Strip Limited has received an offer from an unrelated corporation, Corporate Raider Inc., to purchase all of Strip's common shares in a wholly owned subsidiary, Profits Galore Ltd. All three corporations are Canadian-controlled private corporations and have December 31 year-ends.
The common shares of Profits Galore Ltd. have an adjusted cost base and paid-up capital of $500,000 and a fair market value of $2,400,000. Profits Galore Ltd. has realized and retained income for tax purposes of $900,000 since 1971. All of this realized income was derived from active business assets.
Strip Limited has come to you for your comments on two acquisition alternatives proposed by Corporate Raider Inc.
Plan A would first have Profits Galore Ltd. borrow from the bank $1,900,000 and, then, immediately pay a dividend to its parent corporation, Strip Limited, for the same amount. Corporate Raider Inc. would then purchase the common shares of Profits Galore Ltd. from Strip Limited for the residual fair market value of $500,000. Then, Corporate Raider would inject $1,900,000 into Profits Galore Ltd. through a common share subscription so that the bank loan could be repaid.
Plan B would have Strip Limited transfer its common shares in Profits Galore Inc. to Corporate Raider Inc. on a tax-free basis by jointly electing under section 85 at a transfer price of $500,000. Strip Limited Inc. would accept as consideration only special shares of Corporate Raider Inc. with a paid-up capital of $500,000 and a redemption/retraction value of $2,400,000. These shares would represent 15% of all the voting rights and fair market value of Corporate Raider Inc. Strip Limited would, then, retract the special shares which it holds in Corporate Raider.
REQUIRED
Describe the tax implications of the above acquisition alternatives supported by any relevant calculations.