Incorporating a business can be a powerful step toward growth, but it often comes with significant tax implications. Fortunately, the Income Tax Act offers Section 85 rollovers, a valuable mechanism allowing business owners to transfer assets into a corporation without triggering immediate tax consequences.
WHAT IS A SECTION 85 ROLLOVER?
Section 85 of the Income Tax Act allows Canadian taxpayers to transfer eligible assets into a Canadian corporation on a tax-deferred basis. This means that, instead of paying taxes on any increase in value immediately, the transferor (e.g., a business owner) can defer the tax by choosing a specific value, known as the “agreed amount,” for the asset. This agreed amount is typically set between the original cost of the asset and its fair market value, allowing the transferor to control how much taxable gain, if any, is realized at the time of the transfer.
This option is especially advantageous for business owners who are incorporating sole proprietorships or partnerships or transferring assets to an existing corporation. By deferring taxes, you can keep more capital in the business, promoting growth while staying compliant with tax obligations.
To complete a Section 85 rollover, certain criteria must be met, and specific documentation must be filed. Here’s an overview of the process:
- Eligible Assets: The assets being transferred must be eligible under Section 85, including shares, real estate (not used personally), goodwill, and certain types of equipment. Notably, some assets, like inventory and debt obligations, are not eligible.
- Transfer to a Canadian Corporation: The rollover must involve a transfer to a taxable Canadian corporation. The transferor receives shares in the corporation as consideration, and these shares represent the value of the transferred assets.
- Agreed Amount: The transferor and the corporation must agree on a transfer value between the original cost and the current fair market value. This agreed amount is the basis for calculating any taxable gain. The lower this amount is set (within the allowable range), the more tax deferral is achieved.
- Agreement: The transferor and the corporation should enter into an agreement with a price adjustment clause in case CRA challenges the fair market value.
- Form T2057: Both the transferor and the corporation must file Form T2057 with CRA to report the Section 85 rollover. The form provides details of the asset transfer, the agreed amount, and the resulting shares issued by the corporation.
KEY BENEFITS OF A SECTION 85 ROLLOVER
- Tax Deferral: By deferring tax, you avoid an immediate tax burden, which can free up cash for reinvestment or growth.
- Flexibility: Section 85 allows for flexible tax planning, as you can choose the agreed amount based on your tax goals. This can help minimize or eliminate taxable gains in a given year.
- Efficient Business Structuring: Incorporating under Section 85 can make it easier to attract investors, obtain financing, and limit personal liability while preserving the value of business assets.
IMPORTANT CONSIDERATIONS & RISKS
While Section 85 rollovers offer significant benefits, there are several considerations to keep in mind:
- Share Valuation: Setting an appropriate value for the shares issued in exchange for transferred assets is critical. Shares issued below fair market value could lead to “benefit” issues with CRA, potentially resulting in penalties.
- Future Tax Implications: Keep in mind that deferral doesn’t eliminate tax, it simply delays it until a future disposition of the shares or assets.
- Documentation Requirements: Proper documentation is crucial. Missing or incomplete filings could invalidate the rollover, resulting in immediate tax consequences.
CONCLUSION
Incorporating a business is a big decision, and tax implications are a key factor. Section 85 rollovers provide a valuable tool for deferring taxes on asset transfers, but the process requires careful planning and documentation. By understanding the mechanics and potential risks, business owners can use Section 85 to preserve capital, reinvest in growth, and build a stronger corporate structure.
If you’re considering a Section 85 rollover, reach out to one of our Toronto tax lawyers to explore how this tax-deferral strategy can benefit you and your business in the long run.
If you need any assistance, contact us today. We will review your facts and outline the steps necessary to resolve your legal matter.
SpenceDrake Tax Lawyers
Disclaimer
Each article/blog post is only meant to provide general information. It is posted on a specific date. Laws and rules change. Please know that it may be out of date. It is not meant to provide legal advice, and it does not provide legal advice. It cannot be relied on. Every tax situation is unique, and that may mean situations differ from this article/blog. If you have legal questions, please consult a lawyer.