Moving a Business into a Corporation: Section 85

Can I incorporate without using a section 85 rollover?

Yes. Forming a corporation does not require a section 85 election, and you can choose which assets to transfer. But moving appreciated property to a corporation you control without a valid election can create taxable proceeds at fair market value, even if the corporation pays less or pays nothing. Check each asset before signing a transfer agreement; simply changing the name on an invoice does not move ownership of property. Income Tax Act, section 69; CRA: Fair market value.

If an asset would produce no taxable income at fair market value, a rollover may add paperwork without deferring tax on that asset. You can also leave an asset outside the corporation, subject to its own business and sales tax consequences. Whether to incorporate at all belongs in Sole proprietorship or corporation?.

How does a section 85 rollover work?

Section 85 lets the transferor and a taxable Canadian corporation choose an agreed amount for each eligible asset. That amount becomes the transferor's proceeds and the corporation's tax cost, subject to statutory limits; depreciable property has a separate capital cost rule for CCA. The corporation must give the transferor at least a share, and the parties must make a joint election. A sole proprietor uses Form T2057; a partnership transferring its property uses Form T2058, signed by the partners or their authorized representative and the corporation. Income Tax Act, subsections 85(1), (2) and (5).

The agreed amount can defer an accrued gain or recapture, but the gain does not disappear. It remains embedded in the corporation's asset and often in the shares received. A higher agreed amount may intentionally recognize some income. The legal floor differs for inventory, non-depreciable capital property and depreciable property, so one amount cannot simply be applied to the whole business. Income Tax Act, paragraphs 85(1)(a) to (e). If a partnership transfers its assets, it receives the shares; distributing them to partners under subsection 85(3) requires a qualifying windup within 60 days. Partners who instead transfer their partnership interests use separate T2057 elections. Income Tax Act, subsections 85(2) and (3); CRA circular. See Capital cost allowance for the equipment and building calculations.

Form the corporation, list and value what will move, record it in a transfer agreement, choose the consideration and agreed amounts, complete the transfer, then file the signed election. Use separate T2057 or T2058 forms for property transferred on different dates. Confirm the corporation's new business number and required GST/HST or payroll accounts; close old accounts when appropriate. Incorporation does not move those accounts. CRA: Change of legal status. The CRA circular says an omitted asset is treated as transferred at fair market value unless a valid late election is made; an election already filed cannot simply be revoked.

Which assets can I transfer under section 85?

Common business assets can qualify, but section 85 does not cover every item on a balance sheet. The owner must identify each asset's legal and tax character before putting it on the election. Income Tax Act, subsections 85(1.1) and (2).

There are special restrictions for property owned by non-residents and for some financial, resource and farming assets. A business with those assets needs a property-by-property review. Income Tax Act, subsections 85(1.1), (1.11) and (2).

How do I value the business and its goodwill?

Record the fair market value of each transferred asset and of what the corporation gives for it. The election asks for the asset value and the value of any non-share consideration; retain the working papers behind both. CRA: Transfer of Property to a Corporation Under Section 85.

Start with an asset list showing original cost, adjusted cost base or undepreciated capital cost, estimated fair market value, and any debt attached. Use reasonable evidence for inventory, equipment and land. If several depreciable assets move together, designate their transfer order before the election deadline; otherwise CRA may set it. Income Tax Act, paragraph 85(1)(e.1). If the business as a whole is worth more than its identifiable net assets, the supported balance may be goodwill. Goodwill is generally Class 14.1 property; record its supported value and tax cost separately. CRA: Buying an existing business.

Do not leave self-created goodwill off the election just because its tax cost is low. An omitted transferred asset may be treated as sold at fair market value. A price adjustment clause may address a later valuation change if the parties make the adjustment and meet CRA's conditions. The clause does not itself change the elected amount; if that amount must change, request an amended election under subsection 85(7.1).

What can the corporation give me besides shares?

The corporation can also give cash, a promissory note or an assumed liability, often called non-share consideration. It must still issue a share for a valid section 85 election. If the fair market value of non-share consideration for an asset exceeds its agreed amount, section 85 raises that amount; tax can arise as a result. Income Tax Act, paragraphs 85(1)(a) and (b).

Allocate liabilities and notes to specific assets before filing. Compare each allocation with that asset's permitted agreed amount, and make sure the total value received matches the business property transferred. If a shortfall benefits a related shareholder, section 85 can raise the agreed amount and cause current tax. Income Tax Act, paragraph 85(1)(e.2). The shares' tax cost and paid-up capital may be lower than their market value, so do not treat the note, the shareholder account and the shares as interchangeable cash. For later withdrawals, see Shareholder loans.

When is Form T2057 due, and what if I file it late?

Form T2057 or T2058 is due by the earliest income tax return filing due date of any party to the election for the tax year of the transfer. The election is filed separately from the income tax return. A corporation's filing date can arrive before the individual's, so do not assume the personal return date controls. Income Tax Act, subsection 85(6); CRA circular, filing requirements.

The late or amended election penalty is the lesser of 1/4 of 1% of the excess of fair market value over the agreed amount for each month or part of a month, or $100 per month or part of a month up to $8,000. Income Tax Act, subsections 85(7) to (8). A late or amended election is consequential because CRA may refuse an amendment whose purpose is retrospective tax planning. CRA circular.

