Maximizing Tax Savings for Family-Owned Businesses: Understanding the 88(1)(d) Bump

Navigating the complexities of tax laws can feel overwhelming, but what if there was a way to save your family business from unnecessary tax burdens during a restructuring or transfer? Enter the 88(1)(d) bump—a key provision in the Income Tax Act that offers a smart, tax-efficient solution for businesses. If you’re part of a family-owned enterprise planning for the future, this strategy could be your ticket to significant tax savings when passing your business down to the next generation.

Section 88(1)(d) of the Income Tax Act allows companies to increase the tax cost, or adjusted cost base (ACB), of certain capital property when winding up a subsidiary. Known as the “bump,” this provision can minimize capital gains taxes on appreciated assets, making it a vital tool during corporate reorganizations or intergenerational transfers. For family-owned businesses, which often hold valuable assets like real estate or shares in other companies, using the bump effectively can protect the wealth you’ve worked so hard to build.

At Shajani CPA, we specialize in guiding family-owned businesses through tax-efficient strategies like the 88(1)(d) bump. With our expertise, we help clients ensure that their corporate transactions are structured to maximize tax savings while keeping compliance top of mind. Let us show you how to make the most of the bump to safeguard your business’s financial future.

 

What is the 88(1)(d) Bump?

Definition and Context of the Bump

The 88(1)(d) bump refers to a provision in the Income Tax Act (ITA) that allows a corporate parent to increase the adjusted cost base (ACB) of certain capital properties when winding up a subsidiary corporation into the parent. This provision is a crucial tax planning tool designed to avoid double taxation and facilitate tax-efficient corporate reorganizations, amalgamations, and wind-ups.

In Canadian tax law, Section 88(1)(d) applies when a corporate parent acquires control of a subsidiary and subsequently winds up that subsidiary. It allows the parent to “bump” the tax cost of certain non-depreciable capital properties, such as real estate or shares in other corporations, to their fair market value (FMV) at the time the parent last acquired control of the subsidiary. This increase in cost base mitigates the risk of double taxation, which would otherwise occur if the parent sold the subsidiary’s assets at a gain.

The 88(1)(d) bump forms part of the broader set of corporate reorganization rules that allow for a smooth and tax-efficient transition of property between related corporations. By using the bump, corporations can adjust the ACB of assets to reflect their fair market value, reducing or eliminating the gain that would be realized on a future disposition of those assets. This is particularly valuable for corporate groups, such as family-owned enterprises, which often undertake reorganizations to transfer ownership between generations or to prepare for the sale of business assets.

The Bump as a Tax Planning Tool in Corporate Reorganizations

The 88(1)(d) bump is a powerful tool for tax planning in the context of corporate reorganizations. It provides a means for the parent company to increase the cost base of the subsidiary’s capital property, which would otherwise carry forward the subsidiary’s lower ACB into the hands of the parent. By increasing the cost base, the parent corporation can reduce or eliminate future capital gains tax liabilities on the subsequent disposition of those properties.

The bump is particularly useful in situations where the parent company plans to sell assets of the subsidiary following the wind-up or amalgamation. In such cases, if the bump is applied, the parent is taxed only on the gain that occurs after the bump, rather than on the entire appreciation of the asset from the time it was initially acquired by the subsidiary. This provides significant tax savings and allows for a more efficient allocation of resources during reorganizations.

For example, suppose Parent Co acquires Sub Co and subsequently winds it up. Sub Co owns a piece of real estate with a low ACB of $100,000, but its FMV at the time Parent Co acquired control was $500,000. Without the bump, Parent Co would inherit Sub Co’s ACB of $100,000. If Parent Co sold the real estate for $500,000, it would realize a capital gain of $400,000, resulting in a substantial tax liability. However, if Parent Co applies the 88(1)(d) bump, it can increase the ACB of the real estate to its FMV of $500,000. This eliminates the capital gain on a future sale, as the proceeds would equal the new ACB.

This mechanism becomes even more critical in the context of family-owned enterprises, where assets such as real estate or shares in other corporations often appreciate significantly over time. The 88(1)(d) bump allows these businesses to transfer such assets to the next generation or to a new corporate structure without incurring unnecessary tax liabilities, making it a vital element of long-term tax planning.

Application of the Bump in Winding Up Subsidiaries

The 88(1)(d) bump applies when a corporate parent winds up a subsidiary under certain conditions outlined in the ITA. Specifically, paragraph 88(1)(d) allows for an increase in the tax cost of “eligible capital property” owned by the subsidiary, provided that the following conditions are met:

1. Control of the Subsidiary: The parent must acquire control of the subsidiary. The ITA defines control as owning more than 50% of the voting shares of the subsidiary corporation.
2. Winding Up: The subsidiary must be wound up into the parent. During the winding-up process, the assets of the subsidiary are transferred to the parent, and the subsidiary ceases to exist as a separate legal entity.
3. Eligible Property: The bump applies only to certain types of capital property, referred to as “eligible property.” Under 88(1)(d), eligible property generally includes non-depreciable capital property, such as real estate or shares in other corporations. Ineligible property, such as depreciable assets and inventory, cannot be bumped.
4. Ownership Continuity: The eligible property must have been owned continuously by the subsidiary from the time the parent acquired control until the winding up is completed. Any property acquired after the acquisition of control or disposed of before the wind-up is not eligible for the bump.
5. Fair Market Value Limitation: The bump cannot exceed the FMV of the property at the time the parent acquired control of the subsidiary. The tax cost of the eligible property can be increased only to its FMV at the time control was acquired, not to any appreciation that occurred afterward.
6. Anti-Avoidance Rules: Several anti-avoidance provisions apply to ensure that the bump is not abused. For example, the bump is denied if any “prohibited persons” acquire the property during or after the winding-up process. Prohibited persons typically include related parties or parties that have an economic interest in the parent corporation.

When the conditions are met, the parent corporation can effectively “step up” the tax cost of the eligible property. This is done by adding the amount of the bump to the historic cost of the property. The result is that the parent inherits the property with a higher ACB, reducing or eliminating the capital gain on any future sale of the property.

Example of the Bump in Practice

Consider the following example to illustrate the practical application of the 88(1)(d) bump. Parent Co acquires control of Sub Co, a subsidiary that owns a piece of land. At the time of the acquisition, the land has an ACB of $200,000 but an FMV of $1,000,000. Parent Co decides to wind up Sub Co into itself and applies the 88(1)(d) bump to the land. As a result, the ACB of the land is increased from $200,000 to $1,000,000.

Later, ParentCo sells the land for $1,200,000. Because the ACB of the land has been bumped to $1,000,000, Parent Co realizes a capital gain of only $200,000, rather than $1,000,000. This significantly reduces the tax liability that would have otherwise arisen from the sale.

Key Tax Provisions Related to the Bump

The bump is governed primarily by Section 88(1)(d) of the Income Tax Act, but other subsections and related provisions play a role in determining its application and limitations:

• Section 88(1)(c): This section lays out the default rule that the parent inherits the historic cost of the subsidiary’s capital property unless the bump is applied.
• Section 88(1)(d): Specifies the conditions under which the bump can be applied and the types of property eligible for the bump.
• Anti-Avoidance Provisions: Several anti-avoidance rules, such as those outlined in Section 88(1)(c.3) and 88(1)(d.2), prevent the bump from being used inappropriately, such as in self-dealing transactions or where prohibited persons acquire the property.

The Role of the Bump in Succession Planning for Family-Owned Enterprises

For family-owned enterprises in Canada, succession planning often involves transferring ownership of assets to the next generation or restructuring the business to maximize tax efficiency. The 88(1)(d) bump is a key tool in this process, as it allows businesses to increase the tax cost of valuable assets, such as real estate, shares in other corporations, or intellectual property. This can significantly reduce the tax burden on future sales or transfers, making it easier to pass the business on to future generations without incurring unnecessary tax liabilities.

By using the bump, family businesses can preserve wealth and ensure that the value of their assets is not eroded by taxes. This is particularly important for businesses with significant capital property that has appreciated over time. Without the bump, the transfer of these assets could result in substantial tax liabilities, making it more difficult to maintain the business as a going concern.

