deductibility of Interest on Borrowings Used To Subscribe for Capital 3:17H. Flexibility Without Adverse Income Tax Consequences 3:17

IV. Selecting the Share Structure 3:17A. The Importance of Share Rights and Restrictions 3:18

1. The Valuation Dilemma: The CRA’s Concern 3:20B. Specific Share Characteristics 3:21

1. The Right to Dividends 3:21a. Cumulative or Non-Cumulative 3:22b. Dividend Rate 3:23c. Tax-Free and Taxable Dividends 3:24

2. Redemption and Purchase by a Corporation 3:253. Retraction Rights 3:254. Redemption Amount 3:275. Voting Rights 3:286. Limitation on Payment of Dividends on Common Shares 3:297. Price Adjustment Clauses 3:30

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8. Rights on Dissolution 3:319. Right of Conversion 3:31

V. Determining a Corporation’s PUC 3:32A. The Income Tax Concept of Paid-Up Capital 3:32B. The Corporate Concept of Share Capital 3:33C. The Corporations Statutes 3:38D. Share Exchanges and Internal Reorganizations of Share Capital 3:39

1. Alteration of Share Rights 3:392. Exchange of Shares 3:393. Changes to PUC 3:394. Reallocating PUC 3:41

VI. Income Splitting Through Share Capital 3:41A. The Concept of Income Splitting 3:41B. Attribution Rules 3:42

1. Legislative Background 3:432. Property Versus Business Income 3:453. FMV Transfers and Loans 3:464. Transfers and Loans to Corporations 3:475. Guarantees and Third-Party Loans 3:48

C. Indirect Payments and Benefits: Subsection 56(2) 3:481. Neuman, McClurg, and Other Cases 3:482. When Does Subsection 56(2) Apply? 3:50

D. The Tax on Split Income 3:53E. GAAR 3:54

VII. Deductibility of Interest 3:55A. Bronfman Trust and Proposed Subsection 20(3.1) 3:56B. Subsequent Court Decisions 3:56

Ludco Enterprises Ltd. 3:56Shell Canada 3:57Singleton 3:57

C. Current State of Interest Deductibility and the CRA’s Administrative Views 3:57D. Filling the Hole 3:58E. Tracing 3:58F. Exceptional Circumstances 3:59G. Draft Legislation on Interest Deductibility 3:59H. Other Provisions 3:60

Chapter 4 The Decision To Use a Holding Corporation

I. Introduction 4:2II. Advantages Related to the Flow of Funds 4:2III. Conversion to Deductible Interest 4:4IV. Income Splitting and Estate Freezing 4:5

A. Fair Value Consideration 4:6B. Interest Deductibility 4:8C. The Shareholder’s Future Growth Participation 4:8D. Alternative Freeze Method 4:8E. QSBC Status and Other Considerations 4:9

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V. Considerations Related to Intercorporate Dividends 4:9A. Suspension of the Tax Effects of Dividends 4:9B. Creating Connected Corporations 4:10

VI. Multiple Ownership of a Holding Corporation 4:11VII. Corporate Share Acquisitions 4:11

A. Advantages to the Purchaser 4:111. Purchaser Corporation Bears Acquisition Financing 4:112. Target Corporation Bears Acquisition Financing 4:13

B. Advantages to the Vendor 4:141. Dividends to Holdco 4:152. Redemption of Opco Shares 4:153. Transfer to Purchaser for “High-Low” Shares 4:154. Effect of Subsection 55(2) 4:15

VIII. Other Advantages 4:16A. Overcoming Double Taxation on Death 4:16B. Corporate Breakup and Distribution 4:16C. Avoidance of Employee-Shareholder Loan Provisions 4:16D. Updating of Losses 4:17E. Buy-Sell Arrangements 4:17F. Risk Management 4:17G. A Tax Deferral for Investments? 4:18H. Crystallizing the $750,000 Capital Gains Exemption 4:18I. Using a Holding Corporation To Own Real Property 4:19J. Acquiring a Canadian Corporation 4:19

1. Bumping Up the Cost Base of Non-Depreciables 4:192. Non-Resident’s Acquisition of a Canadian Business 4:20

IX. The Application of Section 84.1 on Share Transfers 4:21A. Section 84.1 4:21B. Prerequisites 4:22C. Application of Section 84.1 4:24

1. Reduction of PUC 4:242. Deemed Dividend 4:253. Arm’s-Length ACB 4:25

D. Mechanics of Section 84.1 4:27E. Circumstances in Which Paragraph 84.1(1)(b) Does Not Apply 4:27F. Non-Arm’s-Length Transfers 4:28G. Comments 4:29

Chapter 5 The Use of Professional and Personal Service Corporations

I. Introduction 5:2II. Professional Corporations 5:3

A. The Nature of a Profession 5:3B. Incorporating a Professional Practice 5:4

1. Review of Relevant Legislation 5:4a. Provincial and Territorial Legislation Governing Professional Corporations 5:4

i. Ontario 5:5

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b. Relevant Federal Legislation 5:6i. GST/HST 5:6ii. Kiddie Tax 5:6

2. Income Tax Treatment of Professional Corporations 5:7C. Professional Corporations for Athletes and Entertainers 5:7

III. Who Can Incorporate—and Claim the SBD? 5:8A. SBD 5:8B. The Basic Requirements 5:9C. Entitlement to a Separate Small Business Limit 5:9

1. Specified Partnership Income 5:92. Personal Services Business 5:10

a. Incorporated Employee 5:11b. Specified Shareholder 5:11c. Reasonably Regarded as an Officer or an Employee 5:11

i. Common Law 5:12ii. CRA Policy 5:15

d. Exceptions 5:16i. More Than Five Full-Time Employees 5:16ii. Amounts Received by an “Associated Corporation” 5:17

3. Corporations Associated Through Subsection 256(2.1) 5:17a. The $500,000 Limit 5:17b. The Meaning of “Associated” and Section 256(2.1) Association Rules 5:17

D. The CRA’s Advanced Tax Rulings 5:181. Incorporated Partnership Structure 5:212. Unincorporated Partnership Structure 5:24

E. Other Challenges 5:261. Taxing Income of a Professional Corporation in the Hands of the Professional 5:26

IV. Management and Executive Management/Personal Corporations 5:28A. Management Business Corporations 5:28B. Executive Management/Personal Service Corporations 5:29C. Income Tax Treatment of EMCs 5:29

1. Active Business Income 5:292. Personal Services Business 5:30

V. Why Incorporate? 5:30A. Advantages 5:30

1. Protection Against Personal Liability 5:302. Tax Benefits 5:32

a. Tax Rates 5:32b. Tax Deferral 5:33c. Income Splitting 5:33d. Private Health Services Plans 5:34e. Club Dues and Fees 5:34f. Death Benefits 5:34g. $750,000 Capital Gains Exemption 5:34h. Changing the Cumulative Net Investment Loss Account 5:34

B. Disadvantages of Incorporating 5:351. Losses 5:352. Costs of Incorporating 5:353. Administrative Difficulty 5:35

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C. Other Available Structures To Limit Liability 5:351. Trusts 5:352. Limited Partnerships 5:363. LLPs 5:36

VI. Conclusion 5:36

Chapter 6 The Small Business Deduction and Associated Corporations

I. Introduction 6:2II. The Relevance of Association 6:3III. The Federal SBD 6:5

A. Eligibility 6:61. Canadian Corporation 6:72. Private Corporation 6:73. Public Corporation 6:74. Prescribed Venture Capital Corporation 6:85. Direct or Indirect Control 6:8

