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Section 85 rollovers

From tax expert Gerry Vittoratos
April 14 2020

Section 85 of the Income Tax Act (ITA) is an important tool in the tax arsenal of corporations. It can be used in many instances to defer taxation for certain transactions, especially complex corporate structures. In this article, we will see the ins and outs of this important section of the ITA.

Purpose of section 85 rollovers

The main purpose of section 85 rollovers is to transfer assets on a tax-deferred basis from a taxpayer (transferor) to a Canadian corporation (transferee). The common example of the use of this section is when a taxpayer, who is self-employed, wants to incorporate his/her business and wants to avoid immediate taxation on the transfer of assets to their newly created corporation.

A taxpayer can be an individual, a corporation or a trust. A Canadian corporation is defined under ITA 89(1) as a corporation incorporated in Canada or a resident of Canada since the 18th of June, 1971.

You can transfer assets between the taxpayers and corporations on a tax-deferred basis, but this is at the discretion of the taxpayer. In certain instances, it might be beneficial to trigger a taxable transaction, such as an estate freeze*. This is done through the elected amount.

Main advantages of using section 85 rollovers

  • Deferring the payment of taxes in the context of transactions which do not give rise to the real economic disposal of goods (example: incorporation of a company).
  • Facilitate corporate reorganizations.
  •  Make certain estate freezes possible:
    • by the transfer of shares to a company;
    • o   by the transfer of assets to a company.
  • Benefit from the legal and tax advantages attached to a company.

Disadvantages of using section 85 rollovers

Potential double taxation of capital gains

The transfer of property to a company may result in double taxation at the capital gains level; either once in the company on the property acquired and once with the taxpayer on the property received in return. For example, if the taxpayer transfers a valuable asset at cost (elected amount) to a corporation and receives consideration in shares, a quick sale of the asset by the corporation and the shares by the taxpayer will create a scenario of double taxation (gain from the difference between FMV and elected amount will be realized on both ends simultaneously). This disadvantage can be minimized if the company's shares are sold at a later date.

Basic conditions of section 85 rollovers

The table below lists the basic conditions for a section 85 rollover:

Conditions

 1

The transferor is either an individual, corporation or a trust [ITA 85(1)]

 2

The transferee is a taxable Canadian corporation [ITA 89(1)]

 3

The asset rolled over is an eligible property [ITA 85(1.1)]

 4

The consideration received from the transferee must include at least one share of capital stock

 5

A joint election (T2057) must be filed by the prescribed deadline [ITA 85(6)]

 

Important terms

Eligible Property – ITA 85(1.1)

Eligible property that can be transferred under section 85 are:

  • Depreciable capital property (includes eligible capital property)
  • Non-depreciable capital property
  • Canadian resource properties
  • Foreign resource property
  • Inventories
  • Real estate property owned by a non-resident but used in a business carried on in Canada

This article will focus on depreciable properties, non-depreciable properties and inventories.

Consideration to transferor [ITA 85(1)]

In return for the transferred property, the corporation (transferee) can provide various types of consideration. The only requirement as per the ITA is that some part of this consideration has to be shares of the corporation.

Non-share consideration (Boot)

If a portion of the consideration paid to the transferor is cash, or new debt of the transferee corporation, this amount is considered the Boot. This amount plays a significant role in the determination of the allowable transfer prices (see below).

Elected Amount

This is the amount that has been elected by both the taxpayer (transferor) and the corporation (transferee) as the transfer price of the property.

Transfer Price and Elected Amount

As mentioned above, the main purpose of the section 85 election is to transfer assets between taxpayers and corporations on a tax-deferred basis. Specific rules govern this transfer price:

General provision and elected amount [ITA 85(1)a)]

The general provision stipulates that the elected amount is deemed to be the disposition amount of the property for the transferor and the acquisition cost for the transferee.

Floor Value [ITA 85(1)b)]

The floor value of the elected amount cannot be less than the non-share consideration (Boot).

Ceiling Value [ITA 85(1)c)]

The ceiling value cannot be above the Fair Market Value (FMV) of the property.

The floor and ceiling values are the general limits of the elected amount.

There are also specific limits based on the type of property that is being transferred.

Inventories and non-depreciable capital property specific limit [ITA 85(1)(c.1)]

The elected amount cannot be below the lesser of:

  • FMV of the property
  • Cost amount

Depreciable property specific limit [ITA 85(1)(e)]

The elected amount cannot be below the lesser of:

  • FMV of the property
  • Cost amount
  • Undepreciated Capital Cost (UCC)
     
Section 85 rollovers


Cost of consideration

As mentioned above, when making the transfer, part of the consideration received by the taxpayer (transferor) for the assets transferred has to include shares of the corporation. It can also include non-share consideration, or Boot (see above). The cost of this consideration is as follows:

Non-Share Consideration (Boot) [ITA 85(1)(f)]

The cost of the Boot received as consideration is the FMV of the property received if it’s one item. If there are multiple items, then the cost will be the lesser of:

  • FMV of the property received
  • FMV of the asset received/FMV of all other assets received (Boot)

Preferred Shares [ITA 85(1)(g)]

The cost of preferred shares received as consideration is the result of the following calculation:

 

Lesser of:

FMV of shares received after the disposition

XX

Disposition amount (elected amount)

XX

Minus:

FMV of non-share consideration (Boot)          X

FMV of preferred shares of that category

FMV of all categories of preferred shares

(XX)

Cost of Preferred shares

XXX

 

Common Shares [ITA 85(1)(h)]

The cost of common shares received as consideration is the result of the following calculation:

Elected Amount

XX

Minus: FMV of non-share consideration (Boot)

(XX)

Minus: Cost of preferred shares (see above) [ITA 85(1)(f)]

(XX)

Cost of Common shares

XXX

 

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