In conclusion, the 88(1)(d) bump is an essential tool for tax-efficient corporate reorganizations, particularly for family-owned enterprises. By allowing the parent corporation to increase the cost base of capital property, it facilitates the transfer of assets in a way that minimizes tax liabilities and preserves wealth for future generations. For businesses looking to undertake a wind-up, amalgamation, or other reorganization, understanding and utilizing the 88(1)(d) bump can be a critical component of long-term tax planning.

 

When Does the 88(1)(d) Bump Apply?

The 88(1)(d) bump is a key tax provision in the Income Tax Act (ITA) that enables a corporate parent to increase the adjusted cost base (ACB) of certain capital properties upon the wind-up of a subsidiary, during corporate amalgamations, or in specific reorganization scenarios. This tool is crucial in facilitating tax-efficient transactions, reducing future tax liabilities, and maximizing wealth preservation. Timing, eligibility, and strategic application are essential for fully leveraging this provision, particularly for family-owned enterprises where succession planning and intergenerational wealth transfer are key concerns.

Winding Up a Subsidiary into Its Parent

One of the most common uses of the 88(1)(d) bump is during the winding-up of a subsidiary into its parent corporation. In this situation, the bump allows the parent to increase the tax cost of the subsidiary’s non-depreciable capital property, such as real estate or shares, to its fair market value (FMV) at the time the parent acquired control of the subsidiary.

Winding-Up Process and Conditions The winding-up of a subsidiary typically occurs when the parent corporation decides to consolidate operations, simplify its structure, or prepare for the sale of assets. In this process, the subsidiary’s assets are transferred to the parent, and the subsidiary ceases to exist as a separate legal entity.

Without the bump, the parent would inherit the subsidiary’s ACB for the transferred property, which is often significantly lower than its current market value. This would lead to a substantial capital gain if the parent later sold the property. By applying the 88(1)(d) bump, the parent can increase the ACB of the transferred property to its FMV, thereby reducing or eliminating any capital gains on a future sale.

Timing of the Wind-Up Timing is a crucial factor when applying the 88(1)(d) bump. The bump applies to properties owned continuously by the subsidiary from the time the parent acquired control until the time of the wind-up. According to Section 88(1)(d)(ii) of the Income Tax Act, the bump can be applied even if the wind-up occurs several years after the acquisition, provided that:

1. Control of the Subsidiary is Maintained: The parent corporation must have acquired control of the subsidiary, typically defined as owning more than 50% of the voting shares. The wind-up does not need to happen immediately after the acquisition of control. However, the subsidiary must retain continuous ownership of the eligible capital property from the time control was acquired until the wind-up.
2. Eligible Property: Only specific non-depreciable capital property qualifies for the bump, including real estate and shares in other corporations. Depreciable assets, such as equipment, or inventory, are ineligible for the bump. The bump can be applied at any point in time, as long as these assets have been owned by the subsidiary continuously since the acquisition of control.
3. Ownership Continuity: For the bump to apply, the property in question must have been owned continuously by the subsidiary from the moment the parent corporation acquired control until the wind-up. If the subsidiary disposes of the property after the acquisition of control but before the wind-up, the property is not eligible for the bump. However, if the property has been held continuously, the wind-up can be delayed, and the bump can still be applied, even if the wind-up occurs years after the acquisition.
4. Practical Considerations on Timing: While the ITA does not impose a strict timeline on when the wind-up must occur following the acquisition of control, businesses should consider practical factors such as:
   • Changes in the FMV of the subsidiary’s property.
   • Future plans for selling or transferring the subsidiary’s assets.
   • Potential tax policy changes or business objectives that might influence the timing of the wind-up.

Given these considerations, while it is possible to delay the wind-up, businesses must carefully manage the timing to ensure that the subsidiary continues to own eligible property and that the bump remains applicable. Delaying the wind-up for an extended period may also expose the business to market fluctuations or tax rule changes that could affect the value of the bump.

Example: Delayed Wind-Up Imagine that Parent Co acquires control of Sub Co in 2018, and Sub Co owns a parcel of land with an ACB of $200,000. At the time of acquisition, the FMV of the land is $1,000,000. Parent Co initially decides not to wind up Sub Co, preferring to maintain Sub Co as a separate entity for operational reasons. Five years later, in 2023, Parent Co winds up Sub Co and applies the 88(1)(d) bump. As long as Sub Co has continuously owned the land since 2018, Parent Co can increase the ACB of the land to $1,000,000, eliminating the capital gain on a future sale.

This delayed wind-up allows Parent Co to continue operating Sub Co without losing the ability to apply the bump, demonstrating the flexibility of the 88(1)(d) provision.

Corporate Amalgamations and Internal Reorganizations

The 88(1)(d) bump is also applicable during corporate amalgamations and internal reorganizations, where businesses seek to streamline their operations, optimize their structure, or prepare for a sale. These transactions often involve transferring assets within a corporate group, and the bump can be used to step up the tax cost of eligible capital property, reducing the potential for future capital gains taxes.

Amalgamations An amalgamation occurs when two or more corporations merge to form a new entity. When a parent corporation amalgamates with a subsidiary, the new amalgamated entity inherits the assets of both predecessor corporations. The bump can be applied to eligible capital property, such as shares or real estate, held by the subsidiary.

Similar to a wind-up, the amalgamated corporation can increase the ACB of these assets to their FMV at the time the parent acquired control of the subsidiary. The bump prevents the amalgamated corporation from inheriting the subsidiary’s low ACB, which would result in higher tax liabilities on a future sale of the assets.

Timing Considerations for Amalgamations In an amalgamation, the timing rules for applying the bump are similar to those for a wind-up. The amalgamation can occur years after the acquisition of control, provided the subsidiary has continuously owned the eligible property during that time. This flexibility allows businesses to plan their amalgamations strategically, ensuring that they can apply the bump when it provides the most tax benefit.

For example, if Parent Co amalgamates with Sub Co in 2023 but acquired control of Sub Co in 2018, the bump can still be applied to Sub Co’s capital property as long as the property was owned continuously since 2018.

Internal Reorganizations Internal reorganizations often involve the transfer of assets between related corporations within a corporate group. Family-owned enterprises frequently use internal reorganizations to streamline ownership structures, prepare for succession, or plan for future asset sales. The 88(1)(d) bump can be applied in these situations to step up the tax cost of eligible property, allowing the assets to be transferred at their FMV without triggering capital gains taxes.

Real-World Application: Family-Owned Businesses and Succession Planning For family-owned enterprises, the timing of applying the bump is particularly important when planning intergenerational transfers. Succession planning often involves restructuring the business to transfer assets from one generation to the next or between related entities, while minimizing tax exposure. The bump allows the family to increase the ACB of valuable assets, such as real estate or shares, to their FMV, reducing the capital gains taxes that would otherwise be incurred on a future sale.

In practice, many family-owned businesses choose to delay the wind-up or amalgamation of subsidiaries until it aligns with the family’s broader succession plans or other business objectives. As long as the subsidiary has continuously owned the eligible property and the other conditions are met, the family can apply the bump even if the wind-up occurs years after the acquisition of control.

Example: Succession Planning in a Family-Owned Business Consider a family-owned business, Shaheena Enterprises, that operates several subsidiaries, including Shaheena Furniture Co, which owns a factory and office building. The parents, who own the business, want to transfer ownership to their children in the next five years. The factory and office building have appreciated significantly, with an ACB of $500,000 but an FMV of $2,000,000. Rather than transferring the business now, the parents choose to delay the transfer until their children are ready to take over.

During this time, the business owners can apply the 88(1)(d) bump during a future wind-up or amalgamation to increase the ACB of the factory and office building to $2,000,000. This eliminates the capital gain that would otherwise be realized upon transfer or sale, ensuring that the children can inherit the business without a significant tax liability.

Conclusion

The 88(1)(d) bump is a highly flexible and valuable tool for corporate groups, especially for family-owned enterprises, seeking to minimize tax liabilities during wind-ups, amalgamations, and internal reorganizations. The timing of the wind-up or amalgamation does not need to be immediate following the acquisition of control. As long as the eligible property has been continuously owned since the acquisition, businesses can strategically plan the timing of these transactions to align with their long-term goals.

