Published: April 13, 2020
Last Updated: November 11, 2021
Tax Free Transfers under s85 of the Canadian Income Tax Act
If you have a business as a sole proprietor and are now seeking a way to transfer assets into a corporation without incurring negative tax consequences, the use of the subsection 85(1) rollover provisions under the federal Income Tax Act (“ITA”) will be beneficial to you.
The rollover can also be useful if you are looking to incorporate a holding company, and would like to transfer assets or shares into that holding company with no negative tax consequences.
This rollover allows a taxpayer to defer all or part of the income that would otherwise arise on the transfer of certain types of assets to a taxable Canadian corporation. Income deferral results in no taxable event occurring at the time of transfer and you will owe no taxes to the tax department at the time of the transfer.
Without the use of the rollover provisions, a disposition of the assets transferred will occur, resulting in tax owing. Deferral of the recognition of income pursuant to subsection 85(1) may be necessary because while the unincorporated business was operating, related assets including intangibles such as goodwill may have accumulated in value. Without the rollover, the transfer of appreciated assets from sole proprietor into the corporation will trigger the recognition of a capital gain that would therefore be taxable.
For example, if for her unincorporated business Shirley purchases a strip mall with 6 employees for one million dollars she is a sole proprietor owning that business property. If, at some point in the future, Shirley decides to incorporate for the various tax advantages, and wants to move the property into the corporation, she can utilize the subsection 85(1) rollover.
The property would have accumulated some value above the original one million dollar price, so that if she were to simply move it into the corporation without the rollover, a taxable event would occur—the realization of a capital gain on the deemed disposition of the property as it is transferred to her corporation. However, if Shirley elects to transfer the property pursuant to subsection 85(1), and the proper computations and elections are made, there would be no tax owing on the property transfer to the corporation. To take advantage of the preferential tax treatment provided by the rollover, the transferor and the corporation must file a joint election under section 85 of the ITA. The rollovers technical requirements are very specific. For example, the transferor must receive at share consideration in the capital stock of the corporation in return for the property transferred. Also, the transferor cannot receive more than the original cost of the property transferred in cash or other non-share consideration, otherwise a taxable event will occur.
Additionally, goodwill coming from the sole proprietorship into the corporation should either be purchased at value or should have an elected amount. If purchased at value, the election has to be at the adjusted cost base of the goodwill, rather than a nominal amount. Failure to, transfer and elect could result in a tax liability to the transferor. Finally, there are certain assets that are not eligible for a section 85 rollover. Examples include real property inventory, and real property of a non-resident.
It is important to deal with legal experts as the value attributed to the transferred assets must be correct or the Canadian Revenue Agency may question and assess the transaction.
If you are looking to transfer assets into a corporation or to reorganize your business affairs into a tax efficient business structure, please contact our office to speak with one of our experienced tax lawyers.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."