Section 85 Rollover: Corporate Reorganization in Canada

You have a client who owns a successful sole proprietorship and wants to incorporate. They plan to transfer business assets to the new corporation, but if they sell the assets to the corporation at fair market value, they could trigger a significant capital gain or recapture of depreciation. The solution is a corporate reorganization section 85 canada election, which allows a tax-deferred transfer of property to a corporation. Without it, the tax bill could derail the reorganization entirely. Many Canadian accountants and business owners rely on this election to restructure without immediate tax consequences. But getting it right requires careful planning and accurate filing.

How Section 85 Rollover Works

Section 85 of the Income Tax Act lets a taxpayer transfer eligible property to a Canadian corporation in exchange for shares, debt, or a combination, at an elected amount between the undepreciated capital cost (UCC) and fair market value (FMV). The key benefit is that the gain is deferred to a later disposition of the shares. The transferor and corporation jointly elect a transfer price that can be as low as the property's adjusted cost base (ACB) or UCC, or as high as FMV. The elected amount sets the cost base for the corporation and the proceeds for the transferor, effectively rolling the tax liability forward.

This rollover is not automatic - it requires a joint election filed on prescribed forms with the Canada Revenue Agency (CRA) by the filing deadline. The most common forms are T2057 for transfers to a taxable Canadian corporation and T2058 for transfers to a Canadian partnership. For a typical incorporation of a sole proprietorship, the business owner transfers assets like accounts receivable, inventory, equipment, and goodwill to the corporation using a Section 85 election.

One important tradeoff: the elected amount cannot exceed the fair market value of the property transferred. If you elect below FMV, the difference is treated as a dividend or capital gain for the transferor depending on the circumstances. The goal is usually to set the elected amount equal to the ACB or UCC to defer tax entirely. But you must ensure the corporation issues shares or debt of an amount at least equal to the elected amount to satisfy the tax rules.

Eligibility and Eligible Property

Not all assets qualify for a Section 85 rollover. The Income Tax Act specifies a list of eligible property. In practice, the most common transfers include:

• Capital property (e.g., land, buildings, equipment)
• Inventory (but not real property inventory like a developer's land)
• Canadian and foreign resource properties
• Goodwill (a common asset in professional practices)
• Accounts receivable (often transferred at cost to avoid immediate gain)

Ineligible property includes real property held as inventory by a developer, and certain intangibles like copyrights in some cases. Also, shares of a corporation can be transferred under Section 85, but only if the corporation is a taxable Canadian corporation.

For a typical small business incorporation, the eligible property list covers most assets. However, there are traps. For example, if the business has a large goodwill value, the elected amount must reflect a reasonable valuation. The CRA may challenge an elected amount that is artificially low, especially if the corporation later sells the goodwill at a higher price. Professional valuations are often necessary.

Eligible vs Ineligible Property Table

Filing the Election: T2057 and T2058 Forms

The election must be filed jointly by the transferor and the corporation. The key forms are T2057 (for transfers to a corporation) and T2058 (for transfers to a partnership). Both require detailed information about the property, elected amounts, and the consideration received.

Deadline: The election must be filed on or before the earliest of the transferor's filing due date for the year of transfer and the corporation's filing due date for its taxation year in which the transfer occurs. Practically, that means you need to file by the corporation's tax return due date (6 months after year-end) or the individual's filing deadline (April 30 of the following year, or June 15 if the individual has a business) - whichever is earlier. Many accountants file the election along with the first tax return of the corporation to avoid missing the deadline.

Late-filing relief is available under subsection 85(6) of the Act, but it involves a penalty and requires that the election be filed within three years of the original deadline. The CRA is generally reasonable if a genuine mistake was made, but you should not count on late relief.

The form requires you to list each property separately, describe the consideration (number and type of shares, and any debt), and state the elected amount. For shares, you must specify the paid-up capital. Getting the share consideration wrong can destroy the rollover, resulting in immediate tax.

Common Mistakes in Filing

• Electing an amount below the floor (e.g., less than UCC for depreciable property) can trigger recapture.
• Forgetting to file the election or missing the deadline.
• Not issuing shares with a sufficient paid-up capital (the elected amount must be reflected in share proceeds).
• Transferring ineligible property and triggering a gain anyway.
• Using incorrect cost base for goodwill - often the most disputed area.

