Pawlina Law

Section 85 Rollover

A section 85 rollover is one of the most commonly used tax deferral mechanisms in Canada. It is available to Canadian taxpayers that are disposing of property to a corporation where the property that is being disposed of has increased in value.

What is Section 85 Rollover?

Normally, when property (shares of a business or assets used in a business) increases in value and the taxpayer disposes of that property, they would have to pay tax on the increase in value. However, a section 85 rollover is a mechanism in the Income Tax Act whereby a taxpayer can defer tax on the transaction described above. It is commonly used for:

  • Individuals who have started a business as a sole proprietor or as a partnership but then desire to convert that business to a corporation.
  • Taxpayers wanting to have a holding corporation and operating corporation structure where the holding corporation owns the operating corporation.

How Section 85 Rollover Works

Section 85 rollover allows a taxpayer to transfer assets of a business or shares of a corporation to another corporation on a tax-deferred basis as long as certain factors are met.

Section 85 rollover also allows all members of a partnership to elect to defer all or part of the income which would otherwise arise on the transfer of certain types of property to a taxable Canadian corporation.

Eligibility and Conditions

You have to elect a dollar amount, as opposed to making a descriptive election, in setting the agreed amount for the purposes of subsection 85. It is crucial that a Section 85 rollover is done correctly to ensure you get the benefit of the rollover.

Legal and Accounting Requirements

A section 85 rollover is very technical. Both your lawyer and accountant will need to work together to get the section 85 rollover complete. Your lawyer will need to prepare the section 85 rollover transactional documents, and your accountant will need to file the correct forms with the Canada Revenue Agency.

Under section 85, the consideration that the owner receives for the property transferred to the corporation has to include at least one share (or fraction of a share) of the capital stock of that corporation for the election to be valid.

Understanding how a Section 85 Rollover works

Section 85 Asset Rollover

Paul owns machines he uses in his sole proprietor business

Paul transfers those machines to his new corporation (Paul Machining Inc.) in exchange for shares in the new corporation

As a result, Paul Machining Inc. now owns the machines and Paul owns the shares of Paul Machining Inc.

Paul owns machines he uses in his sole proprietor business

Paul transfers those machines to his new corporation (Paul Machining Inc.) in exchange for shares in the new corporation

As a result, Paul Machining Inc. now owns the machines and Paul owns the shares of Paul Machining Inc.

 

Section 85 Share Rollover

Applications of Section 85 Rollover

Paul owns shares of Paul Machining Inc.

Paul transfers his shares of Paul Machining Inc. to a new holding corporation (Paul Holdings Inc.) in exchange for shares in the new corporation

As a result, Paul Holdings Inc. now owns the shares of Paul Machining Inc. and Paul owns the shares of Paul Holdings Inc.

Paul owns shares of Paul Machining Inc.

Paul transfers his shares of Paul Machining Inc. to a new holding corporation (Paul Holdings Inc.) in exchange for shares in the new corporation

As a result, Paul Holdings Inc. now owns the shares of Paul Machining Inc. and Paul owns the shares of Paul Holdings Inc.

 

This asset rollover can be used when a sole proprietor business has become profitable and the sole proprietor does not need all the after-tax cash flow that is generated by the business. Using a corporation can allow the business owner to retain earnings in the corporation.

The share rollover can be used by someone wishing to have a holding and operating structure in place. Once the structure is in place, the owner has more flexibility with limiting their liability.

Conclusion

A section 85 rollover provides significant tax deferral benefits and can be a powerful tool for business owners and investors. However, due to its complexity, it is essential to work with professional advisors to ensure the rollover is executed correctly.

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