By OptiVal Editorial Desk

Section 85 Rollover in Canada: Transfer Your Business Into a Corporation Without a Tax Bill

A section 85 rollover in Canada is the tool that lets you move a sole proprietorship or partnership business into your corporation without paying tax on the move itself. Without it, transferring your own business to your own company is still a sale at fair market value in CRA’s eyes, and the gain is taxed that year, even though no cash changed hands.

With a valid election, the assets move at their tax cost instead. The built-in gain does not disappear. It moves into the corporation and your shares, and is taxed later, when the corporation sells the assets or you sell the shares.

What a section 85 rollover in Canada actually does

Subsection 85(1) lets a taxpayer transfer eligible property to a taxable Canadian corporation at an agreed amount, called the elected amount. You and the corporation choose that amount together, inside limits set by the Act, and file a joint election on Form T2057. The elected amount becomes your proceeds and the corporation’s cost.

Set the elected amount equal to tax cost and there is no immediate gain. Set it higher, on purpose, and you can trigger part of the gain in a year when you want it, for example to use capital losses you are carrying. The CRA guide is Information Circular IC 76-19R3, Transfer of Property to a Corporation Under Section 85.

Three conditions decide whether an election is valid at all:

• The buyer is a taxable Canadian corporation.
• The property is eligible property (the next section covers what qualifies).
• The consideration you receive includes at least one share of the corporation. No share, no election, however the paperwork is filled in.

Which property qualifies, and what does not

Most of what a small business owns qualifies: capital property, including equipment and vehicles, inventory other than real estate inventory, resource property, and eligible capital property, which is where goodwill lives. Goodwill is usually the biggest asset in an established proprietorship, and it often cost the owner nothing to build.

Cash is not eligible property and does not go on the form. Receivables transfer cleanly only when they move with all or substantially all of the business, and using section 85 for them rules out a separate section 22 election for the same receivables. If an ineligible asset lands on the form anyway, CRA disregards it on the election and treats it as sold at fair market value.

The agreed amount: where the deferral lives

The elected amount has a ceiling and a floor. It cannot exceed the fair market value of the property. It cannot be less than the fair market value of any non-share consideration you take back, often called boot. Boot includes cash, a promissory note, and debt of yours that the corporation assumes.

A simple example shows how it works. Say your proprietorship owns equipment worth $60,000 with an undepreciated capital cost of $35,000, plus goodwill worth $120,000 that cost you nothing. Elect $35,000 for the equipment (for depreciable property, the elected amount cannot go below the least of the class UCC, the cost, and the fair market value) and a nominal $1 for the goodwill. Total elected amount: $35,001 on assets worth $180,000. You take back shares, and no tax is payable on the transfer. The $144,999 of untaxed gain waits inside the company.

One result surprises owners: the paid-up capital of your new shares is ground down under subsection 85(2.1), roughly to the elected amount minus any boot, so share capital on the balance sheet can look oddly small. That is normal. Your shares carry the deferred gain: worth $180,000, with a tax cost tied to the elected amount.

The three traps that break rollovers

1. Taking back too much boot

If you take $50,000 of boot on the example above, the floor rule pushes the elected amount up to at least $50,000 and tax shows up on the difference. The quiet version is more common: the corporation assumes a $40,000 business loan. Assumed liabilities count as non-share consideration, so that loan is boot whether you call it that or not.

2. Leaving goodwill off the form

CRA’s position is blunt: property transferred but left off the election is treated as disposed of at fair market value. Goodwill with a cost of nil still has to be listed, with a nominal elected amount. Roll over the visible assets and forget the goodwill, and you create the tax bill the rollover was meant to avoid.

3. Treating GST and HST as an afterthought

The T2057 is an income tax election only. GST and HST need their own look at closing: the corporation needs its own registration, and a transfer of a business as a going concern can sometimes be made without GST or HST under a separate election in the Excise Tax Act, with strict conditions and a separate filing. Sort it out before the transfer date. If you are still filing as a proprietor, our guide to the T2125 in Canada covers the return you are leaving behind.

Filing Form T2057: the deadline and the late penalty

File Form T2057 (Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation) separately from any tax return, signed by you and by an authorised officer of the corporation. Partnerships use subsection 85(2) and Form T2058 instead. The deadline is the earliest date on which any party has to file a return for the year of the transfer. That date is often sooner than owners assume, so calendar it at closing.

Late is fixable, at a price. Under subsection 85(7), an election can be filed up to three years late if the penalty is paid with it. After three years, the Minister can still accept a late or amended election where circumstances are just and equitable, but that is discretion, requested in writing with reasons, not a right. An election cannot be revoked once filed.

The penalty is the lesser of two amounts, per month or part month of delay: one quarter of one percent of the excess of fair market value over the elected amount, or $100 per month, capped at $8,000. On the example above, the first measure is about $363 a month, so the penalty runs at $100 a month. Small numbers, but the three year wall behind them is the real risk.

Getting the rollover right starts with clean numbers

Every figure on the T2057 comes out of your books: fair market values, the UCC of each class, the cost of each asset, and the balances the corporation assumes. If the proprietorship books are a year behind, the election is guesswork. Our bookkeeping and tax services include the incorporation clean-up, the opening corporate balance sheet, and the first T2 (corporate returns from $449, bookkeeping from $199 a month, advisory at $125 an hour, CAD, HST extra; see our published pricing).

Thinking about incorporating, or worried a past transfer was never elected properly? Book a free consultation and we will walk through your asset list and deadlines before anything moves.