I have a client that did a short-form vertical amalgamation in 2019. This is my first tax year working with them.
Let’s call them subco (wholly-owned subsidiary) and controlco (controlling company and eventual amalgamated company)
The par value for subco’s shares are $1 each. Controlco bought 3 shares from subco’s shareholders for $66k total in 2014.
On the Schedule 100, since 2014, Controlco has had Gifi code 2244, investment in related canadian corporations, sitting at $66k. That 66k is still on Contolco’s balance sheet in 2019 and 2020 T2s after it has amalgamated, which I believe to be incorrect.
2021 is my first year working with them, and Controlco now wishes to wind up. I have no idea what to do with that 66k balance, and I feel that retained earnings is also off. In 2019, the retained earnings of the two companies simply got added together.
I have started the process of adjusting 2019 and 2020 returns before I file 2021, but I want to make sure I’m doing things correctly. Can someone please tell me exactly what should have happened in 2019 to the Schedule100 when these companies amalgamated?
Specifically, I need to know what happens to the $66k that can no longer logically be classified as an investment in a related company, because that company is now itself as it has amalgamated. Does the 66k also come off retained earnings? How do I amalgamate the retained earnings in 2019?
Thanks in advance for your help.
On the day immediately prior to the amalgamation (deemed year end date) Controlco was deemed to have disposed of its shares in Subco for Proceeds of Disposition equal to the following formula:
Proceeds of Disposition will be equal the greater of 1 or 2
1 is equal to the lesser of
- PUC of the Subco shares (presumably $3.00)
- The tax cost of Subco’s Net Assets
2 is equal to Controlco’s ACB of the Subco shares (presumably $66,000)
Upon amalgamation it is possible for Controlco to have incurred a taxable Capital Gain if the Tax Cost of Subco’s Net Assets was more than 66,000 at that time. Otherwise, a capital loss can not be created as the Proceeds of Disposition will be equal to 2 above (ACB of the Subco shares held by Controlco).
Thanks for the response!
I did come across this in my research but wasn’t sure what to do with it.
Net assets received are less than ACB of Subco shares (about $13k), so the disposition must then be 66k.
The resulting question occurs though… With the 66k investment wiped off only the asset side of the S100, it no longer balances. What’s the next step in regards to balancing the balance sheet?
In my head it makes sense to write down retained earnings or something by 66k, as the cost of the investment essentially has disappeared. But what’s the correct way?
There is a paragraph 88(1)(d) asset bump available if Controlco owned 100% of Subco and Subco owned non-depreciable assets. This bump up is to account for the fact that Controlco spent after tax dollars to acquire the shares of Subco, but since the assets get transferred at “tax cost” upon amalgamation the excess that Controlco paid for the Subco shares would be lost on the amalgamation.
The bump allows the ACB of non-depreciable assets to be increased based on the following formula;
The bump is equal to the Lesser of A or B:
- A equals the ACB of the the Subco shares ($66k) minus the tax values of Net Asset of Subco on date of amalgamation minus any dividends paid by Subco to Controlco (including capital dividends) during the time it held those shares.
- B equals Fair Market Value of Subco’s non-depreciable property minus the ACB of Subco’s non-depreciable property at the time Parentco acquired control of Controlco.
I expect any difference in the $66k over the tax cost of the assets of Subco ($13k) that can’t be bumped with an increase to non-depreciable property will just get lost into retained earnings. Normally the journal entry would have been Credit Investment in Controlco and Debit Share Capital, however share capital is likely considerably less than $66k.
I suppose this leads to the question of what did the $66,000 buy back in 2014?
Subco did not own any non-depreciable assets at the time of amalgamation, so I don’t believe a bump up applies here, but thank you for the thought.
There were intercompany dividends paid out, $85k over the the following couple of years from Subco to Controlco. I imagine that’s what Controlco was buying with the $66k in 2014, though I don’t have access to Subco’s books, and Controlco’s books are… interesting, to say the least. Do the dividends change anything for the 2019 return?
What I believe you’re saying is that since there’s no capital gain on the Subco shares and no non-depreciable asset bump-up to perform, is that to balance S100 I would reduce Retained Earnings of Controlco after the amalgamation. Please correct me if I’ve misunderstood.
Again, thank you very much for the response, it’s very helpful.
I don’t like posting anything directly to Retained Earnings.
If I was preparing an accounting journal entry as part of the amalgtamation, it may look similar to:
Various Assets of Controlco at tax cost: 13,000 Debit
Loss on Disposal of Investment: $52,997 Debit
Share Capital: $3 Debit
Investment in Sub: $66,000 Credit
On the Schedule 1 the 52,997 would be added back to income (cancelling that loss on the financial statements) but the schedule 6 would show Proceeds of 66k and ACB of 66k for no gain or loss. Therefore there would be no adjustment for a loss on the Schedule 1 or on the Capital losses carried forward.
The proceeds of disposition aT the minimum CAN NOT BE less than the tax cost of Subco’s Net Assets. So how did you account for those proceeds? The entire process should have been completed by the accountant incharge of the amalgamation. I genuinely hope this is not a Consolidation Accounting course assignment you are asking. @snoplowguy just gave you a very detailed answer.
I appreciate your concern, @solutions2f, but it’s not for any course assignment. I’ve been struggling thinking through this for weeks and I noticed the “ProTax Community” button at the top of TaxCycle so came here looking for help. I agree, @snoplowguy has been extremely helpful and I’m very grateful. I also agree that the entire process should have been done by the previous accountant, but whoever that was unfortunately didn’t do it right.
Thanks for looking out for the community.
While I realize it isn’t really your problem… it is still something worth mentioning.
Controlco may have had some potential subsection 55(2) issues with the payment of $85k in intercompany dividends (paid after April 20, 2015) if these were treated as tax free dividends between connected corporations. It would seem (based on the fact there is only 13K worth of assets left) that at some point Subco may have run out of Safe Income on Hand and at least a portion of the $85k in dividends could have been considered capital gains stripping? Subsection 55(2) serves to re-characterize tax free dividends received from connected corporations into taxable capital gains if the payments fail the purpose test.
Maybe nothing to worry about, but still shows how much fun tax can be.