Section 85 Rollover – Tax Fee Transfers

Whether it’s a company restructuring for tax planning objectives or a successful sole-proprietor aiming to incorporate– the Section 85 rollover is a valuable tax deferral tool, used extensively in the Canadian business landscape. If you have decided to transform your existing business into another Canadian entity without having to pay taxes then this blog contains a lot, you need to know! 

Purpose of Section 85 Rollover

The main purpose of section 85 rollover is to transfer eligible property (with a built-in gain) on a tax-deferred basis from one company (corporation or sole proprietorship for example) to another corporation.

Electing to apply the section 85 rollover mechanism allows for assets to be transferred to a Canadian Corporation without triggering the tax. If this mechanism did not exist and assets needed to be transferred from one company to another, a sale at fair market value would have been considered, resulting in possible tax implications.

Who can use Section 85 Rollover?

• The transferor is either an individual, corporation, or a trust [ITA 85(1)]
• The transferee is a taxable Canadian corporation [ITA 89 (1)]

How Section 85 Rollover Works?

Section 85 Rollover should be considered whenever there is a disposition of property, which has appreciated in value, to a corporation. When you transfer assets to a corporation, you have two options:

1. Sell the assets to the corporation at a fair market value (FMV).

• The corporation would hold the asset at the FMV 
• You may realize a capital gain that would have immediate personal tax consequences.

2. Elect to transfer the assets to the corporation using Section 85 rollover.

• The corporation would hold the asset at the elected amount (for example initial cost)
• The individual would have no immediate personal tax consequences from the transfer of the assets.
• If an asset is sold in the future, tax consequences would arise in the corporation at that time.

After incorporating a sole proprietorship Section 85 Rollover is a special election filed with the Canada Revenue Agency (CRA) through T2057 Form or T2058 in the case of partnerships by the prescribed deadline [ITA 85(6)]

Time for election. The election must be filed at the earlier of the next sole proprietor’s tax return deadline or the first corporate tax return deadline. Late filing within three years of that date is allowed, subject to penalty. After the three years, you may be able to file late if the CRA believes that it would be “just and equitable” to allow the late filing. Again, a penalty will apply.

To qualify for the election, the transferor will need to receive at least one share in the capital stock of the ‘purchasing’ corporation, as consideration for the transfer of assets. You may also receive a non-share consideration called “boot”.

When filing a joint election, the transferor and transferee must choose an elected amount, which represents the proceeds of disposition for the transferor and the cost to the transferee corporation. The Income Tax Act (ITA) defines the maximum and minimum limits on the elected amount:

1. The elected amount cannot exceed the FMV of the asset at the time of the transfer.
2. The elected amount cannot be less than the FMV of the non-share consideration received by the transferor.
3. The elected amount cannot be less than the lesser of the FMV of the property and its cost at the time of disposition 
4. Where ii and iii differ the greater of the two amounts represents the lower limit.

The election can only be made concerning eligible property [ITA 85(1.1)] which includes but not limited to:

• The capital property, including depreciable assets and accounts receivable.
• The eligible capital property, such as goodwill
• Inventory including a professional taxpayer’s work in progress (excluding real property inventory)
•  Canadian resource property and foreign resource property.

Assets that are ineligible for a tax deferred transfer include:

• Real property that represents inventory to the taxpayer 
• Prepaid expenses

We recommend getting an accountant help rather than doing things by yourself in the wrong way.

When should a Section 85 Rollover be used?

Section 85 Rollover scenarios mostly experienced are:

1. Incorporation of the sole proprietorship. (see our blog post “Incorporate Sole Proprietorship” about incorporation)
2. Shareholder of corporation considering adding a holding company to his/her organizational structure for tax planning and/or creditor proofing.

If you want to know more about it just contact an accounting firm and they will tell you everything.

As with any tax planning scenario, there is no one size fits all answer. This is especially true for the complex Section 85 Rollover. It is a technical tax document and our experienced professionals at Filing Taxes can assist you with structuring and documenting the section 85 Rollover agreement considering your unique business situation. Feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step towards proper management of your finances.