SECTION 85 ROLLOVER COMPLEXITY & MISTAKES

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While a section 85 rollover is an important tax planning strategy, its complexity gives rise to the prospect of serious mistakes, such that an experienced tax lawyer should be engaged to navigate this highly technical tax law procedure. Areas of complexity that can give rise to mistakes in the execution of a section 85 rollover include:

A. Misunderstanding Eligibility and Requirements Ineligible Property

  • Not all assets qualify for a Section 85 rollover. Cash and accounts receivable are explicitly excluded. Failing to properly identify and handle ineligible property can invalidate the entire rollover. Eligible property includes depreciable and non-depreciable capital property, resource property, and inventory [more on eligible property].

  • Ineligible Parties: The rollover must be between an eligible transferor (an individual, trust, or corporation) and a taxable Canadian corporation. If the transferee is not a taxable Canadian corporation, the rollover will not be valid.

  • Missing Share Consideration: The consideration received by the transferor must include at least one share of the capital stock of the transferee corporation. If the transferor receives only non-share consideration (e.g., a promissory note or cash), the rollover is not valid.

B. Errors with the "Elected Amount" Incorrect Range

  • The "elected amount" is the value at which the property is transferred for tax purposes. This amount must fall within a specific range: it cannot be less than the fair market value (FMV) of the non-share consideration received, and it cannot be more than the FMV of the property.

  • Improper Use of "Boot": "Boot" refers to any non-share consideration received, such as cash or a promissory note. If the value of the boot exceeds the adjusted cost base (ACB) of the transferred property, it can trigger an immediate taxable gain for the transferor.

  • Ignoring Specific Limits: There are additional, specific limits on the elected amount for different types of property, such as depreciable property and inventory. Failing to adhere to these limits can result in adverse tax consequences, including a deemed gain.

C. Improper Valuation

  • Incorrect Fair Market Value (FMV): The FMV of the transferred property and the consideration received must be accurately determined. The Canada Revenue Agency (CRA) requires that a "fair and reasonable" attempt has been made to value the assets. Errors in valuation can lead to CRA reassessment and penalties. It's often prudent to engage professional appraisers or valuation experts for complex or intangible assets, like goodwill.

  • Not Using a Price Adjustment Clause: A price adjustment clause in the transfer agreement can protect both parties if the CRA later disputes the FMV of the assets. This clause allows the parties to retroactively adjust the purchase price to align with the CRA's determination, thus preserving the tax deferral.

D. Filing and Documentation Errors

  • Late Filing: A joint election on the prescribed form (Form T2057 for individuals/corporations or T2058 for partnerships) must be filed by the earlier of the transferor's or the transferee corporation's tax return due date for the year of the transfer. Late filing can result in significant penalties (up to $8,000 plus interest).

  • Incomplete or Incorrect Forms: Failure to accurately complete the forms, including providing a specific and adequate description of each property, can invalidate the rollover. Proper supporting documentation should also be retained.

E. Overlooking Other Tax Implications

  • Provincial Taxes: A Section 85 rollover may defer federal income tax, but it does not necessarily defer provincial taxes, such as land transfer tax on real estate.

  • Section 84.1 Anti-Avoidance Rules: When a Section 85 rollover is used in a transaction involving related parties, such as transferring shares of one corporation to a holding company, the anti-avoidance rules in Section 84.1 of the Income Tax Act can be triggered. This can result in a capital dividend account (CDA) reduction or a deemed dividend, potentially leading to a significant tax liability.

  • Recapture of Capital Cost Allowance (CCA): If the elected amount for depreciable property is less than its undepreciated capital cost (UCC), it could lead to recapture of CCA, triggering a taxable income gain.

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