Section 85 Rollover

Tax free transfer of assets to a corporation under section 85 Rollover provisions

In this article , I will explore two scenarios in which section section rollover provisions are most useful to taxpayers , (i) transfer of personally owned assets (sole proprietorship) to a corporation and (ii) transfer of assets from one corporation to another related/associated corporation , e.g. from holding company to operating company

Transfer personally owned assets to corporation

A small business owner operating a sole proprietorship , may decide to incorporate the business ; for income tax purposes, an incorporated entity is considered a separate person from the sole proprietorship. This means any assets previously owned by the sole proprietorship will need to be transferred to the incorporated entity.

Take notice that for income tax purposes, each time there is a transfer of assets from one person/entity to another , a disposition is deemed to have occurred at fair value and therefore taxable income may be triggered as a result.

A sole proprietorship transferring inventory to the newly incorporated entity for example may be deemed to have sold such inventory at its fair market value and therefore taxable income may be recognized.

Section 85.1 of the income tax act allows the sole proprietor in this case to transfer the inventory at its tax cost instead of its fair market value , and therefore deferring any taxable income.

Transfer assets between related corporations

An existing corporation may for example decide to spin off some of its operations into another separate entity , or a holding company may wish to transfer assets to its operating company.

In both instances , transfer of assets to another entity is deemed to have occurred at fair value and taxable income may be triggered to the transferor.

In order to provide relief and therefore defer any potential taxable income , section 85.1 rollover provisions can be utilized to defer any such taxable income.

Remember any transfer of assets from one entity/person to another would be considered a deemed disposition at fair value which may trigger taxable income and section 85.1 was enacted to provide relief and deferral of such taxable income.

How does Section 85 transfer work.

The process is initiated by filing a section 85.1 election form (Form T2057), in this form the taxpayer will be able to identify assets being transferred , the transfer amount of each asset. The transferor may elect to transfer at tax cost , and therefore deferring any taxable income.

Illustration of section 85 provision
	         Customer Lists	         Inventory
FMV              12,000.00       	 100,000.00
Tax Cost	 1   	         	 65,000.00 
Tax Gain/Loss	 11,999.00 	  	 35,000.00  
Elected Amount	 1,000.00 	 	 65,000.00   
Gain Deferred	 11,000.00 	   	 35,000.00     
  • The customer lists and Inventory can be transferred to the new corporation at their tax cost of $1 and $65,000 respectively , total 65,001 .
  • By doing this , a taxable gain of 35,000 (Inventory) is deferred and so is any taxable capital gains from customer lists .
  • Notice, without section 85.1 , these assets will be deemed to have been transferred at Fair Market Value and therefore triggering taxable income.

After the transfer the new corporation will now own the same assets at the transfer amount , in this case , the tax cost , $65,000 for inventory and $1 for Customer lists (Eligible capital property).

Please also take notice of the following points :

  • Section 85.1 does not allow for transfer of asset that may trigger a tax loss , any such losses are denied , therefore tax payers are always advised to transfer those assets at fair market value outside of section 85.1
  • As part of payment for the assets transferred , the transferor is required to receive at least 1 share of the transferee corporation for the section 85 election to be considered valid.
  • If the taxpayer has bad debt accounts from their accounts receivables , taxpayers are advised to transfer those receivables using section 22 election ,mainly because under section 85 bad debts are not allowable.

After completing section 85 transfer, the new corporation Balance Sheet will look as follows,

Assets66,000
Customer List (Goodwill)1
Inventory65,000
Total Assets65,001
Liabilities and Equity
Promissory Note65,000
Share Capital1
Total Liabilities and Equity65,001
Please note that for accounting purposes , the assets may be reported at fair value in the books of the transferee corporation in accordance with ASPE 3840 (assuming private companies)

Please note that this article is simply an executive overview of section 85.1 provisions. Taxpayers are advised to consult a tax professional to assist them as this is a complex subject matter. Contact us anytime if you need assistance with this.

Prosper Chenjelani.

Prosper is the principal for P.A.C Consulting.