Whether used for corporate restructuring, succession planning, or preparing for the sale of business assets, the 88(1)(d) bump provides a powerful mechanism for preserving wealth and reducing tax exposure. By understanding the rules and timing considerations, businesses can make informed decisions to maximize the benefits of this provision.

 

Key Conditions for the 88(1)(d) Bump

The 88(1)(d) bump is a provision in the Income Tax Act (ITA) designed to offer tax relief by allowing a parent corporation to increase the adjusted cost base (ACB) of certain non-depreciable capital properties when winding up a subsidiary. The bump is a highly beneficial tool in corporate reorganizations, especially for family-owned enterprises that wish to facilitate tax-efficient transfers of wealth and assets. However, to take advantage of this provision, specific conditions must be met. This section provides a detailed analysis of the key conditions required to apply the 88(1)(d) bump.

1. Parent Company Must Acquire Control of the Subsidiary

A fundamental condition for applying the 88(1)(d) bump is that the parent company must acquire control of the subsidiary. The acquisition of control is a triggering event that allows the parent to later apply the bump when the subsidiary is wound up.

Definition of Control Under the Income Tax Act, “control” generally means ownership of more than 50% of the voting shares of a corporation. This is defined in Section 88(1)(d)(ii), which states that for a parent company to be eligible for the bump, it must have acquired control of the subsidiary in a legitimate transaction, such as a purchase of shares, an amalgamation, or other corporate reorganization.

It is important to note that control is defined as de jure control, which refers to legal control established by owning the majority of voting shares, as opposed to de facto control, which involves influence over the subsidiary’s management and decisions. The acquisition of voting control is essential to qualify for the bump.

Timing of Acquisition of Control The timing of the acquisition of control is also significant. The bump applies to capital property that the subsidiary owned at the time the parent acquired control and continues to own until the wind-up. For the bump to be effective, the property must have been continuously owned by the subsidiary from the time of control acquisition to the time of its distribution upon the subsidiary’s wind-up. This ensures that the bump applies only to property that was part of the subsidiary’s assets at the time of the parent’s acquisition of control.

For example, if ParentCo acquires control of SubCo on January 1, 2022, only the capital property owned by Sub Co as of January 1, 2022, is eligible for the bump. Any property acquired by SubCo after that date would not qualify for the bump under 88(1)(d).

Acquisition of Control Through Corporate Reorganizations The acquisition of control can occur in various ways, including:

• Share Purchases: The most common way a parent acquires control of a subsidiary is by purchasing a majority of its voting shares. This is often seen in corporate takeovers or acquisitions, where the parent company buys a controlling interest in the subsidiary.
• Amalgamations: In some cases, control is acquired through amalgamation. When two or more corporations merge to form a new entity, the resulting corporation may acquire control of a subsidiary in the process. If the amalgamation leads to the parent acquiring control of the subsidiary, the 88(1)(d) bump can apply to capital property owned by the subsidiary.
• Internal Reorganizations: For family-owned businesses, the acquisition of control might occur as part of an internal reorganization, where a holding company is established to own shares of operating subsidiaries. In such cases, provided that control is acquired legally and that other conditions are met, the bump can be applied to eligible capital property during the wind-up of the subsidiary.

2. The Subsidiary’s Capital Property Must Be Owned Continuously from Acquisition to Distribution

Another key condition for applying the 88(1)(d) bump is that the subsidiary must have continuously owned the eligible capital property from the time the parent acquired control until the wind-up. This condition ensures that only the capital property present at the time of control acquisition benefits from the bump, preventing taxpayers from acquiring new assets after the fact and trying to apply the bump to them.

Continuous Ownership Requirement Under Section 88(1)(d)(ii), the capital property of the subsidiary must be continuously owned from the time the parent acquired control until the property is distributed to the parent during the wind-up. If the subsidiary disposes of the property at any time after the acquisition of control but before the wind-up, that property becomes ineligible for the bump. The requirement for continuous ownership prevents tax avoidance practices such as transferring new assets into the subsidiary after the acquisition of control to take advantage of the bump.

For example, if Parent Co acquires control of Sub Co on January 1, 2022, and Sub Co owns a piece of real estate at that time, that real estate must remain in Sub Co’s ownership from January 1, 2022, until the wind-up to qualify for the bump. If Sub Co sells the property before the wind-up, the bump cannot be applied.

Eligible Capital Property The 88(1)(d) bump applies only to specific types of capital property, referred to as “eligible property” under the ITA. Eligible capital property generally includes:

• Non-depreciable real estate (land).
• Shares in other corporations that are capital property.
• Certain intangible assets such as goodwill (if classified as capital property).

It is important to note that depreciable assets, such as buildings or equipment, and other types of property like inventory or financial instruments, are not eligible for the bump. The bump applies only to capital property that has the potential for significant appreciation over time and which, if sold, would trigger a capital gain.

Capital Property Owned Prior to Acquisition of Control The bump is available only for capital property that was owned by the subsidiary at the time the parent acquired control. If the subsidiary acquires new capital property after the parent gains control, that property does not qualify for the bump. This is consistent with the underlying rationale of the bump, which is to prevent double taxation on pre-existing capital gains, not to provide tax benefits on newly acquired assets.

Timing Considerations Timing is crucial when considering the bump’s application. The property must remain in the subsidiary’s hands throughout the period of control, and the bump is applied at the time of the subsidiary’s wind-up. In practice, businesses may delay the wind-up to allow assets to appreciate further, but they must ensure that the capital property remains continuously owned by the subsidiary during that time.

3. Prohibition of Bumping Certain Ineligible Properties

A crucial limitation on the 88(1)(d) bump is that it applies only to certain types of property, and specific categories of property are explicitly ineligible for the bump. The purpose of this restriction is to prevent abuse of the provision by ensuring that only non-depreciable capital property, which carries the risk of double taxation, is eligible for the bump.

Ineligible Property The following types of property are ineligible for the bump under Section 88(1)(d):

1. Depreciable Property: Depreciable property, such as buildings, machinery, and equipment, cannot benefit from the bump. This is because depreciable property already benefits from capital cost allowance (CCA) deductions, which reduce the taxpayer’s income over time. Allowing a bump for depreciable property would effectively give the taxpayer a double tax benefit—once through CCA deductions and again by increasing the ACB. As such, the ITA specifically excludes depreciable property from eligibility.
2. Inventory: Property that is classified as inventory, such as goods held for resale, is not eligible for the bump. Inventory is not capital property and is typically taxed as business income when sold, so it does not fall under the capital gains tax regime that the bump is designed to address.
3. Financial Instruments and Short-Term Assets: Financial instruments, such as bonds, derivatives, and other similar securities, are generally excluded from the bump. These assets tend to have short-term value fluctuations and are not considered capital property under the ITA. Similarly, cash, receivables, and other short-term assets do not qualify for the bump.
4. Substituted Property and Anti-Avoidance Rules: The 88(1)(d) bump is also restricted by anti-avoidance provisions designed to prevent taxpayers from using the bump inappropriately. For example, the bump is denied if any prohibited persons acquire the subsidiary’s property as part of the transaction or if the property is substituted for other property that would not qualify for the bump. This prevents the bump from being used as a tool for tax avoidance, such as transferring assets to related parties in a way that avoids immediate tax consequences.

Example of Ineligible Property Consider a scenario where Parent Co acquires control of Sub Co, which owns both land and equipment. The land is non-depreciable capital property, while the equipment is depreciable property. When Parent Co winds up Sub Co, it can apply the 88(1)(d) bump to the land but not to the equipment. The equipment is ineligible because it is depreciable property and has already benefitted from capital cost allowance deductions.

Conclusion

The 88(1)(d) bump is an essential tool for tax-efficient corporate reorganizations, particularly in the context of family-owned enterprises and intergenerational transfers. However, to take full advantage of this provision, businesses must carefully adhere to the key conditions outlined in the Income Tax Act. These include acquiring control of the subsidiary, ensuring continuous ownership of eligible capital property, and avoiding the application of the bump to ineligible property. By understanding and following these rules, businesses can maximize the tax benefits of the bump while avoiding potential pitfalls and ensuring compliance with Canadian tax law.

