section 85 rollovers a complete guide

Section 85 Rollovers: A Comprehensive Guide

Navigating the complexities of Canadian tax law requires a comprehensive understanding of tax planning tools. This guide provides tax professionals with essential references and tools to get the most out of the election of Section 85 rollovers, a cornerstone of corporate reorganizations and tax deferral strategies.

What is a Section 85 Rollover?

A Section 85 rollover, as outlined in the Canadian Income Tax Act (ITA), is a powerful tax planning mechanism. It allows taxpayers to transfer eligible assets, such as capital property, to a taxable Canadian corporation in exchange for shares. The primary advantage of a Section 85 rollover lies in its ability to defer immediate tax consequences that would normally arise from such a transfer.

This deferral is achieved by electing an agreed amount between the transferor and the corporation, which can be set at a level that minimizes or eliminates immediate tax liabilities. The transferor can be an individual, trust, or another corporation, while the transferee must be a taxable Canadian corporation.

This tool is particularly valuable for business owners looking to optimize their corporate structure, defer capital gains taxes, and facilitate corporate reorganizations. By strategically using Section 85, taxpayers can effectively manage their tax obligations while transferring assets into a corporate entity.

Accountants often refer to this transaction as a Section 85 rollover, recognizing its significance in tax planning. Careful planning and adherence to the eligibility requirements are essential to successfully execute a Section 85 rollover and maximize its benefits.

Eligibility Requirements for a Section 85 Rollover

To qualify for a Section 85 rollover under the Canadian Income Tax Act, certain conditions must be met by both the transferor and the transferee. The transferor can be any taxpayer, including individuals, corporations, and trusts, provided they are residents of Canada. The transferee, however, must be a taxable Canadian corporation, typically one incorporated in Canada;

The property being transferred must also meet specific criteria to be considered eligible. Generally, this includes capital property, such as land, buildings, and equipment, as well as inventory and eligible securities. Both depreciable and non-depreciable capital property can be rolled over under Section 85.

The consideration for the transfer must include at least one share of the transferee corporation’s capital stock. Additional consideration can be received, providing flexibility in structuring the transaction. However, the type and amount of additional consideration must be carefully considered to avoid adverse tax consequences.

Compliance with these eligibility requirements is crucial for a successful Section 85 rollover. Failure to meet these conditions may result in the transaction being treated as a taxable disposition, negating the intended tax deferral benefits.

Eligible Transferor and Transferee

The Section 85 rollover provision stipulates specific requirements for both the transferor (the entity transferring the property) and the transferee (the corporation receiving the property) to ensure eligibility for tax deferral. Understanding these requirements is paramount for successful tax planning.

An eligible transferor can encompass a broad range of taxpayers, including individuals, partnerships, corporations, and trusts. The key stipulation is that the transferor must be a resident of Canada for tax purposes. This residency requirement ensures that the transaction falls within the jurisdiction of the Canadian Income Tax Act.

The transferee, on the other hand, has a more specific requirement: it must be a taxable Canadian corporation. This means that the corporation must be subject to Canadian income tax and must be incorporated or otherwise considered a Canadian corporation under the Act. The corporation cannot be a non-resident entity or a tax-exempt organization.

These eligibility criteria are designed to ensure that the Section 85 rollover is used appropriately and in accordance with the intended purpose of the legislation. Careful consideration of these requirements is essential to avoid potential pitfalls and ensure the tax deferral benefits are realized.

Eligible Property for Rollover

The scope of property that qualifies for a Section 85 rollover is broad, encompassing various types of assets commonly held by individuals and businesses. However, not all property is eligible, so understanding the specific requirements is crucial for effective tax planning.

Generally, eligible property includes capital property, which encompasses assets that generate income or appreciate in value over time. This can include land, buildings, equipment, and shares of a corporation. Both depreciable and non-depreciable capital property can be rolled over under Section 85.

Inventory, which includes goods held for sale in the ordinary course of business, is also eligible for a Section 85 rollover. This allows businesses to transfer their inventory to a corporation without triggering immediate tax consequences.

