Section 85 rollovers and Section 86 Share Exchange

Section 85 rollovers and Section 86 Share Exchange

Section 85 Rollover

A Section 85 rollover is a tax-deferred transaction allowed under Section 85 of the Canadian Income Tax Act which enables the transfer of certain property between Canadian taxpayers without triggering immediate tax consequences. An 85 rollover typically involves a taxpayer (referred to as the transferor) transferring certain property, such as capital assets, inventory, or eligible securities, to a Canadian corporation (referred to as the transferee) in exchange for shares of the transferee corporation. The property transferred may include assets such as real estate, equipment, goodwill, or shares of another corporation.

The very crux or benefit of an 85 rollover allows the transferor to defer recognition of any capital gains that would otherwise arise from the transfer of the property and kick this capital gains tax to sometime in the future. Since the transfer is occurring between related taxpayers (for example, an individual owns an asset and wishes to transfer this asset to a corporation which he wholly owns), the legislation recognizes that this is not a true third-party disposition. An 85 rollover allows this transfer to occur at no tax for the present transfer and tax will be triggered on the second disposition of that asset which would be when that corporation were to dispose of the asset to a third party at some time in the future.

On the rollover, the taxpayer must select an elected amount which is the tax cost that the transferee corporation is to assume the asset. The elected amount must be a figure between the ACB and the FMV of the property rolled in. To the extent the elected amount is any amount greater than the ACB, this will trigger a small gain. Oftentimes when there is high ACB, the parties will elect to boot out the cost basis via a promissory note at the time of the rollover. This means that the transferee corporation then assumes the asset at a much lower tax cost which increases its capital gain in the future however the transferor individual was able to recoup the return of their cost basis tax free at the time of the rollover.

Both the transferor and the transferee corporation are required to file a T2057 form with the Canada Revenue Agency (CRA) to report the Section 85 rollover transaction.

We generally see s.85 rollovers occurring in three circumstances:

1. An individual operates a sole proprietorship and wishes to convert that business to be housed through a corporation. In such a circumstance, if the individual were to simply begin running the business through a corporation this would constitute a disposition and the individual would have to pay capital gains tax on the value of the business. A section 85 rollover is utilized to neutralize any tax from the transfer of a sole proprietorship into one’s own corporation
2. An operating company wishes to layer-in a holding company into its structure. If the shareholder of the opco were to simply transfer its shares to a holding company, this would trigger capital gains tax. A s.85 rollover is utilized to neutralize the tax that would otherwise result from this transfer of ownership; the resulting structure is an opco-holdco structure.
3. An individual wishes to transfer real property which is personally owned into a corporation for tax planning purposes. Such a transfer will trigger capital gains tax however this can be neutralized if s.85 is invoked. With that said, be advised that any transfer of real property will also trigger Land Transfer Tax which will not be neutralized via s85 since this is Provincial tax that operates under an entirely different tax scheme.

While Section 85 rollovers offer tax deferral benefits, there are limitations and considerations to be aware of including anti-avoidance rules, restrictions on eligible property, and potential recapture of tax deferrals in certain circumstances. It’s essential for taxpayers to seek advice from qualified tax professionals and the corporate lawyers at Kalfa Law Firm to ensure compliance with tax laws and to assess the suitability and implications of a Section 85 rollover for their specific circumstances.

Section 86 Share Exchange

A Section 86 share exchange is a tax-deferred transaction under the Canadian Income Tax Act that allows for the exchange of shares between Canadian taxpayers and Canadian corporations. Essentially, the section of the Act permits a taxpayer to exchange one class of shares for another class of shares within a corporation without paying tax. The exchange of shares under Section 86 allows the transferor to defer recognition of any capital gains or losses that would otherwise arise from the transfer of the shares. The transferor’s tax liability is deferred until a future date, typically when the shares received in exchange for the transfer are disposed of. The fair market value (FMV) of the shares being transferred must be determined at the time of the exchange and recorded. The FMV and ACB of the prior shares are imported over to the new class and number of shares.

A section 86 share exchange is most often used as part of an estate freeze within succession planning.