Section 85.1 Rollover—Share for Share Exchange

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

A rollover generally involves an owner of capital property exchanging this property for other capital property, and potentially other consideration as well. If the conditions of the rollover are met, the proceeds of disposition are deemed to be less than the fair market value (FMV) of the asset, but not less than the adjusted cost base (ACB). As a result, the capital gain is partially or wholly deferred until a future disposition.

Section 85.1 of the ITA provides for a rollover when a taxpayer disposes of shares of a taxable Canadian corporation in exchange for newly issued shares of another Canadian corporation. The provisions of this section are often utilized by corporations who wish to acquire another corporation but would prefer to pay for the transaction with their own shares rather than cash or other consideration. Both parties to the transaction retain cash as the purchaser pays for the purchase with shares, and the vendor defers income taxes until a future disposition of the newly issued shares.

A few key conditions must be met for this rollover to apply. The taxpayer must receive newly issued shares from the purchaser corporation. These shares must be from one class of shares, and no other consideration can be received. Receiving shares from multiple classes, such as a combination of common shares and preferred shares, will preclude the exchange from qualifying for this rollover. Receiving other consideration, such as cash or options to acquire additional shares, will do the same. Other rollover provisions may be available under another section of the ITA in these scenarios.

The vendor and the purchaser must be dealing at arm’s length prior to the exchange. Related parties cannot take part in an 85.1 rollover, but once again other rollover provisions may be available. Also, immediately after the transaction, the vendor cannot control the purchaser corporation. This means that they cannot receive enough shares of the purchaser in the exchange that would give them greater than 50% of the voting rights in the corporation, or greater than 50% of the FMV of all the outstanding shares. There may be other relevant facts that indicate control as well that need to be examined on a case-by-case basis. Assuming all conditions are met, the rollover under section 85.1 will automatically apply and no election forms are required to be filed. The proceeds of disposition for the vendor will be deemed to be their ACB of the shares and the entire capital gain on the disposition will be deferred. It is not possible to recognize a portion of the capital gain by electing for a higher amount. This ACB of the old shares will also become their ACB in the new shares.

For the purchaser, their cost of the purchased shares is the lesser of the paid-up capital (PUC) of those shares or their FMV. PUC for each share is the total amount the corporation initially received for the issuance of the entire class of shares divided by the total number of shares in the class. PUC will not always agree to the vendor’s ACB in those shares as PUC is determined at the corporation level whereas ACB is determined at the shareholder level.

Rollover transactions are complex and require proper planning to ensure that you have considered all possible options and maximized the benefits to you. Please contact me if you would like to discuss further.