Section 85 of the Income Tax Act - Continued

As explained in our previous entry, Section 85 of the Income Tax Act provides a mechanism for taxpayers to transfer certain types of property to a corporation on a tax-deferred basis. It is commonly used for business reorganizations, incorporating sole proprietorships or partnerships, and transferring assets between related corporations while deferring tax on accrued gains.

Eligible Transferor

An eligible transferor is any taxpayer that owns qualifying property and transfers it to a corporation. This includes:

1. Individuals
2. Corporations
3. Partnerships

To qualify as a transferor:

• The taxpayer must own the property before the transfer.
• The transfer must be made to a Canadian corporation.
• The taxpayer must receive at least one share of the corporation’s capital stock as part of the consideration for the transfer.

Eligible Transferee

An eligible transferee under Section 85 must be a Canadian corporation that agrees to receive the property and issue shares as consideration. Key points:

• The transferee corporation must be either a newly incorporated entity or an existing corporation capable of receiving the transfer.
• The corporation must enter into the election with the transferor, agreeing to the terms and the "elected amount."
• If multiple transferors are involved, the corporation must file separate election forms with each transferor.

Qualifying Property

Not all property qualifies for a Section 85 rollover. The following types of property are eligible:

1. Capital Property
   • Depreciable property (e.g., equipment, buildings).
   • Non-depreciable property (e.g., land, shares of another corporation).
2. Eligible Inventory (property held for sale in the ordinary course of business).
3. Resource Properties (e.g., mineral rights, oil and gas interests).

Excluded Property: Certain types of property, like accounts receivable, goodwill, and inventory not specifically eligible, do not qualify under Section 85.

Filing Requirements

A Section 85 election is not automatic and must meet strict filing requirements:

1. Form T2057 (or T2058 for partnerships):
   • Both the transferor and the transferee corporation must complete and file the election form.
   • The form must detail the property transferred, the agreed (elected) amount, and consideration received.
2. Filing Deadline:
   • The election must be filed by the earlier of:
     • The transferor’s tax return filing deadline.
     • The transferee corporation’s tax return filing deadline.
   • Late filings may be accepted but could incur penalties.
3. Supporting Documentation:
   • Attach schedules and calculations showing the fair market value (FMV), adjusted cost base (ACB), and agreed amount.
   • Keep appraisals or valuations to support FMV claims.
4. Amendments: Corrections to the election can be made within the prescribed time period, but penalties may apply.

The Elected Amount

The transferor and transferee must agree on an elected amount for the transferred property. This amount governs how much of the transaction is tax-deferred. The elected amount must satisfy these conditions:

1. Minimum Limit: The elected amount cannot be less than the FMV of any non-share consideration (e.g., cash or debt) received.
2. Maximum Limit: The elected amount cannot exceed the FMV of the property transferred.

Benefits of Section 85

1. Tax Deferral: The transferor defers capital gains or recapture of depreciation on the transferred property.
2. Flexibility: The agreed amount allows planning for optimal tax outcomes.
3. Business Reorganization: Enables seamless restructuring of businesses without immediate tax implications.

Example

Scenario:

• You own a rental property (ACB: $200,000, FMV: $500,000).
• You incorporate a company and transfer the property to it.
• In exchange, you receive:
  • Shares worth $400,000.
  • A promissory note for $100,000 (non-share consideration).

Section 85 Election:

1. You and the corporation agree to an elected amount of $200,000 (equal to the ACB).
2. Result:
   • No immediate capital gains tax (the FMV exceeds the elected amount, but tax is deferred).
   • The corporation assumes the ACB of $200,000 for future transactions.

Filing: Both parties file Form T2057 to ensure proper reporting and maintain deferral status.

This process provides significant tax planning opportunities, but strict compliance is crucial. If you have a specific situation or need more guidance, contact our office for assistance.