Many corporations explore using corporate reorganizations to achieve planning objectives for their shareholders. For example, creditor protection and income splitting to name two key objectives. However, what may appear to be a common transaction can lead to unforeseen income tax consequences when dealing with non-arm’s-length (NAL) parties.
For the most part, shareholders are considered non-arm’s length to any corporations they control, their spouses, and their direct descendants and ascendants.
In a fairly typical transaction, a business owner transfers his shares of an Opco to a newly established Holdco which he owns. By making an election under section 85 of the Income Tax Act, the business owner can complete the transaction on a tax-deferred rollover basis. The business owner can also elect a transfer price. Most would elect a transfer price that allows them to crystalize the available capital gain exemption.
If the business owner elects to use a transfer price of $800,000 (equal to the 2014 lifetime capital gains exemption), he can trigger a capital gain and crystallize his CGE. This assumes a nominal adjusted cost base (ACB) and paid-up capital (PUC).
All of this likely complies with the requirements of section 85 of the Income Tax Act. However, if an NAL is involved at any point in the corporation’s history, adverse tax consequences could be triggered under section 84.1 of the Income Tax Act. This particular section is designed to ensure that NAL transactions do not artificially achieve preferential tax results. In short, the intent of section 84.1 is to prevent taxpayers from converting their capital gains into cash as an outcome of a NAL transaction.
If you have any questions about achieving your own planning objectives feel free to contact one of our professionals at your convenience.