What is a Section 85 Rollover?

Overview

According to the Canadian Income Tax Act, a taxpayer is allowed to transfer qualified property based on a deferred tax to a taxable Canadian corporation. This is according to an election in the act known as the section 85 rollover. Summarily, based on their objectives, this election gives the option to taxpayers to defer a part or the entire tax consequence that would typically be payable on the transfer.

This election is mostly used in but not limited to certain situations. They are:

  • Entrepreneurs (sole proprietors) who wish to incorporate their business.
  • Crystallization of capital gains
  • Planning of estates
  • Asset transfer between businesses.

Requirements for qualification

Primarily, to be eligible for the section 85 rollover, both a transferor and a transferee must be eligible. The definition of an eligible transferor is essentially any taxpayer which includes corporations, individuals, and trusts. An eligible transferee, on the other hand, has to be a taxable Canadian corporation. Typically this means that the corporation has to be formed in Canada.

The transferred property on the other hand, must be an eligible property. Here are examples:

  • Capital properties that are either depreciable or non-depreciable
  • Any inventory apart from those held by real property as inventory
  • Canadian and\or foreign resource properties
  • Real estate properties that are owned by non-residents but are used for business in Canada.

Finally, whatever consideration the transferor receives during the transfer must contain the shares of the transferee. The transferor may also get non-share consideration, which is often called ‘boot’. The fair market value (FMV) of the boot cannot be more than the tax cost of the transferred property. This is to avoid triggering a capital gain. Cash or a note receivable are both examples of a common non-shareholder consideration. Therefore, the FMV of the assets transferred must be equal to that of the entire received consideration.

How does it work?

The implementation of a section 85 rollover requires that both the transferor and transferee agree on the amount on the transfer. The amount agreed upon becomes the transferor’s proceed of disposition and is also the cost of the property acquired by the transferee.
The elected amount should not be any of the following:

  • Below the boot’s FMV or;
  • Exceeding the amount of FMV of the property that is to be transferred.

The lower range of the amount agreed upon must not be lower than the lesser of the following if the taxpayer is transferring inventories or non-depreciable capital possession:

  • FVM of property
  • The entire cost of either the inventories or adjusted cost base (ACB) of the property.

In a situation where the taxpayer is transferring a depreciable property, the lower range of the agreed amount must not be lower than the lesser of:

  • Property FMV
  • ACB
  • Undepreciated capital cost.

Often, you can choose at tax cost or ACB resulting in a tax-free rollover. There are cases where you might consider choosing a higher amount to intentionally trigger capital gains. An example is using carryforwards or crystalizing the gains exemption of the capital.

Scenarios

A sole proprietor wants to transfer non-depreciable capital property from his business to a newly incorporated Canadian company for its common share. Such properties have an ACB of up to $100,000 and an FMV of up to $300,000.

Election of transfer without a section 85 rollover

In the option that a transfer is executed without using the section 85 rollover, you would be required to declare a disposition of the capital property at its FMV. This could lead to a capital gain of up to $200,000 ($300,000-$100,000) on your tax return.

Involving a section 85 rollover

In the option where section 85 rollover is being used, you can transfer capital property at an ACB of $100,000 (elected amount). This will not lead to any capital gain, and there will also be no tax consequences in the interim. If, for instance, no boot is taken into consideration, the common shares’ ACB becomes elected amount of $100,000. This means that the corporation has a capital property that has an ACB of $100,000. The summary of the transaction is explained below.

It is important to note that this doesn’t exclude the transferor from paying tax on his gains. It means that the tax related to the capital gain is deferred until the next sale of capital property, this time, the seller being the corporation.

Specifications & filing deadlines

CRA form T2057 is used to file the joint election. This form is filed before the deadline of the transferor and transferee’s income tax return of both transferor and transferee during the tax year that the transfer took place. This form is addressed to the transferor’s tax center and is filed separately from other returns. In the case that there is more than one transferor in the transaction of a given property, it is only required that one transferor be designated to file all the completed election forms on behalf of every other transferor involved. The designated transferor would be required to make a list of the transferors involved, then submit it to the corporation’s tax center.

If the filing is done within three years from the original due date of the form, the CRA will accept the late filing of the form. What matters, in this case, is that the taxpayer add an estimated penalty fee payment when it is filed.

In a situation where the form is filed after three years from the original due date, the taxpayer would be required to add a written explanation to justify the late filing along with the estimated penalty fee payment. The CRA will then use its own discretion to determine whether or not the late-filed election is accepted.

If you wish to transfer capital property to a corporation and inquire about the Canadian tax implications and all available planning options, contact DFD-CPA for assistance. We are always ready to help you with professional advice and answer all of your questions.


Disclaimer:

This article only provides information in a general nature and is only as current as of the date on which it is posted. It is not updated and therefore may no longer be current. This document should not be relied upon as it does not claim to, nor provide advice on legal or tax matters. All tax situations are specific in nature and will likely differ from the situations that are presented in the article. It is advisable that you seek and consult a tax professional if you have any specific legal or tax questions. This document is intended to provide general information on a particular subject or subject (s) and this article is not an exhaustive treatment of such subject(s). In accordance, the information in this document is not intended to constitute or replace accounting, tax, legal, investment, consulting, or other professional advice or services. Before any decision is made, or any action taken which might affect your personal finances or business, you should consult a qualified, professional adviser.

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