B. Active Business Income 6:81. Ordinary Definition 6:82. Pertaining To or Incident To 6:93. What Is a Business? 6:114. Specified Investment Business 6:125. Personal Services Business 6:166. Specified Shareholder 6:16

C. Carried On in Canada 6:16D. Calculation 6:17E. Sharing the Low Rate of Tax 6:18

IV. Associated Corporations 6:19A. The Effect of Association 6:20B. The Basic Rules 6:20

1. Control of One Corporation by Another 6:212. Control by the Same Person or Group of Persons 6:213. Control by Related Persons 6:214. Specified Class 6:235. Control by One Person and a Related Group of Persons 6:256. Control by Two Related Groups 6:267. De Facto Control 6:27

C. Related Persons 6:33D. The Extended Meaning of Control and Ownership 6:36

1. Definition of “Group” 6:362. Control by a Group 6:363. The Fair-Market-Value Test 6:374. The Lookthrough Provisions 6:41

a. Holding Corporations 6:41b. Partnerships 6:42c. Trusts 6:44

5. The FMV of Shares 6:486. Parent Deemed To Own Shares 6:487. Options and Rights 6:50

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8. Exceptions for Financial Difficulty and Specified Class 6:549. Association with a Third Corporation 6:55

E. Association Overruled 6:591. Subsection 256(6) 6:592. Subsection 256(3) 6:603. Subsection 256(4) 6:614. Subsection 256(5) 6:615. Subsection 256(9) 6:62

F. Anti-Avoidance 6:631. The Objective of Subsection 256(2.1) 6:632. Criteria 6:643. Review of the Case Law Relating to Subsection 247(2) 6:65

V. The Corporate-Partnership Rules 6:67A. Specified Partnership Income and the SBD 6:67B. The Anti-Avoidance Provision 6:69C. The Partnership Lookthrough Provision 6:69D. Partnerships Controlled by Non-Residents or Public Corporations 6:69

Chapter 7 Remuneration of the Owner-Manager

I. Introduction 7:4II. Capacity in Which Owner-Manager Is Remunerated: Shareholder or Employee 7:5

A. The Owner-Manager as Shareholder 7:5B. Determining the Capacity of an Owner-Manager: Shareholder or Employee 7:6C. Deductibility: Payments Received in the Capacity of Shareholder 7:8D. Reasonableness of Payments 7:9

III. Salaries, Bonuses, and Management Fees 7:12A. Introduction 7:12B. Reasonableness of Salaries and Management Fees 7:12C. The CRA’s Attitude to the Reasonableness Question 7:13

1. Active Owner-Managers 7:132. Non-Active Owner-Managers 7:143. Non-Resident Owner-Managers 7:154. Management Corporations 7:155. Reasonableness and Investment Income 7:166. Sale of Major Business Assets or Unusual Transactions 7:167. Summary 7:17

D. Reasonableness and the Jurisprudence 7:17E. Bonus Accruals 7:19

1. Bonus and Contingent Liabilities 7:192. Unpaid Amounts 7:213. Impact on Source Deductions 7:21

IV. Salary or Dividends? 7:23A. The Theory of Integration Under the Act 7:23B. The Salary-Dividend Mix 7:24

1. Salaries 7:242. Dividends 7:263. Maintaining Qualified Small Business Corporation Status 7:27

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C. Flexible and Discretionary Dividend Distributions 7:281. Waiver of Dividends 7:282. Discretionary Dividends 7:293. High-Low Preferred Shares 7:334. Holding Corporations 7:335. Corporate Partnership 7:336. Special Shares 7:34

V. Benefits and Appropriations to Shareholders 7:34A. Payments to Shareholders: Subsection 15(1) 7:35B. Conferral of a Benefit 7:36

1. Stock Dividends 7:362. Rights To Acquire Shares 7:373. Forgiveness of Loans 7:374. Automobiles 7:375. Additions or Improvements to a Shareholder’s Building 7:386. Private Health Services Plan 7:387. Commitment on Acquisition of Shares 7:398. GST Impact 7:399. Review of Selected Cases 7:40

C. Amount or Value of the Benefit 7:421. The CRA’s Assessing Practice 7:432. Review of Selected Cases 7:433. Administrative Relief for Sole-Purpose Corporation 7:47

D. Other Applicable Provisions 7:481. Subsection 69(4) 7:492. Subsection 69(1) 7:49

VI. Loans to Shareholders and Employees 7:49A. Loans to Shareholders and Connected Persons: Subsection 15(2) 7:49

1. Who Is Caught by Subsection 15(2)? 7:51a. Connected Persons 7:51b. Canadian Corporations 7:51c. Non-Shareholders 7:51d. Employees 7:51e. Others 7:53

2. Loans and Indebtedness Excluded from Income 7:53a. Loans Between Non-Residents 7:53b. Loans or Indebtedness Made in the Ordinary Course of Business 7:53c. Non-Specified Employees: Paragraph 15(2.4)(a) 7:55d. Loans To Acquire a Dwelling: Paragraph 15(2.4)(b) 7:55e. Treasury Shares: Paragraph 15(2.4)(c) 7:57f. Automobiles: Paragraph 15(2.4)(d) 7:58

3. Bona Fide Arrangements for Repayment 7:584. Indebtedness Incurred Because of Employment 7:595. Repayment 7:606. Series of Loans and Repayments 7:607. Repayments of Loan Previously Included in Income 7:628. Meaning of “Loan or Indebtedness” 7:639. Loans to Shareholders Under Corporate Law 7:63

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10. Right of Setoff 7:63B. Interest-Free and Low-Interest Loans: Section 80.4 7:64

1. Application of Section 80.4 7:642. Taxable Benefit and Exclusions 7:653. Home Purchase Loans 7:664. Home Relocation Loans 7:665. Relief for Income-Earning Loans 7:676. Relationship of Section 80.4 to Subsection 15(2) 7:687. Deductibility of Outside Financing Charges by Employer 7:68

VII. Other Benefits Available to an Owner-Manager 7:69A. Company-Owned Automobiles 7:69

1. Applicability of Standby Charge 7:692. Restricted Deductions 7:703. Automobile Allowances 7:714. Implications for the Owner-Manager 7:72

B. Entertainment and Other Benefits 7:731. Club Memberships and Recreational Facilities 7:732. 50 Percent Restriction on Entertainment 7:743. Frequent Flyer Programs 7:75

C. Moving Expenses 7:75D. Retiring Allowances 7:76

1. Meaning of “Retiring Allowance” 7:762. Determining the Amount of a Retiring Allowance 7:78

E. Death Benefit Programs 7:791. Tax-Free Receipt 7:792. Taxable Amounts 7:793. Qualifying Payments 7:80

VIII. Deferred Income Plans 7:81A. Background on Pension Reform 7:81B. RRSPs 7:82

1. Comprehensive Retirement Savings Limits 7:82a. Unused RRSP Deduction Room 7:82b. RRSP Dollar Limit 7:83c. Earned Income 7:83d. PA 7:84e. The Factor of Nine 7:85f. Net PSPA 7:85g. PARs 7:85

2. Planning Considerations 7:86a. Alternative to Pension Plans 7:86b. Early and Excess Contributions 7:86c. Spousal RRSPs 7:87d. Group RRSPs 7:87e. Children’s RRSP Deduction Room 7:87

C. RPPs 7:881. Registration 7:882. Pension Plans for Significant Shareholders 7:883. Designated Plans 7:894. RPP Contribution Limits 7:915. Maximum Retirement Benefits 7:93

