The rollover provisions of the Income Tax Act, under subsection 85, permit a taxpayer to elect to transfer “eligible property” to a taxable Canadian corporation in exchange for consideration that includes at least one share of the corporation. “Eligible property” includes most capital property, Canadian or foreign resource property, eligible capital property and inventory, other than inventory that is real property. Where the taxpayer and the corporation agree upon an amount that does not exceed the fair market value of the property disposed of and is not less than the fair market value of any non-share consideration that is received, the amount agreed upon becomes, subject to certain specific limitations, the taxpayer’s proceeds of disposition and the corporation’s cost of the property. By choosing an appropriate amount within those limits the property can be transferred on a tax-deferred basis, that is, the corporation assumes the taxpayer’s potential income tax liabilities for the property.
Taxpayers who own businesses use these rollover provisions to restructure their holdings to address changing financial and personal objectives, including and most notably estate planning objectives.
In a recent Federal court case, Brent Carlson Family Trust v Canada (National Revenue), 2021 FC506 the Court undertook a judicial review of the Canada Revenue Agency (“CRA”)’s rejection of a request to amend several rollovers (Section 85) to reduce the elected amounts and avoid capital gains.
In this case, the taxpayers were trusts holding shares of private corporations. In a series of transactions intended to allow the beneficiaries of the trusts to use their individual capital gains exemptions (CGE) (before an actual sale to 3rd parties), the trusts exchanged their shares of the operating company for operating company shares of other classes. The trusts elected proceeds sufficient to realize capital gains equal to the aggregate CGE of all beneficiaries. Subsequently, the new shares were sold to an arm’s length purchaser.
The CRA audited the transactions and noted that some of the beneficiaries were under age eighteen. As a result, their capital gains were deemed to be non-eligible dividends subject to personal tax at the highest personal rate due to the kiddie tax provisions of the Income tax Act as the gains arose on disposition to non-arm’s length parties.
The taxpayers requested the CRA accept amended elections pursuant to the Income Tax Act to allow the exchange to occur at cost, so that the capital gains would be realized on the subsequent sale to the arm’s length purchaser. Such gains would not be deemed to be dividends and would avoid the kiddie tax. The CRA denied the requested amendments, indicating that they considered the request to be retroactive tax planning. Their decision was based, at least in part, on precedent caselaw restricting access to rectification to correct tax errors.A’s Information Circular IC76-19R3 (Transfer of Property to a Corporation Under Section 85) indicates that a request for amendment may be based on the correction of unintended tax consequences when the parties intended a rollover without immediate tax consequences. The CRA failed to distinguish between amendment, rectification, and rescission, or to explain why allowing the amendment to realize the same capital gain on the arm’s length sale instead of the share exchange.
The Court noted that every request to amend such an election would be intended to avoid unintended tax consequences, suggesting an acceptable ambit of retroactive tax planning in permitting such amendments. The provision does not prohibit an amendment based on an error by a professional advisor (the advisor had failed to factor into their advice the fact that a number of the beneficiaries were still minors at the time of the pre-sale transactions) However, CRA provided no explanation to the taxpayers of how the advisor’s error in prematurely realizing capital gains resulted in the conclusion that allowing amended elections would not be just and equitable.
The Court determined, that due to the lack of a logical and rational chain of reasoning or explanation of the denial, the decision was found to be unreasonable. The CRA was ordered to review their decision again and make a new determination of the request to file amended elections. The Court further ordered that this work be conducted by CRA personnel who had not been involved in any audit role related to the trusts or the family’s tax matters, or in the first or second reviews. The Court noted that this may require referring the matter to a different Tax Services Office.
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