What rollover equity terms should the vendor negotiate?

Rollover equity, which relies on a section 85 rollover, means the vendor takes shares of the buyer’s corporation as part of the price. The terms worth negotiating fall into two groups. One is the tax conditions that decide whether section 85 of the Income Tax Act can apply at all. The other is what the shares actually give you once you hold them. Neither is automatic, so settle both before closing.

The tax conditions

Section 85(1) applies where a taxpayer disposes of eligible property to a taxable Canadian corporation for consideration that includes shares, and the two jointly elect in prescribed form. The CRA publishes Form T2057 for that election. Under s.85(6) the election is due on or before the earliest of the days either party must file a return for the year. A late election is possible within three years under s.85(7), with a penalty. Ask the buyer to confirm its status, to sign and file the form, and to bear any late penalty it causes.

The agreed amount and the cash

The parties cannot pick any number. Section 85(1)(b) raises the agreed amount to the fair market value of consideration other than shares, so the cash portion matters. Section 85(1)(c) caps it at the property’s fair market value, and other paragraphs set floors for certain property. Ask that the agreement say how the amount will be set, and who prepares the figures.

The shares themselves

For a federal corporation, Corporations Canada says the articles set out the classes of shares and, where there is more than one class, the rights, privileges, restrictions and conditions of each. Changing a class’s rights takes an amendment to the articles, and shareholders of a class may in certain circumstances vote separately. Provincial corporations follow their own statutes. Ask which class you receive, what rights it carries, and whether the buyer can change them without your class voting.

Ask also how you will exit. Section 84(3) deems a dividend when a corporation resident in Canada redeems its shares for more than their paid-up capital, subject to exceptions in s.84(6) and (8), so a redemption can be taxed differently from a sale to another person.