Anonymised, illustrative composite. Nothing in this collection covers what a share buyer does the day after closing. This is that transaction, and the difference between the model and the Act was $5,060,000 of assumed deductions.
At a glance
A Canadian corporate buyer acquired 100% of the shares of an Ontario plastics converter for $9,800,000. It had wanted an asset deal and had been refused; the vendor held qualified small business corporation shares and would not trade the exemption. The buyer accepted the share deal and planned to recover inside cost base afterwards, by winding the target up into the acquisition company.
The target's balance sheet at closing: surplus industrial land, fair market value $2,400,000 and cost amount $310,000; building and plant, $3,100,000 against an undepreciated capital cost of $1,050,000; inventory $1,400,000; receivables $900,000; cash $260,000; goodwill worth $3,000,000 at nil cost. Debt before the wind-up, $1,270,000.
The bump is real and it is generous, but it is confined. Subsection 88(1) applies where a taxable Canadian corporation has been wound up and “not less than 90% of the issued shares of each class of the capital stock of the subsidiary were, immediately before the winding-up, owned by another taxable Canadian corporation”, with the balance held by persons dealing at arm's length with the parent. That was satisfied here at 100%.
Paragraph 88(1)(c) then sets the parent's cost of each distributed property, and adds the bump computed under 88(1)(d) only “where the property was a capital property (other than an ineligible property) of the subsidiary at the time that the parent last acquired control of the subsidiary and was owned by the subsidiary thereafter without interruption until such time as it was distributed to the parent on the winding-up”.
The definition is in the same paragraph: “for the purposes of this paragraph, ineligible property means (iii) depreciable property”, together with several categories of property acquired from the parent or moved around as part of the acquisition series. Inventory and receivables are not capital property at all, so there is nothing to bump on them either.
Aggregate room first. Paragraph 88(1)(d) starts from the amount by which the total under 88(1)(b)(ii) — broadly the parent's adjusted cost base in the subsidiary's shares — exceeds the subsidiary's cost amounts plus its money, less its debts, certain reserves and certain dividends. Here: cost amounts $3,660,000 plus cash $260,000, less debt $1,270,000, is $2,650,000. Against a $9,800,000 share cost, that is $7,150,000 of aggregate room.
Then the per-property ceiling. Subparagraph 88(1)(d)(ii) provides that “the amount designated in respect of any such capital property may not exceed the amount determined by the formula A – (B + C)”, where A is the property's fair market value when the parent last acquired control, B is the greater of its cost amount then and immediately before the wind-up, and C is a prescribed amount. For the land: $2,400,000 less $310,000, nothing prescribed, gives $2,090,000.
Then the eligibility filter takes the rest. Building and plant are depreciable property — ineligible. Inventory and receivables are not capital property at all. Goodwill is depreciable property of Class 14.1: subsection 13(38) speaks of “the total capital cost of all property of the taxpayer included in Class 14.1 of Schedule II to the Income Tax Regulations in respect of the business, each of which was an eligible capital property of the taxpayer immediately before that day or is the goodwill property in respect of the business”. It has sat in a prescribed class of depreciable property since 1 January 2017.
Result: of $7,150,000 of aggregate room, $2,090,000 was usable, on a single parcel of land. $5,060,000 evaporated.
The bump raises the cost of the target's non-depreciable capital property to what the buyer actually paid for it, subject to two ceilings and one ownership-continuity test. It has never applied to depreciable property, to inventory or to receivables — which is the whole reason buyers push for asset deals in the first place, and the reason the price gap between an asset offer and a share offer is not arbitrary.
The continuity condition matters as much as the eligibility list. The property must have been capital property of the subsidiary at the time control was acquired and must have been owned “thereafter without interruption” until the wind-up. A buyer that sells the land in month four and buys a different parcel in month six has nothing to bump.
The buyer had also assumed it could reach the same result by amalgamating, because subsection 87(11) extends the bump to a vertical amalgamation. It does, but not on the same terms: 87(11) needs a subsidiary “wholly-owned corporation of the parent” where 88(1) needs 90%, and subsection 87(2)(a) deems “the corporate entity formed as a result of the amalgamation” to be “a new corporation the first taxation year of which shall be deemed to have commenced at the time of the amalgamation”. A wind-up produces no such year end. See the deemed year end nobody budgets for.
The wind-up proceeded and the designation was filed for $2,090,000 against the land, which is what the Act permits. The buyer's post-closing model was rewritten: $3,000,000 of assumed Class 14.1 capital cost allowance on bumped goodwill and $2,050,000 of assumed additional plant depreciation both came out.
The commercial consequence landed on the next deal. The buyer's following acquisition was negotiated with the basis gap priced explicitly — a share price and an asset price with the difference stated — rather than on an assumption that a wind-up would close it afterwards. See amalgamating the buyer and target after closing.
The $5,060,000 the model had assumed was the difference between the buyer's modelled return and its actual one over the hold period. It did not change whether the deal closed; it changed what the deal was worth, and it was discovered after the price had been agreed.
The alternative at negotiation was to pay the vendor for the tax cost of an asset sale. On these numbers the exemption was worth more to the vendor than the incremental basis was worth to the buyer, so the share deal was correct — but that conclusion depends on the bump being modelled at $2,090,000 and not at $7,150,000.
The tell was a single line item in the model called “step-up on goodwill”. Goodwill has been depreciable property of Class 14.1 since the start of 2017, and paragraph 88(1)(c) has excluded depreciable property throughout. A bump on goodwill has not been available for years.
The second tell is the shape of the target: a company whose value is mostly goodwill and depreciating plant has almost no bumpable property, whatever the price paid for its shares.
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