 

Prohibited Persons and Substituted Property: Navigating the Pitfalls of Section 88(1)(d)

The 88(1)(d) bump is a powerful tax-planning tool within the Income Tax Act (ITA), but it is subject to strict anti-avoidance rules to prevent taxpayers from exploiting it for improper tax deferral or avoidance. These rules are designed to ensure that the bump is used only in legitimate corporate reorganizations and that any attempt to transfer assets to related or “prohibited persons” is curtailed. This section explains the key anti-avoidance provisions, the concept of prohibited persons, and how substituted property rules operate, along with common mistakes businesses encounter when navigating these rules.

Anti-Avoidance Provisions of Section 88(1)(d)

The bump rules under Section 88(1)(d) are part of a broader anti-avoidance framework that prevents taxpayers from using reorganizations to avoid tax on appreciated capital property. Specifically, the anti-avoidance provisions prevent what is commonly referred to as “surplus stripping,” where taxpayers attempt to extract accumulated surplus from a corporation without paying the appropriate taxes.

The purpose of these anti-avoidance rules is to ensure that the 88(1)(d) bump is not used to transfer the economic benefit of appreciated property in a tax-deferred manner to parties who should be subject to tax. In other words, the bump allows for an increase in the adjusted cost base (ACB) of capital property under certain conditions, but the tax system imposes safeguards to prevent abuses, such as avoiding capital gains tax or using the bump to facilitate indirect ownership transfers to related parties.

The main anti-avoidance provisions are contained in Section 88(1)(c.3) and 88(1)(d.2), which impose restrictions on who can benefit from the bump and the types of property that can be involved. These provisions aim to prevent a “backdoor purchase butterfly” transaction, where appreciated property is moved tax-free to related persons or substituted with other property that is more favorable for tax purposes.

Who Are Prohibited Persons?

One of the key anti-avoidance mechanisms under Section 88(1)(d) is the concept of “prohibited persons.” These are individuals or entities that are not allowed to benefit from the bump. The rules are designed to prevent a parent corporation from using the bump to transfer appreciated assets to a related person or entity in a tax-deferred manner. The presence of a prohibited person in a transaction can deny the bump entirely, making it essential for businesses to understand and identify these individuals or entities.

Definition of Prohibited Persons A “prohibited person” is broadly defined in the ITA as someone or an entity that is related to or affiliated with the parent or subsidiary corporation involved in the reorganization. These can include:

• Shareholders or persons who, after the wind-up or amalgamation, have significant ownership in either the parent or subsidiary.
• Parties related to the parent corporation, such as family members, holding companies, or trusts.
• Entities in which the parent or its shareholders have an indirect interest or influence.

The underlying principle is that prohibited persons are those who have a vested interest in the parent or subsidiary, or who would benefit indirectly from the transfer of property that has been “bumped” under Section 88(1)(d). By preventing these individuals or entities from acquiring bumped property, the anti-avoidance rules seek to ensure that the bump is used only in arms-length transactions, not for self-dealing.

Prohibited Persons and Ownership Changes Ownership changes involving prohibited persons after the bump can also trigger issues. For example, if a related party, such as a shareholder of the parent company, acquires property that was bumped, the bump is denied. This is because the anti-avoidance rules aim to prevent scenarios where related parties could use corporate reorganizations to avoid realizing capital gains on appreciated property.

Substituted Property Rules

In addition to the prohibited persons rules, the 88(1)(d) bump is subject to strict rules regarding substituted property. These rules are designed to prevent taxpayers from substituting the bumped property with other property in a way that defers or avoids taxes. Substituted property rules prevent taxpayers from engaging in transactions where they exchange the bumped property for other assets that might be more tax-favorable but still allow them to retain the economic benefit of the original property.

Definition of Substituted Property Under the Income Tax Act, “substituted property” refers to any property that is acquired in exchange for the original property that was subject to the bump. The substituted property rules prevent taxpayers from swapping bumped property for new assets without triggering the appropriate tax consequences. The rules are particularly concerned with ensuring that taxpayers do not use the bump to defer capital gains indefinitely by continually swapping property through reorganizations.

For example, if a parent company winds up a subsidiary and applies the 88(1)(d) bump to increase the ACB of a piece of land, it cannot then exchange that land for shares or other assets without triggering tax consequences. The bump is designed to apply only to the original property, and any substitution or exchange will negate the bump.

Anti-Avoidance Provision for Substituted Property Section 88(1)(d.2) outlines the rules for substituted property, specifying that the bump is denied if any property acquired through a series of transactions is substituted for the bumped property. This provision prevents taxpayers from engaging in complex reorganization transactions where the underlying economic benefit of the bumped property is transferred to new property, but no tax is paid. The substituted property rules are designed to ensure that, eventually, capital gains tax is paid on the appreciation of the original property.

For example, a company may not apply the bump to a piece of land and then swap that land for shares in a related corporation without realizing the capital gain. If such a substitution occurs, the 88(1)(d) bump is denied, and the company must pay tax on the appreciation of the property.

Examples of Common Mistakes and Pitfalls in Self-Dealing

Given the complexity of the 88(1)(d) anti-avoidance rules, many businesses inadvertently fall into pitfalls when trying to apply the bump. Some common mistakes include misidentifying prohibited persons, engaging in self-dealing transactions, and inadvertently triggering the substituted property rules.

1. Transferring Property to Prohibited Persons One of the most common pitfalls is failing to identify prohibited persons in a transaction. For example, a business may wind up a subsidiary and apply the bump to certain real estate holdings, but then transfer those holdings to a related entity, such as a family trust or holding company owned by shareholders of the parent corporation. Because the trust or holding company is considered a prohibited person, the bump is denied, and the parent corporation may face significant tax liabilities.

This issue often arises in family-owned enterprises, where multiple related parties are involved in the ownership and management of the business. It is crucial for businesses to ensure that no prohibited person acquires bumped property, either directly or through a series of related transactions.

2. Failure to Recognize Substituted Property Another common mistake involves the substituted property rules. Many businesses engage in reorganizations where assets are swapped or transferred within the corporate group. If bumped property is exchanged for substituted property, such as shares or other assets, the bump is denied. This is particularly problematic in situations where businesses attempt to transfer assets between related entities as part of a tax planning strategy.

For example, a business might apply the bump to land owned by a subsidiary and then transfer that land to another subsidiary in exchange for shares. Because the land is considered substituted property in this transaction, the bump is denied, and the parent corporation must pay tax on the capital gain.

3. Backdoor Purchase Butterflies A “backdoor purchase butterfly” is another common mistake businesses make when applying the bump. In this scenario, a parent company acquires control of a subsidiary and applies the bump to certain property, but the property is then transferred to a related party in a manner that avoids immediate taxation. The anti-avoidance rules in Section 88(1)(d.2) prevent these types of transactions, ensuring that any capital gains on appreciated property are eventually subject to tax.

For instance, a parent company may apply the bump to real estate and then sell the real estate to a related holding company. This type of self-dealing transaction is viewed as a backdoor purchase butterfly, and the bump is denied.

Conclusion

The anti-avoidance rules governing the 88(1)(d) bump are essential for ensuring that the bump is applied appropriately and that taxpayers do not use it to avoid paying taxes on capital gains. These rules, including the concepts of prohibited persons and substituted property, are designed to prevent self-dealing and surplus stripping while ensuring that the bump is used in legitimate corporate reorganizations. By understanding these rules and avoiding common pitfalls, businesses can effectively apply the bump and achieve significant tax savings without running afoul of the Income Tax Act.

 

Real-Life Application: The Impact of the 88(1)(d) Bump on Family-Owned Enterprises

The 88(1)(d) bump provides a valuable tool for family-owned enterprises looking to optimize their corporate structures and ensure that assets are transferred or sold in the most tax-efficient manner. The bump allows for an increase in the adjusted cost base (ACB) of non-depreciable capital property when winding up a subsidiary into its parent, avoiding the double taxation that would otherwise occur when appreciated assets are sold. This case study of a family-owned enterprise demonstrates how the bump can be used effectively to transfer property without triggering immediate tax consequences, resulting in significant savings for the business.

