Section 85 Rollover: A Comprehensive Guide for Canadian Entrepreneurs

Business owners often find themselves in situations where they need to transfer assets. This could be from a sole proprietorship to a corporation for scaling purposes or during corporate reorganizations. Such reorganizations might involve introducing new shareholders, with existing ones either retaining or transferring control. 

Corporate reorganization can arise for various reasons, including preparing a business for sale, asset protection, estate planning, or income splitting, to name a few. However, transferring assets to a new corporation (often termed a holding company) typically implies that the transferor has sold the property to the transferee, leading to potential capital gains and tax implications. 

Fortunately, the Income Tax Act (ITA) of Canada provides a solution known as the Section 85 rollover. This provision allows for a tax-deferred transfer of assets to a Canadian corporation, thereby sidestepping immediate tax consequences. Instead, these taxes are deferred until the corporation sells the assets to an external party. 

Key Requirements for Section 85 Rollover: 

• Assets should be transferred to a taxable Canadian corporation. 
• Only eligible assets qualify for the transfer. 
• In exchange for the asset transfer, the transferor must receive shares of the corporation. 
• Non-share considerations, like promissory notes or assumed debts, can also be part of the transaction. 
• The total consideration (shares and non-share) should match the fair market value of the transferred property. 
• A formal election, determining the elected price for the asset, must be filed. 

Eligible Assets Include: 

• Inventories (excluding land-based inventory). 
• Non-depreciable capital property like securities and land. 
• Depreciable capital property such as equipment, buildings, and intangibles. 

Assets with accrued losses don’t qualify for Section 85. They should be sold to the corporation at their fair market value. 

Elected Amount in Section 85:  

The elected amount signifies the disposition proceeds for the transferor and the acquisition cost for the transferee corporation. The ITA sets boundaries for this amount, ensuring it doesn’t surpass the property’s fair market value or fall below the greater of the non-share consideration or the asset’s tax value. 

Assets to Consider for Rollover:  

Assets that have appreciated in value are ideal for Section 85 rollovers, as this can help avoid immediate taxes. Conversely, assets that have depreciated or remained stagnant in value might not benefit from this provision. 

Special Considerations: 

• Receivables: These can be transferred under Section 85, but there are specific conditions to consider. 
• Goodwill: When incorporating a proprietorship, its internally generated goodwill is transferred to the corporation, typically with an elected amount of $1 to minimize taxes. 

Valuable Tax Tips: 

• Asset Valuation: Always have a valuation ready, especially for intangible assets, to prevent potential disputes with the Canada Revenue Agency (CRA). 
• Price-Adjustment Clauses: Given the subjective nature of asset valuation, it’s wise to include a clause in the transfer agreement that allows for retroactive price adjustments in case of disagreements with the CRA. 

Election Procedures:  

If opting for a Section 85 rollover, ensure you file the election using the CRA’s designated form before the tax return deadline of either the transferor or transferee, whichever comes first. Late filings can result in penalties. 

In Conclusion:  

Section 85 rollovers offer a strategic way to transfer assets between entities while deferring tax liabilities. However, it’s essential to remember that this doesn’t erase the tax obligation; it merely postpones it. Given the complexity of these transactions, it’s always advisable to consult with tax professionals, such as CPAs or tax lawyers, to navigate the process efficiently.