One real-world scenario: A two-partner CPA firm in Ontario decided to incorporate their practice. They transferred client lists, office equipment, and goodwill. The valuation of goodwill was aggressive, and the elected amount was set at the valuation figure. Three years later, the CRA reassessed, arguing that the goodwill was worth more and that a taxable benefit had arisen. The firm had to pay tax plus interest. Using a proper valuation and documenting the elected amount with software tracking could have prevented the dispute.

Using Software to Manage Corporate Reorganizations

Tracking all the moving parts of a Section 85 rollover - valuations, elected amounts, share structure, CRA correspondence - is a natural fit for a platform like Awditify. Awditify's small business features help you manage the numbers before and after the election. For example, when you transfer assets, you need to track the new cost base in the corporation's books and the adjusted cost base of shares in the hands of the shareholder. Awditify's automated transaction categorization can flag capital transactions for correct tax treatment.

Moreover, the GST/HST implications of a rollover are often overlooked. When you transfer business assets, there may be a GST/HST deemed disposition unless you elect under Section 167 of the Excise Tax Act to have the transfer made on a tax-free basis. Awditify's sales tax tracking can help you monitor whether GST/HST is due on the transferred property and track the election.

For the ongoing tax planning after a rollover, you need to model the tax impact of future share dispositions and dividend payments. Awditify's tax planning module lets you track liabilities, deadlines, and run what-if scenarios. This is especially useful when the corporation will pay dividends in the future, as the dividend tax credit and capital dividend account management become critical.

Awditify is built for Canadian accounting needs. It handles the nuances of capital cost allowance, recapture, and terminal loss that come up with asset transfers. Instead of juggling spreadsheets and multiple software tools, you can manage the reorganization from one dashboard. The platform also provides 70+ financial reports, including detailed fixed asset schedules that reflect the rollover adjustments.

For firms handling multiple client reorganizations, Awditify's practice management (Awditify for Accounting Firms) streamlines the workflow - from client onboarding with document collection to filing the election and monitoring CRA deadlines. The client portal makes it easy to request signed forms and share tax slips.

FAQ: Corporate Reorganization Section 85 Canada

What is a Section 85 rollover? A Section 85 rollover is a tax-deferred transfer of eligible property to a Canadian corporation. The transferor and corporation jointly elect a transfer price between the cost or UCC and fair market value, allowing the gain to be deferred until the shares are sold.

Who can use a Section 85 rollover? Any Canadian resident individual, partnership, or corporation can transfer eligible property to a taxable Canadian corporation. It is commonly used when incorporating a sole proprietorship or partnership, or when restructuring a business among related corporations.

What are the filing requirements? The election must be filed on CRA forms T2057 (for corporations) or T2058 (for partnerships) by the earlier of the transferor's and corporation's filing due dates. Late filings may be accepted under subsection 85(6) with a penalty.

What happens if I miss the deadline? If you miss the deadline, the rollover may be void, and the transfer is treated as a sale at fair market value. This could trigger capital gains, recapture, or income on inventory. Late-filing relief is available within three years but comes with a penalty. It is best to file on time.

How can accounting software help with Section 85 elections? A platform like Awditify helps you track asset values, elected amounts, share issuances, and CRA deadlines in one place. It provides Canadian-specific features for capital cost allowance, GST/HST tracking, and tax planning. Using Awditify reduces the risk of errors and saves time during reorganizations.

What to Do Next

A Section 85 rollover is a powerful tool for corporate reorganization in Canada, but it requires precision. You need to identify eligible property, determine elected amounts, file the correct forms on time, and manage the aftermath in the corporation's books. Missing any step can trigger immediate tax. By using a dedicated Canadian platform like Awditify, you can centralize the reorganization workflow - from valuing assets to tracking tax liabilities and filing elections. Whether you are a business owner incorporating or an accounting firm managing multiple files, Awditify's AI bookkeeping, not just generic accounting software, offers the depth needed for complex tax transactions. Book a demo to see how Awditify can simplify your next corporate reorganization.