Case Study: Navigating a Wind-Up or Amalgamation in a Family-Owned Enterprise

Let’s consider a family-owned enterprise, Shaheena Holdings, that owns multiple businesses, including companies involved in real estate and manufacturing. For simplicity, we’ll focus on Parent Co, the holding company, and its relationship with Subsidiary A and Subsidiary B, which owns significant real estate.

Initial Scenario

• Parent Co owns 100% of Subsidiary A, which in turn owns 50% of Subsidiary B. The other 50% of Subsidiary B is owned by a third-party investor.
• Subsidiary A initially acquired its shares in Subsidiary B for $50, giving it an ACB and paid-up capital (PUC) of $50. Subsidiary B’s primary asset is a commercial real estate property, purchased years earlier for $1 million.
• Over the years, the property has appreciated significantly, and by the time Parent Co acquires the remaining shares of Subsidiary B from the third-party investor, the property is worth $2 million.

Subsequent Acquisition

Some years later, Parent Co decides to purchase the remaining 50% of Subsidiary B’s shares from the third-party investor for $1 million. After this transaction, Parent Co owns 100% of Subsidiary B through its ownership of Subsidiary A.

At this point, the cost structure of Parent Co’s holdings looks like this:

• Inside cost of Subsidiary B’s shares: $1 million.
• Combined ACB of Subsidiary B’s shares: $1,000,050 ($50 original ACB plus $1 million for the recently acquired shares).
• Paid-up capital (PUC) of Subsidiary B: $100.

Subsidiary B’s real estate property, initially purchased for $1 million, is now worth $2 million. Parent Co is considering a reorganization of its holdings, potentially winding up Subsidiary B into Subsidiary A or Parent Co itself to consolidate the ownership structure. This is where the 88(1)(d) bump comes into play.

Applying the Bump: Does It Work Here?

The 88(1)(d) bump allows Parent Co to increase the ACB of Subsidiary B’s property (the real estate) to its fair market value (FMV) at the time Parent Co acquired control of Subsidiary B. The bump can be applied when Parent Co winds up Subsidiary B into itself or into Subsidiary A, provided the necessary conditions are met. Let’s walk through how the bump would work in this case.

Step 1: Acquisition of Control

Parent Co acquired control of Subsidiary B when it purchased the remaining 50% of the shares from the third-party investor for $1 million. Control is defined under Section 88(1)(d)(ii) as owning more than 50% of the voting shares, which Parent Co now does. Therefore, the bump becomes available as part of the winding-up process.

Step 2: Eligible Property

The property eligible for the bump includes non-depreciable capital property owned by Subsidiary B at the time Parent Co acquired control. In this case, Subsidiary B’s real estate property is the key asset eligible for the bump. Since the property is non-depreciable and has been owned by Subsidiary B continuously, it qualifies for the bump.

Step 3: Continuous Ownership

For the bump to apply, Subsidiary B must have continuously owned the real estate property from the time Parent Co acquired control until the time of the wind-up. Since the property was owned by Subsidiary B before and after the acquisition of control, this condition is satisfied.

Step 4: Bump Calculation

The 88(1)(d) bump allows Parent Co to increase the ACB of Subsidiary B’s property to its fair market value at the time of control acquisition. The property was worth $2 million when Parent Co purchased the remaining shares of Subsidiary B, so Parent Co can bump the ACB of the property from $1 million (its original cost) to $2 million.

This means that, when the property is eventually sold or transferred, Parent Co will only realize a capital gain on any appreciation beyond the $2 million FMV at the time of the bump, rather than from its original cost of $1 million. This results in substantial tax savings, as Parent Co effectively avoids being taxed on the $1 million appreciation that occurred before it acquired control of Subsidiary B.

Tax-Efficient Transfer of Property

By applying the bump, Parent Co achieves a tax-efficient transfer of Subsidiary B’s property without triggering immediate capital gains taxes. Without the bump, if Parent Co sold Subsidiary B’s property, it would face a capital gain of $1 million (the difference between the original $1 million cost and the $2 million FMV at the time of the sale). However, with the bump applied, the ACB of the property is increased to $2 million, meaning that no capital gain is realized if the property is sold for $2 million or less.

This tax efficiency is particularly important for family-owned enterprises that hold significant capital property, such as real estate, which tends to appreciate in value over time. The bump ensures that the business can reorganize its holdings, consolidate ownership, or transfer assets without incurring punitive tax liabilities.

Savings for the Business

The application of the 88(1)(d) bump in this scenario leads to substantial tax savings. Let’s break down the potential savings:

• Without the Bump: If Parent Co did not apply the bump and later sold Subsidiary B’s property for $2 million, it would realize a capital gain of $1 million (FMV of $2 million minus the original ACB of $1 million). Assuming a capital gains tax rate of 50% of the gain being taxable, Parent Co would face a taxable gain of $500,000. At a tax rate of 25%, this results in a tax liability of $125,000.
• With the Bump: By applying the bump, Parent Co increases the ACB of the property to $2 million, equal to its FMV. If Parent Co sells the property for $2 million, there is no capital gain, and therefore no tax liability. This results in a tax savings of $125,000.

For a family-owned enterprise, these savings are significant, especially when considering that the property in question may continue to appreciate over time. The bump allows the business to reallocate or liquidate assets without facing immediate tax consequences, preserving more wealth for future generations or for reinvestment in the business.

Winding Up or Amalgamation: Choosing the Right Strategy

In this case, Parent Co has the option to either wind up Subsidiary B into Subsidiary A or Parent Co itself, or to amalgamate the entities. Both strategies offer opportunities for tax efficiency, but the bump is most commonly applied during a wind-up.

• Winding Up: If Parent Co chooses to wind up Subsidiary B, it can apply the bump to increase the ACB of Subsidiary B’s real estate property to its FMV at the time of control acquisition. The property is then transferred to Parent Co (or Subsidiary A) at the bumped-up ACB, ensuring that future capital gains are minimized.
• Amalgamation: Alternatively, Parent Co could amalgamate Subsidiary B with Subsidiary A. In an amalgamation, the bump can still be applied, provided that the amalgamated entity inherits the eligible property (the real estate) and that the other conditions of the bump are met. The amalgamated entity would then hold the property at the bumped-up ACB.

Real-World Considerations for Family-Owned Enterprises

The 88(1)(d) bump is particularly valuable for family-owned enterprises where ownership structures are often complex, and assets such as real estate are held for long periods, accumulating significant appreciation. By applying the bump, businesses can ensure that they do not face a substantial tax liability when reorganizing or transferring assets. This allows for smoother intergenerational transfers of wealth, greater flexibility in structuring the business, and more opportunities for reinvestment.

In the case of Shaheena Holdings, applying the bump to Subsidiary B’s real estate property allows the family to consolidate ownership and eventually transfer the property without incurring a large capital gains tax bill. The savings realized through the bump provide more capital for the business to reinvest in growth opportunities or to support future generations of ownership.

Conclusion

The 88(1)(d) bump offers significant tax advantages for family-owned enterprises, allowing for the tax-efficient transfer of appreciated capital property during wind-ups or amalgamations. In the case of ParentCo’s acquisition of Subsidiary B, the bump ensures that the appreciation in Subsidiary B’s property is not subject to double taxation, resulting in substantial tax savings for the business. By applying the bump strategically, family-owned enterprises can optimize their corporate structures, preserve wealth, and minimize the tax burden on future sales or transfers of property.

 

The Bump-Denial Rule: Avoiding Anti-Avoidance Traps

The 88(1)(d) bump in the Income Tax Act (ITA) is a highly valuable tax-planning tool, allowing companies to increase the adjusted cost base (ACB) of certain capital properties when winding up a subsidiary into its parent. However, like many tax provisions, it is accompanied by stringent anti-avoidance rules to prevent abuse. One such provision is the bump-denial rule, which is designed to ensure that taxpayers do not misuse the bump to avoid paying taxes on appreciated property in ways that violate the intent of the law. This section explains the bump-denial rule, explores how it applies in cases of self-dealing or backdoor transactions, and provides practical tips on avoiding the pitfalls that can trigger bump denial.

What is the Bump-Denial Rule?

