Chapter 17 – Sec 85

Sec 85 - Rollovers

 Purpose – defer taxes

 Conditions
 Determine if the agreed amount is acceptable
 Attach an Adjusted Cost Base to the consideration received
 Reduce and Increase the Paid Up Capital
 Transactions below and above FMV

Sec 84.1 Non-arm’s length sale of shares

Sec 55 Capital Gains stripping on the sale of shares by a corporation

Formula:

Non Depreciable Property and Inventory

Lesser of

 Adjusted Cost Base and

 Fair Market Value

Depreciable Property

Least of

 Undepreciated Capital Cost

 Cost
 FMV

General Rule is that all properties must be transferred at FMV except if Sec 85 is
used.

 Purpose of Sec 85 is to defer taxes, not eliminate taxes

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Conditions that must be met to use Sec 85

 Eligible Property (Inventory, non-depreciable property, depreciable property,

eligible capital property/goodwill)
 Transfer to a Taxable Canadian Corporation
 Must receive at least 1 share
 Both parties must agree on a certain amount to transfer the property. (Agreed
Amount)
 Both parties must sign an election Form T2057
 Submit the form to CRA as per 85(6)

Sec 85 Sample

Mr.X is operating a sole proprietorship since 1980. He bought a land for $100,000 in
1980. FMV of the land is 2m

In 2021, he would like to incorporate the business

Without sec 85

POD 2,000,000

ACB 100,000

Capital Gains $1,900,000

With sec 85

POD 100,000 (Agreed Amount)

ACB 100,000

Capital Gains $ nil

Agreed amount: Once the agreed amount falls between the range, it will be accepted
by CRA. Any agreed amounts outside the range would not be acceptable.

Treatment of Agreed Amount: Agreed amount is treated as POD for Mr. X and ACB
for Corp X.

When doing a sec 85 problem you have to follow the following

1. Ensure that the agreed amount is acceptable

2. Attach an ACB to the consideration received
3. Reduce the Paid Up Capital

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 4. Increase the Paid up Capital

Example 1- Rollover

Mr. X transfers land to Corp X using Sec 85. ACB of the land is $400,000. FMV –
$2,200,000. Corp X gave Mr. X cash of 1,700,000 and common shares with a
PUC/FMV of $500,000. Agreed Amount $500,000.

Is the agreed amount acceptable?

o The agreed amount is unacceptable as it is not in the range. The revised

agreed amount should be $1.7M

Non Depreciable Property and Inventory

Lesser of  Adjusted Cost Base= 400,000 OR Fair Market Value= 2,200,000

What is the capital gain without sec 85 and with Sec 85.

Without sec 85

POD 2,200,000
ACB 400,000
Capital Gains $1,800,000
With sec 85
POD 1,700,000 ( Agreed Amount)
ACB 400,000

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 Capital Gains $ 1,300,000
Deferral $500,000
What is the ACB of the consideration received by MR X.

Format for consideration received - Attach an ACB to the consideration received

Consideration FMV ACB 1,700,000

Non Share Consideration 1,700,000 1,700,000
Preferred Shares nil Nil
Common Shares 500,000 Nil
Total 2,200,000 Must be equal to the
(must be equal to the FMV Agreed Amount
of the Property
Transferred)

Reduce the Paid up Capital

(A-B) *C/A

A = PUC of Total Shares received = 500,000

B = Agreed Amount less Non Share Consideration 1,700,000 – 1,700,000 = 0

C= PUC of one class of shares

A-b = 500,000 -0 = $500,000

Legal Capital 500,000

Less PUC reduction 500,000

Tax PUC nil

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Example 2

Mr. X transfer land to Corp X using Sec 85. ACB of the land

FMV – $1,000,000. Corp X gave Mr. X cash of 100,000 and common shares with a
PUC/FMV of $900,000. Agreed Amount $900,000.

Non Depreciable Property and Inventory

Lesser of  Adjusted Cost Base= 400,000 OR Fair Market Value= 1,000,000

Is the agreed amount acceptable?

Yes, the agree amount is acceptable as it is within the range

What is the ACB of the consideration received by Mr. X

Attach an ACB to the consideration received – Use this Format

Consideration FMV ACB 900,000

Non Share Consideration 100,000 100,000
Preferred Shares Nil Nil
Common Shares 900,000 800,000
Total 1M Must be equal to the
(must be equal to the FMV Agreed Amount
of the Property
Transferred)

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Revised PUC of the shares

Reduce the Paid up Capital

(A-B) *C/A

A = PUC of Total Shares received = 900,000

B = Agreed Amount less Non Share Consideration 900000-100,000 =800,000

C= PUC of one class of shares

A-b = 900,000 -800,000 = 100,000

Legal Capital 900,000

Less PUC reduction 100,000

Tax PUC $800,000

Example 3

Building – Depreciable Property

Mr. X transferred building to Corp X using Sec 85. Capital Cost of the building is $

– 170,000; FMV – $1,000,000. Corp X gave Mr. X cash of $300,000 and common
shares with a PUC/FMV of $700,000. Agreed Amount $500,000.

