Incorporate Sole-Proprietorship Business using Section 85 Rollover
February 26, 2018 | Written by: Sohail Afzal
If you have been operating a sole-proprietorship business and you think it’s time to incorporate, consider the section 85 rollover if you want to save on taxes. The Section 85 roll-over has several benefits which businesses can take advantage of to minimize their tax bill.
What’s the Section 85 Rollover Anyways?
In very simple terms, the Section 85 rollover is what allows sole proprietorships, partnerships, and corporations to transfer their assets into another Canadian entity without having to pay taxes. For instance, if you would like to transform your sole proprietorship business into a corporation, you don’t have to pay taxes to sell your business to yourself. It all requires some strategic tax planning.
It is important to understand that there are specific rules that must be applied when doing such transfers. For instance, when transferring a sole proprietorship business into a corporation then you are required to issue a combination of shares and market cash value that is equal to the fair market value of the business. Consult with a tax accountant to understand how many shares and cash value can be issued when incorporating a business.
What’s the Value of Your Sole Proprietorship?
One critical step when using the Section 85 rollover is calculating the fair market value of your business. If you are running a medium to large scale business then you may need to use a professional valuator. For small businesses with simple operations, you can simply use an online calculator or net incomes for the previous years to establish its value.
Think of how much you would sell the sole proprietorship for to any third party. Your allegations should be backed by income and assets. For each asset, the fair market value must be established. Tax accountants can really help you to calculate the value of your business and apply the tax rules for certain assets like goodwill and accounts receivable.
The section 85 Rollover Agreement
This agreement needs to be prepared by your tax accountant and it is a contract between the sole proprietorship business and corporation. The agreement will cover all the details such as the value of the business, assets, and UCC among others. It should also contain a price adjustment clause which comes in handy if the CRA determines that the fair market value was less or more after assessment. You will then submit a T2057 form which should be prepared by a tax accountant to ensure that it is compliant with the section 85 rollover rules. You must also understand that there’s a due date to file this election. There are penalties and interests which you can incur if you do not file on a timely basis.
The Section 86 rollover is a very important election that can help small organizations to lower their tax burden when they want to expand or make changes in their business structure. Use this if you want to convert your sole proprietorship business into a corporation but ensure you speak to a tax accountant to help you understand this election.
Sohail Afzal, CPA, CMA, MBA
Sohail Afzal, (CPA, CMA, MBA) is the founder & CEO of GTA Accounting Professional Corporation. He is a highly experienced Chartered Professional Accountant and businessman himself and understands the challenges that many businesses face when it comes to cash flow management. As an experienced business consultant & tax advisor, he is helping companies grow by providing the technical, financial, and contractual information necessary for strategic decision-making.