The bump-denial rule is an anti-avoidance measure in the Income Tax Act, specifically targeted at preventing tax strategies that use the 88(1)(d) bump inappropriately. The intent of the bump provision is to allow the parent corporation to avoid double taxation on appreciated property by increasing the ACB of the property to its fair market value (FMV) at the time of acquisition of control. However, the bump-denial rule comes into play to prevent taxpayers from using the bump as a way to transfer ownership of property to related or affiliated parties without triggering tax consequences, which would effectively result in tax deferral or avoidance.

The bump-denial rule is codified in Section 88(1)(c.3) and 88(1)(d.2) of the ITA. These provisions prevent a corporation from applying the bump to certain capital property if, as part of the overall series of transactions that includes the winding-up or amalgamation, any “prohibited persons” acquire the property or any substituted property.

How the Bump is Denied: Self-Dealing and Backdoor Transactions

The bump-denial rule is designed to address two main forms of tax avoidance: self-dealing and backdoor transactions. These strategies typically involve shifting the economic benefits of appreciated property within related parties or to individuals who are in a position to avoid taxation. Below, we explore these forms of transactions in detail and explain how the bump-denial rule operates to prevent them.

Self-Dealing

Self-dealing occurs when a taxpayer attempts to use the bump to transfer property to a related person or entity without paying the appropriate taxes. This is considered an abuse of the bump provision because it allows taxpayers to extract value from appreciated assets without realizing capital gains.

Under Section 88(1)(c.3), the bump is denied if, as part of the series of transactions that includes the winding-up or amalgamation, a “prohibited person” acquires the property. A prohibited person is defined broadly in the ITA as any person who is related to the parent corporation or its shareholders. This could include:

• Family members of the shareholders of the parent corporation.
• A trust in which the shareholders or their family members have a beneficial interest.
• A holding company that is owned or controlled by related persons.

In the context of self-dealing, the anti-avoidance rule is meant to prevent situations where the parent corporation uses the bump to transfer property to a prohibited person, such as a family member or a related trust, without triggering capital gains tax.

For example, consider a scenario where ParentCo winds up its subsidiary, SubCo, and applies the bump to a piece of real estate owned by SubCo. If the real estate is subsequently transferred to a holding company owned by the shareholders of ParentCo or their family members, the bump would be denied because the holding company is a prohibited person. This ensures that the shareholders or their family members cannot benefit from the appreciated value of the property without paying taxes on the capital gains.

Backdoor Transactions (Butterfly Transactions)

Another form of tax avoidance that the bump-denial rule seeks to prevent is backdoor transactions, often referred to as “purchase butterfly transactions.” These involve the transfer of property to related persons or entities through complex corporate reorganizations that effectively result in the tax-free extraction of value.

A purchase butterfly transaction typically involves the acquisition of control of a corporation, followed by a series of steps where property is transferred to related persons or entities in a way that allows them to benefit from the appreciated value without realizing capital gains. The anti-avoidance provisions in Section 88(1)(d.2) prevent this type of transaction by denying the bump if the property is transferred to a “prohibited person” or if the property is substituted for another asset that would not be eligible for the bump.

For example, suppose ParentCo acquires SubCo, which owns shares in another corporation. ParentCo applies the bump to increase the ACB of SubCo’s shares, but then transfers those shares to a related holding company in exchange for cash or other property. The bump-denial rule would apply in this case because the holding company is a prohibited person, and the shares were effectively transferred through a backdoor transaction that avoids tax on the appreciation.

In both self-dealing and backdoor transactions, the key principle is that the bump should not be used to extract the economic benefit of appreciated property without paying taxes on that benefit. The bump-denial rule ensures that the bump is used only in legitimate corporate reorganizations where the parent corporation retains ownership of the property, rather than transferring it to related parties in a way that avoids taxation.

Avoiding the Traps: Practical Tips for Staying Compliant

Given the complexity of the bump-denial rule and the high stakes involved in applying the bump correctly, businesses must be cautious when engaging in corporate reorganizations that involve the bump. Below are practical tips for avoiding the common traps that can lead to bump denial.

1. Identify Prohibited Persons Early in the Planning Process

The bump-denial rule is triggered when a prohibited person acquires the property that has been bumped, so it is essential to identify all potential prohibited persons early in the planning process. This includes:

• Family members of the shareholders.
• Entities, such as holding companies or trusts, in which the shareholders or their family members have an interest.
• Affiliated corporations or partnerships.

By identifying these parties upfront, businesses can structure their transactions in a way that avoids triggering the bump-denial rule.

For example, if a family-owned enterprise is considering winding up a subsidiary and applying the bump to real estate, they must ensure that the real estate is not transferred to a family trust or holding company in which the family members have a beneficial interest. Instead, the property should remain with the parent corporation or be transferred to an unrelated third party to avoid bump denial.

2. Be Cautious with Substituted Property

The substituted property rules are another common pitfall for businesses applying the bump. Under Section 88(1)(d.2), the bump is denied if the property that is bumped is substituted with another asset that would not qualify for the bump. This can happen if the bumped property is exchanged for cash, shares, or other assets as part of a complex reorganization.

To avoid this trap, businesses should ensure that the property remains with the parent corporation or is sold directly to an unrelated third party, rather than being exchanged for other assets or transferred to related parties.

For example, if a company applies the bump to a piece of land owned by a subsidiary, it should avoid transferring that land to another subsidiary in exchange for shares or cash, as this could trigger the substituted property rules and result in bump denial. Instead, the land should remain with the parent corporation or be sold directly to a third party at its FMV, ensuring that the bump remains valid.

3. Understand the Full Series of Transactions

The bump-denial rule applies to the entire series of transactions that include the winding-up or amalgamation, so businesses must consider not just the immediate transaction but also any related transactions that occur before or after the wind-up. The CRA takes a broad view of what constitutes a “series of transactions,” and even steps that seem unrelated may be considered part of the series if they are designed to achieve a tax benefit.

For example, if a company winds up a subsidiary and applies the bump to real estate, but then sells that real estate to a related person a year later, the CRA may consider the sale part of the overall series of transactions that included the wind-up. This could trigger the bump-denial rule, even though the sale occurred after the wind-up.

To avoid this, businesses should plan their transactions carefully and ensure that any subsequent transfers of the bumped property are structured in a way that does not involve prohibited persons or substituted property. In some cases, it may be advisable to seek an advance tax ruling from the CRA to ensure that the transaction does not trigger bump denial.

4. Document the Business Purpose of the Reorganization

One of the best ways to defend against a potential bump-denial issue is to clearly document the business purpose of the reorganization. The CRA is more likely to scrutinize transactions that appear to be motivated solely by tax considerations, particularly if they involve related parties. By demonstrating that the reorganization is being undertaken for legitimate business reasons, such as simplifying the corporate structure or preparing for a sale, businesses can reduce the risk of bump denial.

For example, if a family-owned enterprise is winding up a subsidiary and applying the bump, it should document the reasons for the wind-up, such as reducing administrative costs or consolidating ownership. This can help demonstrate that the reorganization is being carried out for legitimate business purposes, not to avoid taxes.

5. Seek Professional Advice

Given the complexity of the bump-denial rules, it is essential to seek professional tax advice when planning a corporate reorganization that involves the bump. A tax professional can help identify potential issues, ensure compliance with the ITA, and provide strategies for avoiding bump denial. In some cases, it may be advisable to obtain an advance ruling from the CRA to confirm that the transaction will not trigger the bump-denial rule.

Conclusion

The 88(1)(d) bump is a valuable tax-planning tool, but it comes with significant risks if the bump-denial rule is triggered. By understanding how the bump-denial rule operates in cases of self-dealing or backdoor transactions, businesses can structure their reorganizations in a way that maximizes tax efficiency while staying compliant with the law. By identifying prohibited persons, avoiding substituted property, and documenting the business purpose of the transaction, businesses can successfully navigate the anti-avoidance traps and apply the bump without facing the risk of denial.

 

Strategic Uses of the 88(1)(d) Bump for Tax Planning

The 88(1)(d) bump in the Income Tax Act (ITA) is a powerful tax-planning tool that enables family-owned enterprises and other corporations to increase the adjusted cost base (ACB) of certain capital properties in order to avoid double taxation during corporate reorganizations. By increasing the ACB of non-depreciable capital property, such as real estate or shares in other corporations, the bump helps mitigate capital gains tax upon the future sale or transfer of these assets. The strategic application of the bump is particularly beneficial in situations such as succession planning, wealth transfer, and cross-border tax planning. This section explores how family-owned enterprises can leverage the bump in these contexts, along with its use in private equity transactions.

