Section 85 Rollover

| Published on
September 17, 2021
| Updated on
September 20, 2021
By Jeffrey (JP) McAvoy
| Published on
September 17, 2021
| Updated on
September 20, 2021

A Section 85 Tax Rollover (“Rollover”) is a tax strategy used to defer tax that would otherwise be payable upon a transfer of an asset such as property to a corporation.  It is effective for a number of reasons and used frequently for estate planning purposes, such as an Estate Freeze.  It is also used regularly by sole proprietors who have incorporated their business or corporations looking to employ more sophisticated tax structures as they grow to save or defer taxes.  It is important to remember that tax deferred is tax saved.  Let’s get into the specifics to illustrate a Section 85 Tax Rollover.

First, it is called a Section 85 Tax Rollover in reference to the specific section of the Income Tax Act (“ITA”) where the tax strategy is discussed. It addresses the transfer of property to a corporation.  

The ITA allows for the transfer if the taxpayer and the corporation jointly elect to transfer eligible property.  Eligible property can include capital property, inventory, real estate and Canadian and foreign resource properties. The tax strategy and resulting deferral can be realized as the taxpayer and the corporation jointly choose the "elected value" for which the transfer is completed and the tax is paid at some point later in the future.

Elected Value

Given that a Section 85 Rollover takes place between a taxpayer and a corporation, each must agree on the value for which the transfer is to take place. The value must be justified and fair market value for the property transferred must equal the fair market value for the property received. It is therefore key to understand the fair market value of the assets being transferred before completing a Section 85Rollover.

To provide the required justification, Chartered Business Valuators (“CBVs”) are often used to assess the fair market value of the property being transferred.

When transferring assets through a Section 85 Tax Rollover, the Canada Revenue Agency (“CRA”) requires that you have made a “fair and reasonable” attempt to determine the fair market value. In our opinion, a fair and reasonable attempt often requires using a CBV to determine the fair market value.

Price Adjustment Clause

When doing a Section 85 Tax Rollover, we always use a Price Adjustment Clause.  With this, if CRA suggests that the valuation is incorrect, the Price Adjustment Clause allows us to revisit the valuation used without penalty.  In our Price Adjustment Clause, we allow for the fair market value to be adjusted upwards and downwards.  It is also drafted so as to allow us to go back and decide not to make the tax election, or even transfer the assets without the benefit of the rollover if it is later decided to be a better tax strategy.

Estate Freeze

The most frequent form of estate freeze we see involves the transfer of assets to a corporation or the reorganization of an existing corporation to include a Family Trust. A Section 85 Rollover will allow for the transfer of a taxpayer’s shares of an operating company to a holding company.  In exchange, a taxpayer receives preferred shares of the holding company while the common shares are acquired by a Family Trust that is able to benefit from future growth.

By using a corporation we can usually implement an estate freeze on a tax-deferred basis.  The corporation provides flexibility as to how to deal with the tax and legal rights affecting the assets transferred to the corporation.  A Family Trust allows for additional flexibility and provides for further credit proofing.

By combining all of these strategies in the most effective manner possible, we are able to assist the taxpayer make the best decisions for their business and their family.   

Conclusion

Section 85 Tax Rollovers provide an excellent tax strategy for a business owner.  To implement correctly a lawyer and an accountant need to be involved.  We regularly work with a business owner’s accountant to ensure the best result is achieved for our common client. Feel free to speak with one of our professionals if you are interested in discussing this excellent business law strategy or any other matter at your convenience.

About the Author

JP McAvoy
JP is the Managing Partner of Conduct Law, a Business Law Firm with Offices in Ottawa, Ontario and Orlando, Florida. His legal practice is focused on business and business owners.  Called to the bar in 2001, he received his LL.B and JD from Queen’s University in 1999. He represents a diverse range of clients throughout Canada, the United States, and Eastern Asia. In addition to practicing law, JP is a College Professor, Best-Selling Author and Host of the top rated podcast The Millionaire's Lawyer.  JP's accomplishments earned him an Ottawa Business Journal Forty Under Forty Award. Read JP's full profile.