How does the bump in tax cost work after a share purchase?

When you buy a corporation’s shares you pay for the company, but its assets generally keep the tax cost they already had. That can leave a gap between what you paid and the tax cost of what the company owns. A bump is a way, in limited cases, to close part of that gap after closing. It is technical, and whether it is available turns on the facts of the deal.

What the Income Tax Act allows

The usual route is a winding-up. Where a taxable Canadian corporation is wound up into a parent, also a taxable Canadian corporation, that owned the portion of each class of its shares the Act requires, the subsidiary’s property passes to the parent at its existing tax cost. The parent may then designate an increase for capital property of the subsidiary, other than ineligible property, that the subsidiary held when the parent last acquired control and kept until the winding-up. The designation is made in the parent’s tax return for the year of the winding-up.

What limits the bump

The Act treats depreciable property as ineligible, so buildings, furniture and equipment generally cannot be bumped. The increase is also capped: for each property, by its fair market value when the parent last acquired control less the greater of its tax cost at that time and its tax cost just before the winding-up (and a prescribed amount), and overall by how much the parent paid for the shares compared with the subsidiary’s net tax cost. Depreciable assets matter to buyers because their cost is recovered gradually through capital cost allowance rather than deducted at once.

Winding up or amalgamating

Corporations Canada describes a vertical short-form amalgamation as the combination of a holding corporation with one or more wholly-owned subsidiaries, approved by a directors’ resolution without a shareholder vote. Whether a bump is available through an amalgamation is a question for your tax adviser, because a missed condition can mean no bump at all.

Plan before you sign

Property that the subsidiary acquired from the buyer’s side as part of the same series of transactions is excluded, so the bump is easiest to protect when it is planned before closing. Raise it with your accountant and lawyer when you choose between an asset sale and a share sale.