Section 85 Rollover

Why use Section 85?

Section 85 is useful and complex planning tool for sole proprietorship’s thinking about incorporating their business and it is also useful for succession planning such as estate freezes.

How does it work?

Sole Proprietorship to Incorporation

If an individual were to incorporate a business this would typically mean setting up a corporation and selling the assets to the corporation at fair market value which would result in taxes payable for the individual. However, to avoid this situation, an individual can transfer the assets of the business to a newly setup corporation through Section 85. It has to be done through Section 85 joint election which is filed at the time of the transfer by the transferor and the transferee.

Individual setting up the corporation must become shareholder of the corporation, i.e. they must buy at least one share of the newly setup corporation. . Since assets are being transferred from an individual to a corporation, the corporation will pay consideration based on the elected price (fair market value). The elected price cannot exceed the fair market value (FMV).  The taxpayer will receive preferred shares in return.

The taxpayer may want to set the elected price that is greater than the tax cost thereby triggering a gain. It may be beneficial to trigger a capital gain if the taxpayer is carrying capital losses from previous years that can offset this gain. However, the elected price cannot generate a capital loss as it will not be allowed.

Going back to deferred taxes, taxes are not paid when assets are transferred to the corporation, taxes will become payable when the corporation sells the assets. Therefore, there are no immediate taxes payable.

Succession Planning

If you want to transfer your business to the next generation, you could setup a holding company and issue shares in the holding company to yourself and anyone else you choose (successor).

You will have to make an election under Section 85(1) that would allow you to sell your shares to the holding company at the Adjusted Cost Base of the shares. The holding company would then issue preferred shares to you and common shares to your successor who will pay a nominal price for the shares. You can then crystallize the fair market value of the assets on a specific date which would trigger capital gains and thus ensuring that all future capital gains are transferred to the successor.

Consequences of crystallizing would be capital gain taxes would be payable by you. However, there is a way to avoid capital gains taxes by using the lifetime capital gains exemption. This would allow you to eliminate or lower your taxes payable based on how much lifetime capital gains exemption you have remaining.

CRA form: T2057 Election on disposition of property by a taxpayer to a taxable Canadian corporation

Deadline to file T2057 is the earliest date that any party of the election has to file their income tax return in the year of the transfer. If the deadline to file T2057 was missed then the taxpayer has three years from the due date to file the form, however, the taxpayer will have to include penalties payable at the time of filing. After three years, if the form still has not been filed, they can still file the form by providing justification for late filing, but it is at CRA’s discretion whether or not to accept the form.

Disclaimer: Information provided may not be complete or accurate. It should not be considered financial advice.