At Eb Conseil Fiscal, we understand that tax optimization is crucial for preserving your wealth and maximizing your tax benefits. A common situation faced by entrepreneurs is the transfer of assets between an individual and a corporation they control. This transfer, often done during incorporation, must be carried out at fair market value (FMV). As tax experts, we assist you in managing these transactions to comply with regulations while minimizing the tax impact.
Let’s consider the common example of an entrepreneur who, after starting as a sole proprietor, decides to incorporate. The sale of this entrepreneur’s assets to their new corporation must be done at FMV since it occurs between related parties. However, the Income Tax Act offers a favorable measure: the tax rollover. This provision allows the deferral of capital gains or tax consequences related to the transaction, postponing taxation to a later date. A strategic advantage for those looking to optimize their long-term tax planning.
What is a tax rollover?
A tax rollover is an option that allows, under certain conditions, the deferral of taxes related to the disposition of assets between a taxpayer and a corporation. The term “taxpayer” here includes not only individuals but also partnerships, corporations, and trusts. Opting for a rollover avoids an immediate tax impact, provided that only certain types of assets, such as capital properties and inventory (except real estate), are involved. Items like accounts receivable, cash, and real estate in inventory are not eligible for this rollover.
How does a tax rollover work?
In a tax rollover, the sale of assets cannot be made at a price higher or lower than the FMV. However, the rollover allows setting an agreed-upon amount that will serve as the basis for calculating tax, thereby eliminating the immediate tax trigger. This agreed amount must be equal to or greater than the cost of the asset and less than or equal to the FMV. This mechanism is particularly advantageous when assets have appreciated in value, as it allows for deferral of tax payment until a future sale.
Consideration in a tax rollover
The consideration received by the transferor after a rollover must be equivalent to the FMV of the transferred assets. For the rollover to be eligible, the transferee, that is, the corporation receiving the assets, must issue at least one share of its capital stock to the transferor. In addition to issuing shares, other forms of consideration, such as demand notes, assumption of liabilities, or cash payments, are possible. However, it is crucial that this non-share consideration does not exceed the agreed-upon amount.
Situations where a tax rollover can be beneficial
The benefits of a tax rollover are numerous and can apply to various situations. Here are some examples where a rollover may be advantageous:
- Incorporation of a sole proprietor: The rollover allows for the transfer of assets to a new corporation without immediate tax impact.
- Eligibility for the capital gains deduction: Optimize your gains while minimizing taxation.
- Transfer of appreciated assets to a corporation: You can transfer assets with increased value without immediately triggering taxes.
- Estate freeze: Allows you to freeze the value of assets to transfer future growth to the next generation while deferring taxes.
- Crystallization of the capital gains deduction: Protect the current value of an asset while taking advantage of the tax deduction.
Administrative formalities
To benefit from this tax provision, it is essential to complete and submit the prescribed T2057 form at the federal level and TP518 form in Quebec. These forms must be submitted to the relevant tax authorities to formalize the rollover election.
At Eb Conseil Fiscal, we guide you through every step of this complex process to ensure you comply with all tax obligations while maximizing your benefits. Whether you’re in the incorporation phase or looking to protect your assets for the long term, our experts are here to provide tailored solutions.
