Anonymised, illustrative composite. An estate freeze, an elected amount the parties had every right to choose, and a subsection that ignores what they chose the moment part of the value lands on a related shareholder.
At a glance
A founder in his early sixties was planning an estate freeze ahead of an anticipated sale of his manufacturing business within three to five years. His operating company shares had a fair market value of $3.2 million and an adjusted cost base of $150,000. On his advisor’s structure, he rolled those shares into a newly formed holding company under a joint election, choosing an elected amount equal to his adjusted cost base — the standard freeze mechanic, designed to defer the entire accrued gain and let future growth accrue in new common shares issued to a family trust for his adult children.
His son, already active in the business and expected to eventually run it, was made a direct 20% shareholder in the new holding company from the day it was formed — not through the trust, but personally, holding growth shares the family’s advisor had priced at a nominal amount relative to what the freeze shares and the family trust’s interest were actually worth.
On review ahead of the eventual sale, the buyer’s tax counsel flagged the son’s day-one shareholding as a related-party benefit-conferral issue rather than a straightforward freeze. The son had received a real economic interest in the holding company’s growth, priced well below what an arm’s-length purchaser would have paid for it, at the same moment his father was electing to defer tax on the full value of the shares he contributed. That combination is precisely what ITA s.85(1)(e.2) exists to catch.
The father’s elected amount, as filed, was $150,000 — his adjusted cost base, producing a nil immediate gain on the rollover and full deferral of the $3.05 million of accrued value into the shares he received. An independent valuation prepared for the tax review estimated the fair market value of the growth-share interest the son received, net of what he had actually paid for it, at approximately $400,000 — the portion of the father’s transferred value that had, in substance, moved to his son rather than into shares the father himself held or a trust he controlled.
ITA s.85(1)(e.2) is triggered where the fair market value of the transferred property exceeds the greater of the consideration actually received and the elected amount itself, and “it is reasonable to regard any part of the excess as a benefit that the taxpayer desired to have conferred on a person related to the taxpayer.” Where that condition is met, the provision does not ask what the parties elected. It states the result directly: “the amount that the taxpayer and the corporation agreed on in their election in respect of the property shall, regardless of the amount actually so agreed on by them, be deemed … to be an amount equal to the total of the amount referred to in subparagraph 85(1)(e.2)(ii) and that part of the excess.”
Read against these facts: the father’s own elected amount ($150,000) was the lower of the two comparators in the opening test, so the “excess” is measured against it. The $400,000 of value that landed on the son, as a person related to the father, was found to fall within that excess. The subsection therefore deemed the elected amount to be $150,000 plus $400,000 — $550,000 — regardless of the $150,000 the father and the holding company had actually agreed on. Because the elected amount stands in for the father’s proceeds of disposition under s.85(1)(a), the bump crystallised an immediate $400,000 capital gain in the year of the freeze, taxable at ordinary capital-gains rates, on a transaction the family had structured specifically to defer any gain at all.
The one exception in the text did not reach this fact pattern. s.85(1)(e.2) expressly excludes a benefit conferred on “a corporation that was a wholly owned corporation of the taxpayer immediately after the disposition” — language written for the case where the related party is a holdco the transferor fully controls, so no value has really left the transferor’s hands. The son here held his shares personally, not through any entity the father wholly owned, so the carve-out never engaged. This is a different failure mode from a foreign transferee, where the election is unavailable at the threshold (see rollover into a foreign topco), and from an excess-cash problem, where the election is valid but the boot floor sets a minimum (see boot in excess of tax cost). Here the election was valid, the transferee was a taxable Canadian corporation, and the trap was entirely about where the value went.
The family restructured before filing the year’s return. The son’s growth shares were repurchased at fair value and reissued to the family trust instead, with the son’s eventual participation restructured as a separate purchase of shares from the trust, priced independently, once he had built enough equity of his own to pay for it at fair market value. That removed the related-party benefit from the original rollover transaction itself, and an amended election preserved the deferral the freeze had been designed to achieve. The restructuring cost roughly $35,000 in professional fees and delayed the son’s formal ownership stake by two years.
Had the original structure been filed as designed, the father would have owed tax on a $400,000 capital gain he had structured the entire freeze specifically to avoid recognising that year — a result indistinguishable, from a cash-flow perspective, from not having done a freeze at all for that portion of the value. Discovered years later on a CRA reassessment rather than caught in review before filing, the same $400,000 would have arrived with interest and, potentially, gross-negligence penalties if the benefit-conferral pattern were found to have been deliberate rather than an oversight in how the son’s participation was structured.
The tell is that everyone involved genuinely believed the elected amount was a number they got to choose. It is, right up until a related person benefits from the gap between what was elected and what the property was worth — at which point s.85(1)(e.2) treats the choice as never having been made. Any rollover where a related person other than a wholly owned holdco of the transferor receives shares in the transferee at the same time needs the pricing of that related person’s interest checked independently, not assumed to be clean because the transferor’s own election looks conservative.
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