Using the Bump for Succession Planning

Succession planning is a critical process for family-owned enterprises, especially those aiming to transfer ownership and assets to the next generation in a tax-efficient manner. The 88(1)(d) bump plays a vital role in ensuring that valuable assets—such as real estate, shares in related corporations, or intellectual property—can be passed on without incurring significant capital gains tax.

Avoiding Capital Gains on Appreciated Assets Family-owned enterprises often hold assets that have appreciated significantly over time. When transferring ownership of these assets to the next generation, the business may face substantial capital gains tax liabilities. The 88(1)(d) bump helps alleviate this burden by allowing the business to step up the ACB of the property to its fair market value (FMV) at the time the parent corporation acquired control of the subsidiary. This increase in the ACB reduces or eliminates the capital gain that would otherwise be realized upon the sale or transfer of the property.

For example, consider a family-owned business that has held a piece of commercial real estate for several decades. The real estate was initially purchased for $1 million, but it is now worth $5 million. Without the bump, if the property is transferred to the next generation, the business would face capital gains tax on the $4 million appreciation. However, by applying the 88(1)(d) bump during a corporate reorganization, the business can increase the ACB of the property to $5 million, thus avoiding the capital gains tax that would have been triggered by the transfer.

Winding Up a Subsidiary as Part of Succession Planning In many family-owned enterprises, succession planning involves the winding-up of a subsidiary that holds significant assets. This often occurs when the parent company or holding company wishes to consolidate ownership of the business or transfer assets directly to family members. In such cases, the bump can be applied during the wind-up to increase the ACB of the subsidiary’s property, allowing for a more tax-efficient transfer of wealth.

For example, suppose ParentCo, a holding company owned by a family, owns 100% of SubsidiaryCo, which holds several valuable assets, including shares in another corporation. When ParentCo decides to wind up SubsidiaryCo as part of the succession planning process, it can apply the 88(1)(d) bump to increase the ACB of the shares and other non-depreciable capital property owned by SubsidiaryCo. This ensures that the next generation, who will inherit these assets, will not face a significant tax liability when they eventually sell or transfer the assets.

Corporate Reorganizations and Wealth Transfer

Corporate reorganizations are commonly used by family-owned enterprises to optimize ownership structures, consolidate assets, or prepare for future transactions. The 88(1)(d) bump provides an essential tool for facilitating these reorganizations in a tax-efficient manner, particularly when the goal is to transfer wealth from one generation to the next.

Reorganizing Ownership Structures As family-owned enterprises grow and evolve, they often need to restructure their ownership to reflect changes in the business or the family’s long-term goals. For example, a family may want to create a new holding company to own the shares of several operating companies or divide the ownership of different business units among family members. These reorganizations typically involve the transfer of shares or other capital property between entities within the corporate group, which could trigger capital gains taxes if not managed carefully.

By applying the 88(1)(d) bump during a corporate reorganization, the business can increase the ACB of the transferred property, effectively reducing or eliminating any capital gains tax that would arise from the reorganization. This allows the family to restructure ownership without facing an immediate tax burden, preserving more wealth for reinvestment or future distribution.

Facilitating Wealth Transfer The bump is particularly useful in transferring wealth between generations within a family-owned enterprise. For example, if a family-owned business wishes to transfer ownership of a subsidiary to the next generation, the bump can be applied to increase the ACB of the subsidiary’s assets before the transfer. This ensures that the future owners—usually the children or grandchildren of the original owners—inherit the business at its current FMV without being burdened by the capital gains tax on the appreciation that occurred during the parents’ ownership.

By applying the bump during the wind-up or amalgamation of a subsidiary, the family can transfer the assets to the next generation in a more tax-efficient way, ensuring that the family’s wealth is preserved for future generations. This strategy is particularly valuable for high-value assets, such as real estate, intellectual property, or investments in other businesses.

Leveraging the Bump in Cross-Border Tax Planning

The 88(1)(d) bump also has significant applications in cross-border tax planning, particularly for family-owned enterprises or multinational corporations that operate across multiple jurisdictions. When a Canadian parent corporation acquires control of a foreign subsidiary, the bump can be applied to certain capital property owned by the subsidiary, allowing the parent to avoid capital gains taxes when the property is sold or transferred.

Cross-Border Acquisitions In cross-border acquisitions, a Canadian parent corporation may acquire control of a foreign subsidiary that owns capital property, such as real estate, shares in foreign corporations, or intellectual property. By applying the bump, the Canadian parent can increase the ACB of the foreign subsidiary’s capital property to its FMV at the time of acquisition. This provides tax relief when the property is sold or transferred in the future, particularly if the parent plans to repatriate profits or sell the subsidiary’s assets.

For example, if a Canadian parent company acquires a U.S. subsidiary that owns real estate, the bump can be applied to increase the ACB of the real estate to its FMV. This reduces the capital gains tax that the parent would face when selling the real estate, ensuring that the business can exit its foreign investments in a tax-efficient manner.

Avoiding Double Taxation Cross-border tax planning often involves managing the risk of double taxation, where income or capital gains are taxed both in the foreign jurisdiction and in Canada. The bump can help mitigate this risk by allowing the Canadian parent to increase the ACB of the foreign subsidiary’s capital property, reducing the capital gain that would be realized upon the sale or transfer of the property in both countries. This provides significant tax savings and helps optimize the company’s overall tax position.

Foreign Affiliates and the Bump Canadian tax rules related to foreign affiliates also provide opportunities for using the 88(1)(d) bump. For example, a Canadian parent corporation may hold shares in a foreign affiliate that owns capital property. If the foreign affiliate is wound up or amalgamated with the Canadian parent, the bump can be applied to the capital property owned by the foreign affiliate, reducing the Canadian tax liability upon the eventual sale of the property. This is particularly useful for multinationals seeking to streamline their corporate structure or repatriate profits from foreign operations.

Using the Bump in Private Equity Transactions

Private equity transactions often involve the acquisition of multiple subsidiaries or business units, many of which hold valuable capital property. The 88(1)(d) bump can be a strategic tool for private equity firms seeking to optimize the tax outcomes of these acquisitions.

Acquisition of Control and the Bump When a private equity firm acquires control of a target company, it can apply the bump to increase the ACB of the company’s capital property to its FMV at the time of acquisition. This provides significant tax relief when the private equity firm eventually exits the investment by selling the company or its assets.

For example, if a private equity firm acquires a manufacturing company that owns several plants and real estate holdings, it can apply the bump to increase the ACB of the real estate. This reduces the capital gains tax that the private equity firm will face when it sells the company or liquidates its assets, ensuring that more of the investment’s return is retained.

Facilitating Exits The bump is particularly valuable for private equity firms looking to exit their investments in a tax-efficient manner. By increasing the ACB of the capital property owned by a target company, the private equity firm can reduce or eliminate the capital gains tax that would otherwise be triggered when the company is sold. This makes the investment more attractive to potential buyers and maximizes the firm’s return on investment.

Conclusion

The 88(1)(d) bump is a versatile and highly effective tool for tax planning, particularly for family-owned enterprises, multinational corporations, and private equity firms. By using the bump during succession planning, corporate reorganizations, and cross-border acquisitions, businesses can transfer wealth and assets in a tax-efficient manner, preserving more of their capital for reinvestment or distribution. Whether facilitating the transfer of property to the next generation, restructuring a corporate group, or optimizing the tax outcomes of an acquisition, the bump provides significant opportunities for reducing tax liabilities and maximizing wealth preservation.

 

FAQ: Common Questions About the 88(1)(d) Bump

The 88(1)(d) bump is an important tax planning tool in the Income Tax Act (ITA) that allows a parent corporation to increase the adjusted cost base (ACB) of certain capital property when winding up a subsidiary. This bump prevents double taxation and facilitates efficient corporate reorganizations. However, applying the bump can be complex, especially given the numerous anti-avoidance provisions and special rules. Below, we address 10 common questions related to the bump, helping clarify its application and how businesses can avoid triggering the bump-denial rules.

