Anonymised, illustrative composite. An arm’s-length sale structured with a rollover component, and a floor buried inside section 85 that has nothing to do with the shares the seller received and everything to do with the cash she took.
At a glance
The vendor sold her distribution business to an arm’s-length strategic buyer for $9 million, structured as $7 million cash at closing and $2 million of rollover equity in the buyer’s acquisition holding company — a modest stake she negotiated to keep some upside if the combined business grew. Both parties agreed to jointly elect under ITA s.85(1) on the share portion, on the ordinary assumption that a rollover election defers tax.
Her adjusted cost base in the shares she was selling was $500,000. Her advisor’s first draft of the closing tax structure modelled an elected amount equal to that $500,000 — the lowest figure the election technically allows, and the one that produces the largest possible deferral.
That model treated the election as though the parties could simply choose the number that deferred the most tax, the way the rollover works when the seller takes shares alone. Here she was taking $7 million in cash — more than fourteen times her adjusted cost base — and the election does not let cash of that size pass through tax-free just because the parties also elected on a separate block of rollover shares in the same transaction.
Adjusted cost base: $500,000. Cash received: $7,000,000. Fair market value of the rollover shares: $2,000,000. Total proceeds: $9,000,000. The gap between the $7 million in cash and the $500,000 cost base — $6.5 million — is the portion of the price that the election structure could not shelter, whatever the parties elected on paper. At capital-gains rates with a 50% inclusion rate, that produced roughly $3.25 million of taxable income and a combined federal-and-Ontario tax bill in the neighbourhood of $1.6 million, payable in the year of closing rather than deferred to whenever she eventually sold the rollover shares.
ITA s.85(1)(b) sets the floor: subject to paragraph (c), “where the amount that the taxpayer and the corporation have agreed on in their election in respect of the property is less than the fair market value, at the time of the disposition, of the consideration therefor (other than any shares of the capital stock of the corporation or a right to receive any such shares) received by the taxpayer, the amount so agreed on shall, irrespective of the amount actually so agreed on by them, be deemed to be an amount equal to that fair market value.” Cash is consideration “other than … shares” — boot, in the language advisors use for it — and paragraph (b) does not let the elected amount sit below the boot’s fair market value no matter what figure the vendor and the buyer actually wrote down.
Because the elected amount stands in for the vendor’s proceeds of disposition under s.85(1)(a), forcing it up to $7 million forces the deemed proceeds up to $7 million too — producing a $6.5 million gain against her $500,000 cost base the moment the cash consideration is counted, regardless of the $2 million rollover component sitting beside it in the same transaction. The rollover shares did not rescue any part of the cash from tax; they simply carried whatever deferral remained once the cash floor had already been applied.
s.85(1)(c.1) adds a second, independent floor that runs alongside s.85(1)(b) rather than in place of it: for capital property other than depreciable property, the elected amount also cannot be set below the lesser of the property’s fair market value and its cost amount. In a deal with real cash boot, the boot floor in paragraph (b) is almost always the higher of the two and the one that actually decides the outcome — but paragraph (c.1) is why electing below cost is never an option even in a deal with no cash at all.
This is a different question entirely from whether the election is available at all, which turns on the transferee’s residence (see rollover into a foreign topco), and from whether value has leaked to a related shareholder, which is governed by s.85(1)(e.2) and turns on who benefits, not on how much cash changed hands (see benefit conferral overrides the elected amount). Here the transferee was a genuine taxable Canadian corporation, every party dealt at arm’s length, and the only issue was arithmetic: how much of the price was cash.
The parties filed the election at the deemed $7 million figure rather than the $500,000 the vendor had hoped for, because s.85(1)(b) left no other lawful number to file. The vendor paid the resulting tax out of her cash proceeds — the structure had, in effect, already reserved the money for it, since the $7 million cash component comfortably covered the $1.6 million tax bill it triggered. The deal itself did not need to be restructured; the correction was entirely to the tax return, filed on the basis the statute actually required rather than the basis the first draft had assumed.
Had the parties filed the election at $500,000 as first modelled, the return would have understated the vendor’s income by $6.5 million — not a planning choice CRA would simply accept on audit, but a filing position contrary to a mandatory deeming rule. A reassessment years later would have added interest, and depending on how the position was represented to CRA, potentially penalties, on top of the tax that was always going to be owed. Catching the floor before filing rather than after cost nothing beyond the advisor’s time to model it correctly the first time; catching it after would have cost the interest and the risk.
The tell is that the vendor’s advisor modelled the rollover shares and the cash as though they belonged to two separate questions — how much deferral does the rollover give me, and separately, how much cash am I taking — when s.85(1)(b) ties them together into one floor. Any deal that mixes cash and rollover equity needs the boot compared against the vendor’s cost base as a first step in the modelling, before any conversation about the elected amount happens, because the boot decides the floor and the elected amount can only ever sit at or above it.
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