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6. Early Retirement 7:937. Past Service Contributions 7:948. IPPs Versus RRSPs 7:949. Advantages of an IPP 7:95

a. More Tax Sheltering 7:95b. Protection if Plan Does Not Perform 7:95c. Creditor Proofing 7:95d. Suitability for Owner-Managers 7:96e. Maximum Benefits 7:96

10. Advantages of an RRSP 7:96a. Ability To Split Income 7:96b. Locking In 7:96c. Flexibility in Retirement Options 7:96d. Administration 7:96e. Early Termination 7:97f. Plan Surpluses 7:97g. Simplicity 7:97h. Flexibility in Annual Contributions 7:97

D. DPSPs 7:971. Eligibility 7:982. Contribution Limits 7:983. Effect on RRSP Contributions 7:994. Allocations and Vesting 7:995. Taxation of Withdrawals 7:996. Qualified Investments 7:101

E. Salary Deferral Arrangements 7:102F. RCAs 7:103G. Employee Benefit Plans 7:106

Chapter 8 Transferring Assets to a Private Corporation

I. Introduction 8:3II. Transfers Pursuant to Section 85 8:3

A. Who Can Use Section 85? 8:3B. Eligible Assets 8:3

1. Non-Resident Transferors 8:42. Real Property 8:4

C. The Elected Amount 8:51. General Limitations 8:62. Specific Limitations 8:6

D. Restrictions on the Consideration Received 8:71. Benefit-Conferral Rules: Paragraph 85(1)(e.2) 8:72. Valuation 8:93. Consideration Received: Other Issues 8:11

E. Selecting the Elected Amount 8:12F. Flowthrough of Income Tax Characteristics of Transferred Property 8:12

1. Flowthrough of Cost for Depreciable Property: Subsection 85(5) 8:122. Retention of CCA Characteristics 8:133. Preserving the Tax-Free Zone: ITARs 26(5.2) and 20(1.2) 8:13

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4. Surplus Accounts: Foreign Affiliates 8:135. Loss of Flowthrough of Tax Characteristics: The 50-Percent Rule 8:13

G. Consequences to the Transferee Corporation 8:141. CCA 8:142. Income or Capital 8:14

H. Implications of Non-Income Tax Legislation 8:151. Goods and Services Tax 8:15

a. Election Under ETA Section 167 8:16b. Election Under ETA Section 156 8:16c. Sale of Receivables 8:17d. Transfer of Real Property 8:17e. Sale of Shares 8:17

2. Provincial Sales Tax 8:173. Land Transfer Tax and Fees 8:184. Canada Pension Plan 8:18

I. The Stop-Loss Rules 8:181. Non-Depreciable Property 8:182. Depreciable Property 8:19

a. Application 8:19b. Effect 8:19c. Ordering 8:20

3. Anti-Avoidance Rules: Subsections 69(11) to (14) 8:20J. Form of Consideration Received 8:21

1. Extracting the Cost Base 8:212. Extent to Which Paid-Up Capital Should Be Created 8:223. The Effect of Section 84.1 8:244. Restrictions on Paid-Up Capital 8:25

a. Disposition of Shares by a Non-Resident: Section 212.1 8:25b. Amalgamations 8:25

K. Transfer from a Partnership 8:251. Cost of Non-Share Property Received 8:262. Cost of Preferred Shares Received 8:263. Cost of Common Shares 8:264. Proceeds of Partnership Interest 8:275. Disposition of Partnership Property 8:27

L. Filing Requirements 8:271. Who Files? 8:272. Filing Deadline 8:283. Mistakes 8:284. Late and Amended Elections 8:285. Valuation Problems 8:296. Description of Property 8:30

M. Section 116 Clearance Certificates 8:31N. The General Anti-Avoidance Rule: Section 245 8:32

III. Transfers Outside Section 85 8:34A. Claiming Reserves 8:34B. When an Election Under Section 85 May Not Be Advisable 8:34

1. Available Losses 8:342. Use of Section 85.1 8:34

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IV. Accounting Ramifications 8:35Appendix 8:36

Checklist for a Subsection 85(1) Rollover 8:36General 8:36Requirements 8:36Assets 8:37Paid-Up Capital 8:38V-Day 8:38Employees 8:38GST and Provincial Taxes 8:38Non-Residents 8:38Other Consequences of Election 8:39Election 8:39

Chapter 9 Removing Assets from a Private Corporation

I. Introduction 9:4II. Appropriations of Corporate Property to Shareholders 9:4

A. Tax Consequences to the Corporation: Subsection 69(4) 9:4B. Tax Consequences to the Shareholder: Subsection 15(1) 9:5C. Price Adjustment Clauses 9:6D. Shareholder Appropriations as Dividends 9:7

1. What Is a Dividend? 9:72. Tax Consequences of a Dividend to an Individual 9:7

E. Capital Dividends 9:71. The Capital Dividend Account 9:72. Payment of a Capital Dividend 9:10

F. Transfers for Less Than FMV Consideration 9:10III. Winding Up a Corporation 9:11

A. Subsection 69(5) 9:11B. Subsection 84(2) 9:12C. Subsection 88(2) 9:12D. Adjustments to the Capital Dividend Account 9:14E. Pre-1972 CSOH 9:15F. Timing 9:16G. Additional Comments 9:16

IV. Intercorporate Dividends 9:17A. The Use of Intercorporate Dividends To Reduce Capital Gains 9:18

1. The Purpose Test 9:202. Significant Reduction 9:223. Safe-Income Determination Time 9:234. Part IV Exception 9:245. Effect and Timing of a Subsection 55(2) Assessment 9:25

B. The Concept of Safe Income 9:261. Definition 9:282. Income Earned or Realized 9:283. Portion of Gain Attributable to Income 9:304. Losses 9:325. Holding Period 9:33

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6. Shares Acquired on a Rollover 9:337. Safe Income That Relates to Fixed-Value Preference Shares 9:33

a. Acquired on a Rollover 9:34b. Implications for Common Shares 9:36c. Access to Safe Income 9:37

8. Stock Options and Splits 9:379. Stub Period 9:3810. Consolidation of Safe Income 9:3811. Income Earned Before 1972 9:4012. Separate Dividend Designation 9:4013. Allocation of Safe Income to Different Shares 9:4114. Additional Comments 9:43

C. When Subsection 55(2) Does Not Apply 9:44D. Series of Transactions or Events 9:45E. Share Redemptions 9:48

V. The Paragraph 55(3)(a) Exemption 9:49A. Unrelated Persons: Timing of Relationship 9:49B. Significant Increase in Total Direct Interest 9:49C. First Type of Triggering Event: Disposition of Property to an Unrelated Person 9:51D. Second Type of Triggering Event: Significant Increase in the Interest of an

Unrelated Person 9:54E. Third Type of Triggering Event: Disposition of Shares of the Dividend Payer 9:54

1. Disposition of Shares of the Dividend Payer 9:542. Disposition of Property That Derives Its Value from Shares of the

Dividend Payer 9:55F. Fourth Type of Triggering Event: Disposition of Shares of the Dividend Recipient 9:57

1. Disposition of Shares of the Dividend Recipient 9:572. Disposition of Property That Derives Its Value from Shares of the

Dividend Recipient 9:583. 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) 9:60I. Continuity Rule Under Paragraphs 55(3.01)(b) and (c) 9:61J. Presumption Under Paragraph 55(3.01)(d) 9:62K. Paragraph 55(3.01)(e) 9:63L. Application Rules for Paragraph 55(3)(a) and Subsection 55(3.01) 9:65M. The Clause 55(3)(a)(iii)(B) Trap 9:66N. The Department of Finance’s Responses to Paragraph 55(3)(a) Uncertainties 9:67

