85 Rollover

One of the most common scenarios that prompts an individual to consider Incorporation is when a sole proprietor has a “good” year, resulting in strong revenue and/ or profits, but then realizes that they are “on the hook” for a substantial tax bill as the income is fully attributable to themselves, as an individual. This results in them being in a higher tax bracket, which can be substantially higher than the tax level for a corporation.

A transfer of a sole proprietorship (or partnership) can be done, into a company, by using Section 85 of the income ta. This is generally referred to as a “rollover,” as the used in the business are transferred (or “rolled over”) to your company, with no immediate tax consequences. The long term result could be a double taxation, which is generally avoided with careful planning and the passage of time. The assets that have been paid for by yourself can be bought by the company by way of a promissory note and paid out to you from after tax profits on a tax free basis. The assets worth more than what you paid (called “goodwill”) are paid for using special shares. You only pay tax when these shares are sold or redeemed.

This results in a business now paying substantially less in taxes (only 12% for example, on profits up to $500,000, versus ~50% if you were paying for the same profits as income, personally, through a sole proprietorship or partnership).

As part of this process, a Holding Company is often setup. This is a separate, often “numbered” company, which usually does not do business independently itself, but rather, owns the “operating” business. Section 85 can be used here to transfer your shares (roll them) into a holding company. The same principles apply as when you roll your proprietor assets into a company. Shares rolled into a holding company are done so on a tax deferred basis. The holding company buys your shares with special shares. This allows future earning to belong to the holding company, which also has the right to receive dividends from the operating company on a tax free basis. This procedure, however, has been made more complicated by recent changes to the Income Tax Act. Great care must be taken in determining if this process is available to you and your compan, and you should consult with a tax accountant familiar with the new requirements before embarking on this type of re- organization.

To discuss if a Section 85 Rollover might be a good option for your business, Contact Us today.