When can I use a section 85 Rollover? What are the Benefits?

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Contact our law firm for corporate structuring at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

A Section 85 Rollover is a provision in the Canadian Income Tax Act that allows individuals, partnerships, trusts, or corporations to transfer "eligible property" to a taxable Canadian corporation on a tax-deferred basis. This means that you can transfer assets that have appreciated in value without immediately triggering a capital gain and the associated tax liability.

Potential reasons for undertaking a Section 85 Rollover include:

• Incorporating a Sole Proprietorship: This is one of the most common uses. If you've been operating a successful sole proprietorship and want to transition to a corporate structure, a Section 85 rollover allows you to transfer your business assets (like equipment, inventory, and especially goodwill) to the new corporation without incurring immediate taxes on any accrued gains.

• Corporate Reorganizations: When restructuring an existing corporate group, such as adding a holding company (Opco-Holdco structure) or consolidating assets, a Section 85 rollover can facilitate these changes without immediate tax consequences.

• Estate Planning and Succession: It's a valuable tool for transferring assets to the next generation or to key employees within a family business. This allows for an orderly transition of ownership while deferring tax liabilities.

• Asset Segregation and Protection: You might want to move certain assets into a separate corporation for liability protection or other business reasons. A Section 85 rollover allows this without triggering a taxable event.

• Crystallizing Capital Gains Exemption: In some specific scenarios, you might intentionally trigger a capital gain using a Section 85 rollover to utilize your lifetime capital gains exemption (LCGE) if you have one available.

Realizable benefits that are possible from undertaking a Section 85 Rollover include:

• Tax Deferral: The primary benefit is the deferral of capital gains and recapture taxes. Instead of paying tax on the appreciation of the assets at the time of transfer, the tax liability is deferred until the corporation eventually sells those assets or the shares of the corporation are sold by the original transferor. This preserves cash flow for the business.

• Flexibility in Elected Amount: You and the corporation can jointly elect an "agreed amount" for the transfer of the assets. This amount can be set anywhere between the asset's tax cost (Adjusted Cost Base or Undepreciated Capital Cost) and its fair market value, allowing for strategic tax planning. Often, it's set at the tax cost to fully defer the gain.

• Preservation of Capital: By deferring taxes, more capital remains within the business for reinvestment, expansion, or operational needs.

• Facilitates Corporate Structuring: It enables various corporate reorganizations, such as mergers, spin-offs, and the creation of holding companies, without immediate tax impediments.

• Smooth Intergenerational Transfers: For family businesses, it provides a tax-efficient way to transfer ownership and future growth to heirs, aiding in succession planning.

• Avoids Double Taxation (in certain contexts): Without a Section 85 rollover, transferring assets to a corporation at fair market value would typically trigger a personal tax liability for the transferor, and then the corporation would hold the asset with a stepped-up cost base. While a Section 85 defers the initial personal tax, the overall tax liability is still recognized, just at a later time or potentially within the corporation which may be subject to different tax rates.

As with any tax planning / structuring strategy, there are numerous considerations of great significance that will need to be address, and be impacted by the specific facts and circumstances, including but not limited to:

• Eligible Property: Not all assets qualify for a Section 85 rollover. Generally, it applies to capital property (depreciable and non-depreciable), eligible capital property (like goodwill), and certain types of inventory. Cash and prepaid expenses generally do not qualify.

• Taxable Canadian Corporation: The transferee must be a taxable Canadian corporation.

• Consideration: The transferor must receive at least one share of the transferee corporation as part of the consideration. If non-share consideration (like a promissory note or cash, often referred to as "boot") is received, it can trigger immediate tax consequences if it exceeds certain limits.

• Joint Election: The transferor and the corporation must jointly elect for the Section 85 rollover by filing a prescribed form (Form T2057 for individuals/trusts/corporations, or T2058 for partnerships) with the Canada Revenue Agency (CRA). This election must be filed by a specific deadline.

Significance of Professional Advice: Section 85 rollovers are complex and involve strict rules. It is highly recommended to seek advice from a tax accountant and a lawyer to ensure compliance and to properly structure the transaction for your specific circumstances. Not only are there serious issues that can arise when a section 85 rollover is not properly conceived or implemented, but there are critical considerations that are not accounted for between different provincial jurisdictions, with rollovers in Toronto versus Calgary revealing significant discrepancies.

For knowledgeable and experienced legal representation when undertaking a corporate rollover or other tax-driven corporate re-structuring, contact corporate business lawyer Christopher Neufeld at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.

