Section 85.1 share-for-share exchange

Sellers meet this rule when the buyer is a corporation that offers its own shares instead of cash. Subsection 85.1(1) of the Income Tax Act applies where a Canadian corporation, the purchaser, issues shares to a taxpayer, the vendor, in exchange for shares of a taxable Canadian corporation that the vendor holds as capital property. The CRA says the provisions are generally intended to provide a tax-free (rollover) exchange. See whether to accept shares instead of cash.

How the deemed amounts work

Unless the vendor reports any part of the gain or loss in the return for that year, the vendor is deemed to have disposed of the exchanged shares for proceeds equal to their adjusted cost base immediately before the exchange. The vendor is deemed to have acquired the purchaser’s shares at a cost equal to that same adjusted cost base.

When subsection 85.1(1) does not apply

• The vendor and purchaser were not dealing with each other at arm’s length immediately before the exchange, other than only because of the purchaser’s right to acquire the exchanged shares referred to in paragraph 251(5)(b)
• The vendor, alone or with non-arm’s-length persons, controlled the purchaser or beneficially owned a majority of its shares by fair market value immediately after the exchange
• An election under subsection 85(1) or 85(2) was filed for the same shares
• The vendor received consideration other than shares of the particular class of the purchaser
• The vendor is a foreign affiliate of a taxpayer resident in Canada and included any part of the gain or loss in its foreign accrual property income

Ask whether the offer is for shares of one class only, since other consideration takes the exchange outside the rule. A later loss on the new shares can also bring in the stop-loss rule through subsection 112(7), which has its own exceptions.