Anonymised, illustrative composite. Every other file in this collection assumes a vendor that already has shares to sell. This one starts a step earlier, with three partners, a signed letter of intent and ninety days.
At a glance
Three partners had run an agricultural equipment servicing business as a general partnership since 2011: two individuals with 40% each and, for the third 20%, a partner holding through his own corporation. Revenue was $8,600,000 and normalised EBITDA $1,240,000. A strategic buyer had signed a letter of intent.
The partners wanted the lifetime capital gains exemption, and it is only available on qualified small business corporation shares. A partnership interest is not a share. That is why the partners were pushing a share deal at $5,200,000 rather than the buyer's asset offer at $5,650,000 — and it is why the business had to become a corporation before it could be sold at all.
The rollover route for a partnership is not subsection 85(1), which transfers property from a taxpayer. It is subsection 85(2), which transfers partnership property, and subsection 85(3), which then winds the partnership up. Three conditions in that pair broke on these facts.
First, the election. Subsection 85(2) applies where partnership property goes to a taxable Canadian corporation for consideration including shares and “the corporation and all the members of the partnership have jointly so elected, in prescribed form and within the time referred to in subsection 85(6)”. Every member, not just the transferor. One partner declining ends the transaction.
Second, the deadline. Subsection 85(6) fixes the filing date by reference to the earliest return due date among the electing parties. The transfer was set for 3 March. For the two individuals, who carry on a business, paragraph 150(1)(d)(ii) gives the following June 15; for the corporate partner, whose year ended 30 September, paragraph 150(1)(a) requires a return “within six months after the end of the year” — 31 March. The file had the June date in it.
Third, and the one that was missed entirely: what the partnership was still holding on the day it wound up.
Subsection 85(3) applies only where, among other conditions, “the affairs of the partnership were wound up within 60 days after the disposition” and “immediately before the winding-up there was no partnership property other than money or property received from the corporation as consideration for the disposition”. Read the exception precisely: money, and the corporation's own consideration. Nothing else.
The balance sheet on the planned transfer date carried $84,000 of cash — permitted, it is money; a service vehicle worth $34,000 with an undepreciated capital cost of $11,000 that the 20% partner intended to keep; and a $46,000 GST/HST refund receivable the bookkeeper had left behind. The vehicle and the receivable are partnership property, neither is money, and neither came from the corporation. Left in place, both would have failed condition (c) and taxed each partner on the disposition of a partnership interest at fair market value instead of rolling it.
The transferred property, with elected amounts: equipment, undepreciated capital cost $410,000 against a $980,000 fair market value, elected at $410,000 (paragraph 85(1)(e) floors the election at the least of undepreciated capital cost, cost and fair market value); inventory at its $1,120,000 cost; goodwill, worth $3,100,000 at nil cost, elected at $1.
The whole of subsection 85(3) hangs on a condition about what the partnership still owns, not about what it transferred. That is the unit error waiting on every one of these files: the checklist asks whether the business was transferred; the statute asks whether anything was left behind.
The second decided point is the exemption clock, and the honest answer is narrower than the one usually given. Paragraph (b) of the definition of a qualified small business corporation share in subsection 110.6(1) requires that a share, “throughout the 24 months immediately preceding the determination time, was not owned by anyone other than the individual or a person or partnership related to the individual”. Paragraph (c) is expressly confined to the period of ownership: it applies “throughout that part of the 24 months immediately preceding the determination time while it was owned by the individual or a person or partnership related to the individual”.
Paragraph (b) carries no equivalent limitation and is worded negatively — a share that did not yet exist was not owned by anyone. Whether that satisfies paragraph (b) for a share issued weeks before a sale is a reading question the words of section 110.6 do not settle on their face, and no answer is asserted here. What is settled is the practice: nobody incorporates a partnership inside a live sale process and relies on the exemption. See the 24-month rule and shares that failed the holding period test.
The share deal was abandoned. The partnership sold its assets at $5,650,000 and the partners paid tax without the exemption. The incorporation went ahead three weeks after closing, for the partner keeping a residual service business — on the correct footing this time.
For a transaction begun early enough the sequence is: elect under 85(2) with all members signing; diarise the deadline off the earliest year end; strip the partnership to cash and the corporation's own shares before the wind-up, moving any stray asset into the election itself; wind up within 60 days; then wait out the holding period before opening a process.
If the transfer had gone ahead with the vehicle and the GST/HST receivable still in the partnership, subsection 85(3) would not have applied. Each partner would have disposed of a partnership interest at fair market value, and the shelter the whole structure was built for would have failed on a $34,000 truck.
A different exit has a different provision. Where a partnership ceases to exist and one partner carries the business on alone, subsection 98(5) applies: it operates where “within 3 months after the particular time one, but not more than one, of the persons who were, immediately before the particular time, members of the partnership” carries the business on alone and continues to use the former partnership property. Three months rather than sixty days, a different condition, and no corporation required.
The tell was on the balance sheet, one line below the cash: a vehicle and a refund receivable allocated to neither side of the transaction. Any asset in neither the transfer schedule nor the excluded-assets schedule will still be sitting in the partnership on the day it winds up.
The second tell was a year end. Three partners on three fiscal periods, with a filing deadline belonging to whichever files first, puts the election date on the closing agenda rather than in the accountant's year-end file.
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