Serious Issues in Conception & Implementation of Section 85 Rollovers

A Section 85 rollover under the Canadian Income Tax Act is a powerful deferral mechanism, but its successful execution depends on absolute precision, meaning that a poorly conceived plan can inadvertently trigger immediate and costly tax liabilities. The primary objective of a Section 85 rollover is to allow a taxpayer to transfer eligible property to a taxable Canadian corporation in exchange for share consideration while deferring capital gains. However, if the transaction is structured without a thorough pre-assessment of asset valuations or cost base calculations, the intended tax neutrality collapses. Failing to accurately verify the adjusted cost base (ACB) or the fair market value (FMV) of the transferred assets means the transfer price might be set incorrectly, which can instantly expose the taxpayer to unexpected capital gains taxes or recaptured depreciation. Consequently, what was intended to be a seamless, tax-deferred corporate reorganization can transform into an immediate financial burden purely due to inadequate planning.

Implementation errors frequently manifest in the precise mechanics of the consideration received, particularly when the corporate documentation fails to match the strict legal requirements of the rollover. To qualify for the deferral, the transferring party must receive shares of the transferee corporation as part of the consideration, yet inexperienced practitioners sometimes overlook this absolute prerequisite by issuing only non-share consideration, such as promissory notes. Furthermore, the aggregate value of any non-share consideration (commonly referred to as "boot") cannot exceed the tax cost or adjusted cost base of the transferred property without triggering an immediate capital gain. If the legal documents, including corporate resolutions and share issuance registries, are poorly drafted or misaligned with the intended economic reality, the Canada Revenue Agency (CRA) can invalidate the rollover treatment. This operational disconnect between accounting entries and formal corporate execution represents a critical vulnerability that routinely compromises otherwise viable tax strategies.

The strict administrative requirements surrounding the filing of the T2057 election form present another minefield where procedural missteps yield severe statutory consequences. A Section 85 rollover is not automatically granted by virtue of executing the transfer; it must be formally elected by submitting a fully completed Form T2057 within rigid statutory timelines, generally on or before the earliest date on which any party to the election is required to file an income tax return for the tax year. Late filings, missing signatures from either the transferor or the corporate transferee, or incomplete asset descriptions can result in the CRA rejecting the election entirely or imposing substantial late-filing penalties. Even worse, if an omission is deemed to reflect gross negligence rather than an innocent oversight, the ability to retroactively amend or late-file the election may be denied. Without a valid, timely filed election form, the transaction is treated as a standard disposition at fair market value, forcing the immediate realization of all deferred gains.

Serious structural issues also arise when the transaction inadvertently triggers the harsh anti-avoidance or income attribution rules embedded within the Income Tax Act. For instance, if the rollover involves transferring property between related parties or family members, a failure to align the fair market value of the transferred property with the fair market value of the shares issued can trigger a taxable benefit under section 15 or section 246, or result in a gift loan scenario under subsection 85(1)(e.2). This specific corporate benefit rule penalizes transactions where the excess value of the transferred asset is deemed to be a gift to other shareholders, resulting in a retroactive adjustment that increases the proceeds of disposition without a corresponding increase in the corporation's tax cost. Navigating these interconnected statutory provisions requires a sophisticated understanding of how corporate distributions intersect with family attribution rules, as a single miscalculation can permanently distort the tax architecture of a family business.

Finally, a poorly conceived Section 85 rollover can severely disrupt the long-term commercial and operational flexibility of the business, creating structural imbalances that complicate future sales or successions. If assets are rolled into a holding company or operating company without a clear exit strategy, the owner may inadvertently compromise their future eligibility for the Lifetime Capital Gains Exemption (LCGE) by failing to maintain the proper ratio of active business assets to passive assets. Additionally, inflating the paid-up capital (PUC) of the newly issued shares beyond the tax cost of the transferred assets creates a ticking tax bomb, as a mismatch between PUC and ACB can convert what should be tax-free capital returns into taxable dividends upon a future corporate redemption or liquidation. Ultimately, the long-term legal and financial repercussions of an improperly implemented rollover often eclipse the immediate tax concerns, saddling the corporation with a defective capital structure that requires expensive, complex remedial legal work to undo.

