Legal and Tax Considerations for a Section 85(1) Rollover from an Accounting Perspective

The Tax Benefits of Section 85(1) When Incorporating

When growing your business, you may be considering incorporating to take advantage of tax savings or to avoid personal liability. Even though incorporating may not change the day-to-day operations of your business, the act of incorporating is more than just a status change. It involves changes to the structure of your business, which can create new tax costs. Luckily, there are provisions in the income tax act that can help you defer some potential taxes, including the Section 85(1) provision.

Deferring Capital Gains Taxes with Section 85(1) Rollover

To understand Section 85(1), let’s use a hypothetical scenario. You are a sole proprietor dentist. As part of your business, you own an office, which you purchased for $300,000. You also own $200,000 in equipment. Over the span of 2 years, your business grows and you decide to incorporate. Because the corporation is a separate business entity, this requires an asset transfer – that is, you have to transfer the assets from your personal ownership to the corporation. Moreover, you must transfer the assets at a fair market value. This poses a problem: despite the fact that you own the corporation, the asset transfer is tantamount to a legal sale. As a result, on your personal tax return, you would have to pay capital gains taxes on the transfer of the assets to the new corporation. Capital gains can be significant, particularly when it involves things like property, whose value can skyrocket.  

Luckily, 85(1) allows you to defer these capital gains taxes through an asset rollover. This provision of the income tax act rolls the assets over to the corporation through an exchange of assets for shares in the newly formed corporation. In our dentist scenario, you would transfer the assets to the corporation at cost base using the section 85(1) rollover in return for shares of the corporation. As a result of the rollover, there are no immediate tax consequences. Taxes will only be incurred if you sell the corporation or if the corporation decides to sell the assets at a future date.

Avoiding Complications

While an 85(1) rollover may sound straightforward, it is a complicated and multi-layered process that requires experienced professionals with knowledge of the CRA’s provisions. Beyond this, it involves accountants and lawyers working hand-in-hand. Accountants prepare an instruction letter that lays out the cost base for the transfer of assets. This can be difficult because it involves assessing the fair market value of assets, which can be tangible (e.g. properties or equipment) and intangible (e.g. goodwill). Moreover, because the rollover requires a transfer of shares in return for the assets, a lawyer has to execute the transaction.

NOVAA and Section 85(1) Rollovers

At NOVAA, we aren’t just traditional accountants who manage your books. We are a full-service firm that covers the full breadth of your tax services and accounting needs. Our experienced team have worked closely with lawyers executing 85(1) rollovers, including when incorporating or executing an asset rollover will help you achieve your business goals. Beyond this, we pride ourselves on making sure our clients understand what they’re doing, translating tax codes so that non-specialists can understand when and how such decisions can be beneficial to them.

For more information on how NOVAA can help you with incorporation or a Section 85(1) rollover, book a free consultation.