 Is the agreed amount acceptable?

 What is the ACB of the consideration received by MR X?
 What is the revised PUC?

Example 4

Goodwill – Class 14.1

Mr. X transferred goodwill to Corp X using Sec 85. Capital Cost of the goodwill is
$400,000. UCC – 25,000; FMV – $1,000,000. Corp X gave Mr. X cash of 300,000,
common shares with a PUC/FMV of $700,000. Agreed Amount $600,000.

 Is the agreed amount acceptable?

 What is the ACB of the consideration received by MR X
 What is the revised PUC

New Rules – Treat as Class 14.1

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Sec 84.1(1)

Tax consequences: PUC reduction and Dividend.

When do you use Sec 84.1(1) – When there is a non arm’s length sale of shares by an
individual to a connected company. See page 985

For Example:

An individual own shares of company A

The individuals sold those shares to another company ( let us say Company B)

After the sale Company A and B are connected.

This is a case where Sec 84.1(1) will be applicable.

PUC reduction

(A-B) * C/A

A is the increase in the paid-up capital in respect of all shares

B the greater of old shares:

 The paid-up capital of the subject shares

 The ACB of the subject shares

(LESS) fair market value of non-share consideration received

C allocate the reduction to more than one class of shares/ total PUC

Dividend calculation

(A+D)-(E+F)

A increase in the paid-up capital in respect of all shares of the capital stock of the
purchaser corporation of the new shares

D is the fair market values of the non-share consideration

E greater of subject shares immediately before the disposition:

 Paid-up capital
 ACB of old shares

F PUC reduction calculated in part one

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Exercise 1- Mr. X owns 100 % of the shares of ABC Company. ACB/PUC $100,000.
FMV $2m. Mr. X sold the shares of ABC Company to Company X, which he recently
incorporated, for 2 million dollars. As payment for the ABC shares, Mr. X received cash
of $1,200,000 and shares with a PUC/FMV of $800,000

Tax Consequences 84.1?

PUC reduction Calculation

(A-B)* C/A= (800,000- 0)= 800,000 PUC reduction

Legal PUC 800,000

PUC reduction (800,000)

Tax PUC NIL

Dividend Calculation

(A+D)-(E+F)= (800,000+1,200,000)-(100,000+800,000)

2,000,000-900,0000= 1,100,000

Exercise 2-Mr. X owns 100 % of the shares of ABC Company. ACB/PUC $400,000.
FMV $3m. Mr. X sold the shares of ABC Company to Company X, which he recently
incorporated, for 3 million dollars. As payment for the ABC shares, Mr. X received cash
of $200,000 and shares with a PUC/FMV of $2,800,000

PUC reduction Calculation

(A-B)* C/A= 2,800,000-(400k-200k)

= 2,800,000-200,000)= 2,600,000 PUC GRIND

Legal PUC 2,800,000

PUC reduction (2,600,000)

Tax PUC 200,000

Dividend Calculation

(A+D) -(E+F)= (2,800,000+200,000)-(400,000+2,600,000)

3,000,000-3,000,0000= 0 Deemed dividend

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Exercise 3

Mr. X owns 100 % of the shares of ABC Company. ACB/PUC $1,400,000. FMV $2m

Mr. X sold the shares of ABC Company to Company X for 2 million dollars. As payment
for the ABC shares, Mr. X received cash of $1,800,000 and shares with a PUC/FMV of
$200,000

Tax Consequences?

 Estimate of PUC reduction: 200K

 Estimate Deemed dividends: 400k

PUC reduction Calculation

(A-B)* C/A= 200,000-(1,400,000-1,800,000)

= 200,000- 0= 200,000 PUC GRIND

Legal PUC 200,000

PUC reduction (200,000)

Tax PUC NIL

Dividend Calculation

(A+D) -(E+F)= (200,000+1,800,000)-(1,400,000+200,000)

2,000,000-1,600,0000= 400,000 Deemed dividend

Sec 55(2) Capital Gains Strip

Read Sec 55(2) –

Signals that 55(2) is applicable

An intercorporate dividend has occurred

Conversion of a possible capital gains into a dividend

The dividend is followed by a disposition of shares by the corporation.