VI. Butterfly Reorganizations 9:68A. Basic Steps 9:69B. The Use of Subsection 85(1) 9:69C. The Application of Subsection 55(2) 9:71D. Failure To Comply with Paragraph 55(3)(b) 9:71

1. Capital Dividend Account 9:722. Refundable Dividend Tax on Hand 9:733. Safe Income 9:73

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E. Dividends to Which Paragraph 55(3)(b) Applies 9:741. The Meaning of “Reorganization” 9:752. The Meaning of “Distribution” and “Direct or Indirect Transfer” 9:773. The Types of Butterflies and Other Requirements Under

Paragraph 55(3)(b) 9:79a. Spinoff Butterfly (Single-Winged) 9:79b. Split-Up Butterfly (Single-Winged) 9:79c. Split-Up Butterfly (Multi-Winged) 9:80

F. The Pro Rata Test 9:81G. Types of Property 9:84

1. Investments in Other Corporations 9:852. The Impact of Liabilities 9:86

H. Certain Rules That Affect Share Transactions 9:871. Transactions That Affect Shares of the Distributing Corporation Before the Butterfly

Distribution 9:87a. Reorganization of Capital 9:87b. Transfer of Shares of a Distributing Corporation to a Transferee

Corporation 9:88c. Redemption of Shares of a Specified Class and Permitted Exchange That Involves

Shares of a Specified Class 9:902. Transactions That Affect Shares of the Distributing and Transferee Corporations

After the Butterfly Distribution 9:923. Sequential Butterfly 9:94

I. Application of Subsection 55(3.1) 9:951. Paragraph 55(3.1)(a): Acquisitions of Property in Contemplation of a

Butterfly 9:96a. The Meaning of “Property Became Property Of ” 9:96b. The Meaning of “In Contemplation Of ” 9:97c. Exceptions 9:98

i. Subparagraph 55(3.1)(a)(i) 9:98ii. Problems with subsection 251(3.1) 9:99iii. Subparagraph 55(3.1)(a)(ii) 9:100iv. Subparagraph 55(3.1)(a)(iii) 9:100v. Clause 55(3.1)(a)(iv)(A) 9:101vi. Clause 55(3.1)(a)(iv)(B) 9:102vii. Clause 55(3.1)(a)(iv)(C) 9:103

2. Paragraph 55(3.1)(b): Demise of the Purchase Butterfly 9:103a. Subparagraph 55(3.1)(b)(i) 9:106b. Subparagraph 55(3.1)(b)(ii) 9:107c. Subparagraph 55(3.1)(b)(iii) 9:108d. 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 9:1121. Part IV Tax and RDTOH 9:1122. Parts IV.1 and VI.1 9:1133. 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 10:2II. Non-Tax Issues Concerning Equity Participation 10:3

A. Minority Interests 10:3B. Lack of a Secondary Market 10:3C. Financing Aspects 10:4

III. Employee Stock Option Plans 10:4A. The Advantages of Stock Option Plans 10:5B. The Income Tax Implications of Stock Option Plans 10:5

1. Application of Paragraphs 110(1)(d) and (d.1) 10:62. Transfers and Dispositions of Stock Options 10:73. Death of an Employee Who Owns a Stock Option 10:84. Application of Benefit Provisions 10:85. Cost Base Considerations 10:96. Miscellaneous Points Regarding Section 7 10:9

C. Non-Residents and Stock Options 10:13D. Stock Option Plans Granted by CCPCs 10:16E. Potential Tax Trap with Stock Options 10:17

IV. Employee Share Purchase Plans 10:18A. The Income Tax Implications of Financing Arrangements 10:18

1. Loans Received by Shareholders or Employees 10:192. When Share Values Decrease 10:22

B. Corporate Law Considerations 10:25C. Creation of Special Shares for Employees 10:25

1. Convertible Equity and Convertible Debt 10:252. Freeze Shares 10:263. The $750,000 Capital Gains Exemption 10:26

V. Phantom Stock Purchase Plans 10:27VI. Transferring Equity Through a Reorganization 10:29

A. Corporate Joint Venture 10:291. Is It a Partnership? 10:292. The Nature of the Employee Corporation 10:30

B. Creation of a New Corporation 10:30VII. Alternative Arrangements 10:31

A. Purchase Through a Holding Corporation 10:311. Application of Subsection 7(1.1) 10:312. Application of Subsection 15(2) 10:323. Application of Section 80.4 10:32

B. Purchase Through Family Members 10:33C. 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 11:2II. 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 11:4C. Estate of Deceased Shareholder 11:5

III. Funding a Buy-Sell Agreement 11:5A. Cash Savings of the Parties 11:6B. Sinking Fund Contributions 11:6C. External Financing of the Share Purchase 11:6D. Retarding the Growth and the Value of the Shares 11:6E. Life Insurance 11:6F. Combination of Insurance and Current Earnings 11:7G. Payment over Time 11:7H. Sale of Assets 11:7

IV. The Effect of a Shareholders’ Agreement on the Valuation of a Corporation’s Shares 11:8A. Some Basic Considerations 11:8B. Position of the CRA: IT-140R3 and IC 89-3 11:8C. The Position of the Courts 11:10D. Alternatives When the Buy-Sell Price Is Less Than FMV 11:12

1. Subsection 164(6) 11:122. Spousal Rollover 11:133. Price Adjustment Clause 11:14

E. Corporate-Owned Life Insurance 11:14V. The $750,000 Capital Gains Exemption for Qualified Small Business

Corporation Shares 11:16A. QSBC Share Defined 11:16B. The Holding-Period Tests 11:18C. The Effect of Corporate-Owned Insurance on QSBC Status 11:19D. Subsection 110.6(8) 11:20

VI. Shares That Are Purchased for Cancellation 11:20A. Advantages 11:21

1. Cash Flow Saving When Insurance Funding Is Used 11:212. Mitigation of Insurance Cost Inequalities 11:213. Simplifying the Agreement 11:214. Potential Reduction of Income Tax on Death 11:21

a. The Pre-1995 Tax Regime 11:22b. The Current Tax Regime 11:23

5. Payment over Time 11:25B. Potential Disadvantages and Traps 11:26

1. Insufficient CDA 11:262. Capital Gains Exemption Not Used 11:263. Potential Denial of Capital Losses 11:264. Timing of Share Purchase 11:275. Shares with a Low PUC and a High ACB 11:276. Last Surviving Shareholder: Left Holding the Bag? 11:277. Realizing the Capital Loss 11:288. Insurance-Related Issues 11:28

VII. Survivor Buyout Shareholders’ Agreements 11:29A. Tax Consequences to the Deceased Shareholder and the Estate 11:29B. Tax Consequences to Surviving Shareholder 11:29C. 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 11:311. Is the Corporate Purchase Workable in the Light of Subsection 55(2)? 11:312. Potential for Double Taxation in Cross-Purchase 11:33

X. Implications of the Rules Governing Preferred Shares 11:33XI. Shareholders’ Agreements and the Deemed Control Provisions:

Paragraph 251(5)(b) and Subsection 256(1.4) 11:34XII. Conclusion 11:37

Chapter 12 Tax Considerations in Buying or Selling a Business

I. Introduction 12:6A. Assets Versus Shares 12:6

1. Some Important Issues 12:62. Biases 12:7

II. Collecting the Necessary Information 12:8III. The Purchase and Sale of Shares 12:9

A. Using Holding Corporations To Make an Acquisition 12:91. Deductibility of Interest on Money Borrowed To Buy Shares 12:102. Deductibility of Interest Incurred To Redeem Shares 12:103. Interest Expense: Maximizing the Value of the Deduction 12:114. Unnecessarily Increasing Provincial Capital Taxes 12:115. Scientific Research and Experimental Development 12:126. Provincial Allocation 12:12

