Canada: Canadian Income Tax Reorganizations

Last Updated: April 29 2016
Article by David Rotfleisch

Canadian Income Tax Reorganizations – Toronto Tax Lawyer Introduction

The topic of tax planning for Canadian income tax reorganizations is broad and is often the subject of one or more papers on its own right. The focus of this Toronto Tax Lawyer analysis is limited to income tax reorganizations likely to be encountered by a Canadian entrepreneur in various stages of the business.

Income Tax Reorganizations to Change Structure- s85 Rollover

Basic income tax planning means that a business owner may decide to start business in a partnership or sole proprietorship form in order to take personal deductions of start-up losses. Once the business becomes profitable it is usually advisable to incorporate.

A transfer of a sole proprietorship or a partnership to a corporation takes place under section 85 of the Canadian Income Tax Act. Section 85 is the general rollover provision for capital assets including shares and is used in many different types of reorganization. To qualify for an income tax deferral under section 85 of the tax act an individual or a corporation has to transfer assets or shares of another corporation into a corporation and receive as consideration shares of the transferee corporation. Other consideration such as cash or a promissory note can be received as well, but there are complex rules applicable in that case. The section 85 rollover is done by way of agreement and our Toronto tax lawyers have extensive experience in preparing s85 rollover agreements.

s85 Rollover Tax Deferral

Under section 85, the disposition of property by the transferor may give rise to the recognition of gain or loss by the Canadian taxpayer. The resulting income tax liability may be deferred on a transfer by a taxpayer to a corporation for consideration that includes shares issued by the transferee, as stated above. This income tax deferral is accomplished by having the transferor and transferee elect that the proceeds of disposition of the assets transferred will be the cost base of those assets. This means that no gain is recognized by the transferor as a result of the section 85 reorganization. That elected amount is also the cost to the transferee of the assets acquired.

Uses of s85 Rollovers

Some of the most common tax planning applications of section 85 by our Toronto tax lawyers are listed below:

  • The incorporation of a business by an individual or a partnership
  • The creation of a holding company by an individual or a partnership
  • The transfer of property to a corporation in the context of an estate freeze and/or income splitting reorganization
  • The transfer of property within a group of corporations for business or tax reasons
  • The division of a corporation under paragraph 55(3)(b)
  • The purchase of property for consideration which consists in whole or in part of shares

Section 85 of the Tax Act does not restrict the deferral of tax liability to a specific type of transaction nor to a transaction carried out for a specific purpose. It applies to any disposition of eligible property to a taxable Canadian corporation. Common control is not required and the transfer need not be reorganizational. However, most elections under section 85 involve related parties or apply to tax reorganizations, because the deferral of tax liability on the transfer of property is conditional on shares of the transferee being received as consideration by the transferor, so tax planning to use a section 85 reorganization on an arms length basis is more rare.

As stated above, under section 85, a joint election by the transferor and the transferee has the effect of deeming the proceeds of disposition of the property to be equal to an elected amount. The same amount is deemed to be the cost of acquisition of the property. The election can thus be regarded as substituting a deemed amount for the figure determined under the income tax rules otherwise applicable to both the transferor and the transferee.

In the case of the entrepreneur section 85 would be applicable on the transfer if the assets of the proprietorship or the partnership into the corporation in exchange for shares of this corporation. The results would be that the business originally carried on in an unincorporated form has now been acquired by the corporation on a tax deferred basis. The corporation will then continue the business.

A formal written rollover agreement will be entered into between the entrepreneur as vendor and the corporation as purchaser. It will have some of the normal provisions of an arm's length agreement of purchase and sale including all necessary conveyances of title to assets.

S85 Rollover Form

The tax rollover election is filed with CRA on a form T2057. The s85 T2057 election form has to be filed by the first tax filing date of the transferor or transferee. If the filing date is missed there is a penalty of up to $8,000 per annum. The election cannot be filed more than 3 years after the transfer took place without consent of CRA.

Income tax planning for Section 85 tax rollovers is complex and the rollover agreements must be properly prepared. Our Toronto tax lawyers have extensive experience with s85 rollover agreements and elections and would be pleased to provide tax help to you.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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