Resource property, which includes rights and licenses related to natural resources, can also be transferred under Section 85. This is particularly relevant for businesses involved in the extraction and development of natural resources.

Certain types of property are specifically excluded from Section 85 rollovers. These include real property that is considered inventory, such as land held for development and sale, and certain types of debt obligations. Careful consideration should be given to the nature of the property being transferred to ensure it meets the eligibility requirements for a Section 85 rollover.

Consideration for the Transfer: Shares and Boot

In a Section 85 rollover, the transferor receives consideration from the transferee corporation in exchange for the transferred property. This consideration typically consists of shares of the transferee corporation’s capital stock. Receiving at least one share is a fundamental requirement for the rollover to qualify under Section 85.

The type of shares received can vary, including common shares, preferred shares, or a combination of both. The specific type of shares issued will depend on the objectives of the transferor and the corporation, as well as the overall tax planning strategy.

In addition to shares, the transferor may also receive other forms of consideration, commonly referred to as “boot.” Boot can include cash, promissory notes, or other property. However, receiving boot can trigger immediate tax consequences, as it is considered proceeds of disposition for the transferor.

The amount of boot received can impact the tax implications of the rollover. If the boot exceeds the transferor’s adjusted cost base of the transferred property, a capital gain may be triggered. Careful planning is necessary to minimize the amount of boot received and to manage the potential tax consequences.

The flexibility in the type of consideration allows taxpayers to negotiate arrangements tailored to their specific needs. Understanding the implications of shares and boot is crucial for optimizing the tax benefits of a Section 85 rollover.

Understanding the Agreed Amount

Central to the Section 85 rollover is the concept of the agreed amount, a figure mutually decided upon by the transferor and the transferee corporation. This elected amount serves as the transferor’s proceeds of disposition and the corporation’s cost basis for the transferred property. Strategically selecting the agreed amount is paramount to deferring immediate tax consequences.

The agreed amount can range from the adjusted cost base (ACB) to the fair market value (FMV) of the property, subject to certain limitations. Choosing an amount equal to the ACB allows for a complete deferral of capital gains or recapture of depreciation. Conversely, electing the FMV may trigger immediate tax implications.

Careful consideration of the agreed amount is crucial, as it directly impacts the capital gain or recapture realized by the transferor. The agreed amount must be justifiable and supported by proper documentation to withstand scrutiny from tax authorities. Factors such as the nature of the property, the transferor’s tax situation, and the corporation’s future plans should influence the decision.

Tax planning professionals can provide valuable guidance in determining the optimal agreed amount, considering both the immediate and long-term tax implications. Strategic selection of the agreed amount is a key element in maximizing the benefits of a Section 85 rollover.

Tax Implications of Section 85 Rollover

A Section 85 rollover enables a taxpayer to transfer assets to a corporation while deferring immediate tax consequences. However, it’s crucial to understand the tax implications that arise both at the time of the rollover and in the future.

Deferral of Tax: The primary benefit is deferring capital gains tax or recapture of depreciation that would otherwise be triggered upon the transfer. The transferor only pays tax when the shares received are eventually sold.

Potential for Future Tax: While the tax is deferred, it’s not eliminated. The transferor will eventually pay tax on the accrued gain when the shares of the corporation are disposed of. This future tax liability should be considered when planning the rollover.

Impact on Corporation’s Cost Base: The agreed amount elected for the transfer determines the corporation’s cost base in the assets. This cost base will affect future depreciation deductions or the calculation of capital gains if the corporation later sells the assets.

Section 84.1 Considerations: Be mindful of Section 84.1, which can apply when transferring property to a corporation controlled by non-arm’s length parties. This provision can recharacterize a capital gain as a dividend, which is taxed at a higher rate.

Section 84.1 Considerations

When undertaking a Section 85 rollover, particularly when the transferor and transferee are not dealing at arm’s length, Section 84.1 of the Income Tax Act becomes a critical consideration. This provision aims to prevent the extraction of corporate surplus as a capital gain, which is taxed at a lower rate than dividends.

