Can I roll shares into a holdco before selling to defer tax?
Yes, if the conditions are met. Section 85 of the Income Tax Act lets you transfer shares to a taxable Canadian corporation for consideration that includes its shares, with a joint election, and defer tax on the gain as far as the elected amount allows. It defers tax rather than removing it, and the holding company, not you, then sells, which affects the lifetime capital gains deduction and can bring in section 84.1.
A rollover into a holding company changes who the seller is. You exchange your shares of the operating company for shares of your holdco, and the holdco then sells the operating company to the buyer. Tax is not avoided. It moves, and some reliefs do not move with it.
What the rollover defers
Under subsection 85(1), when a taxpayer disposes of eligible property to a taxable Canadian corporation for consideration that includes shares, and both jointly elect in the prescribed form (CRA form T2057), the agreed amount, within the limits the subsection sets, is deemed to be the taxpayer’s proceeds and the corporation’s cost. The cost of the shares you receive follows from that amount, so the unrealized gain stays in them. Cash or a note worth more than the agreed amount raises the agreed amount to match, and that part is taxed.
Who sells, and what that costs
After the rollover the holdco sells the operating company’s shares, so the gain arises in the holdco. The lifetime capital gains deduction in subsection 110.6(2.1) is for an individual, and the definition of a qualified small business corporation share starts with shares owned by the individual, a spouse or common-law partner, or a related partnership. A holdco that sells cannot claim it. Getting the cash to you is a second step, for example as taxable dividends, which section 82 includes in income. If you want the deduction, ask your adviser whether to plan for it before or with the rollover, as in crystallizing the exemption.
Section 84.1 and your own holdco
A holdco you control is related to you, and section 251 deems related persons not to deal at arm’s length, so section 84.1 can apply where the operating company would be connected with it after the transfer. Section 84.1 limits the paid-up capital the new shares can carry and treats cash or notes above the greater of the old shares’ paid-up capital and adjusted cost base, as the section adjusts them, as a deemed dividend. See selling shares to your own holding company.
Why a deferral draws scrutiny
The general anti-avoidance rule defines a tax benefit to include a deferral of tax and can treat a transaction as an avoidance transaction because it is part of a series, and the Act deems a series to include related transactions completed in contemplation of it, so a rollover that leads to a sale can be treated as part of the same series as the sale. Whether a step is a misuse or abuse is a question for your advisers.
Sources
This answer is checked against primary sources. Links were last confirmed on the dates shown.
- 01Government of CanadaGovernmentIncome Tax Act, R.S.C. 1985, c. 1 (5th Supp.)
- 02Canada Revenue AgencyGovernmentT2057 Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation
- 03Canada Revenue AgencyGovernmentLine 25400 – Capital gains deduction
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