Section 85 Rollover—Transfer of Property to a Corporation

The disposition of capital property by a taxpayer generally results in a capital gain or loss. However, the Income Tax Act (ITA) contains many provisions which allow for a deferral of capital gains on certain exchanges of property. These provisions are known as rollovers.

A section 85 rollover is one of the most frequently used tax planning tools. This rollover may apply when a taxpayer, including individuals, corporations, trusts or partnerships, disposes of property to a taxable Canadian corporation in exchange for at least one share of the corporation. Eligible property that can be disposed as part of the rollover includes capital property, such as shares, debt or equipment, eligible capital property such as goodwill or other intangible assets, resource property or inventory. Beyond shares of the corporation, the taxpayer can also receive other non-share consideration such as cash or a note payable. This non-share consideration is commonly referred to as “boot”.

Section 85 rollovers are frequently used when a proprietor incorporates their business. While operating as a proprietor, the business owner may have purchased capital assets or inventory that have appreciated in value. The business may also have internally generated goodwill as the business has an established customer list and a recognizable brand name. The sale of these assets to the newly formed corporation would trigger capital gains and require income taxes to be paid by the proprietor absent a section 85 rollover.

This rollover is also frequently used as part of business reorganizations. A business may wish to reorganize their assets into a more tax-efficient structure or reorganize as part of succession planning to transfer the future growth of the company to a child or another individual. Transferring the future growth is commonly referred to as a freeze. A freeze is achieved by exchanging common shares of a business for new shares which have fixed value, such as redeemable preferred shares, while another individual subscribes to newly issued common shares. This type of planning frequently involves the incorporation of a holding company. The owner of the operating business can sell their shares to the newly formed holding company in exchange for shares of the holding company as well as other assets. A section 85 rollover allows the owner to reduce or eliminate the capital gain on the disposition of the shares of the operating business.

There are many additional rollovers available under other sections of the ITA and the conditions for each differ. Two of the primary benefits of utilizing section 85 instead of other rollovers is the ability to receive boot in the transaction, and the ability to elect at any amount between the ACB and FMV of the transferred property. Certain transferors, particularly in the succession planning example discussed above, may wish to receive cash or a note payable as part of the transaction rather than just shares as there is greater risk associated with shares. Certain transferors may also wish to realize a partial capital gain rather than deferring the whole amount for a variety of reasons, such as utilizing their lower tax brackets, the availability of capital losses to offset the gain, or the availability of the capital gains deduction. Electing at an amount between ACB and FMV allows the taxpayer to do so.

The elected amount cannot exceed the FMV of the property, it cannot be less than the lesser of the FMV and tax cost of the property, and it cannot be less than the FMV of any boot received. The elected amount becomes the proceeds of disposition for the transferor for purposes of calculating the capital gain on the disposition, and the ACB of the property for the transferee. The elected amount less any boot received becomes the ACB of the shares received from the transferee.

A section 85 rollover is a joint election between the transferor and transferee. A T2057 election form must be filed by the earlier tax return due date of the two parties. Late-filing is allowed for up to three years after the due date, but a penalty of $100 per month will apply.

Rollover transactions are complex and require proper planning to ensure adverse tax consequences don’t occur. Please contact me if you would like to discuss further.