Purpose of Section 84.1: Section 84.1 is designed to address situations where an individual transfers property to a corporation they control, receiving consideration that could be seen as a disguised dividend. This provision can recharacterize what would otherwise be a capital gain into a deemed dividend.

Impact on Rollover: If Section 84.1 applies, the capital gain that the transferor anticipated deferring under Section 85 may instead be treated as a dividend. This can significantly increase the tax liability arising from the transaction.

Planning Considerations: To avoid the application of Section 84.1, careful planning is essential. This may involve structuring the transaction to ensure that the consideration received by the transferor is not considered to be a distribution of corporate surplus. Consulting with a tax professional is highly recommended to navigate these complexities.

Filing the Section 85 Election (Forms T2057 and T2058)

To formally elect a Section 85 rollover, the transferor and transferee must jointly file specific forms with the Canada Revenue Agency (CRA). These forms, T2057 and T2058, provide the CRA with detailed information about the transaction and the agreed-upon tax treatment.

Form T2057: This form is used by the transferor to report the details of the property transferred, the consideration received, and the elected amount. It requires comprehensive information about the transferor, the transferee, and the property involved.

Form T2058: This form is the counterpart to T2057 and is filed by the transferee corporation. It confirms the corporation’s agreement with the transferor’s election and provides details about the shares issued as consideration.

Filing Deadline: The election must be filed on or before the earliest date on which either the transferor or the transferee is required to file their income tax return for the year in which the transfer occurred. Missing this deadline can invalidate the election.

Accuracy and Documentation: Accuracy is paramount when completing these forms. Ensure that all information is consistent and supported by appropriate documentation, including valuation reports and legal agreements. Seek professional assistance to avoid errors and ensure compliance.

Potential Benefits of a Section 85 Rollover

Section 85 rollovers offer several key advantages for taxpayers transferring assets to a corporation. The primary benefit is the deferral of immediate tax consequences, such as capital gains or recapture of depreciation, that would otherwise arise upon the transfer of assets at fair market value.

Tax Deferral: By electing an appropriate transfer price within the limits allowed by Section 85, taxpayers can postpone paying taxes on the appreciation of assets until a later date. This deferral can significantly improve cash flow and allow for reinvestment of funds.

Corporate Restructuring: Section 85 rollovers facilitate corporate reorganizations by allowing business owners to transfer assets into a corporation without triggering immediate tax liabilities. This can be useful for estate planning, liability protection, and business expansion.

Estate Planning: Transferring assets to a corporation through a Section 85 rollover can be an effective estate planning tool, allowing for a smoother transition of ownership to future generations while minimizing immediate tax implications.

Flexibility: The ability to choose an elected amount within certain limits provides flexibility in managing the tax consequences of the transfer. This allows taxpayers to tailor the transaction to their specific circumstances and financial goals.

Section 85 Rollover: Planning Considerations and Recent Changes (2024)

In 2024, several planning considerations and legislative updates affect Section 85 rollovers. Taxpayers should be aware of these changes to optimize their tax planning strategies. One crucial aspect is the potential application of Section 84.1, which can impact transactions involving non-arm’s length parties.

Increased Capital Gains Inclusion Rate: Prior to June 25, 2024, taxpayers could crystallize accrued capital gains at a 50% inclusion rate. After this date, the rate increased to 66.67% for corporations and trusts, and for individual gains exceeding $250,000. This change necessitates careful timing of transactions to maximize financial advantages.

Fair Market Value Documentation: Accurate determination and documentation of fair market value for transferred property and non-share consideration are crucial. This information is required on Forms T2057 and T2058, and supporting working papers should be maintained.

Professional Advice: Given the complexities of Section 85 rollovers and the evolving tax landscape, consulting with corporate lawyers and accountants is essential. These professionals can provide guidance on technical requirements, evaluate benefits, and prepare necessary documentation for a seamless transfer.