SECTION 85 ROLLOVER - Most Important Corporation Tax Provision
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Section 85 of the Income Tax Act (Canada) is widely regarded as one of the most important provisions for corporations and business owners, not because it grants a permanent tax exemption, but because it provides a crucial mechanism for tax deferral, known as a "rollover." This unique election allows a taxpayer (an individual, trust, or another corporation) to transfer certain eligible property to a taxable Canadian corporation without immediately triggering the income tax that would otherwise arise on the asset's accrued gain. In Canada, where corporate restructurings, incorporations, and business successions are common, Section 85 is the primary tool that prevents immediate tax liability from becoming a crippling barrier to growth and efficient organization.
The core brilliance of Section 85 lies in its ability to override the general rule of the Income Tax Act, which dictates that a disposition of property is deemed to occur at Fair Market Value, resulting in a taxable capital gain or income. Instead, Section 85 permits the transferor and the corporation to jointly elect an “agreed amount” that serves as both the transferor’s proceeds of disposition and the corporation’s cost base for the acquired property. By electing an agreed amount that is equal to the asset's tax cost (such as its Adjusted Cost Base or Undepreciated Capital Cost), any accrued capital gain or recapture is effectively deferred. The tax liability is not eliminated; it is simply postponed and transferred to the corporate level, awaiting a future taxable event, such as the corporation's eventual sale of the asset [more on tax deferral].
For a corporation, Section 85 is invaluable as it allows for tax-neutral corporate reorganization. As a business matures, its legal and financial structure often needs to evolve to optimize tax efficiency, limit liability, or prepare for expansion. Without a Section 85 rollover, any internal transfer of highly appreciated assets (like land, intellectual property, or shares of a subsidiary) between affiliated companies would trigger immediate taxation on those accrued gains, consuming valuable capital. Section 85 removes this impediment, making it possible for businesses to efficiently carry out mergers, spin-offs, and transfers to holding companies (e.g., for creditor protection or estate planning purposes) without an immediate and unwarranted tax bill.
Beyond corporate restructurings, the Section 85 rollover is the linchpin for incorporating a sole proprietorship or partnership. A successful self-employed individual who has built up valuable assets (such as goodwill, equipment, or non-depreciable capital property) must transfer these to their new corporation to continue the business under the corporate structure. Since these assets have often appreciated in value, transferring them at Fair Market Value would generate a significant personal tax liability, penalizing the act of incorporating. Section 85 resolves this by allowing the assets to be "rolled" into the new corporation at the transferor's original cost, deferring the personal tax until a later disposition of the new corporate shares.
The flexibility of the agreed-amount election provides powerful planning opportunities, particularly in estate planning and for utilizing the Lifetime Capital Gains Exemption. While a Section 85 rollover is typically used to elect an agreed amount at the asset's tax cost to achieve full deferral, taxpayers may intentionally elect a higher amount to trigger a partial capital gain. This controlled recognition of a gain is often done to allow an individual shareholder to utilize their Lifetime Capital Gains Exemption on the corporate shares received, effectively "crystallizing" a tax-free gain that can be sheltered by the exemption before a major transaction, thus maximizing the tax benefit available to the owner.
Despite its significant advantages, Section 85 is not a universal free pass; it is a highly prescriptive and technical provision. Its application is limited to eligible transferors (taxpayers), eligible transferees (taxable Canadian corporations), and eligible property (such as capital property, inventory, and resource property), and the consideration received must include at least one share of the transferee corporation. Crucially, the elected amount must fall within strict statutory limits. Given the complexity and potential for severe tax penalties, it is critical that your section 85 rollover is correctly structured, with the appropriate legal and supporting paperwork, such that it might effectively respond to any scrutiny. With over two decades of legal experience, which includes designing and implementing a multitude of section 85 rollovers and other corporate tax planning strategies, we can put that knowledge and experience to use for the advancement of your business.
Our law firm strives to provide strategic tax-driven legal advice and direction to Calgary businesses looking to optimize their business structures and corporate transactions. Contact our law firm at Chris@NeufeldLegal.com or 403-400-4092 to schedule a confidential initial consultation for your business' tax structuring and tax planning initiatives.
