SECTION 85 ROLLOVER
Corporate tax planning to dispose of eligible capital property to a taxable Canadian corporate on a tax-free basis, by way of a tax deferral on the received share consideration.
Contact our law firm for corporate rollovers at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
Importance of Section 85 | How Section 85 Operates | Tax Advantages of Section 85 | Problems arising with Section 85
Importance of Section 85 Rollovers
Section 85 of the Income Tax Act serves as a critical tax-deferral mechanism for Canadian business owners seeking to transfer assets into a corporation (or between related corporations) until its disposition to a third party. Our legal practice specializes in the precise execution of these rollovers, ensuring that capital gains or recaptured depreciation are deferred effectively. By electing to transfer property at its cost base rather than its fair market value, our corporate clients can maintain liquidity while restructuring their holdings. Our law firm provides the comprehensive documentation and tax-election filings necessary to facilitate these complex transfers while adhering to strict regulatory requirements.
The importance of a Section 85 rollover cannot be overstated when it comes to long-term corporate tax planning and organizational restructuring. This provision allows for the seamless transition of personally held business assets or partnership interests into a corporate entity, which is often a prerequisite for professional scaling. Without the protection of a valid Section 85 election, such a transfer would be treated as a disposition at fair market value, potentially resulting in a significant and premature tax burden. We work closely with our clients to evaluate asset eligibility and to establish the appropriate elected amounts to optimize their tax positions.
Beyond mere deferral, Section 85 rollovers are foundational to sophisticated estate planning and business succession strategies. Our legal team utilizes these rollovers to facilitate estate freezes, allowing business owners to lock in the current value of their shares and pass future growth to the next generation. This process is essential for minimizing future probate fees and capital gains taxes upon the death of a shareholder. We ensure that the share exchange components of the rollover are structured to comply with both the Income Tax Act and provincial corporate statutes.
In addition to succession planning, the Section 85 rollover is an indispensable tool for preparing a business for an eventual sale or third-party investment. By moving assets into a corporate structure well in advance of a transaction, owners may become eligible for the Lifetime Capital Gains Exemption (LCGE) upon the sale of qualified small business corporation shares. Our firm manages the legal intricacies of these transfers, including the preparation of bills of sale, director resolutions, and the required T2022 or T2023 election forms. We focus on providing a robust legal framework that protects the client's financial interests and ensures the continuity of their business operations.
How does a Section 85 Rollover Operate
A Section 85 rollover, governed by the Income Tax Act, is a fundamental tax-deferral mechanism utilized during the transfer of eligible property to a taxable Canadian corporation. This provision allows a taxpayer to transfer assets, such as shares, inventory, or capital property, at their tax cost rather than their fair market value. By electing a specific agreed amount within the statutory limits, the taxpayer can avoid the immediate triggering of capital gains or recaptured depreciation that would otherwise occur upon a disposition. Our law firm provides the necessary legal framework to ensure these transfers are executed in strict compliance with federal tax regulations, preserving liquidity for the business.
The operational success of a Section 85 rollover depends on the issuance of shares by the transferee corporation as part of the consideration for the transferred property. While the taxpayer may receive non-share consideration, often referred to as boot, the value of such consideration must not exceed the cost base of the assets to maintain the tax-deferred status. We assist clients in structuring the share provisions and promissory notes to ensure the total consideration reflects the fair market value of the assets. This process requires precise valuations and meticulous drafting of the purchase and sale agreement to satisfy the requirements of the Canada Revenue Agency (CRA).
Filing requirements represent a critical administrative phase where precision is mandatory to avoid significant penalties or the loss of the tax deferral. The taxpayer and the corporation must jointly execute and file Form T2057, and in some cases a provincial equivalent, within the prescribed timelines. Our legal team manages the preparation of these forms, ensuring the agreed amount is calculated correctly and that all asset descriptions are legally robust. We also implement price adjustment clauses within the underlying contracts to provide a safeguard in the event that tax authorities challenge the valuation of the transferred property.
Beyond the initial tax deferral, Section 85 rollovers serve as a strategic component of long-term corporate reorganizations and estate planning. This mechanism is frequently employed to facilitate an estate freeze, allowing the growth of a business to accrue to the next generation while the founder retains a fixed value in preferred shares. It is also an essential tool for incorporating a sole proprietorship or a partnership without incurring an immediate and prohibitive tax liability. Our law firm offers comprehensive legal counsel to integrate these rollovers into a broader business strategy, ensuring your corporate structure remains optimized for both current operations and future transitions.