1. What Happens if Prohibited Persons Acquire Property?

Answer: If a prohibited person acquires property that has been bumped under 88(1)(d), the bump will be denied. This means the ACB of the property will not be increased to its fair market value (FMV), and the parent corporation will face capital gains tax on the original ACB of the property when it is sold.

Prohibited persons include individuals or entities related to the parent company or its shareholders. This includes family members, affiliated companies, trusts, and partnerships that the shareholders control. The bump-denial rule ensures that related parties cannot use the bump to avoid paying capital gains tax.

How to Avoid Bump Denial: Businesses must ensure that no prohibited persons acquire the property during the transaction. The property should be retained by the parent corporation or transferred to an unrelated third party.

2. How Does the Bump Apply During a Wind-Up Versus an Amalgamation?

Answer: The bump can be applied both during a wind-up and an amalgamation, but the rules and processes differ slightly:

• Wind-Up: In a wind-up, a subsidiary’s assets are transferred to the parent corporation, and the subsidiary is dissolved. The bump allows the parent to increase the ACB of eligible non-depreciable capital property (e.g., real estate, shares) to its FMV at the time the parent acquired control of the subsidiary.
• Amalgamation: In an amalgamation, the parent and subsidiary merge into a new legal entity. The bump can still be applied to the eligible property transferred from the subsidiary, provided the amalgamated entity retains ownership of that property. However, if the property is disposed of or transferred to a related party, the bump may be denied.

Both scenarios allow the parent to increase the ACB of the property, but special attention must be paid to the continuity of ownership in amalgamations.

3. What Happens if the Subsidiary Has Claimed Capital Cost Allowance (CCA) on the Property?

Answer: If the property in the subsidiary has claimed Capital Cost Allowance (CCA) in the past, the bump still applies, but only to the non-depreciable portion of the property. The bump cannot be applied to depreciable property such as buildings or equipment, which have already benefitted from CCA deductions.

For example, if the subsidiary owns a building and the land beneath it, the bump would apply only to the land, as it is non-depreciable. The building, having been depreciated, is ineligible for the bump, and any capital gains realized from its sale would still be taxed based on its original ACB.

4. Are There Exceptions to the Bump-Denial Rules?

Answer: While the bump-denial rules are strict, there are some situations where the bump may still be available despite related-party transactions. For example:

• Arms-Length Transactions: If the property is sold to an unrelated third party, the bump is typically not denied. The bump-denial rules are designed to prevent related parties from using the bump to avoid taxes, but they do not apply to bona fide arms-length transactions.
• Corporate Reorganizations: In some reorganizations where the property remains within the new amalgamated entity and is not transferred to prohibited persons, the bump can still apply. However, careful structuring and planning are required to avoid triggering substituted property rules or transferring the property to related entities.

In complex cases, seeking an advance ruling from the CRA can help clarify whether the bump-denial rules apply.

5. What Happens if the Acquisition of the Subsidiary Occurred Several Years Ago?

Answer: The 88(1)(d) bump can still be applied even if the acquisition of the subsidiary occurred several years ago, provided that the subsidiary has continuously owned the eligible property since the parent acquired control.

There is no specific time limit in the ITA for when the wind-up or amalgamation must occur after the acquisition of control. As long as the subsidiary holds the property continuously, the parent can apply the bump when it decides to wind up or amalgamate the subsidiary. However, any property acquired by the subsidiary after the parent’s acquisition of control will not be eligible for the bump.

For example, if Parent Co acquired control of Subsidiary Co five years ago and Subsidiary Co has continuously owned a piece of real estate since then, Parent Co can still apply the bump to that real estate when it decides to wind up Subsidiary Co.

6. Can Replacement Property Rules Still Be Used After the Bump is Taken and the Property is Sold?

Answer: Yes, the replacement property rules under Section 44 of the Income Tax Act can still be used after the bump is taken and the property is sold, provided certain conditions are met.

If the bumped property was used in an active business, and it is sold, the parent corporation may defer the capital gain by purchasing a replacement property within a certain period (usually one year for most properties or two years for properties that were involuntarily disposed). The replacement property must be used for similar business purposes to qualify for the deferral.

However, it is important to ensure that the replacement property is not acquired by prohibited persons or substituted for ineligible property, as these actions could invalidate the bump and the replacement property deferral.

7. Does the Bump Apply to All Types of Property?

Answer: No, the bump applies only to non-depreciable capital property. Eligible property includes:

• Real estate (land).
• Shares in other corporations that are capital property.
• Intangible assets such as goodwill (if classified as capital property).

Ineligible property includes:

• Depreciable property (e.g., buildings, machinery).
• Inventory.
• Financial instruments such as bonds or derivatives.
• Cash or short-term assets.

For example, if Subsidiary Co owns land and a building, only the land is eligible for the bump. The building, being depreciable property, would not qualify, and any capital gain on its sale would be based on the original ACB.

8. What Happens If the Property is Substituted for Other Property?

Answer: The bump is denied if the bumped property is substituted for other property, such as cash, shares, or other ineligible assets, during or after the wind-up or amalgamation. This is known as the substituted property rule, designed to prevent taxpayers from exchanging bumped property for assets that could defer taxes indefinitely.

For example, if Parent Co applies the bump to increase the ACB of real estate owned by Subsidiary Co and then exchanges the real estate for shares in another corporation, the bump would be denied, and the original ACB of the real estate would apply.

To avoid triggering the substituted property rule, businesses should ensure that the bumped property is either retained by the parent corporation or sold directly to an unrelated third party.

9. How Does the Bump Interact with Safe Income?

Answer: Safe income represents the portion of a corporation’s retained earnings that can be distributed as dividends without triggering capital gains tax. The bump does not affect safe income directly, but both the bump and safe income are used in tax planning strategies to manage tax liabilities.

If the parent corporation plans to distribute dividends before or after a wind-up or amalgamation, it must consider how the bump and safe income will interact. Proper tax planning can help balance these two strategies to minimize capital gains and dividend taxes.

10. Can the Bump Be Applied Retroactively?

Answer: No, the bump cannot be applied retroactively. The bump is applied at the time of the wind-up or amalgamation, and it only applies to the eligible property that is held by the subsidiary at the time the parent corporation acquired control. If the property has already been sold or transferred before the wind-up or amalgamation, the bump cannot be applied.

To ensure that the bump is applied correctly, businesses must carefully plan the timing of their transactions and ensure that the eligible property is held continuously by the subsidiary from the time of control acquisition to the wind-up or amalgamation.

By understanding these common questions and issues, businesses can maximize the tax benefits of the 88(1)(d) bump while avoiding potential pitfalls. Proper planning and attention to the details of prohibited persons, substituted property, and timing are essential for taking full advantage of this provision.

 

Conclusion

The 88(1)(d) bump is a powerful and versatile tax planning tool that offers significant value to family-owned enterprises and corporate groups looking to restructure or transfer assets in a tax-efficient manner. By allowing a parent corporation to increase the adjusted cost base (ACB) of eligible capital property, the bump helps mitigate or eliminate capital gains taxes that would otherwise arise when assets are sold or transferred. Whether used in succession planning, corporate reorganizations, or cross-border transactions, the bump provides substantial opportunities for tax savings and wealth preservation.

However, the application of the bump can be complex, especially with the presence of anti-avoidance provisions such as the bump-denial rules, prohibited persons, and substituted property restrictions. Given these complexities, it is essential for businesses—especially family-owned enterprises— to seek expert tax advice to navigate the rules effectively and avoid costly mistakes. Properly applied, the bump can help families transfer wealth across generations, optimize corporate structures, and achieve long-term financial goals.

At Shajani CPA, we specialize in helping family-owned enterprises and businesses leverage tax planning tools like the 88(1)(d) bump to their advantage. Our team of experienced tax professionals can provide tailored advice to ensure that your business maximizes tax savings while remaining fully compliant with Canadian tax laws. Contact Shajani CPA today to explore how the bump and other tax strategies can help your business achieve optimal outcomes and secure your family’s financial future.

Let us guide you through the complexities of tax planning and help you preserve your wealth for future generations.

 

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. ©2024 Shajani CPA.

Shajani CPA is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning service.

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