Section 85 Jurisdictional Differences: Toronto versus Calgary

Executing a Section 85 rollover in Toronto can introduce several adverse tax consequences and heightened financial frictions that do not exist or are substantially mitigated for a comparable transaction in Calgary. While Section 85 of the federal Income Tax Act permits a tax-deferred transfer of eligible property to a corporation nationwide, the underlying provincial statutory frameworks diverge sharply. The most immediate and punitive difference manifests in real estate transfers due to Ontario’s dual-layered land transfer tax system, a burden entirely absent under Alberta’s land registration model. Furthermore, provincial corporate income tax discrepancies, separate provincial administration rules, and disparate personal tax brackets upon future wealth extraction ensure that a Toronto-based corporate restructuring faces structurally higher overall tax liabilities and complex optimization hurdles.

A primary pitfall of executing a Section 85 rollover involving real property in Toronto is the immediate imposition of Land Transfer Tax (LTT), whereas a Calgary rollover incurs no such transaction tax. Ontario treats the transfer of land to a corporation as a taxable disposition for LTT purposes, calculating the tax based on the fair market value of the property or the value of any outstanding liability assumed by the corporation. For instance, if a business owner executes a Section 85 rollover to transfer a $2 million commercial property to a corporation in Toronto, the transaction triggers a combined provincial and municipal land transfer tax bill of $72,950 (calculated on the graduated brackets of both the Ontario provincial LTT and the City of Toronto municipal LTT). Conversely, Alberta does not levy a provincial or municipal land transfer tax; instead, a comparable transfer of a $2 million commercial property in Calgary faces only nominal, flat-rate land title registration fees totaling less than $1,000. This distinct regional advantage leaves the Calgary corporation with full liquidity, while the Toronto rollover triggers a substantial, immediate cash outflow for a transaction that produces no actual third-party cash proceeds.

Beyond immediate land transfer taxes, the long-term deferral value of a Section 85 rollover is fundamentally shaped by provincial corporate income tax rates, where Ontario imposes a heavier fiscal burden than Alberta. When a corporation eventually disposes of the rolled-over capital property or continues to operate the transferred active business, its corporate tax rate dictates how much capital can be retained and reinvested. For active business income exceeding the small business deduction threshold, Ontario's provincial corporate tax rate stands at 11.5%, which, when combined with the 15% federal rate, creates a general corporate rate of 26.5%. Alberta, by contrast, maintains a highly competitive general provincial corporate tax rate of just 8%, yielding a combined rate of 23%. This 3.5% provincial differential means that a Toronto corporation faces a higher tax drag on active business earnings and future capital gains realizations, eroding the compounding benefits that corporate integration is intended to provide.

The administrative burden and compliance costs associated with navigating corporate tax structures also differ significantly between the two jurisdictions, particularly regarding provincial tax administration. In Ontario, corporate income taxes are harmonized and administered entirely by the Canada Revenue Agency (CRA) through a single T2 corporate return, which provides a deceptively simple filing stream but subjects the taxpayer strictly to federal interpretation timelines. Alberta, conversely, is one of the few provinces that independently administers its own corporate tax system via Tax and Revenue Administration (TRA), requiring a completely separate AT1 Alberta Corporate Income Tax Return. While a separate provincial return increases baseline legal and accounting compliance fees for a Calgary entity, it affords unique procedural advantages, localized audit paths, and direct provincial dispute resolution mechanisms that are entirely unavailable to a Toronto corporation bound strictly to the CRA's centralized federal apparatus.

Finally, the ultimate extraction of corporate wealth post-rollover highlights the final adverse tax reality for Toronto-based business owners compared to their Calgary peers. A Section 85 rollover merely defers personal tax liabilities by flowing the asset's original adjusted cost base into corporate share attributes, meaning that any eventual extraction of corporate earnings via dividends will inevitably trigger personal provincial tax. Ontario's top marginal personal income tax bracket is among the highest in the country at 53.53%, leading to highly punitive integration tax rates on both eligible and non-eligible dividends. Alberta retains a significantly lower top marginal personal tax rate of 48%, coupled with structurally higher and more generous tax bracket thresholds. Consequently, even if a Section 85 rollover successfully defers immediate capital gains at inception, the subsequent unwinding, dividend distribution, or estate freeze implementation will structurally subject the Toronto taxpayer to a steeper personal tax cliff upon wealth extraction than a comparable taxpayer in Calgary.

When can I use a section 85 Rollover? What are the Benefits? A section 85 rollover is a provision in the Canadian Income Tax Act that allows individuals, partnerships, trusts, or corporations to transfer "eligible property" to a taxable Canadian corporation on a tax-deferred basis. This means that you can transfer assets that have appreciated in value without immediately triggering a capital gain and the associated tax liability. Read more.

 

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