B. Corporate Rollovers To Defer Tax 12:121. Introduction 12:122. Illustration of Corporate Rollovers 12:133. Some General Comments on Corporate Reorganizations 12:134. Section 85: Transfer of Property to a Corporation 12:145. Section 85.1: Share-for-Share Exchange 12:14

a. Conditions Necessary for Section 85.1 To Apply 12:14b. Tax Treatment of the Vendor 12:15c. Tax Treatment of Acquireco 12:15d. 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 12:178. A Statutory Amalgamation (Section 87) Versus the Windup of a Wholly Owned

Subsidiary (Subsection 88(1)) 12:18a. Application 12:18b. Tax Results Generally 12:18c. Legal Feasibility 12:18d. Bumping Non-Depreciable Assets Under Subsection 88(1) 12:19e. The Meaning of “Control” When a Chain of Corporations Is Acquired 12:20f. Possible Taxable Capital Gains 12:21g. Taxation Year 12:21h. 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 12:22j. Maximizing the Paragraph 88(1)(d) Bump 12:22k. Property Ineligible for the Paragraph 88(1)(d) Bump 12:23l. Preventing the Backdoor Butterfly: Paragraph 88(1)(c.3) 12:23

i. Example 1 12:24ii. Example 2 12:24

m. Pre-Acquisition Planning 12:259. Tendering Shares of One Corporation for Shares of Another Corporation:

Section 85.1 Versus Subsection 87(9) 12:25a. Section 85.1 12:26b. Subsection 87(9) 12:26

10. Corporate Tax Instalments 12:26a. Short Fiscal Period 12:27b. Amalgamations 12:27c. Windups 12:27d. Transfers 12:27

11. When the Vendor Is Prepared To Take Back Shares 12:2712. Reducing a Capital Gain Through a Tax-Free Intercorporate Dividend 12:2813. Selling Shares of a Corporation and Gaining Access to Safe Income 12:2914. Pre-Sale Dividends and Safe Income 12:30

C. An Instalment Sale: Deferring Taxable Gains by the Vendor 12:30D. QSBC Shares and the Lifetime Capital Gains Exemption 12:33

1. The 24-Month-Holding-Period Test 12:332. The Qualified-Assets Test 12:34

a. Direct Ownership 12:34b. Indirect Ownership 12:35

3. Planning Strategies 12:354. GAAR and QSBC Shares 12:365. Safe Income Exemption Versus the Capital Gains Exemption 12:366. Purchase of Shares from Retiring Shareholders 12:37

E. Capital Gains Deferral for Eligible Small Business Shares: Section 44.1 12:38F. Proper Timing of an Acquisition 12:39

1. Timing of Acquisition and Disposition 12:402. Non-Arm’s-Length Transactions 12:413. 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 12:422. The Use of a Quebec Financing Corporation 12:433. Exchangeable Shares: Exchanging Canadian Shares for Foreign Shares on a

Tax-Deferred Basis 12:434. The Death of the Cross-Border Butterfly 12:445. Non-Resident Share Acquisition Structuring 12:446. Unlimited Liability Corporation 12:457. Minimizing Canadian Taxes on the Disposition of a Canadian Subsidiary:

A Capital Gains Strip 12:458. 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 12:4711. One Approach to Avoiding Problems Under Section 212.1 12:4712. Where Should a Foreign Acquiror Incur Its Financing Obligation? 12:48

H. The SBD: Financing an Acquisition Through a Reduced Tax Burden 12:481. The Saving Provision in Section 256 12:482. Financing an Acquisition Through Tax Savings 12:48

I. Salary to the Vendor Under a Personal Services Contract: Tax Considerations 12:49J. Financing an Acquisition Through a Retiring Allowance 12:49

1. Retiring Allowance Defined 12:502. Tax Deferral 12:503. Deduction at Source 12:50

K. Upgrading of Pension Plans 12:51L. Terminated Employees and Retirement Compensation Arrangements 12:51M. Unexercised Stock Option Rights and Corporate Takeovers 12:51N. When Shares of a Target Corporation Are Held by the Target’s DPSP 12:52O. “Underwater” Loans to Employees 12:52P. Change of Control of a Loss Corporation 12:53Q. Debt Parking in Acquisition of Shares and Debt 12:53R. Reverse Takeovers: Tax Considerations 12:53S. Warranty Payments Arising Under the Purchase Agreement47 12:54

IV. The Purchase and Sale of Assets 12:54A. Allocating the Purchase Price in a Bulk Asset Purchase 12:54

1. Section 68 and the Allocation of Purchase Price 12:552. Instalment Sale Reserves: How To Optimize the Purchase Allocation 12:563. 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 12:57D. Sale of Inventory 12:59

1. Instalment Sale: Allocation to Inventory 12:59E. Depreciable Property 12:60

1. Recapture of CCA 12:602. Capital Gains and Losses 12:603. Recapture of Depreciation: Is It Active Business Income? 12:604. Property Used in More Than One Business: An Increased Exposure to

Recapture 12:615. Regulation 1103(1): A Special Election To Avoid Recapture 12:616. Changes in CCA Classes 12:627. Depreciables: Impact of the Half-Year Rule 12:628. Sale of Land and Buildings 12:629. Analyzing the Real Nature of the Assets Being Purchased 12:6310. Class 13: Leasehold Interests 12:6311. The Available-for-Use Rule 12:6412. The Replacement-Property Rules 12:6413. Non-Arm’s-Length Sales of Depreciable Property and Eligible Capital

Property 12:6514. Preventing the Realization of Losses in Certain Affiliated-Party Transactions 12:65

Detailed Contents / xxiii

F. Valuation of CCA Claims 12:65G. Intangible and Eligible Capital Property 12:67

1. Depreciable Versus Non-Depreciable Intangibles 12:672. ECEs Defined 12:673. Goodwill as an ECE 12:674. Disposal of Eligible Capital Property 12:685. Recapture of Eligible Capital Amount as Active Business Income 12:686. Capital Dividend Account and Disposition of Eligible Capital 12:687. Bad Debts Arising from the Sale of Eligible Capital Property 12:688. Amount Not Due Until a Later Year in Respect of Eligible Capital Property 12:699. Eligible Capital Property and the Replacement-Property Rule 12:69

H. Capital Property Other Than Depreciable Property 12:691. Capital Property Owned on December 31, 1971: The Median Rule 12:692. The FMV of Publicly Traded Securities: ITAR 26(11) 12:703. Tax Treatment of Capital Gains and Capital Losses 12:704. Instalment Sales of Capital Property 12:715. Life Insurance Policies 12:71

I. Prepaid Expenses 12:711. Administrative Practice 12:712. Deferred or Prepaid Expenses 12:723. Consistency Desired: Changes Permitted 12:72

J. Reserves, Foreign Exchange, and Settlement of Debt 12:721. Reserves and Warranties 12:722. Foreign Exchange Gains and Losses 12:733. Debtor’s Gain on Settlement of Debt 12:73

K. Deferring Taxation Through Sections 99 and 25 12:74L. Taxation Year Planning 12:74M. The CDA: Be Very Careful 12:75

V. Other Considerations 12:76A. Dividends Versus Capital Gains: Which Should a Shareholder Choose? 12:76

1. Some General Observations 12:762. Deemed Dividends Versus Capital Gains for Shareholders of Acquired

Corporations 12:773. Squeezing Out the Minority Shareholders in a Takeover 12:774. Dissenting Shareholders: Tax Treatment 12:78

