There are various income tax restrictions when control of a corporation is acquired. Most of the restrictions are meant to prevent the shifting of losses or other tax attributes after an arm’s length acquisition of the corporation (“loss trading”, where someone buys a corporation and moves a profitable business into it in order to benefit from its loss carryforwards).
The main rules and restrictions include:
- There is a deemed taxation year end for the corporation immediately before the acquisition of control, with a new deemed taxation year beginning immediately thereafter. This will typically result in a short taxation year.
- The short taxation year will mean tax returns need to be filed earlier, and certain deductions such as capital cost allowance (tax depreciation) will have to be pro-rated. It also counts as a year for purposes of any rules that allow balances, credits or losses to be carried forward for a fixed number of years.
- Net-capital losses cannot be carried back or forward beyond the acquisition of control.
- Capital losses accrued to the time of the acquisition of control are triggered and realized in the year ending immediately before that time. The cost bases of the loss properties are written down accordingly.
- As noted, the corporation’s capital losses, including those triggered by the above rule, cannot be carried forward beyond the acquisition of the control. However, the corporation can elect to trigger part or all of accrued gains on other property, which can be offset by the triggered losses. This will result in a stepped-up cost base of the accrued-gain properties.
- Non-capital losses (e.g. business and property losses) cannot be carried back or forward beyond the acquisition of control, except in the case of certain business losses. In general terms, the business losses can be carried back or forward if the same or similar business is carried on by the corporation with a reasonable expectation of profit, and then only to the extent of the income from that same or similar business.
- Investment tax credits cannot be carried forward or back, except, in general terms, to the extent of tax payable in respect of the same or similar business carried on with a reasonable expectation of profit.
When is there an acquisition of control?
The main rule provides that control of a corporation is acquired when a person or group of persons acquires more than 50% of the voting shares of corporation, where the person or group did not own more than 50% of the voting shares immediately before that time. (Thus, for example, if you already own 51% of the voting shares and now acquire another 10% of the voting shares, there is no acquisition of control.) This type of control is often called “de jure” control, or control as a matter of law, since the voting shares give you a legal right to elect the directors who will run the corporation.
There are some notable exceptions to the main rule. For example, if you acquire shares of a corporation from a person to whom you are related, there is normally no acquisition of control even if that acquisition puts you over the 50% vote threshold. Therefore, if your father owned 80% of the voting shares of a corporation and you acquired all of those shares, there would not be an acquisition of control. There is also an exception if you acquire shares in a corporation to which you are already related.
Similarly, where a person who controls a corporation dies, the acquisition of the deceased’s voting shares by the estate of the deceased does not constitute an acquisition of control. Additionally, the distribution of the shares to a beneficiary who was related to the deceased does not result in an acquisition of control.
More than 75% rule
Another rule, which does not rely on the “de jure” concept of control, generally provides that there is an acquisition of control of a corporation when a person or group of persons acquires shares with a fair market value of more than 75% of the fair market value of all the shares in the corporation (regardless of votes).
The rule does not apply if the person or group already owned more than 75% of the shares based on fair market value (before the most recent acquisition of shares), or if the person or group otherwise has de jure control over the corporation.
Similar rules for trusts
Similar rules restrict or deny losses in the same manner as that described above for a trust that undergoes a “loss restriction event”.
For a trust, a loss restriction event can occur when a person becomes a “majority-interest beneficiary”, or a group of persons becomes a “majority-interest group of beneficiaries”, of the trust. These terms generally refer to a beneficiary or group of beneficiaries where the interests in the trust of the beneficiary or group in either the income or capital of the trust are greater than 50% of all of such interests in the trusts.
There are various exceptions to the loss restriction event rules, which are similar to those that apply to acquisitions of control of a corporation. For example, there is no loss restriction event where a person acquires an interest in a trust from an affiliated person (e.g. a spouse).
Similarly, where a beneficiary dies, the acquisition of the deceased’s interest in the trust by the estate of the deceased does not result in a loss restriction event. Where the interest in the trust is distributed to a beneficiary who was affiliated with the deceased, there is also no loss restriction event.