- There are various tax restrictions that apply when “control” of a corporation or trust is acquired. Some of the major restrictions are:
- Net capital losses cannot be carried forward to years after the acquisition of control or back to years before the acquisition. This is a major exception to the regular rule that normally allows a three-year carry-back and indefinite carry-forward of net capital losses.
- Non-capital losses (e.g. business losses) can be carried forward or back, but only to the extent of income generated by the business that generated the losses, or a similar business (this is a very general summary of a complex rule).
- Investment tax credits (e.g. for scientific and experimental research) are restricted unless the same or a similar business is carried on, along the same lines.
- There is a deemed taxation year-end immediately before the acquisition of control, and a new taxation year begins immediate after the acquisition. This will typically result in at least one short “stub” taxation year ending upon the acquisition of control. The short stub year will accelerate the tax-filing date for the tax return for that short year and will require the pro-ration of certain deductions like capital cost allowance (tax depreciation).
- All capital properties with accrued losses are written down to fair market value, resulting in capital losses in the taxation year ending upon the acquisition. As noted above, these losses cannot be carried forward to years beyond the acquisition of control. However, the corporation or trust can elect to trigger any accrued capital gains in the taxation year ending upon the acquisition, to the extent of the capital losses in that year, including those resulting from the write-down rule described above. The capital gains can be offset by those capital losses, and result in an increased adjusted cost base of the gain properties. The following is an example of the application of this rule:
Corporation Xco used the calendar year as its taxation year. In 2020, there was an acquisition of control of Xco. At that time, it owned the following capital properties:
Property 1: $100,000 adjusted cost base; $60,000 fair market value
Property 2: $100,000 adjusted cost base; $130,000 fair market value
Xco will have a deemed year-end immediately before the acquisition of control, resulting in a short 2020 taxation year (that is, from January 1, 2020 to the acquisition of control). It will have a deemed new taxation year, and from that point on it can choose to maintain a calendar year end (in which case it will have another short taxation year ending on December 31, 2020) or have a new off-calendar taxation year end that would generally be 12 months after the acquisition control.
In the short 2020 taxation year ending at the acquisition of control, Property 1 will be written down to $60,000, resulting in a $40,000 capital loss and $20,000 allowable capital loss. Xco can elect to trigger the accrued capital gain on Property 2, resulting in a $30,000 capital gain and $15,000 taxable capital gain, which can be offset by the allowable capital loss. The adjusted cost base of Property 2 will be bumped up to $130,000.
Acquisition of control of corporation
So when does an “acquisition of control” of a corporation occur?
It occurs when a person or group of persons acquires sufficient shares of the corporation to have more than 50% of the votes. However, it does not occur if the person or group already owned shares giving them more than 50% of the votes. For example, if I own 52% of the voting shares and then buy more shares to get up to 62% of the voting shares, there is no acquisition of control. Another exception to this rule generally applies where a person acquires shares from a related person. For example, if I own 45% of the voting shares of a corporation and I buy another 10% of the shares from my spouse, there is no acquisition of control.
An acquisition of control also occurs where a person acquires more than 75% of the shares of the corporation calculated by fair market value, regardless of the number of voting shares. As above, there are some exceptions. For example, if you acquire more than 75% of the shares of the corporation that you already controlled, or acquire the shares from a related person, there is no acquisition of control.
Acquisition of control of trust
An acquisition of control of a trust occurs when a person becomes a “majority-interest beneficiary” of the trust, or a group of persons becomes a “majority-interest group of beneficiaries” of the trust. (The acquisition of control is technically called a “loss restriction event”.) Generally speaking, this means acquiring more than 50% of the income interests or capital interests in the trust based on their fair market value. As with the corporate rules, there are exceptions. For example, if you are already a majority-interest beneficiary and acquire a larger interest in the trust, there is no acquisition of control. Also, if you acquire an interest from an “affiliated person” (similar to but not quite the same as “related person”), there is no acquisition of control.