Stop, drop and do a Section 85 Rollover: Canadian Entrepreneurs listen up when incorporating a sole proprietorship!
Section 85 Rollover: What is it?
In the Sole Proprietorship article, a Section 85 Rollover (s. 85 rollover) was mentioned. In brief, this refers to section 85 of the Income Tax Act (Canada) , through which you may be able to transfer the unincorporated business to an incorporated company on a tax deferred basis.
To add some context for understanding when a section 85 rollover would be used, it often takes place as a result of a small business converting its operations from a sole proprietorship or partnership into an incorporated entity. Many first time entrepreneurs minimize their start-up costs by avoiding incorporation until they start to see their business take off and begin to get some return.
There are risks involved with this strategy however, especially from a liability perspective and those are discussed in the sole proprietorship article. There is also the likely disadvantage of a higher income tax rate with an unincorporated business, but for now, back to our Section 85 rollover discussion.
Assets used in a sole proprietorship are personal property of the business owner, as the sole proprietorship is not in any way a separate entity, as is a corporation (see corporations discussed here). When those assets are transferred to an incorporated business they are transferred by way of a purchase and sale agreement. This transaction could attract capital gains tax to the entrepreneur on the disposition of assets.
A Section 85 rollover is a vehicle in which you can defer those taxes when transferring the assets into the incorporated company.
A written Section 85 rollover agreement will be prepared by a lawyer which outlines the terms on which the assets are sold to the company in exchange for shares in the company. The shares would be typically called “rollover shares”.
A valuation of the business may be needed at that time, and the transfer would be reported on your personal income tax return. You will also have to qualify under s. 167 of the Income Tax Act as a transfer of all or substantially all of the business, so that HST will not apply to the transfer. As you can see, there are a lot of considerations which must be made when doing a Section 85 rollover. For that reason, you are strongly urged to consult a lawyer in order to advise you properly if the Section 85 rollover is appropriate in your particular situation and to ensure it is done properly.
When considering transferring an unincorporated company (or its assets) to an incorporated one, please ensure you get legal and accounting advice, and in particular, get tax advice, as your individual circumstances will have to be considered by whomever is giving you advice on your potential Section 85 rollover.
Garnet Brooks is a lawyer in the business law practise group at the law firm, Wickwire Holm, located in Halifax, Nova Scotia, Canada.
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