B. Price Adjustment Clauses 12:791. Purpose 12:792. Interpretation Bulletin IT-169 12:793. Effect of IT-169 on Price Adjustment Clauses 12:80

C. Earnouts: What and Why 12:801. General Considerations in Structuring an Earnout 12:812. Different Approaches to an Earnout 12:81

a. The Base-Period Earnout 12:82b. The Increment Earnout 12:82c. The Cumulative Earnout 12:82d. The Reverse Earnout 12:82

3. Tax Issues 12:834. Tax Treatment of Shares Sold Subject to an Earnout Agreement 12:845. Problems Under Section 55: Tax-Free Intercorporate Dividends 12:86

xxiv / Taxation of Private Corporations and Their Shareholders

D. Non-Competition Clauses 12:871. Default Income Inclusion: Subsection 56.4(2) 12:872. Non-Application of Section 56.4 12:88

a. Employment Income Exception: Paragraph 56.4(3)(a) 12:88b. Asset Sale Exception: Paragraph 56.4(3)(b) 12:88c. Share Sale Exception: Paragraph 56.4(3)(c) 12:90

3. Reasonable Allocation of Purchase Price to Restrictive Covenant: Section 68 12:91a. Exceptions to Application of Section 68 12:91

i. Employee-Provided Covenant Exception: Subsection 56.4(6) 12:92ii. Goodwill Amount Exception: Subsection 56.4(7) 12:92iii. Disposition of Property Exception: Subsection 56.4(8) 12:94

b. Capital Gains Election: Subsection 56.4(9) 12:954. Treatment of the Purchaser 12:965. Anti-Avoidance Rules 12:966. Clarification Rules 12:977. Filing Prescribed Form 12:978. Restrictive Covenant Rules: Problems and Anomalies 12:97

E. Structures to Consider 12:991. Incorporating a Division: An Alternative to a Purchase and Sale 12:992. A Partnership of Corporations 12:99

F. Interest and Other Financing Costs 12:1001. Interest Expense 12:1002. Expenses of Issuing Shares and Borrowing Money 12:1033. When the Parent Borrows 12:1054. Aborted Financing 12:1055. Withholding Tax 12:1056. Purchase and Sale of Shares 12:1067. Purchase and Sale of Assets 12:1068. Appraisal Costs 12:1069. Tax Treatment of Costs Incurred in Resisting a Takeover 12:107

G. Tax Treatment of Interest on the Purchase Price 12:108H. Discounts and Premiums on Corporate Debt 12:109I. Dispositions of Capital Property by Non-Residents 12:110

1. Taxable Canadian Property 12:1102. Liability of Purchaser in Certain Cases 12:1113. Disposition of Taxable Canadian Property by Non-Residents 12:1124. Capital Gains Incurred by Non-Residents: The Canada-US Tax Treaty 12:115

J. How To Use RRSPs To Assist in Acquiring a Business 12:115VI. Tax Clauses in Acquisition Agreements 12:115VII. Application of GST to the Purchase and Sale of a Business 12:117

A. Special Elections 12:117B. The Application and Impact of GST 12:118C. Financial Institutions and Other Exempt Users 12:118D. 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 13:3A. Ordering of Deductions 13:3B. Losses: Some General Comments 13:3

II. Non-Capital Losses 13:4A. Carryover of Non-Capital Losses 13:4B. Using Non-Capital Losses To Reduce Part IV Tax 13:5C. Using Foreign Tax Credits While Increasing Non-Capital Losses 13:6D. Ontario Harmonization’s Impact on Non-Capital Losses 13:6

III. Net Capital Losses 13:6IV. Allowable Business Investment Losses 13:7V. Acquisition of Control: Impact on Losses Carried Forward 13:10

A. Introduction 13:101. Sale of Current-Year Losses 13:102. ABILs and Property Losses 13:103. Sale of Accrued but Unrealized Losses 13:11

B. When Does an Acquisition of Control Occur? 13:11C. 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 13:132. Change in Executor 13:143. Distribution to a Beneficiary 13:14

D. Circumstances in Which an Acquisition of Control Is Deemed To Occur 13:14E. Restrictions on Losses That Arise on an Acquisition of Control 13:15

1. Deemed Year-End on an Acquisition of Control 13:152. Effect of an Acquisition of Control on the Carryover of Net Capital Losses 13:163. Effect of an Acquisition of Control on the Carryover of Non-Capital Losses 13:174. Reasonable Expectation of Profit 13:185. Depreciable Property 13:196. Eligible Capital Property 13:197. Additional Tax Implications 13:20

VI. Offsetting Profits and Losses Within a Related Group 13:20VII. Amalgamations: Flowthrough of Losses 13:20

A. General Comments 13:20B. Timing Problems: Effective Date of Amalgamation 13:21

VIII. Liquidations: Flowthrough of Losses 13:22IX. Other Loss-Consolidation Strategies 13:24

A. Group Loss-Consolidation Techniques 13:241. Transfer of Assets Within an Affiliated Group 13:242. Transfer of a Profitable Business Within an Affiliated Group 13:263. Implementation of Intercorporation Charges 13:264. Transfer of a Profitable Business to a Partnership 13:265. Preferred Share/Loan Transactions 13:27

B. Preserving Losses 13:281. Revising Discretionary Deductions 13:282. Other Loss-Preservation Strategies 13:29

xxvi / Taxation of Private Corporations and Their Shareholders

X. Other Loss-Restriction Rules 13:30A. Using Third-Party Losses on Asset Sales: Subsection 69(11) 13:30B. Restrictions on Transferring CCA to a Third Party: Subsection 13(24) 13:31C. 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 13:33B. Implications of the Debt-Forgiveness Rules 13:33C. Debt Parking 13:34

XII. When To Recognize Capital Debts Established To Be Bad Debts 13:35XIII. Loan Guarantees and Non-Interest-Bearing Loans: Deductibility of Debts Gone Bad 13:36

A. Capital or Income Loss 13:36B. Deductibility of Interest on Funds Borrowed To Honour a Guarantee 13:38

XIV. Nil Assessments: Confirming the Amount of Available Losses 13:40XV. Carrying Back Losses 13:42XVI. The Impact of Bankruptcy on Losses 13:42XVII. How Dividends Received May Reduce the Amount of a Loss 13:43

A. Shares That Are Capital Property 13:43B. Shares That Are Non-Capital Property 13:44

XVIII. Taxable Preferred Share Financing 13:44A. Term Preferred Shares 13:45B. Guaranteed Shares 13:46C. Collateralized Preferred Shares 13:46D. Taxable Preferred Shares 13:46E. Additional Points To Be Noted 13:48

XIX. Limited Partnership Losses 13:49XX. A Review of the Concept of Control 13:49

A. Income Tax Act Provisions 13:49B. Review of the Jurisprudence 13:50C. Control by a Group of Persons 13:58D. The CRA’s Position 13:59E. Summary of the Current Law 13:60

Chapter 14 Provincial and Territorial Taxation of the Private Corporation

I. Constitutional Power 14:3II. History of Provincial Taxation 14:4III. Differences in Provincial and Territorial Tax Rates 14:5

A. Overview 14:5B. The SBD 14:5

1. Ontario 14:62. Quebec 14:6

C. Manufacturing and Processing Deduction 14:6D. Provincial and Territorial Tax Holidays 14:6

1. Overview 14:6a. Newfoundland and Labrador 14:7b. Nova Scotia 14:7

Detailed Contents / xxvii

c. Ontario 14:7d. Quebec 14:8

2. General Planning for Tax Holidays 14:8IV. Allocating Taxable Income Among Federal and Provincial or Territorial Jurisdictions 14:10

