SECTION 51(1) SHARE CONVERSION - corporate tax planning strategy
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A section 51(1) conversion is a legislated tax strategy that allows a taxpayer to exchange a "convertible property" for shares in the same corporation without triggering an immediate tax liability. This means the taxpayer doesn't have to report a capital gain or loss at the time of the exchange. The intended purpose of section 51(1) is to provide flexibility for corporate restructurings, such as those related to succession planning or corporate reorganizations, without creating an immediate tax burden for the shareholder.
To effectuate a section 51(1) conversion, the critical conditions and aspects include:
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Convertible Property: This is the property being exchanged. It must be a capital property and can be:
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Another share of the capital stock of the same corporation.
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A bond, debenture, or note of the same corporation, provided it has a conversion privilege.
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No Other Consideration: A crucial condition for this rollover is that the taxpayer receives no consideration other than the new shares. A small exception exists for cash received in lieu of a fractional share.
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Tax Deferral, Not Elimination: Section 51(1) is a deferral mechanism, not a tax elimination. The tax liability on any accrued capital gains is simply postponed. The tax will be realized later when the new shares are eventually sold or disposed of.
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Adjusted Cost Base (ACB) Carry-over: The adjusted cost base (ACB) of the original convertible property is transferred to the new shares. If multiple classes of shares are received, the ACB is allocated among them based on their fair market value.
The process by which a section 51(1) conversion is undertaken involves:
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In a typical section 51(1) conversion, a shareholder holds an existing share with a certain ACB and a higher fair market value (FMV). By exchanging this share for a new class of shares of the same corporation, the transaction is deemed not to be a disposition. Therefore, the capital gain that had accrued is not triggered. The ACB of the original share is simply carried over to the new share. This postpones the tax until the new share is eventually sold, at which point the difference between the sale price and the carried-over ACB will be recognized as a capital gain.
The legitimate strategic use of a section 51(1) conversion includes:
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Corporate Reorganizations - A section 51(1) conversion is widely used in corporate restructurings to change a company's capital structure without immediate tax consequences for the shareholders. For example, a corporation might need to convert one class of shares into another to simplify its share structure or prepare for a new investment.
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Estate Freezes - An estate freeze is a common tax planning strategy for family-owned businesses. A business owner with common shares (which appreciate in value) might convert them into preferred shares with a frozen value using section 51(1). This allows the future growth of the company to accrue to newly issued common shares held by the next generation, effectively "freezing" the value of the original owner's shares for estate purposes. This strategy defers the capital gains that would have been realized on the future appreciation of the business.
Although a section 51(1) share conversion is a major tax deferral tool, it does not eliminate the tax liability entirely; it simply defers it. The tax is postponed until a later date, such as when the corporation sells the assets or when the individual sells their shares in the corporation. Due to the complexity and strict rules involved, it is highly recommended to seek professional tax law advice is retained when undertaking a section 51(1) share conversion [more on complexity and mistakes].
Given the complexity and potential for severe tax penalties, it is critical that your section 51(1) share conversion is correctly structured, with the appropriate legal and supporting paperwork, such that it might effectively respond to any scrutiny. With over two decades of legal experience, which includes designing and implementing a multitude of section 51(1) share conversion and other corporate tax planning strategies, we can put that knowledge and experience to use for the advancement of your business.
Our law firm strives to provide strategic tax-driven legal advice and direction to Calgary businesses looking to optimize their business structures and corporate transactions. Contact our law firm at Chris@NeufeldLegal.com or 403-400-4092 to schedule a confidential initial consultation for your business' tax structuring and tax planning initiatives.
