Section 88 Rollover—Wind-Ups

The disposition of capital property by a taxpayer generally results in a capital gain or loss. However, the Income Tax Act (ITA) contains many provisions which allow for a deferral of capital gains on certain dispositions. These provisions are known as rollovers.

A disposition includes the winding-up of a corporation. A wind-up involves a corporation’s assets being sold or distributed to its shareholders, all liabilities being settled, and the outstanding shares being cancelled. There are many business reasons to complete a wind-up, such as simplifying the organizational structure, integrating the business with the parent corporation’s business, ending the business, or other tax reasons such as the utilization of losses. In the absence of a rollover, there may be a capital gain on the wind-up based on the fair value of the assets and there may be an income inclusion for recapture as well.

Section 88 of the ITA may allow for a tax-deferred rollover on the wind-up of a subsidiary into its parent corporation. To qualify, the parent corporation must own at least 90% of each class of shares of the subsidiary. The remaining shares must be owned by parties with which the parent corporation deals with at arm’s length. Both the parent and the subsidiary must also be taxable Canadian corporations.

Assuming the above conditions are met, the property disposed by the subsidiary corporation and distributed to the parent is deemed to be sold for proceeds equal to the subsidiary’s cost base in these assets.

Accordingly, the parent’s cost base in these assets is equal to the subsidiary’s cost base. If the parent corporation’s cost base in the subsidiary’s shares exceeds the cost base of the assets received, they may be eligible for an election to bump-up the cost base of certain assets. This bump-up only applies to non-depreciable property such as land, shares, or partnership units, and the bump-up cannot exceed the fair market value of the assets. Analyzing this bump-up and calculating the maximum amount is complex and we would be happy to advise separately.

The parent is deemed to dispose of their shares in the subsidiary for proceeds equal to the greater of:

(i) the lesser of the paid-up capital in respect of those shares immediately before winding-up and the net tax cost of the subsidiary’s assets, and

(ii) the total adjusted cost base of such shares to the parent immediately before the winding-up.

As a result of the deemed proceeds, the parent company will not recognize a capital loss on the disposition but there may be a capital gain if their adjusted cost base of the shares is less than both amounts mentioned in (i) above.

The deeming rules above do not apply to the minority shareholders in the subsidiary corporation. Therefore, any assets distributed to the minority shareholder may give rise to a capital gain on these assets, and a capital gain or loss on the disposition of their shares will be calculated based on the fair value of the property received.

Many additional tax balances of the subsidiary corporation will flow through to the parent corporation at the time of the wind-up. Loss carry forward balances, including net capital losses, non-capital losses, farm losses and limited partnership losses, will be available to claim in future years by the parent corporation subject to the typical carry forward periods. Other tax balances, such as the capital dividend account, refundable dividend tax on hand account and general or low-rate income pool balances, will also be absorbed by the parent corporation.

In certain situations, the winding-up of a corporation may give rise to a deemed dividend based on the value of property distributed to the shareholders compared to the paid-up capital of the shares. This deemed dividend is generally taxable to the shareholders. If the rollover provisions above do not apply, other provisions contained within section 88 may allow for the corporation to utilize non-taxable balances, such as the capital dividend account, to reduce the amount of the taxable dividend.

Rollover transactions are greatly beneficial to business owners as they allow you to optimize your business without requiring a current outlay of cash to pay income taxes. It is imperative that you conduct proper planning to ensure all conditions are met and your transaction will qualify for tax-deferred treatment. Please contact us if you would like to discuss further.