A. Significance of Permanent Establishment 14:101. Federal Taxation 14:102. Provincial/Territorial Taxation 14:10

B. Definition of “Permanent Establishment” Under the Federal Regulations 14:11C. The Allocation of Income to a Permanent Establishment 14:13

1. What is Included in “Salaries and Wages Paid”? 14:142. What Is Gross Revenue? 14:163. Where Should the Gross Revenue Be Allocated? 14:164. Double Taxation 14:17

D. Allocation of Investment Income 14:17V. Provincial and Territorial Income Tax Differences: An Overview 14:18

A. Scientific Research and Experimental Development 14:19B. M & P Tax Incentives 14:19

1. Manitoba 14:202. Newfoundland and Labrador 14:203. Nova Scotia 14:204. Ontario 14:205. Prince Edward Island 14:206. Quebec 14:207. Saskatchewan 14:218. Yukon 14:21

C. CCA 14:221. CCA in Year of Acquisition 14:222. Computation of Capital Cost 14:22

a. Ontario 14:22b. Quebec 14:22

D. Non-Residents’ Withholding Taxes 14:22E. Charitable Donations 14:23F. Political Contributions 14:23G. Availability of Non-Capital Losses 14:23

1. Alberta 14:242. Quebec 14:24

H. Planning with Non-Capital Losses 14:24I. Loss Carryforward or Carryback in the Year of Startup or Shutdown 14:25

VI. Other Provincial and Territorial Tax Credits 14:25A. Political Contributions 14:25B. Film, Television and Media Incentives 14:26C. Venture Capital and Small Business Financing Incentives 14:27

1. Labour-Sponsored Venture Capital Corporations 14:272. British Columbia Venture Capital Tax Credit 14:27

D. Alberta 14:28E. British Columbia 14:28

1. Logging Tax Credit 14:28

xxviii / Taxation of Private Corporations and Their Shareholders

2. Mining Exploration Tax Credit 14:283. Book-Publishing Tax Credit 14:28

F. Manitoba 14:291. Book-Publishing Tax Credit 14:29

G. Ontario 14:291. Cooperative Education Tax Credit 14:292. Apprenticeship Training Tax Credit 14:293. Book-Publishing Tax Credit 14:294. Ontario Mineral Exploration Program 14:30

H. Quebec 14:301. On-the-Job Training Tax Credit 14:302. Design Credits 14:303. Book-Publishing Tax Credit 14:30

I. Saskatchewan 14:31VII. Ontario Corporate Minimum Tax 14:31VIII. Payroll Tax 14:32

A. Newfoundland and Labrador 14:331. Meaning of “Employee” and “Employer” 14:332. “Remuneration” and “Establishment” 14:33

B. Manitoba 14:341. Meaning of “Employee,” “Employer,” and “Remuneration” 14:342. Meaning of “Permanent Establishment” 14:34

C. Ontario 14:351. Meaning of “Employee” 14:352. Meaning of “Employer” 14:363. “Permanent Establishment” 14:36

D. Quebec 14:361. Meaning of “Employee,” “Employer,” and “Wages” 14:372. Meaning of “Establishment” 14:373. Quebec Vocational Training Tax 14:37

E. Northwest Territories 14:371. Meaning of “Employee,” “Employer,” “Remuneration,” and

“Fixed Place of Business” 14:38F. Nunavut 14:38

IX. Elective Provisions 14:38A. Interprovincial Asset Transfers 14:39

X. Provincial General Anti-Avoidance Rules 14:39A. Alberta 14:39B. British Columbia 14:39C. Manitoba 14:39D. Ontario 14:40E. Quebec 14:40F. Saskatchewan 14:40

XI. Provincial Capital Tax 14:40A. Overview 14:40B. 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 15:2II. The Trustee’s Discretionary Powers 15:3

A. Discretionary Powers and the Rules of Equity 15:31. The Prudent-Person Rule 15:42. The Even-Hand Rule 15:5

B. The Fales Case 15:5C. Billes: The Canadian Tire Case 15:6D. The Rules of Equity 15:8

III. The Estate’s Holding of Private Corporate Shares 15:9A. Trustee’s Duty To Be Appointed Director 15:9B. Trustee’s Duties as Trustee and as Director 15:9C. Trustee’s Duties as Trustee and as Shareholder 15:10D. Selection of Beneficiaries 15:11E. Distribution of Corporate Earnings: Income or Capital? 15:11F. Duty Not To Profit 15:14G. Some Income Tax Considerations 15:15

1. Residence of Trust 15:152. Associated Corporations 15:15

H. Delegation of Administrative Powers 15:16IV. Farm Corporation Rollover 15:16V. Spousal Rollover 15:17

A. Requirements for Rollover 15:18B. Meaning of “Vested Indefeasibly” 15:19C. Untainting the Spousal Rollover 15:19

VI. Income Tax Elections 15:19VII. Term of the Trust 15:20

A. The 21-Year Rule 15:20B. The Rule Against Perpetuities 15:20C. The Rule Against Accumulations 15:21

VIII. Conclusion 15:21

Chapter 16 Tax Planning and Tax Avoidance

I. Introduction 16:3II. Common Types of Avoidance Transactions 16:5

A. Benefits and Loans to Shareholders 16:6B. Indirect Payments or Transfers 16:9C. Attribution of Income (Imputed Interest Income) 16:12D. Indirect Transfer of Value 16:12E. Bumping the Cost Base of Property (Including Shares) 16:14

1. Paragraph 69(1)(a) 16:152. Paragraph 13(7)(e) and Subsection 14(3) 16:153. Section 84.1 16:15

F. Creating Losses 16:161. Subsection 40(3.4) and Subsection 14(12) 16:162. Subsection 13(21.2) 16:17

xxx / Taxation of Private Corporations and Their Shareholders

3. Subsections 112(3) to (3.32) 16:184. Subsections 112(4) to (4.22) 16:19

G. Increasing PUC 16:191. Subsection 84(1) 16:192. Section 84.1 16:203. Subsection 85(2.1) 16:20

H. Converting Capital Gains into Intercorporate Dividends: Subsection 55(2) 16:21I. 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) 16:223. Circumventing the 24-Month Rule: Paragraph 110.6(14)(f ) 16:234. Former Subsection 245(1.1) and GAAR 16:23

J. Laundering Gains: Subsection 69(11) 16:24III. Specific Statutory Avoidance Tests 16:24

A. The Purpose Test 16:251. Introduction 16:252. The Canadian Approach 16:26

a. “Principal Purpose” 16:28b. “One of the Main Purposes” 16:29c. “One of the Purposes” 16:30

B. The Reasons Test 16:32C. Principal Business 16:34D. The Reasonableness Test 16:35E. The Deeming Test 16:36F. The “Knowingly” Test 16:37

IV. Judicial Anti-Avoidance Doctrines 16:37A. What Is Tax Avoidance? 16:38B. Judicial Doctrines 16:41

1. Business-Purpose Test 16:412. Sham 16:443. Incomplete Versus Illegal Transactions 16:47

a. Incomplete Transactions 16:47b. Illegal Transactions 16:49

4. Agency 16:545. Piercing the Corporate Veil 16:566. Step Transactions 16:57

a. What Is a Composite Transaction? 16:60b. The Step Transaction Doctrine in Canada 16:60

7. Abuse of Law 16:658. Object and Spirit 16:669. Substance over Form 16:69

a. What Is Form and What Is Substance? 16:69b. Substance over Form in Canada 16:71

