Crucial Tax Deferral when Incorporating a Calgary Business
Business incorporation lawyer assisting Calgary entrepreneurs and start-ups incorporate the appropriate corporate entity to advance their commercial ventures.
Contact Neufeld Legal PC at 403-400-4092 or Chris@NeufeldLegal.com
Transferring business assets from a sole proprietorship or partnership to a newly formed corporation could trigger significant and immediate tax consequences if not undertaken in accordance with the available tax procedures to rollover those business assets to the corporation in accordance with the Income Tax Act (Canada). This is typically undertaken through a Sections 85 corporate rollover that enables the business assets to be transferred to the corporation on a tax-deferred basis.
Section 85 of the Income Tax Act (Canada) provides a mechanism for deferring taxes on the transfer of certain "eligible property" from a taxpayer (an individual, partnership, trust, or another corporation) to a "taxable Canadian corporation," with the crucial aspects of the tax deferral process operating as follows:
A. Avoids Immediate Disposition at Fair Market Value (FMV)
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Normally, when you transfer property, it's considered a "disposition" at its fair market value, which can trigger immediate capital gains tax if the FMV is higher than your original cost (Adjusted Cost Base or ACB). Section 85 allows the transferor and the corporation to jointly elect an "agreed amount" for the property being transferred.
B. Elected Amount (Transfer Price)
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The core of the tax deferral lies in the ability to choose an "elected amount" for the transfer. This elected amount becomes:
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The proceeds of disposition for the transferor (the person giving up the property).
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The cost (or Adjusted Cost Base) of the property for the transferee corporation (the company receiving the property).
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The key is that this elected amount can be set at a value between the transferor's Adjusted Cost Base (ACB) (or Undepreciated Capital Cost - UCC for depreciable property) and the property's Fair Market Value (FMV).
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To achieve full tax deferral: The elected amount is typically set equal to the transferor's ACB/UCC. This means no immediate capital gain (or recapture of depreciation) is triggered for the transferor at the time of the transfer, as their proceeds of disposition equal their cost.
C. Consideration Must Include Shares
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For a valid Section 85 rollover, the transferor must receive at least one share of the transferee corporation as part of the consideration for the transferred property. Other forms of consideration, like cash or a promissory note (often called "boot"), can also be received. However, if the "boot" exceeds the ACB/UCC of the transferred property, it will trigger immediate tax on that excess.
D. Tax "Rolled Over" to the Corporation
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Since the elected amount becomes the corporation's cost for the property, the "built-in" gain (the difference between the property's FMV and the elected amount) is effectively transferred to the corporation. The tax on this gain is deferred until:
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The corporation sells the property to a third party.
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The transferor sells the shares they received in the rollover.
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E. Formal Election Required
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To utilize Section 85, both the transferor and the transferee corporation must jointly file a prescribed form (Form T2057 for individuals / corporations, Form T2058 for partnerships) with the Canada Revenue Agency (CRA) by a specific deadline. Without this election, the transfer is deemed to occur at FMV, and any accrued gains would be immediately taxable.
However, it's crucial to understand that it's a deferral, not an elimination, of taxes. The tax liability will eventually arise when the property/assets are disposed of by the corporation, or the shares received in the rollover are disposed of by the transferor. As such, due to its complexities, it is highly recommended to you consult with an experienced tax lawyer when considering a Section 85 rollover.
So if you are looking to incorporate a new corporation or deal with the corporate legalities impacting your company, whether in Calgary or elsewhere in Alberta, we welcome you to contact our law firm at 403-400-4092 or via email at Chris@NeufeldLegal.com, for an experienced corporate lawyer to undertake your business' incorporation-related legal work.
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