SECTION 85 ROLLOVER - corporate tax planning strategy

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One of the most significant corporate tax planning strategies is the section 85 rollover, which allows a taxpayer to transfer eligible property to a taxable Canadian corporation on a tax-deferred basis. This provision, outlined in Section 85 of the Income Tax Act (Canada), is commonly used in various business and personal scenarios to defer or postpone tax liabilities that would otherwise arise from the disposition of property.

The objective goal of a section 85 rollover is to avoid the immediate taxable event that would otherwise occur when a person sells or transfers an asset that has appreciated in value, which would result in the immediate realization of a capital gain and require the taxpayer to pay tax on it immediately. A properly structured section 85 rollover instead allows the transferor and the corporation to jointly elect to transfer the property at an "elected amount," which can be set at a value that defers the tax [more about tax benefits].

To effectuate a section 85 rollover, the critical components and requirements, include:

  • Transferor: The person or entity transferring the property. This can be an individual, a trust, or a corporation.

  • Transferee: The recipient of the property, which must be a taxable Canadian corporation.

  • Eligible Property: The types of assets that can be transferred under this provision are specifically defined in the Income Tax Act. They include:

    • Depreciable and non-depreciable capital property (e.g., land, buildings, equipment, shares in another corporation).

    • Resource property.

    • Certain types of inventory.

    • Eligible capital property, such as goodwill.

  • Consideration: In exchange for the transferred property, the transferor must receive at least one share of the capital stock of the transferee corporation. Other forms of consideration, such as cash or a promissory note, are also permitted, but these may have tax implications. This non-share consideration is often referred to as "boot."

  • Elected Amount: The most crucial element of a section 85 rollover is the "elected amount," which the transferor and the corporation agree upon. This amount becomes the proceeds of disposition for the transferor and the cost of the property for the corporation. The elected amount must fall within a specific range:

    • It cannot be more than the fair market value (FMV) of the transferred property.

    • It cannot be less than the FMV of any "boot" (non-share consideration) received.

    • For depreciable property, there are specific rules to prevent a loss of undepreciated capital cost (UCC).

  • Filing: To formalize the rollover, the transferor and transferee must complete and file the prescribed form with the Canada Revenue Agency (CRA), typically Form T2057, "Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation."

A section 85 rollover is a versatile tool used in a variety of tax-planning and business-structuring situations, including:

  • Incorporating a Sole Proprietorship: A business owner who has built up a successful sole proprietorship can use a Section 85 rollover to transfer the business assets, including goodwill, to a new corporation without triggering an immediate tax liability.

  • Corporate Reorganizations: It is used to restructure a company's assets, for example, by transferring assets from an operating company to a holding company for asset protection or other tax-planning purposes.

  • Estate and Succession Planning: A Section 85 rollover can facilitate the transfer of a family business to the next generation in a tax-efficient manner, deferring the tax consequences of the transfer.

  • Capital Gains Crystallization: In some cases, a taxpayer might use a Section 85 rollover to strategically trigger a capital gain to take advantage of available capital losses or the lifetime capital gains exemption.

Although a section 85 rollover is a major tax deferral tool, it does not eliminate the tax liability entirely; it simply defers it. The tax is postponed until a later date, such as when the corporation sells the assets or when the individual sells their shares in the corporation. Due to the complexity and strict rules involved, it is highly recommended to seek professional tax law advice is retained when undertaking a section 85 rollover [more on complexity and mistakes].

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.

What is a Section 85 Rollover