How do I transfer my accounts receivable?

First separate unpaid invoices included in business income, or to be included for the transfer year, from other amounts owed. Income-basis receivables may qualify under section 85 when transferred with substantially all business assets; cash-basis receivables do not qualify on that basis. If the corporation buys all or substantially all business property, including all outstanding income debts, and will continue the business, the parties can instead elect under section 22 using Form T2022. Do not elect under both sections for the same debts. Income Tax Act, section 22; CRA: Transfer of Property to a Corporation.

Where that price is below the receivables' face value, section 22 permits the seller to deduct the difference, excluding debts previously deducted as bad debts, and requires the buyer to include the same difference in income; it also transfers specified bad-debt treatment. Without the election, that result should not be assumed. List open invoices, amounts already included in income, doubtful debts and the proposed purchase price before the transfer. Income Tax Act, subsections 22(1) and (2).

Do I charge GST/HST on the transfer?

A section 85 election does not settle GST/HST. Apply the normal tax rules to each taxable asset unless a separate business-transfer election applies. If the corporation acquires all or substantially all property needed to carry on the business or a separable part, the parties may jointly elect on Form GST44 where CRA administers the account. GST/HST is generally not payable on the covered transfer; isolated assets do not qualify. Excise Tax Act, section 167; CRA: Selling a business.

The seller can be registered or unregistered, but a registered seller cannot make this election with an unregistered buyer. Taxable services to be supplied later, leases and licences remain outside the relief; taxable real estate also remains taxable if the buyer is unregistered. A registered buyer files GST44 by the due date of its first GST/HST return for the period in which tax would otherwise have become payable. If neither party is registered, the buyer keeps the signed GST44 instead of filing it. Excise Tax Act, subsections 167(1) and (1.1). In Québec, check Form FP-2044-V for the joint GST/HST and QST election. The new corporation needs its own business number and required GST/HST account; the old account does not transfer automatically. CRA: Change of legal status. See When to register for GST/HST for the new corporation's registration test.

Do I pay land transfer tax if real estate moves to the corporation?

Possibly. Section 85 defers federal income tax; it does not exempt a conveyance from provincial land transfer tax. In Ontario, when the corporation issues shares as any part of the price for land, taxable consideration is deemed to be the land's fair market value at registration, including for an income tax rollover. An unregistered transfer of the beneficial interest can also be caught. Ontario: Transfers involving corporations. Ontario has a narrow exemption for qualifying transfers of land used in an active family business to a family business corporation. Ontario: Family business corporation exemption.

Land transfer rules and exemptions differ by province and municipality; Toronto, for example, has a municipal land transfer tax. Before moving land, gather title, mortgage terms, valuation and the province where the land sits; check that jurisdiction's tax and registration rules. If the land is a rental, see Holding and investment corporations before deciding whether to transfer it.

What do I file for the business in the year I incorporate?

The old owner and the corporation each report their own period of business activity. A sole proprietor reports pre-transfer income and any taxable transfer result on the personal T1, usually with Form T2125; the corporation files a T2 for its own tax year, even if no tax is payable. The corporation's first tax year begins on incorporation and its T2 is due within six months after year-end. CRA: Sole proprietorship; CRA: Determining your corporation's tax year; CRA: When to file a T2.

The partnership's T5013 requirement depends on its facts. If it must file and ends operations, outstanding returns are due by the earlier of 90 days after all business or activity ends or the usual filing date. CRA: Partnership Information Return guide. Keep the incorporation documents, transfer agreement, valuation support, asset tax costs, liabilities, outstanding invoices, GST/HST account details and signed elections together. The corporation's continuing tax treatment is covered in How corporations are taxed.

Example

Illustrative only; all amounts are Canadian dollars. A sole proprietor transfers equipment with original cost of $40,000, undepreciated capital cost of $25,000 and fair market value of $60,000. Inventory has a tax cost of $20,000 and fair market value of $40,000. The corporation gives the proprietor shares worth $80,000 and a $20,000 note, allocated to the inventory.

The parties elect $25,000 for equipment and $20,000 for inventory on Form T2057. The corporation allocates $60,000 of shares to equipment, and $20,000 of shares plus the $20,000 note to inventory. The note equals the inventory's elected amount. At the stated market values without an election, the equipment could produce $15,000 of recaptured past deductions and a $20,000 capital gain, while inventory could produce $20,000 of business profit. The election can defer those amounts if its conditions are met. The corporation's tax cost follows the elected amounts; for CCA, the equipment's capital cost remains $40,000 with $15,000 deemed previously deducted. See Capital cost allowance for that rule. GST/HST is assessed separately.

Different for you?

• You are still deciding whether to incorporate: compare the structure choices in Sole proprietorship or corporation?.
• You have goodwill, land, a large note or several asset classes: the valuation and elected amounts need business formation review before the transfer agreement and election are signed.
• You have equipment or buildings with past depreciation: work through the separate capital cost allowance and recapture rules.
• Your business or property is in Québec: check the provincial election and other local requirements with business formation.
• You want to move a rental property: assess the structure in Holding and investment corporations.
• You will draw on the note or shareholder account: see Shareholder loans.
• You expect to sell shares later: see Selling your business for the separate share-sale rules.
• The incorporated business will mainly serve one client: check Personal services business.