Conditions where foreign spin-offs are eligible for the election

How a Canadian resident shareholder elects for eligible foreign spin-off shares

Who can elect, and the results of making an election

How the adjusted cost base (ACB) is recalculated when an election is made under section 86.1

Conditions where foreign spin-offs are eligible for the election

Canadian residents who receive foreign spin-off shares have to include the value of the shares in their income as a foreign dividend. However, under certain conditions, the shareholder can elect to not include the amount in income. These conditions are:

• The shareholder must have received the dividend for all the common shares of the original corporation that the shareholder owned

• The shareholder must have received solely common shares of the spin-off corporation

• The shares of the spin-off corporation must have been owned by the original corporation immediately before the spin-off

• Both the original corporation and the spin-off corporation have to be resident in the same country

• The country in which the corporations are resident must have a tax treaty with Canada

• Both corporations must never have been resident in Canada

• For public corporations, the shares of the original corporation must have been widely held and actively traded on a designated stock exchange at the time of the spin-off

• For private corporations, the shares of the original corporation must have been widely held and be required, under the Securities Exchange Act of 1934 of the United States, to be registered with the Securities and Exchange Commission of the United States, and they must be so registered

• Under the tax laws of the country of residence of the corporations, the spin-off must not be taxable to shareholders resident in that country

• The corporation has to provide certain information to the Canada Revenue Agency within a particular period

How a Canadian resident shareholder elects for eligible foreign spin-off shares

The Canadian resident shareholder can elect to defer being taxed on the spin-off shares by including a letter with the shareholder's income tax return for the year in which the distribution occurs. EFILE and NETFILE cannot be used to file T1 returns for the tax year to which the election relates. For corporations who are filing electronically via the Corporation Internet Filing (CIF) service, use the "Notes to Financial Statements" section to submit all the required information. If you are unable to fit all the required information in that section, send the letter to your tax centre after you have filed electronically. The letter has to contain all of the following:

• written notification that the shareholder is electing to defer tax relating to the distribution of spin-off shares from a U.S. (or other foreign) corporation, including a description of both the original and spin-off shares

• the number, cost amount otherwise determined, and fair market value of the client's original shares, both immediately before the distribution and after the distribution

• the number and fair market value of the spin-off shares immediately after distribution

Attach to the election any T5 slip (or 1099-DIV slip) you receive regarding this income. For information regarding filing a late election, go to Extension under the taxpayer relief provisions.

Who can elect, and the results of making an election

Shareholders who are individuals, trusts, and corporations can make an election under section 86.1 of the Income Tax Act.

This election allows the shareholder to exclude from income the amount that otherwise, would be considered a taxable foreign dividend. However, if this election is made, the adjusted cost base (ACB) of the spin-off shares will not be their fair market value as would otherwise be the case. Instead, the ACB will be the cost of the original shares that generated the distribution of the spin-off shares. This cost will be allocated between the original shares and the spin-off shares, as explained in the following example.

How the adjusted cost base (ACB) is recalculated when an election is made under section 86.1

This is best explained by an example:

X-co owns 10,000 shares of Y-co. The Y-co shares have a total fair market value (FMV) of $100,000 or $10 per share. X-co has 40,000 existing and outstanding shares. These shares are widely held and actively traded on a designated stock exchange. X-co decides to spin off its interest in Y-co to its shareholders by distributing to each of its shareholders 0.25 (one quarter) of a Y-co share for each X-co share held.

A particular Canadian resident shareholder, Mrs. Smith, holds 400 shares of X-co with an ACB of $25 per share. She receives 100 shares of Y-co as a stock dividend from X-co as a result of the spin-off transaction.

Assume that the spin-off meets all of the conditions and is an eligible distribution.

The FMV of the X-co shares after the distribution is $40 per share.

Mrs. Smith elects under section 86.1 to not include in income the dividend in the amount of $1,000 (that is, 100 shares of Y-co at $10 per share). Therefore, she needs to calculate what her new ACB is for both her X-co shares and her Y-co shares, as follows.

Mrs. Smith's ACB for her X-co shares will be reduced by an amount determined by the following formula:

A × B ÷ C

A is the ACB of an X-co share prior to the distribution

B is the FMV of the fraction of a Y-co share that she receives for each X-co share she held

C is the sum of the FMV of the X-co share after the distribution and the FMV of the portion for the Y-co share received for each X-co share.

That is

A = $25

B = 0.25 × $10 = $2.50

C = $40 + $2.50 = $42.50

Therefore, the ACB of Mrs. Smith's X-co shares are reduced by: $25 × $2.50 ÷ $42.50 = $1.47 per share.

In general, when the election under section 86.1 is made, the ACB of the spin-off share is deemed to be the amount by which the ACB of the original share is reduced using the above formula. Since Mrs. Smith only received 0.25 (one quarter) of a Y-co share for each X-co share she held, each 0.25 share of Y-co will now have an ACB of $1.47. In other words, the ACB of each Y-co share after the election is now $5.88 ($1.47 times 4).

As a result, the new ACB of the shares can be summarized as follows:

X-co shares

$25 − $1.47 = $23.53 for each share; 400 × $23.53 = $9,412.00 for all the X-co shares.

Y-co shares

$1.47 × 4 = $5.88 for each share; 100 × $5.88 = $588.00 for all the Y-co shares.

In total, the new ACB of all shares owned by Mrs. Smith is $9,412.00 + $588 = $10,000, which is the same as the ACB of the X-co shares that she owned before the distribution (400 × $25 = $10,000).