The Section 85 provision allows the tax-deferred transfer of property to a corporation, also known as the “Section 85 Rollover”. Section 85 of the Canadian Income Tax Act (ITA) is crucial for individuals and businesses who want to plan their taxes efficiently. This article explains the concept, benefits, and considerations of the Section 85 Rollover. It’s a valuable resource for legal and financial professionals navigating these transactions.
What is Section 85 Rollover?
Section 85 Rollover is a mechanism available for taxpayers in Canada to transfer their property to a corporation in exchange for shares while deferring the immediate tax implications that usually arise from such a transfer. Section 85(1) of the Income Tax Act (ITA) outlines this provision. It allows individuals or trusts to defer recognition of a capital gain or recapture of depreciation that would normally be realized on the transfer of property to a corporation, provided that the property and the transfer meet specific criteria outlined in the ITA. It is also required that the consideration received in return includes shares of the corporation to which the property is transferred.
To use the Section 85 Rollover, the transferor and the corporation must make a joint election to the Canada Revenue Agency (CRA) on Form T2057, Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation. This election allows the transferor to set an elected amount that establishes the basis for the transfer to minimize immediate tax while complying with the law. The elected amount must be within certain bounds, which means it cannot be less than the property’s adjusted cost base (ACB) or more than its fair market value (FMV) at the transfer time. The ITA guides determining these values and imposes conditions on the transaction to ensure it aligns with tax policy objectives.
The ITA also includes several subsections and related provisions that address different scenarios and specifics of property transfers under Section 85. For example, Section 85(1.1) deals with situations involving eligible capital property, while other subsections outline the implications for different types of properties and circumstances surrounding the rollover.
Complying with these detailed legal requirements is important because the CRA closely scrutinizes such elections to prevent abuse of the tax deferral benefits. Legal and tax professionals play a crucial role in navigating these complex regulations, ensuring that taxpayers maximize their benefits under Section 85 Rollover while adhering to the spirit and letter of Canadian tax law.
Eligible Properties and Parties
Eligible properties include tangible, intangible, and certain financial assets, excluding cash. The transaction must have a legitimate business or personal planning purpose, and both parties must agree and jointly elect to apply the provisions of Section 85. The transferor must receive shares in the corporation, and the corporation must be subject to taxation under ITA. The ITA’s comprehensive approach to defining eligible properties and parties for the Section 85 Rollover aims to provide flexibility for taxpayers while safeguarding against potential exploitation of the tax system.
Here are examples of such eligible properties:
- Tangible Personal Property: This category covers tangible assets like machinery, vehicles, and equipment that are employed in business operations. These assets are indispensable for the smooth functioning of many businesses, and transferring them to a corporation can be instrumental in enhancing operational efficiency and achieving growth.
- Real Property: Land and buildings are valuable assets that may be transferred to a corporation using the Section 85 Rollover. This includes commercial real estate such as office buildings, manufacturing facilities, retail spaces, and residential properties held for investment purposes.
- Intangible Assets: Intellectual property (IP) such as patents, trademarks, copyrights, and trade secrets are eligible for transfer. These assets are particularly relevant for technology companies, creative industries, and businesses where branding and proprietary technology constitute significant value.
- Inventory: Businesses can transfer goods held for sale without triggering immediate tax consequences. This applies to a wide range of businesses, including manufacturers and retail operations.
- Eligible Capital Property: Certain intangible assets, such as goodwill and customer lists, do not have a finite lifespan. Despite the evolving treatment of eligible capital property under Canadian tax law, including its integration into the capital cost allowance system, these assets are important in business transfers.
- Shares and Debt of Other Corporations: In some instances, it is possible to transfer eligible shares or debt of other corporations held by the transferor. This allows for intricate corporate restructurings and the consolidation of business interests under a single corporate entity.
The primary advantage of a Section 85 Rollover is the deferral of capital gains tax. Typically, transferring assets at fair market value (FMV) to a corporation would result in immediate recognition of any accrued capital gains, leading to a tax liability for the transferor. The Section 85 Rollover allows for the transfer at an elected amount, potentially minimizing or deferring the capital gains tax.
Additionally, this provision facilitates business restructuring, succession planning, and incorporation of sole proprietorships or partnerships by providing a tax-efficient mechanism to move assets into a corporate entity without triggering an immediate tax burden.
Critical Considerations and Requirements
To successfully execute a Section 85 Rollover, several critical steps and considerations must be addressed. These include, but are not limited to:
- Election Agreement: Both the transferor and the corporation must jointly file an election with the Canada Revenue Agency (CRA) using Form T2057, Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation. This agreement specifies the elected amount (consideration) for the transferred property, which should reflect a careful balance between minimizing taxes and adhering to CRA requirements.
- Elected Amount: The elected amount must be between the property’s adjusted cost base (ACB) and its FMV, ensuring that any chosen value within this range is justifiable under audit.
- Timing and Deadlines: The election must be filed by the taxpayer’s filing due date for the year in which the transfer occurs. Late filings are permitted under certain conditions but may incur penalties.
- Legal and Tax Advice: It is crucial to seek expert legal and tax advice when considering a Section 85 Rollover to ensure compliance with statutory requirements and optimize tax benefits.
Cost of Consideration
The cost of consideration in a Section 85 Rollover under the Income Tax Act (ITA) of Canada refers to the value assigned to shares or other consideration received by the transferor in exchange for the transferred property. This value is critical in the transaction as it determines the tax implications for the transferor and the corporation receiving the assets. The agreed-upon amount, which both parties elect, becomes the cost base of the consideration for the transferor. This amount is chosen strategically to minimize immediate tax liabilities while complying with the ITA’s requirements. It must be within certain limits – at least the asset’s adjusted cost base (ACB) to the transferor and not more than its fair market value (FMV) at the transfer time.
The cost of consideration directly affects the capital gains or losses recognized by the transferor and the consequent tax treatment of the transferred assets in the hands of the corporation. For the transferor, selecting an appropriate elected amount is crucial to optimizing tax outcomes, allowing for a deferral of capital gains tax or avoiding recapture on depreciable property. For the corporation, the cost of consideration becomes the property’s cost base for future tax calculations, affecting depreciation claims and the calculation of capital gains or losses upon the eventual disposition of the assets. The interplay between the elected amount, the ACB, and the FMV requires careful consideration and planning, often necessitating professional advice to navigate the complexities of the ITA and ensure the most favourable tax treatment.
The Section 85 Rollover defers capital gains tax on asset transfers to a corporation, making it a valuable tool for tax-efficient business restructuring. However, executing this rollover requires careful planning and consultation with legal and tax professionals. Understanding the ITA provisions, benefits, and obligations for compliance with Canadian tax law is essential while leveraging the advantages.
If you are in search of guidance from a Toronto corporate lawyer, contact us and see how our firm can help you.
The information provided above is of a general nature and should not be considered legal advice. Every transaction or circumstance is unique, and obtaining specific legal advice is necessary to address your particular requirements. Therefore, if you have any legal questions, it is recommended that you consult with a lawyer.