C. Conclusions 16:74V. GAAR: Canada’s Answer to Tax Avoidance 16:75

A. Introduction 16:75

Detailed Contents / xxxi

B. Analysis of Section 245 16:771. The Coming-into-Force Provisions 16:772. The “Charging” Provision: Subsection 245(2) 16:773. The McNichol and RMM Canadian Cases 16:77

a. McNichol 16:78b. RMM Canadian 16:78c. Comments on McNichol and RMM Canadian 16:79

4. The Tax Benefit Definition: Subsection 245(1) 16:815. The Definition of Tax Consequences: Subsection 245(1) 16:826. The Definition of Avoidance Transactions: Subsection 245(3) 16:82

a. Bona Fide Purpose 16:83b. Meaning of “Purpose” 16:84c. Primary Purpose 16:85d. Non-Tax Purpose 16:85e. Series of Transactions 16:86

7. Misuse or Abuse 16:88a. Background 16:88b. Is Subsection 245(4) a Rule of Interpretation? 16:89c. Is Subsection 245(4) an Exempting Provision? 16:90d. The CRA’s Position 16:91e. When Should Subsection 245(4) Be Applied? 16:91f. What Do the Terms “Misuse” and “Abuse” Mean? 16:91g. Interpretive Approach 16:92h. Selected Supreme Court of Canada Cases 16:93

i. Selected Cases Decided by Other Courts 16:978. Determination of Tax Consequences 16:102

a. Recharacterizing the Transaction 16:102b. Applying for a Determination 16:103c. Third-Party Adjustments 16:104

C. Application of GAAR: A Summary 16:1051. Conceptual Application of GAAR 16:1052. The GAAR and Specific Anti-Avoidance Rules 16:1053. Judicial Considerations 16:106

a. General Rules of Statutory Interpretation 16:106i. The use of extrinsic materials as interpretive aids 16:107

b. Onus of Proof 16:1094. The Department of Finance’s Approach 16:1095. The CRA’s Approach 16:111

a. GAAR Assessments and Rulings 16:111b. Information Circular 88-2 and Supplement I 16:112

6. Selected Jurisprudence 16:113a. GAAR Assessments Upheld 16:113b. GAAR Assessments Overturned 16:114

D. Planning for GAAR 16:1161. Developing Tax Plans 16:1162. Documenting Transactions 16:1173. Warranties and Indemnities 16:117

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4. Advance Income Tax Rulings 16:1175. Transitory Transactions 16:1186. Resisting an Assessment 16:118

Chapter 17 Scientific Research and Experimental Development and Investment Tax Credit Incentives

I. Introduction 17:3A. History of the Program 17:3

II. The Incentives 17:3A. Deduction 17:3B. ITCs: A Two-Tiered System 17:4

III. Filing Requirement 17:4IV. Definition of SR & ED 17:5

A. Carried On in Canada 17:6B. Deduction of SR & ED Expenditures 17:7

1. Salaries or Wages of Employees 17:7a. Incurred 17:8b. Computation of Salaries or Wages Under the Proxy and Traditional

Methods 17:8c. Specified Employees 17:9d. Work Performed Outside Canada 17:10e. Unpaid Salaries or Wages 17:10

2. Contract Payments 17:103. Third-party Payments 17:124. Materials 17:125. Leases 17:136. Election for Overhead 17:13

a. Proxy Election 17:13b. Traditional Method 17:14c. Expenditures Directly Attributable to SR & ED 17:15

7. Capital Expenditures 17:16V. Concept of Pooling SR & ED Expenditures 17:17

A. Components of the SR & ED Pool 17:17B. Acquisition of Control 17:18

VI. ITCs for Qualifying SR & ED Expenses 17:19A. General Rules 17:19B. Eligibility for the 35 Percent Small Business Credit Rate 17:19C. Refundable ITC 17:21

1. Qualifying Corporation 17:212. Qualified Expenditures 17:223. Refund on SR & ED Credits 17:22

D. Anti-Avoidance Provisions 17:22E. Qualifying Expenditures 17:22

1. General 17:222. Prescribed Proxy Amount 17:233. Prescribed Current Expenditures 17:244. Prescribed Capital Expenditures 17:24

Detailed Contents / xxxiii

a. Capital Assets Available for Use 17:255. Government and Non-Government Assistance 17:256. Contract Payments 17:277. Unpaid Amounts 17:28

F. Shared-Use Capital Equipment 17:28G. Subcontracting Payments to Non-Arm’s-Length Parties 17:29H. Recapture of SR & ED Credits on the Sale or Conversion of Property 17:30

VII. Offsetting Refund Against Other Taxes 17:33VIII. Assignment of ITCs to Third Parties 17:33IX. Carryover of ITCs 17:34

A. Reorganization of Corporations Through Amalgamation and Windup 17:34B. Acquisition of Control 17:34

X. Partnerships and ITCs 17:35A. Filing Due Dates 17:35B. Specified Members of a Partnership 17:36C. Allocation of Unused ITCs 17:36

XI. Provincial and Territorial Incentives 17:37A. Ontario 17:37

1. Ontario Innovation Tax Credit 17:372. Ontario Business-Research Institute Tax Credit 17:383. Ontario Research and Development Tax Credit 17:394. Harmonization Between Federal and Ontario SR & ED Regimes 17:40

B. Alberta R & D Tax Credit 17:41C. British Columbia R & D Tax Credit 17:41D. Manitoba R & D Tax Credit 17:42E. New Brunswick R & D Tax Credit 17:42F. Newfoundland and Labrador R & D Tax Credit 17:43G. Nova Scotia R & D Tax Credit 17:43H. Prince Edward Island Innovation and Development Tax Credit 17:43I. Quebec Credit for R & D Wages 17:44J. Saskatchewan R & D Tax Credit 17:44K. 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 17:45B. Ontario Colleges of Applied Arts and Technology 17:45C. Ontario Centres of Excellence 17:46D. Networks of Centres of Excellence 17:46E. Hospital Research Institutes 17:47F. Other Organizations 17:48

Appendix 2: Case Study 17:48

Chapter 18 Dividend Taxation: The Eligible Dividend Regime

I. Introduction 18:2II. Impact on Shareholders 18:3

A. Federal Tax Treatment 18:3B. Provincial and Territorial Tax Rates 18:3

xxxiv / Taxation of Private Corporations and Their Shareholders

III. Impact on Corporations 18:4A. Eligible Dividends 18:5

1. Definition of “Eligible Dividend” 18:52. Designation Requirement 18:53. Administrative Guidance 18:5

B. Part III.1 Tax and the EEDD 18:71. Tax and Designation 18:72. Status of Corporation 18:73. Calculation of Tax 18:74. Anti-Avoidance 18:75. Shareholder Liability 18:86. Election for Separate Dividend 18:87. Corporate Filing Obligation 18:9

C. GRIP 18:9D. LRIP 18:11

IV. Examples 18:11A. GRIP 18:12B. LRIP 18:13

V. Implications in Selected Situations of Interest 18:14A. Basics of the Opening GRIP Calculation: Transitional Relief 18:14B. Asset Sale Versus Share Sale 18:16C. Non-Resident Shareholders 18:17D. Subsection 55(2) and GRIP 18:18E. CCPC Status Changes 18:18

1. GRIP of a New CCPC 18:192. LRIP of a New Non-CCPC 18:19

F. Impact of Losses 18:19G. Election Not To Be a CCPC 18:20H. Selected Observations About CCPCs 18:20

VI. Conclusion 18:21