Rolling Over your Tech Business into a Corporation

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Given that most tech businesses do not start as an incorporated company, and instead are the product of the significant hard work of one individual (effectively a sole proprietorship) or a group of individuals (effectively a partnership), the transition to a corporation also requires the transfer of the prior developments and assets into the corporation, which can result in a significant tax bill if not done correctly. As such, undertaking a legally permissible rollover, to effectuate the transfer while deferring taxes, is absolutely essential.

A. Tax Deferral (The Primary Benefit):

Avoids Immediate Capital Gains: Without a Section 85 election, if you transfer appreciated assets (assets worth more than their original cost) from yourself (as a sole proprietor) to a new corporation, it would be considered a taxable disposition at fair market value (FMV). This would trigger an immediate capital gain on your personal tax return, leading to an immediate tax bill.
Postponement of Tax: A Section 85 rollover allows you to elect a transfer price (referred to as the "agreed amount") for the assets that is typically equal to their tax cost (Adjusted Cost Base or Undepreciated Capital Cost). This means no capital gain (or only a small, intentional gain) is realized at the time of the transfer. The tax liability on the accrued gain is deferred until the corporation eventually sells the assets to a third party, or when you ultimately sell your shares in the corporation.
Preserves Cash Flow: By deferring taxes, you avoid a large upfront tax payment, allowing you to retain more capital within the newly incorporated business for reinvestment, operational needs, or expansion. This is incredibly valuable for startups and growing businesses.

B. Facilitates Incorporation of a Sole Proprietorship:

This is one of the most common uses of a Section 85 rollover. If your sole proprietorship has built up valuable assets (e.g., equipment, customer lists, intellectual property, or goodwill), simply transferring them to a new corporation without a Section 85 election would trigger significant personal tax liabilities. The rollover makes this transition tax-efficient.

C. Strategic Corporate Reorganizations:

Transferring assets between related corporations: Section 85 can be used to move assets between companies within a corporate group (e.g., from an operating company to a holding company) without triggering immediate tax. This can be beneficial for:
- Asset Protection: Moving valuable assets into a holding company to shield them from the operating risks of an active business.
- Estate Planning: Facilitating the transfer of wealth and business ownership to the next generation in a tax-efficient manner (often in conjunction with an "estate freeze").
- Preparing for Sale: Consolidating assets or reorganizing the corporate structure to make a future sale of the business more efficient and attractive to buyers.

D. Flexibility in Setting the Transfer Price:

The agreed amount for the transfer can be any value between the asset's tax cost (ACB or UCC) and its fair market value. This flexibility allows for strategic tax planning:
- Full Deferral: Electing the transfer at tax cost results in no immediate gain.
- Crystallization of Gains: In some cases, a taxpayer might intentionally elect a higher amount (above tax cost but below FMV) to trigger a capital gain. This could be done to utilize existing capital losses, or to realize a capital gain that can be offset by the Lifetime Capital Gains Exemption (LCGE) available to individuals on the sale of Qualified Small Business Corporation (QSBC) shares.

E. Estate Planning and Succession:

Section 85 is instrumental in estate freezes, where the current value of the business is "frozen" for the current owner, and future growth accrues to the next generation (often through common shares subscribed by the children). This helps minimize future tax liabilities upon the original owner's death.

We understand how computer algoritms and technological processes intersect with the law and commercial aspects of the Internet, and working with corporate business officers, tech entrepreneurs and IT departments as they strive to realize upon the financial potential of the Net, AI and other computer-based technologies. For more information as to how our law firm can apply our knowledge of the law, technology and the Internet to your business pursuits, contact us via email at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.

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