Contact our law firm for corporate rollovers at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
Tax Advantages of a Section 85 Rollover
A Section 85 rollover is a fundamental tax-deferral mechanism under the Income Tax Act that allows for the transfer of eligible property to a taxable Canadian corporation without triggering immediate capital gains or recapture. Our law firm provides specialized legal services to help business owners, partnerships, and trusts navigate this process by electing an agreed-upon amount for the transfer that is lower than the fair market value. By setting the elected amount at the asset's original tax cost, the transferor can effectively postpone the tax liability that would otherwise arise upon the disposition of the property. This strategy is particularly effective for high-value assets such as real estate, machinery, and intangible property like goodwill.
The primary advantage of utilizing a Section 85 rollover is the preservation of corporate cash flow through the deferral of significant tax payments. When a business owner incorporates a sole proprietorship or moves assets into a holding company, the immediate payment of capital gains tax can drain necessary capital from the enterprise. Our legal team ensures that the transaction is structured so that the transferor receives shares in the corporation as consideration, which is a mandatory requirement for the rollover to be valid. This allows the business to retain its liquid resources for reinvestment, operational expansion, or debt reduction rather than remitting those funds to the CRA.
Beyond simple asset transfers, our firm employs Section 85 rollovers as a cornerstone for sophisticated estate planning and intergenerational business succession. By implementing an estate freeze, a business owner can lock in the current value of their shares and transfer the future growth of the company to the next generation or a family trust. This process minimizes the tax burden that would otherwise be realized upon the death of the founder, ensuring a more orderly and cost-effective transition of ownership. We provide the precise legal documentation and valuation support required to establish these share exchanges while remaining in full compliance with anti-avoidance rules.
Navigating the technical requirements of Section 85 is essential to avoid the severe penalties and interest associated with incorrect filings or improper valuations. Our legal team works closely with your accounting professionals to prepare and file Form T2057, ensuring that all eligible properties (including capital property, inventory, and resource property) are correctly documented. We also assist in structuring boot, or non-share consideration such as promissory notes, to ensure it does not exceed the asset's cost base and trigger an unintended taxable gain. Our comprehensive approach provides the legal certainty needed to protect your business interests and optimize your long-term tax position.
Problems arising with Section 85 Rollovers
The execution of a Section 85 rollover requires precise adherence to the cost blind nature of the Income Tax Act, where any deviation in the valuation of consideration can trigger immediate tax consequences. A primary issue arises when the fair market value of the assets transferred does not exactly equal the aggregate of the boot (non-share consideration) and the fair market value of the shares issued. If the CRA determines that the value of the transferred property exceeds the value of the consideration received, and this excess is deemed a gift to other shareholders, a section 15(1) benefit or a section 86(2) gift-to-surplus adjustment may be applied. Such an adjustment can result in a significant tax hit that the rollover was specifically designed to avoid. Legal counsel must therefore ensure that the price adjustment clauses are robust and that valuations are defensible to mitigate this risk.
Another significant problem involves the improper handling of "boot" and its relationship to the adjusted cost base (ACB) of the transferred assets. Under Section 85, the amount of non-share consideration received by the transferor cannot exceed the elected amount without triggering a capital gain. If a client receives cash or debt-to-shareholder exceeding the tax cost of the asset, the rollover fails to remain tax-deferred for that excess amount. Furthermore, the paid-up capital (PUC) of the shares issued must be carefully managed to avoid an immediate deemed dividend under Section 84. Professional legal oversight is required to structure the consideration mix so that it aligns with the taxpayer's tax attributes and the elected values.
The administrative requirements of filing the T2022 election form present a frequent source of liability and complication. This form must be filed on or before the earliest date on which any party to the election is required to file an income tax return for the taxation year in which the transfer occurred. Late-filed elections are subject to significant penalties, calculated as the lesser of $8,000 or one-quarter of one percent of the amount by which the fair market value of the property exceeds the elected amount for each month of the delay. Incomplete or inaccurate descriptions of the transferred property on the election form can also lead to the CRA's refusal to recognize the rollover. Ensuring that all schedules are meticulously prepared and filed within the statutory timelines is a critical component of the legal services provided.
Finally, the interaction between Section 85 and other restrictive provisions of the Income Tax Act, such as Section 84.1 or Section 55(2), can transform a straightforward reorganization into a costly tax trap. Section 84.1 specifically targets non-arm's length transfers where an individual attempts to extract corporate surplus as a capital gain rather than a dividend, potentially stripping the PUC and creating an immediate tax liability. Similarly, if the rollover is a precursor to a corporate divestiture, the anti-avoidance rules in Section 55(2) regarding inter-corporate dividends may apply to re-characterize tax-free dividends as capital gains. As such, our law firm would need to conduct a comprehensive review of the entire corporate structure and the ultimate goals of the transaction to ensure that the Section 85 election does not inadvertently trigger these punitive anti-avoidance measures.