By: Rajesh K. Sharma, Advocate (LinkedIn)
What is a Rollover?
In the context of Canadian tax law, a "rollover" refers to a provision in the Income Tax Act (ITA) that allows a taxpayer to defer the immediate recognition of income, gains, or losses when transferring property or reorganizing corporate structures. The essence of a rollover is that the taxpayer can move assets without triggering a taxable event, provided that certain conditions are met. The tax on the transaction is deferred until a later date, usually when the asset is eventually sold or disposed of under non-rollover conditions.
Fact Pattern Scenario
John's Corporation Reorganization
John owns 100% of the shares of a private Canadian corporation, ABC Ltd., which he has been running successfully for 20 years. John is considering retirement and wants to reorganize his company's share structure to allow his daughter, Sarah, to gradually take over the business.
Step 1: Initial Setup
John holds 1,000 common shares of ABC Ltd., each with an adjusted cost base (ACB) of $50 and a current fair market value (FMV) of $500 per share.
Step 2: Reorganization under Section 86
John decides to reorganize the share structure by exchanging his 1,000 common shares for 500 new preferred shares and 1,000 new common shares in ABC Ltd. under Section 86 of the ITA. The preferred shares are issued to John with a redemption value equal to the FMV of his old common shares ($500,000), and the new common shares are issued with no immediate value.
Application of the Rollover:
Under Section 86, John can elect to apply a rollover, which means that the exchange of his old shares for the new preferred and common shares will not trigger any immediate capital gains tax. The ACB of the old common shares ($50,000) is transferred to the new shares on a proportionate basis.
- The 500 preferred shares will have an ACB of $25,000 (50% of the original ACB).
- The 1,000 new common shares will have an ACB of $25,000 (50% of the original ACB).
Step 3: Future Sale
Several years later, Sarah decides to redeem the preferred shares from John. At that time, the preferred shares are worth $600,000. Because the preferred shares were issued in exchange for the original common shares under a rollover, John's cost base remains at $25,000 for the preferred shares. He will now realize a capital gain of $575,000 ($600,000 - $25,000) when the preferred shares are redeemed.
Outcome:
By utilizing the rollover under Section 86, John was able to reorganize the share structure of ABC Ltd. without triggering an immediate taxable event, thus deferring the capital gains tax until the preferred shares were redeemed.
Key Points from the Scenario:
- Deferral of Tax: The rollover allowed John to defer the capital gains tax that would have been payable had he sold the shares directly without the reorganization.
- Reorganization Flexibility: The rollover provided flexibility in restructuring the corporation’s share capital, facilitating a smooth transition of ownership to Sarah.
- Tax Planning Tool: Rollovers are powerful tools for tax planning, enabling the deferral of taxes during reorganizations, estate planning, or when transferring assets between related parties or entities.
This scenario demonstrates how rollovers can be used strategically in corporate and personal tax planning to achieve specific financial and succession goals while managing tax liabilities effectively.
Rollovers under Income Tax Act (ITA)
Here is a comparative chart of the different rollovers available under Sections 51, 73, 85(1), 85(2), 86, 87, and 88(1) of the Income Tax Act (ITA):
Section | Rollover Type | Description | Assets Covered | Key Conditions |
51 | Convertible Property | Allows tax-deferred conversion of securities into shares in the same corporation | Convertible securities (options, warrants, etc.) | Conversion must be according to terms of the convertible property; only shares must be received. |
73 | Spousal and Family Rollovers | Allows tax-deferred transfer of property between spouses or to a trust for minors | Capital property, RRSPs, RRIFs | Transfer must be to a spouse or a trust for minor children; assets must be held as capital property. |
85(1) | Transfer of Property to a Corporation | Allows tax-deferred transfer of property to a Canadian corporation | Capital property, Canadian and foreign resource properties, inventory | Joint election required; the transferor must receive shares in exchange. |
85(2) | Partnership Transfer to a Corporation | Allows tax-deferred transfer of partnership property to a corporation | Capital property, resource properties, inventory | The partnership must receive shares in the transferee corporation in exchange for the property. |
86 | Corporate Reorganization | Allows tax-deferred exchange of shares in a corporation during reorganization | Old shares in a corporation | Exchange must be for new shares in the same corporation; no other consideration should be received. |
87 | Amalgamations | Permits tax-deferred merger of two or more Canadian corporations | All assets and liabilities of predecessor corporations | All shareholders must receive shares in the amalgamated corporation; no property is disposed of. |
88(1) | Wind-Up of Subsidiary into Parent | Allows tax-deferred transfer of assets from a subsidiary to a parent corporation | All assets of the subsidiary | The parent must own at least 90% of the subsidiary; the subsidiary must be wound up. |
This chart provides an overview of the key features, assets covered, and conditions for each type of rollover under the specified sections of the ITA, which are essential for tax planning and corporate reorganization.